European expansion presents growth path for papermakers.

The European Union (EU) welcomed 10 new members in May this year as the so-called accession countries expanded the remit of the organization into the Baltics and Central and Eastern Europe.

While the new members are already driving broad political and socio-economic changes across a whole host of international stages, the impact of the accession countries on the paper industry is likely to be slightly less dramatic--at least in the short term.

For a start, papermakers have had several years to position themselves for the arrival of the new member countries, so there is unlikely to be any rash of investment activity this year. In fact, it is fair to say that the multinationals that are keen on Eastern Europe are there now, having built up their presence over the past few years.

On the other hand, the economic benefits of joining the EU are making a positive impact and that is likely to prove welcome for the groups that have already found their niche in the post-Soviet bloc.

In alphabetical order, the new members of the European trade bloc include Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland, Slovakia and Slovenia. Within that collection lie some vast differences in terms of cultural identity, heritage and the relative development of the paper markets in each state; but although the business environments may be quite diverse, the economy of each country appears to be benefiting from the accession (Table 1).

GDP growth rates look especially positive for the Baltic countries (Estonia, Latvia and Lithuania), but according to the latest figures from the International Monetary Fund (IMF), practically all of the new members will easily outstrip the average GDP growth forecast for the Euro zone both this year and in 2005.

IP BULLISH ON EASTERN EUROPE

Of course, as any economist will point out, a lot of this growth is coming from a relatively low base. But the fact remains that this is an expanding market in the midst of a mature European economy, so it is clearly worthwhile taking a close look at the prospects on offer.

In fact, International Paper's CEO, John Faraci, announced in October that Eastern Europe would be one of the company's target growth areas as he aims to double or even triple the company's turnover (sales) in the region. IP is already a big player in Eastern Europe, which contributed US$600 million in revenues and US$250 million in EBITDA (earnings before interest, tax, depreciation and amortization) to the group's 2003 accounts. But it seems as though Faraci will be looking to leverage even more growth from the region, since IP has earmarked 6% of its 2003/2004 capital expenditures budget in a bid to further bolster its presence in the region.

The company says that it will look to expand via organic growth and joint ventures in the areas of uncoated freesheet and packaging. However, at this stage it is still unclear whether that investment will go toward boosting output in the mills where IP is already active in Russia, Poland or even Turkey, or whether other opportunities are on the table.

Among the other multinationals with a significant presence in the region is SCA. Over the years, the Swedish group has built up a range of mainly corrugated operations in the Czech Republic (50,000 metric tons/yr), Estonia (17,000 mtpy), Hungary (35,000 mtpy), Lithuania (35,000 mtpy), Poland (35,000 mtpy) and Slovakia (converting). In May this year, though, the group announced that it was building a new facility for the production of litho-laminated packaging in the Tatabanya-Komarom region of northern Hungary.

Given the nature of the underlying market, the investment is reasonably modest at only EUR 11.4 million, but the project does highlight one of the trends being seen across Eastern Europe. According to Aleksei Novitsky, consultant with Jaakko Poyry, the investment is fairly typical of the expansion that will take place in the next couple of years.

"In the short term, you're not going to see substantial new investment, although in the long term the investment climate will change," he said. "What is much more interesting is that you are seeing a stable customer base in the new accession countries so there is a growing market, but it will be about 3-5 years before that starts to make a real difference. In the meantime, you will get smaller rebuilds and quality upgrades that are domestic market oriented, especially in packaging grades. If you are asking whether anyone is likely to invest in 'export' capacity, then I'd have to say probably not."

That is a view echoed by Harri Taittonen, analyst with UBS. "The thing is, there are a reasonable number of mills in the region already, so they don't seem to have any particular need for big greenfield sites. What we will see is more modest but steady investment in the area, because even though it's just 10-15% of the European market, there is still a lot of growth there. According to a recent conference I went to, people like Mayr-Melnhof and others with an Eastern European focus seem especially confident these days."

Mayr-Melnhof's financial reports certainly seem to bear that out. The Austrian group is geographically well positioned to take advantage of opportunities on its doorstep and it has made the most of it with a series of investments in recent years. Partly as a result, the group recently posted its "best ever" half-year results, with net sales up 7.4% on the same period last year to show a rather healthy EBITDA margin of 17.2%.

Wilhelm Hormanseder, CEO of Mayr-Melnhof, said, "The course of expansion was carried on in the first six months of this year with four acquisitions in the folding carton area. In line with our growth strategy, the focus was on Central and Eastern Europe, with an additional facility each in Poland and Romania as well as the first production site in Russia."

Not only that, but "persistent, dynamic development in Central and Eastern Europe" helped push utilization rates up to 97% in the group's Karton division.

FINE RETURNS

In fact, a cursory glance at the other multinationals operating in the region shows that there are some interesting moves taking place, even if there are no huge greenfield mills in the cards in the short term.

Neusiedler, for example, reports that it has been very successful in Russia and Slovakia with the Syktyvkar and Ru omberok mills, respectively. Even while proclaiming the success of its East European strategy, the company has invested even further in 2004 with the completion of a rebuild of PM 18 at the Slovakian mill and the reconstruction of a bark-fired boiler. According to the company, taking PM 18 from 100,000 metric tons/yr to 290,000 mtpy represents the culmination of a EUR 240 million investment program. Not only that, but further investment in Russia and elsewhere will push the company toward being the largest cut-size producer in Europe by the end of 2004 with a capacity of 1.4 million metric tons.

Not surprisingly, Gunther Hassler, the CEO of Neusiedler, said that he is content with the progress to date. "All the expenditure has fulfilled its potential and I'm very happy with the development. Of course, there are some people that are talking about two-digit growth rates. I think we're a bit more realistic than that, but it certainly looks good compared to the growth rates you see in Western Europe and it offers us a lot of opportunities for the future," he pointed out.

TARGET: FOCUSED DEVELOPMENT

Hassler said that management will remain targeted on 'focused' development of its assets in the future, whether that means Central Europe, Eastern Europe or Russia.

Although Neusiedler certainly looks well positioned, it is packaging that is still most widely anticipated to do best in the short to medium term in Eastern Europe. On that score, Kappa Packaging is set to play perhaps the most interesting part in the future of the Eastern European market this year.

The group already has a number of plants in the region and announced another EUR 11 million investment in August--a litho-laminated corrugated board (LLCB) greenfield plant at Olomouc in the Czech Republic.

The really big news is that Kappa may soon be in the midst of an auction sale Clearly, whoever buys the EUR 3 billion turnover company will also secure some important strategic assets in the region, and everyone from Jefferson Smurfit, Saica and Mondi through to Stora, SCA and IP will likely be poring over the numbers to see if the company makes a good strategic fit.

BALTIC SEES

Another aspect of the accession is that the EU now boasts an extra 27 million hectares or so of commercial forests, which account for 25% of current commercial forests in Western Europe. In some countries, the raw material is already well-utilized, but some of the Baltic States do look interesting from a fiber sourcing point of view.

However, potential pulp plans have already been largely abandoned for Estonia and Lithuania and Metsaliitto's EUR 1 billion pulp mill project near Riga in Latvia is reportedly having an extremely hard time getting through the various regulatory hoops. As a result, commentators are indicating that Russia might still prove a more likely location for such a significant investment in the foreseeable future.

On the other hand, if the economies continue to do as well as they have to date, it seems likely that other opportunities will open up.

Inevitably, the new European Union accession countries are not going to provide a massive boost for the European paper industry that will ease everyone's overcapacity issues overnight. What is clear is that their added economic weight will offer a decent sideplate of nourishment as the big players jostle for the real prize in the East--a rejuvenated Russian market.

World Output (Real GDP - % change)                    Forecast  Forecast
                                    2001  2002  2003  2004      2005

World                                2.4  3.0    3.9  5.0       4.3
US                                   0.8  1.9    3.0  4.3       3.5
Euro Area                            1.6  0.8    0.5  2.2       2.2
Central & Eastern Europe             0.2  4.4    4.5  5.5       4.8
Source: IMF

World Output (Real GDP - % change)                    Forecast  Forecast
                                    2001  2002  2003  2004      2005

Albania                              7.6  4.7    6.0  6.2       6.0
Bosnia & Herzegovina                 4.4  5.5    2.7  5.0       4.0
Bulgaria                             4.1  4.9    4.3  5.2       5.2
Croatia                              4.4  5.2    4.3  3.7       4.1
Cyprus                               4.0  2.0    2.0  3.0       3.5
Czech Republic                       2.6  1.5    3.1  3.3       3.4
Estonia                              6.4  7.2    5.1  5.8       5.4
Hungary                              3.8  3.5    2.9  3.5       3.7
Latvia                               8.0  6.4    7.5  6.5       6.0
Lithuania                            6.4  6.8    9.0  7.0       7.0
Macedonia                           -4.5  0.9    3.1  4.0       4.5
Malta                               -1.2  1.2   -1.7  1.3       1.7
Serbia & Montenegro                  5.5  4.0    3.0  4.4       4.5
Poland                               1.0  1.4    3.8  5.8       5.1
Romania                              5.7  5.0    4.9  5.0       5.0
Slovak Republic                      3.8  4.4    4.2  4.8       4.3
Slovenia                             2.7  3.4    2.3  3.9       4.1
Source: IMF
                                = accession countries joining EU in 2004

2003                   Total  Total    Newsprint   Uncoated    Coated
000 Tonnes             Paper  Graphic             Mechanical  Mechanical

Czech Republic           941  279        101          50           0
Hungary                  542  227          0           4           0
Poland                 2,362  705        191           1           0
Slovak Republic          673  280          0           0           0

2003             Uncoated    Coated   Sanitary &  Total        Case
000 Tonnes       Woodfree   Woodfree  Household   Packaging  Materials

Czech Republic     116        12         31         602        266
Hungary            223         0         37         268        234
Poland             513         0        223       1,252        851
Slovak Republic    277         3        132         251        206

2003                 Cartonbd    Wrappings  Others
000 Tonnes         & O.P. & B.*

Czech Republic          86          250       29
Hungary                 34            0       10
Poland                 212          189      182
Slovak Republic         28           17       10

Source: CEPI

Table 1: Output and production capacity in Eastern Europe

WHAT YOU WILL LEARN

* How the recent growth of the EU into Eastern Europe will affect pulp and paper.

* How different companies are approaching the Eastern European market.

* The challenge of integrating pulp and paper standards in the new "accession" countries.

ADDITIONAL RESOURCES

* "Southern Europe moves toward even greater integration," Jim Kenny, Solutions!, September 2003. To access this article, type the following Product Code in the search box at www.tappi.org: 03SEPSO32.

RELATED ARTICLE: CHALLENGES FOR MILLS AIMING TO MAKE THE GRADE

The inclusion of 10 new countries in the European Union is certain to generate some welcome extra revenue for papermakers operating across the region, but they will also have to face up to some tough technical challenges as well.

Even as each of the countries embarks on the process of fully integrating with Western Europe, the paper industry--like other sectors of the economy--will have to match the standards necessary to operate according to EU regulations. According to the Confederation of European Paper Industries (CEPI), accession represents one of the most interesting challenges facing the organization over the coming years.

As CEPI's managing director, Teresa Presas, pointed out, environmental and legislative issues are likely to present some major challenges as the accession countries move toward the norms prevailing in Western Europe. While some countries have secured transition periods and derogations in certain areas, CEPI will have to play a vital role in offering help and advice over the transitional period and beyond in areas such as:

* packaging and packaging waste legislation

* recovery and recycling targets

* integrated pollution prevention and control (IPPC)

* energy issues and emissions trading

* discharge of dangerous substances into water

* control of volatile organic compound emissions

* landfill of waste

* sustainability

On a positive note, the extra investment will be forthcoming if the markets grow at the rate anticipated. For example, figures from Jaakko Poyry show that annual paper and paperboard demand growth in Eastern Europe is forecast to be around 4.6%--stronger even than China. The consultant recently predicted that fine papers may prove the best medium term bet for growth, with publication papers doing well in the short term.

However, other analysts believe that packaging materials will climb sharply over the next five years as FMCG firms set up base across the region. Needless to say, papermakers will welcome growth from whatever source it comes, and it does look as if it will.

JIM KENNY, CONTRIBUTING EDITOR/EUROPE

ABOUT THE AUTHOR

Jim Kenny is contributing editor/Europe, for Solutions! magazine, and is based in Brussels, Belgium. He is the former vice president of editorial for Paperloop and today heads his own company, DSI. Contact him by phone at [phone], or by email at [e-mail].

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