Tembec's balance sheet illusions could make investors disappear

By DEREK DeCLOET

Tuesday, April 26, 2005 / GLOBE AND MAIL

In investing, numbers often lie. The numbers say that Tembec, one of the country's largest forest products companies, is among the cheapest stocks money can buy. With a market capitalization that's less than one-third of the company's $1.1-billion in net assets, how can you go wrong?

Don't be fooled. More than $500-million in shareholder wealth has been eviscerated since last summer, and if you watch what the bond market says, more pain lies ahead. Tembec's debt has been tumbling in recent weeks, an ominous sign. On Thursday, the company will report its second-quarter results, which management has already warned will be abysmal. It's rude to say it out loud, but in dark corners people are starting to wonder whether the company may be forced to consider bankruptcy protection.

The sad part is that many of Tembec's woes are not management's fault. Chief executive officer Frank Dottori couldn't have predicted the Canadian dollar would rise from 65 cents (U.S.) to the 80-cent range so quickly, crushing the company's profit margins. He couldn't help the fact that the Brazilians have built hyper-efficient new pulp mills that render Tembec's smaller mills uncompetitive. But it is also a case study for executives and investors on the dangers of foolhardy acquisitions.

Any analysis has to start with the balance sheet, which is rated R and should not be shown to small children or others who are easily frightened. Tembec started out in 1973 by buying and saving one doomed pulp mill in Temiscaming, Que., and steadily got bigger, partly by purchasing other doomed mills. Management bought small assets and tried to pay as little as possible, a strategy that has left it with 55 factories spread out over three continents.

There's nothing wrong with acquisitions as long as you're careful about how much debt you accumulate along the way -- especially in cyclical businesses, where you never know when the cycle is going to turn against you. But Mr. Dottori failed to heed this, with damaging consequences.

With $1.6-billion (Canadian) in long-term debt, Tembec's interest costs run to more than $30-million a quarter. It would be manageable except everything else has gone against them. Pulp prices have been good but not great, and since it's sold in U.S. dollars, price increases have been sabotaged by the rising Canadian dollar and euro. New mills in South America, Asia and Europe are adding millions of tonnes of new capacity and hurting prices.

To make matters worse, the Quebec government has proposed a 20-per-cent cut to the tree harvest in the province, exacerbating a shortage of fibre in Eastern Canada. In Ontario, power prices have gone up. You get the idea. Next week: a plague of locusts strikes. The bright side, if you can find one, is that Tembec doesn't have any huge debt repayments until 2009. But since it's not even covering its interest costs at the moment, a financial crunch could come sooner.

Having lost so much lately -- the stock is down 42 per cent this year -- a shareholder might be tempted to take comfort in the $2.4-billion in fixed assets on the balance sheet. But demand for high-cost pulp mills paying developed world wages is, shall we say, not robust. One forest industry insider, speaking on condition of anonymity, reckons the plants aren't worth half as much as it says on the books. Tembec's $1.1-billion book value is an illusion.

This is starting to dawn on bond investors, who have been marking down Tembec's debt in earnest. Yields on the company's 2009 bonds have jumped to more than 10 per cent, from the low 8-per-cent range at the start of the year, according to Bloomberg data. If the bond guys are getting nervous, you can bet there won't be much left for equity holders if Tembec renegotiates its debts. Is there a way out? If the loonie slides back to where it was two years ago, maybe. But a huge restructuring seems inevitable.

vox@globeandmail.ca

Forestry profits rising on efficiency gains, survey says

SOURCE: GLOBE AND MAIL / BY PETER KENNEDY / FRIDAY, APRIL 15, 2005 PAGE B10

VANCOUVER -- The trend towards bigger, more efficient sawmills is helping to boost lumber recoveries and make the Canadian forest sector more profitable, according to a PricewaterhouseCoopers survey. The survey released yesterday said profits reported by the top 10 forest companies in Canada soared to $930-million in 2004, compared with $242-million a year earlier.

The biggest winners were the solid-wood producers such as Canfor Corp. and West Fraser Timber Co., the survey said.

This was due in part to high lumber prices and investment in sawmilling technology that sent profits in the British Columbia lumber sector rising to a record $1.5-billion in 2004.

That was up from $340-million a year earlier, according to preliminary estimates by PwC. "We have seen a lot of capital invested on process controls, and lumber recovery to increase capacity and reduce costs,'' said Craig Campbell a partner with PricewaterhouseCoopers in Vancouver.

"Half a dozen significant capital projects, in excess of $50-million each, have been announced or are already under way at sawmills in the interior of B.C.,'' Mr. Campbell said.

This is part of a broader trend that has allowed the North American sawmilling sector to produce 40 per cent more lumber in the past 17 years, even though the number of mills is down 34 per cent. The B.C. industry, for example, has been able to increase the amount of lumber it can recover from the same amount of logs in the last decade by 1.4 billion board feet.

Mr. Campbell said record earnings in B.C. have helped to offset the impact on Canadian forest sector results of softwood duties, unfavourable exchange rates and an oversupply of newsprint.

Norbord Industries Inc. was the most profitable of the 10 companies included in the survey. The Toronto-based producer of oriented strandboard posted a profit of $424-million in 2004, up from $240-million.

CANADA'S TOP 10 FORESTRY FIRMS
2004 PROFIT (LOSS) IN $ MILLION
1 Abitibi Consolidated -$36
2 Domtar -42
3 Canfor 421
4 West Fraser Timber 212
5 Tembec -1
6 Cascades 23
7 Norboard 424
8 Norske -29
9 Fraser Papers -56
10 Pope & Talbot 14
TOTAL $930

Climate change could sour US maple sugaring

from the April 06, 2005 edition - http://www.csmonitor.com/2005/0406/p11s01-sten.html

By Christa Farrand Case | Correspondent of The Christian Science Monitor

PUTNEY, VT. - In the predawn darkness of Putney's maple-studded hills, Don Harlow begins his mornings by coaxing his truck down a rutted forest path. At the end is a cylindrical tank twice his height into which hundreds of gallons of sweet maple sap have flowed, siphoned through 11,000 taps and 40 miles of plastic tubing.

Mr. Harlow carts the sap up to his sugaring house to boil it down to syrup. It's a ritual Harlow loves, and one his family has performed for more than 100 years - albeit with horses and metal buckets in earlier days.

Despite having one of the most coveted labels in the industry - "pure Vermont maple syrup" - on their products, Harlow and other sugarmakers in the state are struggling to compete with Canada, where maple syrup production has more than tripled since the 1970s.

While much of Canada's syrup boom can be attributed to generous subsidies from the government, as well as its aggressive promotion of maple products, some researchers believe another factor may be coming into play: climate change.

As temperatures rise and weather patterns become more erratic, New England's maple trees are facing growing threats that may eventually force syrup aficionados and leaf-peepers out of the region and into Canada.

When Harlow took over the farm in the 1950s, the US produced 80 percent of the world's maple syrup, with Canada supplying the remaining 20 percent. Now the countries' market shares have flip-flopped, with Quebec alone providing over three-quarters of the global supply.

"Due to changes in both sap collection technology ... and climate ... the maple syrup industry is migrating from New England into Canada," concluded the New England Regional Assessment Group in a 2001 report. The study, spearheaded by University of New Hampshire researchers, also predicted that if current climate projections hold true, New England forests will be dominated by oak and hickory trees - not maples - by the end of the century.

Admittedly, maple trees won't flock northward one spring like Canada geese. Rather, the transformation of New England forests will come by a gradual change in the competitive balance of one species over another, says Timothy Perkins, who is nearing completion of a research project on the impact of global change on the maple sugar industry.

A projected rise in temperature of 6 to 10 degrees F. over the next century could heighten drought conditions, air pollution, and pests - stress factors that affect maples more than oaks or hickories.

But it's difficult to tell the degree to which climate change is affecting New England maples at the moment, says Dr. Perkins, director of the University of Vermont's Proctor Maple Research Center.

But a change that does present an immediate threat to the industry, he says, is a temperature-driven trend toward shorter sugaring seasons in New England but not in Canada.

At Morse Farm in Montpelier, Vt., that meant the sap "crop" was only one-third its usual size this year. The season started late, but winter morphed into spring practically overnight, reducing the number of freeze-thaw cycles that propel sap flow.

Just as air whistles out of a pierced car tire, sap flows out of a tree because the pressure on the inside of the tree is greater than the pressure outside the tree.

When the air temperature drops below freezing, a maple acts as a giant suction system, bringing the sap out of its branches and back down to its roots.

When the temperature rises above freezing, the action is reversed, sending sap surging through the branches - and out of any "wound" in the tree, such as the holes drilled for taps.

Traditionally, northern New England's climate has provided the optimal freeze-thaw patterns for sugaring. But in recent years, the transition from winter to spring has accelerated, leaving fewer days for the mercury to hopscotch across Vermont thermometers' 32-degree F. mark.

In Canada, however, warmer daytime temperatures have increased the number of freeze-thaw cycles there.

Technological improvements have also changed the season's timing in both countries. Back in the day of metal buckets, sugarmakers were wary of tapping their trees too early, when temperatures were liable to drop significantly below freezing for long periods.

"If [the sap] freezes hard, it can bust your bucket," explains fifth-generation sugarmaker Rick Marsh.

But now, with plastic tubing, sugarmakers can tap weeks earlier and get more out of their taps. This is especially true for those who have installed vacuum systems that draw more sap than would drip into a bucket. In Canada, tubing has facilitated greater sap collection in areas where deep snows make it difficult to reach individual trees for daily collection.

In recent years, Canada's booming syrup production flooded the global market, driving prices down and putting the squeeze on US sugarmakers. Five years ago, Harlow ended the season $30,000 in the red, but couldn't raise his prices to cover costs because of the low prices of Canadian syrup.

Jacques Couture, president of the Vermont Maple Sugar Makers' Association, has found himself in a similar position. But he notes that as someone who makes his living off sugaring, "It's pretty hard for me to criticize someone from another country who's doing the same thing."

"To the Canadians' credit, they've put a lot of effort into developing markets - not just in Canada, but in the world," notes Mr. Couture, who has mail-order customers in China, Japan, and Europe.

Back in Putney, Harlow's jovial tone turns somber as he acknowledges his biggest competition comes from Canada.

Is he worried? "Oh no, we can sell Vermont syrup anytime," says the fourth-generation sugarmaker. "The worst Vermont syrup I ever had was fantastic." (*)

Logging firm denied road-use appeal

By Frank Dobrovnik

Source: Sault Star / Tuesday, April 12, 2005 - 09:00

Local News - The Supreme Court of Canada will not hear a British Columbia timber company’s appeal to use a logging road in Lake Superior Provincial Park, effectively ending three years of legal wrangling and what an environmental group calls unsanctioned access.

Calling it “a victory for our protected areas,” a representative for the Wildlands League said Friday’s decision to dismiss leave to appeal, with costs, amounts to Canada’s top court barring the numbered company from continuing to use the road. “They’ve lost every decision and appeal along the way, so clearly they’re supposed to stop using the road,” said Evan Ferrari, director of the league’s parks and protected areas program.

The battle began after a B.C. man, Michael Jenks, bought former Algoma Central Railway land east of the park in November 2002 and Ontario’s Ministry of Natural Resources refused him access via Sand River Road. Most recently, last September the Ontario Court of Appeal sided with the MNR, saying that the 1995 park management plan allows access to Crown land rather than private land.

Although the MNR halted logging operations in the park in the late 1980s, it has allowed Clergue Forest Management to continue to use the road to access Crown land east of there.

The appeals court also granted Jenks’s company a temporary injunction to continue using the road while seeking leave to appeal to the Supreme Court. The Wildlands League, which was given intervener status in the Ontario appeals process, wrote to Jenks and the province last week “to discuss long-term closure of the road,” Ferrari said.

The “bigger issue” is now to “stop anyone from using the road, and possibly changing the forest management plan and park management plan . . . that the right-of-way will be rehabilitated,” he said.

One appeal court judge, in a written decision, said the management plan could have stated more clearly whether the road is limited to access to Crown land.

The environmental group is also heartened by recent moves by the Ontario government to update the Provincial Parks Act. One proposal is to ban industrial activities within parks altogether.

As to whether the ACR was allowed to sell off vast swaths of Northern Ontario to private interests in the first place, “that’s a much bigger fish to fry,” Ferrari said.

“It’s private land,” he said. “We have so many problems with the 85 per cent of Northern Ontario land that is in the public hands . . . as far as the forestry practices are concerned, we have no recourse.(*)

Forest Industry Needs to Grow

QUEBEC VIEW: LOGGING By KONRAD YAKABUSKI

SOURCE: Globe and Mail; Wednesday, April 6, 2005

The fate of Canada's forests has always been determined by the balance of power between the forces of industrialization and conservation.

For most of our history, the industrialists ruled the roost. We chopped our trees -- or rather, we allowed a handful of big companies to do so -- with alacrity so long as the exercise provided jobs and export income. Pleadings for preservation were like cries in the wilderness.

If there was a turning point -- a moment when the environmentalists moved from the margins to the mainstream and when sustainability became a collective concern -- it probably came in the late 1980s in British Columbia.

For months, the province fixated on the fate of Canada's tallest tree, a 94-metre Sitka spruce in Vancouver Island's Carmanah Valley. By 1990, MacMillan Bloedel, then the province's largest forest company, had badly lost the public relations battle and British Columbia declared most of the valley off limits to loggers.

It would take Quebeckers another decade before they would make sustainable forest management a political hot potato. The turning point came in 1999, when a popular folk singer named Richard Desjardins produced and narrated a devastating documentary, L'erreur boréale, the title a play on the term aurora borealis, or northern lights. The film, which chronicled the systemic overharvesting of trees in Mr. Desjardins' native Abitibi region, made the rounds of the Montreal festival circuit and permeated the collective consciousness. "Horror borealis" became the environmentalists' battle cry.

Jean Charest's Liberals heard them loud and clear while campaigning in 2003 and promised a top-to-root review of forest management practices once elected. The result of that promise -- the creation of a provincial commission chaired by former Hydro-Québec head Guy Coulombe that tabled a damning report in December -- will change Quebec's forest industry for good. And for the good.

Unfortunately, the situation will first get much worse for the forest companies -- and especially for the 245 Quebec communities that depend primarily on them -- before it gets better.

At the end of March, the Charest government passed legislation implementing the Coulombe commission's principal recommendation -- an immediate, 20-per-cent reduction in the estimated sustainable yield of Quebec's softwood forest that will translate into similar-sized cuts in companies' logging rights for the three years that began on April 1.

The axe comes just as Quebec's forest industry, which generates $15-billion in annual shipments and is responsible for at least 90,000 direct jobs, is showing the rot of decades of mismanagement. The fault is not entirely that of the industry. Successive provincial governments encouraged overexploitation of the forest with low stumpage fees -- the industry paid gross royalties of an underwhelming $390-million last year, even though that's a big improvement from $150-million a decade ago -- and incentives to keep inefficient, labour-intensive mills operating.

For decades, the promise of jobs in hard-pressed regions gave the industry the long end of the branch in bargaining with Quebec City. In fact, until 2001, the provincial government relied on data supplied by the companies to calculate the maximum sustainable yield, or the amount of trees that can be cut each year without sacrificing the forest's ability to regenerate (with the help of replanting) on a long-term basis. Needless to say, the industry did not err on the side of caution.

Years of overharvesting has meant that the diameter of trees cut today is substantially smaller than it was two or three decades ago.

Hence, it takes more trees to produce the same amount of lumber, paper and other wood products. This has made Quebec an increasingly expensive place to operate, despite relatively low stumpage.

With 20 per cent less wood to process in coming years, guess where the axe falls next? As it is, dozens of Quebec's saw mills are already operating at below 50 per cent of their capacity. And lofty lumber prices won't save them.

Although it produces 25 per cent of Canada's softwood lumber, and virtually all of its hardwood products, the Quebec forest industry is still primarily known as a paper maker. The province accounts for 45 per cent of Canada's newsprint production and Canada is the world's biggest supplier of newsprint.

Bowater, Kruger and Abitibi-Consolidated -- the biggest of the bunch and the biggest newsprint maker on the planet -- are household names in Quebec. Unfortunately, their names are not always uttered with affection. Indeed, Abitibi offers a case study of what has gone wrong in the province's forest industry.

In January, Abitibi finally announced the permanent shutdown of its Port-Alfred newsprint mill. There were days of local protests. But it shouldn't have been a surprise. The first of the mill's four paper-making machines was installed in the 1920s. How could a Model T be expected to outrace a Mustang GT?

Indeed, the average age and capacity of Abitibi's 20 newsprint-making machines in Quebec do not make it the envy of the industry.

Quebec, over all, is the newsprint-making jurisdiction with the oldest machines on the planet. In parts of the United States and Scandinavia, recently installed paper-making machines surpass 350,000 tonnes in capacity, compared with Abitibi's Quebec average of 130,000 tonnes. The bigger machines mean fewer fixed costs and less labour for the same amount of output.

The Quebec industry has no choice but to improve productivity. But replacing an old, low-capacity machine with a modern, high-output one, or one that uses recycled fibre, costs at least $500-million.

To its credit, Abitibi has just spent $210-million to switch its Alma, Que., mill from producing newsprint to a higher-grade alternative offset paper. Still, more than a quarter of the $385-million in capital expenditures Abitibi made in 2004 was related to the construction of its joint venture newsprint mill in China. Its Quebec operations are shrinking.

In January, in the face of the Coulombe report, a $219-million operating loss in 2004 and a crumbling share price, Abitibi CEO John Weaver said "new realities" in the North American newsprint market have forced the company to undertake a "strategic review" of all its operations.

Abitibi is not alone in its misery. The balance of power in Quebec's forest has shifted from the industrialists to the environmentalists. But it just might be what the industry needs to save itself from itself.

konrad@sympatico.ca