Paper & Forest Products Practice Pulp, paper, and packaging in the next decade: Transformational change If you thought the paper industry was going to disappear, think again. Graphic papers are being squeezed by digitization, but the paper and forest-products industry overall has major changes in store and exciting prospects for new growth. by Peter Berg and Oskar Lingqvist © VisionsofAmerica/Joe Sohm/Getty Images August 2019 From what you read in the press and hear on the and pulp for hygiene products. Although a relatively street, you might be excused for believing the small market as yet, pulp for textile applications is paper and forest-products industry is disappearing growing. And a broad search for new applications fast in the wake of digitization. The year 2015 saw and uses for wood and its components is taking worldwide demand for graphic paper decline for place in numerous labs and development centers. the first time ever, and the fall in demand for these The paper and forest-products industry is not products in North America and Europe over the past disappearing—far from it. But it is changing, five years has been more pronounced than even the morphing, and developing. We would argue that most pessimistic forecasts. the industry is going through the most substantial transformation it has seen in many decades. But the paper and forest-products industry as a whole is growing, albeit at a slower pace than before, as In this article, we outline the changes we see Insights 2019 other products are filling the gap left by the shrinking happening across the industry and identify the 1 Pulp, paper, and packaginggraphic-paper in market the next (Exhibit decade: 1). Packaging Transformational is challenges change CEOs and their leadership teams will Exhibit 1 of 5 growing all over the world, along with tissue papers, need to manage over the next decade. Exhibit 1 The global paper and paperboard industry continues to grow despite decline in the graphic- paper segment. Global paper and paperboard market, million metric tons CAGR,1 CAGR, 450 1992–2007, % 2010–18, % 400 Others 0.6 1.1 Other Tissue 3.9 3.6 350 Newsprint 1.1 –6.1 300 Graphic paper Printing and writing 3.2 –1.5 250 Carton- 200 3.3 1.7 board 150 Packaging Container- 100 4.3 2.7 board 50 0 1992 2000 2010 2018 Average per annum 3.0 1.0 1 Compound annual growth rate. Source: Resource Information Systems Inc (RISI), Feb 2019 1 The graphic-paper segment includes newsprint, printing, and writing papers. 2 Pulp, paper, and packaging in the next decade: Transformational change Changing industry structure levels in specific segments have generally, if The structure of the industry landscape is changing. not universally, increased (Exhibit 2). In some The changes are not dramatic individually, but the segments such as North American containerboard accumulation of changes over the long term has now and coated fine paper, ownership concentration reached a point where they are making a difference. as defined by traditional approaches to drawing segment boundaries may be reaching levels where Consolidation has been a major factor in many it would be difficult for companies to find further segments of the industry. The big have become acquisition opportunities that could be approved by bigger in their chosen areas of focus. At the competition authorities. aggregate level, the world’s largest paper and forest-products companies have not grown A grouping of companies has emerged that is Insights 2019 much, if at all, and several of them have reduced not identical to, but partly overlaps with, the group of largest companies, and is drawn from various Pulp, paper, and packagingin size. What theyin the have next done decade: is focus their Transformational efforts change geographies and market segments. Companies Exhibit 2 of 5 on fewer segments. As a result, concentration Exhibit 2 Segment concentration has increased over the past ten years in most segments. Herndahl–Hirschman Index (HHI),¹ by segment and region Competitive Moderately concentrated Highly concentrated Containerboard Uncoated wood free Coated wood free Tissue 3,545 2,369 1,976 1,844 1,893 1,715 1,393² 932 North America 1,589 1,401 1,088 1,073 883 690 700 705 Western Europe 1,002 730 556 640 397 488 221 296 Asia 2008 2018 2008 2018 2008 2018 2008 2018 1 Σ(market share)², HHI <1,000 competitive, 1,000–1,800 moderately concentrated, >1,800 highly concentrated. ²At the next level of granularity; consumer tissue and away-from-home tissue are highly concentrated segments (HHI ~2,500). Source: Brian McClay & Associates; Resource Information Systems Inc (RISI); McKinsey analysis Pulp, paper, and packaging in the next decade: Transformational change 3 in this group have positioned themselves for performance among companies across the industry further growth through high margins and low debt continues to pique the interest of investors and (Exhibit 3). Our analysis suggests the financial private-equity players in an industry that is already resources available to some members of this group undergoing substantial restructuring and M&A. for strategic capital expenditure could be five to ten times greater than other top players in the industry. This potentially represents a powerful force for Changing market segments change in the industry, and over the next few years Whether companies are well positioned for further it will be interesting to see how these companies growth or still needing to earn the right to grow, they choose to spend their resources. Some of these can expect demand to grow for paper and board companies with large war chests and sizable annual products over the next decade. The graphic-paper cash flows deployable for strategic capex might market will continue to face declining demand even face a challenge to find opportunities on a worldwide, and our research has yet to find credible scale that matches these resources. arguments for a specific floor for future demand. Insights 2019 But this decline should be balanced by the increase Pulp, paper, and packagingWhere there arein theleaders, next there decade: are also Transformational laggards. in demand change for packaging—industrial as well as Exhibit 3 of 5 We believe the pronounced differences in consumer—and tissue products. All in all, demand Exhibit 3 Pulp-and-paper companies are building up signi cant muscle for structural actions and further growth. Performance and nancial strength Growth potential Europe North America Latin America Asia Europe North America Latin America Asia High 5 High 4 Turnaround Financial restructuring 3 4 2 3 Debt War burden, 2018,¹ chest,³ 1 net debt/ $ billion EBITDA² 2 0 1 –1 Asset Growth restructuring opportunities 0 –2 0 20 40 60 –1 0 1 2 Low EBITDA margin, High Low Yearly cash ow High 2018,¹ % available for strategic capital expenditures,⁴ $ billion 1 Based on full-year 2016 or latest available interim report, excluding nonrecurring items. 2 Earnings before interest, taxes, depreciation, and amortization. 3 Indicates further debt potentially to be used in expansion assuming net debt/EBITDA may not exceed 3. 4 EBITDA less maintenance capital expenditures (assumed 4% of sales), less assumed change in assumed working capital, less tax, less dividends and nancial costs. 4 Pulp, paper, and packaging in the next decade: Transformational change for fiber-based products is set to increase globally, How these demand trends will translate into industry with some segments growing faster than others profitability will of course be heavily influenced by (Exhibit 4). the industry’s supply actions. Supply movements are notoriously difficult to forecast more than a few That picture is not without its uncertainties. years out, but we believe the following observations One hazy spot in the demand skies might be are relevant to this discussion. concerns over how fast demand will grow in China. Expectations of growth from only a few years ago — Graphic papers, particularly newsprint and have proved a bit too optimistic, not only in graphic coated papers but also uncoated papers, will papers but also in tissue papers and packaging. continue to face a severe decline in demand and And recently, as a result of turmoil in the market significant pressure to restructure production for recycled fiber, Chinese users of corrugated capacity. We are likely to see continuing machine packaging have reduced their consumption, through conversions into packaging and specialty papers, weight reductions and use of reusable plastic boxes. as well as more innovative structural moves that Insights 2019 Given China’s weight in the global paper and board include innovations in distribution and the supply Pulp, paper, and packagingmarket, even in relatively the next modest decade: changes Transformational can have chain. change Such structural changes are already Exhibit 4 of 5 significant impact. having an impact and the profitability of graphic- Exhibit 4 Growth prospects in pulp and paper vary signi cantly among segments and regions. Market demand CAGR¹ >2% CAGR 0–2% CAGR <0% Latin Eastern Other China North Western Japan America Europe Asia America Europe Tissue Tissue Graphic papers Mechanical Newsprint Wood free Packaging papers Kraft paper and specialty Cartonboard Containerboard Hardwood pulp Market bleached hardwood kraft pulp Softwood pulp Market bleached softwood kraft pulp Higher Lower 1 Compound annual growth rate. Source: Resource Information Systems Inc (RISI), Feb 2019 Pulp, paper, and packaging in the next decade: Transformational change 5 paper companies has reemerged from several start-up of capacity (hardwood pulp), limited years in the doldrums. The turbulence in graphic capacity additions, and a certain measure of papers has meanwhile spilled over to packaging industry psychology. In the past two years, and tissue segments, with capacity increases in prices globally went through what we would segments that don’t really need it.