The US economy (the UK’s biggest single export market) is doing very well at the moment from the following perspective:
- GDP is growing at a steady 3%.
- They have a record 6.2 million job vacancies and saw 313,000 new jobs created in February 2018.
- They enjoyed a 4.5% rise in wages (the highest since 2009) in February 2018 over the same month last year.
Just when it looked like the recent US tax cuts were successfully accelerating the rate of growth in the world’s largest economy (thanks to some more consumer spending, a little more business investment and reshoring of some of the $2.2 trillion that US companies have in foreign banks), a potential trade war has been initiated by president Trump. Whilst the typical economic cycle brings a recession every 8-10 years, there is a school of thought that suggests a longer economic cycle of circa 14 years after a financial crisis. On that basis, the next downturn may not be due until circa 2023…if we can avoid an all-out trade war.
Speaking of our industry, a couple of my clients have commissioned a detailed report from the Know It All market research team to help them to identify the tipping point – where is all the new capacity springing up, when will the price of containerboard begin to fall and how much new capacity would be too much? (They’re paper makers and hence worried about a potentially deflationary over supply situation). I’m happy to give you – our cherished reader – an overview of the report’s findings (by all means get in touch if you’d like a full copy of the report).
Europe still finds that there is not enough containerboard to go around just now. Expect yet another price rise to take effect between June and August. However, the current received wisdom is that we are close to the top of the current paper price cycle. This year will see a much-needed circa one million tonnes of additional containerboard capacity come on stream:
- Burgo are commissioning a new PM in Avezzano, Italy.
- Leipa are starting up a rebuilt paper machine in the coming weeks in Schwedt, Germany.
- International Paper’s rebuilt PM at their Madrid mill is scheduled to start production at the end of quarter two.
However, if we look further out to 24-36 months…the current containerboard deficit looks like turning into a potential surplus as a total of circa five million tonnes of additional capacity comes on stream. To put that into context, the European containerboard market currently has capacity of circa 32 million tonnes. Depending on the rate of economic growth in Europe (an important sensitivity), we could even be looking at a glut. Before you rush off to sell your paper company shares, it’s worth noting that the last handful of years has seen 4.5 million tonnes of additional capacity introduced – which has still been insufficient to meet demand. Your shares will pay handsome dividends for a while yet.
I was also struck by another observation; one that you may find controversial. I believe that considerable restraint has been shown on pricing by paper makers. Don’t laugh – I’m not kidding. It’s understandable if you initially scoff at this notion when considering that the price of paper for box making has risen by 50-70% in the last 20 months (depending on your starting point).
However, I would ask an interesting question – why haven’t paper makers put up their prices every month? Seriously; they’re making a commodity and they can sell every tonne for the coming year without any problem whatsoever. So why not just keep shoving up the price every month and profiteer? The answer has been restraint for the good of their own industry.
Many players are vertically integrated and need to give their box plant colleagues enough time to pass on price rises. However, more fundamental is a wish to avoid boxes becoming uncompetitive as a packaging medium – thereby forcing substitution into other materials or prompting some to largely engineer packaging out of their supply chain altogether.
That same wise, strategic-level of restraint needs to be applied when it comes to new capacity; all of you in the paper making field can’t massively increase capacity at the same time without causing a deflationary glut.
Naturally you can’t get into a smoke-filled room and talk to each other. Hence, each major investment decision making team needs to try and identify the coming level of market growth and align growth plans accordingly. If you’d like to grow your market share, it may make far more sense to simply buy a competitor. This would also be a far quicker way to achieve what you want.
We must be at or close to the top of the paper cycle; meaning that share values are likely to be at or near their peak. Food for thought if you’re a Smurfit Kappa Group shareholder in particular. For what it’s worth, I would advise SKG shareholders to stick with the excellent, stable and sane management team that is at the helm and serving stakeholders’ interest so well. SKG has a first class pedigree in accessing relatively low-cost kit and consistently delivering about as good a return on equity as you’re going to get in corrugated. At the same time, they are ambitious and steadily growing their North American footprint…IPC want to buy it precisely because it’s already a great business.
Raj Bhardwaj is Editor of the Know It All newsletter and also runs a software and consultancy business with a focus on the packaging sector. You can contact him via e-mail: raj@knowitall.co.uk
