Mills around Sappi neck only add to its debt drag

Monday, Feb 10, 2014
SAPPI, the once high-flying pulp and paper group with a big presence in Western Europe and the US, has stumbled through five difficult years that raise sharp questions about past decisions and whether investors should buy yet another revival story, or cut their losses.

Long-suffering investors — including Allan Gray (19%), Investec Asset Management (13.8%) and Coronation (10%) — must be wondering just when to call it quits and bow out of a company that has repeatedly caused investors to swoon with talk of an imminent recovery, before releasing yet another dire and inconsistent set of results.

Over the past three years alone, Sappi’s share price has shed 12.3% — being left far behind by the JSE’s all share index, which climbed 37% over that time.

Of course, Sappi has answers for its topsy-turvy financial results. The trouble is, these answers are not always convincing. And the future does not seem much clearer, given the relatively gloomy outlook for the product Sappi specialises in: fine glossy paper used in magazines and brochures.

With such clouds looming, it is clear that Sappi needs a new plan.

Only now, it needs a new CEO too.

Three weeks ago, Sappi announced that CEO Ralph Boëttger would be relinquishing his post on June 30 this year, due to a serious illness. He has been Sappi CEO for just short of seven years.

A successor for Boëttger is being sought -which raises questions for shareholder activist Theo Botha.

Although Boëttger denies it, Sappi’s problems date back to 2008 when it paid à750m (R11bn at today’s rates) for four mills in Western Europe -a paper market plagued by overcapacity and falling prices.

This reinforces Sappi’s flawed history, which is one of a company with an apparent obsession to be the biggest out there — and willing to trade its profitability, rising debt and strategy to get there.

This week, Boëttger mounted a rousing defence of Sappi’s strategy, in response to questions from Business Times.

On the troubled Western Europe market, he said: “The paper markets were stronger a year ago, but the actions we took over the past three quarters have improved profitability, in particular in Europe, and the outlook is that we will show improved profitability for 2014 when compared to 2013. Going forward, we expect each quarter to be better than the equivalent quarter a year ago.”

Sounds encouraging, but the problem is not only does it sound like an assurance Sappi has given before, but Boëttger is also talking about overall profitability.

This becomes a problem when you look at Sappi’s last quarterly results, which show that key figures like earnings per share and operating profit are actually dropping — continuing the trend of previous results.

In fact, investors debating whether to stick around will be keeping a keen eye on one figure that is going up — net debt.

Debt is now $2.35bn (or about R26bn) — up from the $2.1bn from the first quarter last year.

Again, Boëttger had an answer. “Net debt has peaked due to the final phases of the major capital projects,” he said.

“For 2014 we expect capital expenditure to be less than $300m and along with the expected improvement in profitability when compared to the prior year, should allow us to reduce our debt levels to approximately $2bn by the end of the financial year.”

Botha, a stalwart presence at Sappi’s AGMs for many years, grilling the group on its strategy, disagrees. He presented a list of questions to chairman Danie Cronje at Sappi’s AGM last week, and debt was high on the list.

“I said with unstable profits and decreasing profit margins, it was unlikely that the company would be able to meet its debt commitment in the future,” he said.

“With 87% of borrowings overseas in euros and US dollars, and the weak rand, there’s a potential risk to the repayment of these loans. But Cronje said there was no way Sappi would not be able to service its debt. That’s what they’ve said before. In fact, all the answers to my questions were the same as they’ve been saying the last three to four years. I don’t think they will be able to service the debt.”

Sappi is obviously sensitive about this. André Oberholzer, Sappi’s head of corporate affairs, pointed out later that while much of the debt was in US dollars, about 90% of the income coming to South Africa was in US dollars.

“So if a weak rand has any effect it will be positive for Sappi. That’s why we report in US dollars,” said Oberholzer.

While Sappi has taken fearful heat for its strategy of doubling down on fine, glossy paper by buying M-Real’s four mills in Europe in 2008 at a time when that market was struggling, Boëttger said it was wrong to link Sappi’s debt levels to that acquisition.

“The M-Real deal was funded through a rights issue”. (Actually, that deal was only partly funded by the rights issue of à450m.)

However, Boëttger went on to say, correctly, that Sappi’s debt levels were also high — “in excess of $2.1bn” — before he became CEO in 2007.

But that raises a more important question: while the decision to buy the M-Real mills was a board decision supported by shareholders, to what extent was it already in place before he joined Sappi in 2007? Was that decision thrust on him? And is he now being made to look like the fall guy for a strategic blunder?

“The decision to do the deal in Europe was part of the strategy which my management team and I developed after we had reviewed the previous strategy, which was focused on coated fine paper. I take full responsibility and stand by that decision,” he said.

By many accounts, that strategy seemed flawed -and the recent results would appear to underscore that assessment.

Boëttger will be gone by mid-year — and then what? Will his successor be able to tell the wood from the trees?

It is unclear, and the share price suggests not. Despite a modest recovery in the share price in the past year, up 18% at R33.72, it is still short of recovering the ground it lost over the last decade. And Sappi has not paid a dividend since the end of the fateful 2008.

If Botha is right about inability to service debt, it might be a very long time before shareholders see a dividend from Sappi.