By ERIC REGULY | Saturday, November 5, 2005 | Globe and Mail
American airlines and the Canadian forest products sector have, sadly, a lot in common. Both industries suffer from a capacity glut, brutal competition, legacy costs, waning pricing power, rising energy prices and sinking demand for some products. Four of the Big Six airlines, including Delta and United, are dealing with the grim reality in the bankruptcy courts. You have to wonder whether the same fate awaits some of the forestry firms.
Canada's oil, rocks and trees economy is running on two of three cylinders. The trees are sputtering out, especially in Eastern Canada. The share prices of Tembec, Domtar and Abitibi-Consolidated have fallen between 50 and 70 per cent this year alone. Dominion Bond Rating Service this week downgraded the debt of Domtar and Abitibi. Domtar just killed its dividend and Abitibi may be next. Tembec is a rotting stump of a company and is in danger of becoming a penny stock.
Buying opportunity? Companies in crisis are sometimes worth a flyer.
Samuel Johnson said: "The prospect of hanging tomorrow focuses the mind today," and forestry company bosses are doing a lot of focusing. Surplus mill capacity is being shut down. Assets are being sold to reduce debt and buy time with nervous bankers. Higher-margin products are being pumped out.
But judging from the deteriorating financial performance of the companies, the reshaping isn't happening fast enough. Things are more likely to get worse before they get better, especially if the Canadian dollar keeps rising and energy prices, which have come off their peak, reverse direction.
Forestry companies, especially of the Canadian variety, are complicated beasts. Like French auto makers after the Second World War, some began life as instruments of social policy. Job One was to keep northern towns alive; Job Two was to turn the brutal art of killing trees into a profit machine. Job One hasn't completely vanished from their DNA.
Politicians put pressure on them to keep mills going and use tax incentives to sweeten the argument. The companies are often slow to respond to obvious signs of excess capacity. Sometimes managers know they have to close a mill but wait for a rival to move first -- and wait and wait in a damaging game of brinkmanship.
The other complicating factor is the sheer range of products, from newsprint and ground wood papers to pulp and paperboard. Want to dull up your dinner party? Talk about lignosulfonates, better known as tree-sap chemicals, to those lacking PhDs in tree engineering. A lot of the products can be out of favour at once, with dire results. Newsprint is a fine example of relentless decline. Tembec makes it. Abitibi is the continent's biggest newsprint maker.
The newspaper you are holding may not exist in a decade as more and more readers migrate to the websites. Readership and circulation apparently are in irreversible decline as competing media become more popular. In the United States, circulation has dropped by about 1 per cent a year since 1990, in spite of the big rise in the number of households. In 1950, more than 120 per cent of households bought a newspaper (that is, some households bought more than one paper). Today, only about half of households take papers. Junior is plugged into his iPod; papers are so uncool if you're under 30.
As a result, total North American newsprint consumption has fallen from about 11.7 million tonnes in 1994 to 9.5 million tonnes. Newspapers are not only getting fewer in number and smaller in size, they're also using paper that weighs less. The circulation scandal in the United States, in which certain titles allegedly inflated their numbers, hasn't helped the case for papers as mass-market advertising vehicles. The Newspaper Association of America has forecast a 1-per-cent drop in ad linage this year even as the U.S. economy expands at an impressive rate.
Abitibi and Tembec have been reducing capacity as demand falls. Newsprint prices have gone up recently, but are still well below their mid-1990s peak. The truth is newsprint is in slow, steady decline and the survivors will have to find something more valuable to produce. Abitibi is pushing hard in "equal offset" paper, used in reference and instruction books such as the Dummies guides. The market for such paper is growing. There is no guarantee it will turn around the newsprint maker's fortunes.
The eastern forestry products companies face something close to the perfect storm. They are getting clobbered by the rising Canadian dollar (60 per cent of Abitibi's production is in Canada). Oil prices, while down in recent weeks, are still about $20 (U.S.) a barrel higher than they were a year ago. Profits are vanishing, liquidity is becoming an issue and deals are being done out of apparent desperation. Abitibi has sold its stake in PanAsia Paper, bought only two years ago and touted as its most promising growth asset, so it could pay down debt.
The time will come when the stocks will look attractive again. It's not now.
ereguly@globeandmail.ca
