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Challenging but Better Results for Paper & Forest in '08

Dec. 7, 2007 - Financial strength rating agency Fitch Ratings said it expects that fiscal 2008 will be an anxious year in the U.S. Paper & Forest Products industry.

According to Fitch, lumber and panel producers will be occupied with right-sizing production capacities to advance a more profitable 2009. Paper producers will focus on system efficiency in order to make less paper more profitably. Containerboard mills at least through next year will enjoy full capacity runs to feed Europe, but will likely see at best a stagnant domestic market for corrugated boxes.

Modestly better results in 2008 are expected but with few distinctions. Manufactured wood companies such as Weyerhaeuser will see lower losses in lumber and oriented strand board (OSB) and, in Weyerhaeuser's case, better profits overall from other contributing businesses. International Paper is strategically on a good path with international diversification in low-cost fiber baskets to feed developing economies, and Smurfit-Stone Container's makeover of its production system should yield better earnings if its progress on costs can beat inflation in the wood basket.

In an otherwise unremarkable year, sporadic consolidations spurred by excess capacity and the benefits of systems integration will be compelling, if enterprise prices are cheap, but financial metrics will be influenced more by constrained capital expenditures rather than by business combinations or earnings. Debt reduction and capital/liquidity preservation will motivate corporate strategies next year as uncertainties still cloud our prognosis for an improving business picture, a view relying on cost efficient productivity and a cheap U.S. dollar rather than growth in fundamental product demand.

LUMBER & PANELS

Lumber and wood panel capacity will balance to demand in 2008 before a recovery in housing. Finished goods inventories will work back through the pipeline and cause producers to take additional curtailments at sawmills and OSB plants, rather than run EBITDA negative. Prices are stabilizing, and profit margins should get a break from some additional weakness in log prices as 2008 unfolds. U.S. producers should see operating margins return to a marginal 3%, a remembrance of 2003. Canadian lumber producers will continue to bear most of the industry's pain despite their higher efficiency in the West due to the unfavorable terms built into the Softwood Lumber Agreement. New OSB capacity coming on-stream will replace older plants that will be taken out of service. Fiscal 2008 will be a year of adjustment that will precede a better 2009 when demand starts to run ahead of supply rather than behind it. Fitch's outlook for this segment of the industry is negative, but believes that companies emerging from 2008 will be in a better business environment than when they entered.

PULP & PAPER

Pulp production is being fueled by export containerboard volumes and also by export pulp demand created by the weak U.S. dollar. Prices are also being pushed by Canadian and Brazilian costs of production and higher prices for domestic fiber created by fewer operating sawmills generating wood chips. Additional softwood and eucalyptus pulp capacities coming online in South America and recycled containerboard capacity in China could disrupt the steady pace of price increases seen this year. U.S. producers should still have one good year left in 2008, but it will be a draw for Canadian pulp exporters.

Paper demand in North America is saturated and will continue to be negatively influenced by the move to electronic advertising and a lower level of economic activity. Supply curtailments by International Paper at Bastrop, LA and Pensacola, FL and by Domtar at Woodland, ME, Port Edwards, WI, and Gatineau, QC may buttress domestic uncoated freesheet prices and even provide an opportunity for appreciation, but the grade will still lose some volumes to lower priced uncoated mechanical products made by AbitibiBowater and supercalendered grades which will be made by NewPage. Coated freesheet made by the latter has also been losing market share, and in a slowing economy this decline in demand will dominate prices, despite the fall in imports due to the weak U.S. dollar. The deciding profitability factor for North American paper producers will be cost reduction which can still be wrung from high cost capacity. Fitch's outlook for this segment of the industry on balance is stable.

CONTAINERBOARD & PAPERBOARD

The sinking value of the U.S. dollar should keep containerboard exports going and mills running at near capacity despite a slowing box demand in North America. North American producers should benefit at the expense of their European counterparts, and the weakness of the dollar will offer the opportunity to raise containerboard prices further, some of which will be jammed down and through North American converting operations. The restructuring of North American box plants by the integrated producers will continue into 2008 and should aid efforts to raise box prices. Improving operating margins will be best for those producers backward-integrated into virgin pulp production. Recycled producers will face higher fiber costs as China continues to suck waste paper out of North America to feed it own increasing recycled capacity.

Profits in paperboard because of excess converting capacity will still struggle to stay ahead of cost inflation, particularly in recycled boxboard. The merger of Altivity Packaging with Graphic Packaging may spawn some price increases, but a slowing demand for consumer non-durables, domestic beverage and consumer goods packaging could flatten any increase in prices, despite a healthy increase in export demand for virgin derived products. Fitch's Outlook for corrugated and paperboard packaging is stable.

SOURCE: Fitch Ratings




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