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PAPER MARKET OUTLOOK -- Stocks Are on the Rise

February 2005

Technology Editor

Experience has taught printers to error on the side of caution when it comes to managing paper. Any tendency toward overreacting is understandable, given how essential this raw material is to the process. It's easy to imagine the sense of helplessness from having a press sit idle or turning away business for want of paper.

The critical role of paper helps explain much of the past volatility in the marketplace. In recent years, paper buyers and suppliers have both taken steps to instill more stability and rationality in the market, and there were some indications of this effort paying off in 2004. It is still possible, though, that the industry has yet to experience sufficient pressure to spark a big and prolonged swing in the market.

Proposed price increases did generally "stick" this past year as suppliers put customers on allocation. The commercial sector took these developments in stride, for the most part. There were some signs of stockpiling.

Papermakers have taken dramatic actions in an attempt to bring supply and demand more in line. The latest industry moves have been more limited in scope, but indicate that this reshaping is ongoing.

From a dollar standpoint, the biggest news was MeadWestvaco's agreement to sell its papers business and associated assets for $2.3 billion to a new company controlled by Cerberus Capital Management L.P., a New York-based private investment firm. The operation is basically remaining intact, however, with the current management team continuing to lead the business.

SMART Papers agreed to acquire Fraser Papers' pulp and papermaking operations in Park Falls, WI, as well as a converting, distribution and customer service facility in West Chicago, IL. The transaction includes the premium specialty brands Torchglow, Worx, Glacier, Brights, Synergy, Passport, Genesis, Pegasus, Outback, Magna Carta and Mosaic.

Paper Mergers Covered

Mohawk Paper Mills, meanwhile, signed a letter of intent to purchase International Paper's Fine Papers Business, which includes the writing, text and covers papers and artist papers segments. The Strathmore, Brite Hue, Via and Beckett brands are also to be transferred in the sale.

With growth in the U.S. economy expected to remain strong, but moderate from 2004 rates, the outlook for paper in the first half of 2005 is status quo. The mechanical paper sector is likely to remain the most challenging, in part due to a strike at UPM North America's Miramichi facility along with work being done on machines by other producers.

One potential new wrinkle that popped up last year is the poor standing of the dollar relative to most major currencies. Paul Leclair, chief economist with the Pulp and Paper Products Council, tends to discount speculation about this trend having had an impact on the U.S. paper market.

"Exchange rates may not be as important as we sometimes think. Hedging operations enable companies to protect themselves against variations in currencies. They may be protected against exchange rate variations for six months to a year," he explains. "Eventually, those positions do expire and then the exchange rate starts to kick in more significantly."

Leclair expects the trend in exchange rates to remain basically the same or get weaker—despite some short-term, small appreciations in the U.S. dollar—through the first half of the year. This is due to longer term structural factors, he says, and will hold true for the dollar against all major currencies. Of particular significance for the paper market is the U.S. dollar's weakness against the Canadian "Looney," the economist adds.

The impact of the exchange rate with Canada can potentially be more significant since it is by far the largest source of U.S. imports, he explains. The weaker dollar makes Canadian mills less competitive and can also result in upward pressure on prices.

Excess capacity sometimes overwhelms the impact of exchange rates, Leclair says, as it has in Europe for the past couple of years. "Over the short term, manufacturers have an interest in running their machines and shipping wherever they can," he observes.

Stable or declining capacity is pretty much a North American phenomenon, the economist asserts. "It's certainly not the case in Europe or places like China and Brazil. Overseas, capacity is growing at a very rapid pace," Leclair says. "As a general rule, paper is consumed where it is produced, however."

While he sees at least the potential for a surprise, such as the exchange rate developing into a financial issue, Leclair expects it to be a relatively stable year for the paper market overall.

Don Jones, director of purchasing at Malloy Inc., offers a similar assessment from the printer's perspective. He regularly updates the company's book publisher clientele on trends in the paper market through its "Malloy Quarterly" newsletter. The shop primarily buys coated offset grades in rolls and sheets for its sheetfed and web press arsenal.

Jones says he noticed a significant change in that market around the start of the new year. "The white offset market is very different than it was a couple months ago when grades were tightly allocated and prices were going north. It seems to be the most volatile category now," he observes.

Although not tied to the recent tightness in the market, Jones points out that there has been some decline in demand for white offset papers as buyers shift to a high-bright groundwood grade. He estimates this change in buying pattern has siphoned away about 10 percent of the demand for white offset stock. "That market force is here to stay."

Regardless of the current conditions in the paper market, Malloy's advice to customers remains consistent, adds Joe Upton, vice president of sales and marketing. "To ensure paper is available for your work, try to preschedule jobs as far in advance as possible," he summarizes.

Upton believes publishers and other print buyers may have gotten too accustomed to the market conditions in 2001 through 2003. Slack demand meant paper and press time were readily available, even for rush orders, he points out.

Jones feels it's also important for printers to take a measured approach to managing paper. "We tried to stay consistent throughout the recent market volatility," he explains. "We have suppliers that we've been loyal to for a number of years and programs set up to deal with our ongoing paper demand."

According to Jones, the word "allocation" is still being bandied about, but it's really not being enforced as much at some mills as it is at others. "We haven't even heard rumblings of a price increase in the last month or so," he continues. "Of course, we could see an announcement tomorrow saying white offset is going up $2 a 100 weight, but I don't anticipate that happening."

The latest paper report from Foex Indexes Ltd. backs up these assessments. It notes that, in the U.S., 2004 shipment numbers were above 2003 totals in all main grades except for newsprint, but this growth slowed toward the end of the year. Price increases momentum is easing off in North America after several increases during 2004, the report concludes.

A New Roll for the Web

A variety of forces have combined to dramatically reshape the North American paper market in recent years. One that is still evolving and yet to have its full impact is the Internet.

Development of the papiNet global transaction standard for the paper and forest supply chain will likely be the most far-reaching—although largely transparent—application of this information conduit. Online marketplaces for buying and selling excess, overstocked and discontinued paper are a more interactive and visible realization of the technology's potential. They're also a timely innovation given the recent market conditions.

A previous "Paper Market Outlook" highlighted, which has expanded into handling sheets and rolls, as well as broadened its focus to include paperboard, Kraft and specialty paper, along with commercial grades. In 2004, went online with a similar vision to improve paper selling and purchasing.

According to John Von Colln, president, the Website was created to serve paper companies and printers, as well as design houses, artists, schools and any other buyers of paper in volume. Although not the main intent, the company also touts the environmental benefits of saving this paper from being tossed into the recycling bin.

Any potential buyer can search a database of available stock, but a registered account (free) is required to execute a purchase via a shopping cart function. Buyers are encouraged to use a feedback system to share positive and negative purchasing experiences, which are incorporated into a seller's feedback profile for review by potential buyers.

Sellers can also register an account for free, but pay a fee for successful transactions equal to 10 percent of the final sales price, not including taxes, shipping or trimming fees, if applicable. They can enter an individual listing via an "Item Submission Page" or upload a database with multiple items to save time. Product categories include coated, uncoated, text/cover, bond/writing, carbonless, pressure-sensitive, envelopes, specialty and index (Bristol and board) stocks.

An e-mail receipt is sent to the seller when a purchase is made. The seller is responsible for calculating the final amount due, including shipping, and informing the buyer via e-mail. Goods are to be shipped upon receipt of payment.


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