Shrinking market demand, with anticipated 5% annual declines in paper demand going forward, will underpin continued challenges for European paper and forest products companies in 2014, says Moody's Investors Service in a report published today.
Moody's report is entitled "European Paper and Forest Products Companies: Challenges to Persist in 2014 Amid Shrinking Market Demand".
"In light of the sliding demand for paper, we believe that greater diversification will be key for European paper companies to support profitability levels in 2014 and beyond," says Matthias Volkmer, a Moody's Vice President-Senior Analyst and author of the report. "While capacity cuts made in response to declining demand are credit positive, these effects will be felt only temporarily."
Moody's notes that diversification away from paper is key for profitability improvements in 2014. Preliminary financial results reported by six of the eight European paper and forest product companies that Moody's rates indicate further erosion in the profitability of their European paper operations in 2013.
As Moody's expects that paper demand will continue to slide this year, the rating agency anticipates that the profitability of less diversified players, such as Lecta S.A. (B2 stable) and Norske Skogindustrier ASA (Caa2 negative) will remain pressured.
Conversely, the credit metrics of peers with greater product diversification, such as Mondi Plc (Baa3 stable), an integrated paper and packaging group, may improve during 2014. Moody's also notes that, while a string of graphic paper capacity reduction announcements during 2013 have helped to restore prices, particularly in newsprint, most market constituents expect that demand will continue to decline by 5% a year across graphic paper grades, owing to the ongoing shift to digital media.
Against this backdrop, the full realisation of targeted cost savings, including further capacity reductions, will be key to maintaining, if not improving, profitability and cash flow generation.
Moody's anticipates that pulp prices are likely to fall in 2014. This is because substantial new capacity in Latin America (mostly in hardwood pulp) will enter production during the next three years, adding around 7 million tonnes to global pulp capacity. While Lecta is likely to benefit from lower input costs, the profitability of companies that are long in pulp and sell excess supplies in the market, such as Ence Energia y Celulosa, S.A. (Ba3 stable), Metsä Board Corporation (B2 positive), Portucel, S.A. (Ba3 stable), Stora Enso Oyj (Ba2 negative) and UPM-Kymmene (Ba1 stable), could suffer.
However, Moody's would not expect this factor on its own to affect the ratings of these companies. Moody's expects that refinancing activity will likely be limited in this sector in 2014. With the exception of Metsä Board and Norske Skog, most rated European paper producers have fairly small upcoming debt maturities in 2014-16. Almost all issuers continue to maintain liquidity in excess of their annual working cash needs, either in support of long-term investment and expansion projects, or as a protective measure during performance troughs.