Paper sector outlook

Early this morning, Finland-based Stora Enso, Europe's largest paper producer, warns that its second quarter operating income will be half the €223 million generated in the same period last year. Main culprits: higher pulp and oil prices, and factory stoppages for maintenance and due to technical problems. Shortly thereafter, its compatriot UPM-Kymmene also warned that it now expects 2008 operating profit to be lower than in 2007 for similar reasons, despite having expected a flat year-on-year trend as recently as early 2008. Stora and UPM will both release their second quarter results on 24 July.

Yesterday, Standard & Poor's released an industry report card on the US forest products sector. Pam Rice and her colleages issued a rather gloomy, if predictable, comment: "two-thirds of the rating actions we took in the past three months were negative, and now almost 40% of the companies we rate have negative outlooks or are on CreditWatch with negative implications, with just over 50% having stable outlooks. As a result, any material adverse deviations from our base case assumptions will likely lead to more downgrades." At the end of May, Standard & Poor's made similar comments about the European paper sector: despite the sector-wide downgrades of October 2007 and April 2008, over half of Europe's forest products companies still have negative rating outlooks, "indicating a high likelihood of further negative rating actions."

All this echoes Moody's global paper and forest products report of 1 April 2008: "many companies in the printing and writing paper, paper packaging and wood-based building products sectors are expected to experience negative rating pressure" and "over the past year, approximately 75% of rating actions in the paper and forest products industry have been negative, constituting either outright downgrades or negative outlook changes."

Let me look at the lowest-rated names. If a company is already rated, say, B- or B3, further downgrades will presumably require a further deterioration in liquidity. S&P's liquidity snapshot of 16 May 2008 is particularly helpful in that respect. M-real will report its second quarter results on 23 July 2008. It is rated B-/stable by S&P and B3/negative by Moody's. At 31 March 2008, €197 million of its long-term interest bearing liabilities were due by the end of the year, but its €500 million syndicated credit facility (2009) was still completely available, so no imminent liquidity crisis can reasonably be expected in 2008. Lecta is rated B+/stable by S&P, but its senior unsecured debt is rated B-. It was downgraded by Moody's a week ago, to B1 corporate family rating and B3 senior unsecured debt rating, with a stable outlook. Both agencies could well change the rating outlooks on Lecta to negative as the year progresses. Moving up the rating scale, Norske Skogindustrier ASA (BB-/Watch Negative and B1/negative) is the best candidate for (more) downgrades, especially by S&P. It reports on 7 August 2008, so watch rating news around that date.