Sappi takes hard look at its timber troubles
LAST week, Sage bemoaned a low rating: this week it is Sappi. Chairman Eugene van As cannot understand why investment communities think only half as much of Sappi as they do of similar businesses.
Sage's financial performance is not the reason behind its low price–earnings ratio, but it is at Sappi. Van As furnished many of the reasons behind Sappi's rating himself: earnings dropped by three quarters, there were foreign exchange losses of perhaps R200–million, gearing is almost 100%, interest cover only 1,3 times, debt in US subsidiary SD Warren is too highly priced, much downtime was taken, 27 management positions have been changed and new young blood is in short supply.
"We are concentrating on growing our people. Sappi stagnated in developing young talent to the stage that we can no longer buy a company and put management in. You cannot grow big business unless you have young people," says Van As.
The weak share price, currently R40, is even more galling for those on the Sappi share incentive scheme, who paid as much as R56,75 for their shares (some even paid R69). At a presentation to press and analysts this week, Van As confessed: "It is galling to come and face analysts who rate you the bummest paper company in the world."
So how to fix it? Sappi has amicably reached agreement to buy out the 22% minority shareholding in SD Warren for $138–million, either as cash or through a vendor placement of Sappi scrip, so the high–cost debt can be refinanced. Sappi will then have 97%, and aims to buy the balance. The paper mill was flooded during October when 425mm of rain fell in 12 hours and 30 days of production was lost because machines and electricals were under water. It will be Sappi's biggest insurance claim yet. Sappi is also to buy out the IDC's holdings in Saiccor and Bonuskor, probably through scrip.
Sappi's business in England was not much better. Management had to be brought in from Germany. "It was almost World War 2 again, the Germans winning this time," says Van As. Sappi England made another loss, compounded by contract problems with the North American agent which cost £4–million.
Van As expects there to be consolidation among Europe's paper producers, and for Sappi to be one of the survivors. "We won't buy anything for money. It must be an equity deal and partners must come for the ride too. Something has to happen as there are too many players."
In the year to September, Sappi's turnover climbed by 15% to R15,3–billion, operating income fell 45% to R1,2–billion and the net finance cost jumped 28% to R684–million (comparisons are against unaudited figures for the 12 months to September 1995 as Sappi changed its year-end). Operating margins more than halved to 8%: Van As never again expects to see the 27%+ Sappi made in 1990 when it was a fully integrated SA producer. Good years should yield between 17% and 20%.
Net income of R404–million looked sick against the previous R1,36–billion, and earnings were 230c a share against 846c. A 140c dividend will be paid against 120c for seven months in 1995. Cash generation was R2,3–billion, all spent on three big rebuilds. "We had planned for increases in production to come during a buoyant period, but it became a year of disaster."
Van As says Sappi would like to reduce its debt, but will not take short–term decisions to pretty–up the balance sheet if it is no good for the company in the long run.
In the bigger picture, Van As has transformed Sappi from a SA producer of commodity products into a global forest products group with manufacturing facilities on three continents and an international sales network marketing in 70 countries. Production capacity of pulp is 2,6–million tons, and of paper 3,2–million tons. Fine paper and pulp make up 85% of turnover.
Warren makes up 48% of turnover, Europe 19%, and exporting out of Sappi's SA assets another 14%, leaving the domestic market accounting for only 19% of turnover.
There is some good news. Forex losses were once–off and are written off. "It was not some treasury maverick who decided to hedge. We thought it wise to cover a third of our dollar income and delayed the decision for six weeks, during which time pulp prices nearly halved."
On management, Van As says Sappi was myopic. "New eyes on old problems have led to significant improvements. We had frankly gone backwards in productivity, but are now moving forward rapidly."
The market outlook for Sappi's products is also broadly better. Van As expects a slow improvement from the current low base , although he warns that new coated–paper capacity scheduled for late 1997 could adversely disrupt prices later in the year. "With the completion of our capital expenditure programme in SA, all the mills are beginning to settle down after the start-up of the new units which will have lower costs and better products. Sappi is therefore well equipped to benefit from any upturn in the market. We will benefit substantially from the weaker rand in the new year. Earnings for the next financial year are therefore expected to improve."
Since January, Sappi shares have fallen from R58 to the current R40, the decline having flattened since September. All that remains to be determined is the turning point: the downside is limited from here. I think it's time to buy.