Tissue: above the fray? As the most consumer-driven sector of the paper industry, tissue has fared better than most paper grades. Still, it's not a market for the weak of heart.

Editor's Note: The following are reports from three key tissue markets: North America, Europe and Brazil. The section on North America was written by Jan Bottiglieri, managing editor of Solutions! magazine. She can be reached at [e-mail]. Our European report was prepared by Jim Kenny, contributing editor/Europe for Solutions! He can be reached at [e-mail]. The report on Brazil is an edited version of an article by Renata Mercante Savastano in O Papel, the publication of ABTCP (Associacao Brasileira Tecnica de Celulose e Papel)--the Brazilian Technical Association of Pulp and Paper. It is produced here as part of an editorial exchange between TAPPI and O Papel.

NORTH AMERICA: Playing by different rules

Every family has one member who's a little bolder, a little more dynamic, than anyone else in the room--the one who plays by slightly different rules. For the North American paper industry, that has to be the tissue sector.

Highly competitive, staunchly secretive, and far more consumer-driven than other paper industry sectors, the US$ 10 billion North American tissue industry continues to carve its own patterns of growth and change. Since 1995, more than 40 mergers or acquisitions have dramatically altered its playing field, making tissue one of the most concentrated industry sectors.

The tissue sector also enjoys the highest operating rates of any North American paper market, consistently topping 90%, according to American Forest & Paper Association statistics. And, although North American markets for tissue products are mature, they continue to grow, as does the sector's production capacity. A few new machines and incremental capacity growth increased tissue capacity by 3.5% in 1999 and 3.6% in 2000, according to the AF&PA; estimates project that 2001 will register a 3.3% capacity increase, followed by an additional 2.7% in 2002, due to a total of four new machines slated for startup during 2001-2002.

"Historically, the tissue market has been fairly disciplined in its approach to adding capacity, and the recent spate of new machines is no exception," said Jim Thompson of Talo Analytic International Inc., an Atlanta-based consultancy firm that has worked extensively within the tissue sector. "The worst period of undisciplined capacity expansion in the tissue industry occurred in the 1970s, and the last five years have not had any effect like those did.

"Tissue consumption is mature, but it does grow directly with population growth, so machines do need to be added at a regular pace as long as per capita consumption remains the same or grows slightly," said Thompson.

TWO SIDES TO THE STORY

A few top players dominate both of the sector's two businesses--Procter and Gamble, Georgia-Pacific and Kimberly Clark on the consumer products side; and Georgia-Pacific, Kimberly Clark and SCA Tissue North America on the commercial, or "away-from-home" (AFH) side (Kimberly-Clark now calls its AFH business "Professional.") Complicating the equation is the fact that these two businesses each face their own issues and marketing challenges.

The consumer-side players are often referred as the "big three" in North American tissue. According to reports published by G-P, these three companies represent an 80% market share for consumer tissue, towel, and napkin products. Because of the large number of brands offered by each--ranging from value-priced to super-premium offerings--it is not likely that consumers are even aware of the frenzied mergers and acquisition (M&A) activity that created these mega-companies. "The name of the game is to give consumers what they want but manufacture it in plants that provide huge economies of scale," said Thompson.

It's interesting to note that, on the fiber side, two of the three (P&G and K-C) have almost completely exited the pulp business. Although still a major pulp producer, G-P is also moving away from the pulp business, as evidenced by its August 2001 deal with Domtar for the sale of four of G-P's integrated mills (Ashdown, Ark.; Nekoosa and Port Edwards, Wis.; and Woodland, Maine.)

"These companies see pulp as a plentiful, truly commodity input. They are all smart folks, so one could also read from this that they believe that pulp will stay abundant for the foreseeable future--say, five to ten years," said Thompson. "If a company doesn't have pulp mills and their associated huge investments to amortize, they can be much more flexible in manufacturing tissue. Tissue machines, and their concomitant converting plants, probably represent the least investment per dollar of income that exists in the paper and paperboard industry. Plus, if markets turn soft, they can be run on staggered schedules, such as 10 days out of every 14, for instance. And guess what happens now when you are down? You are not consuming pulp and, in fact, you are assisting the pulp market in becoming soft because of your lessening of demand. This action helps your position by driving down the price of pulp."

Only two of the "big three" have a presence on the commercial side of the tissue market: K-C and G-P. The other big AFH player was formed when G-P divested most of the Wisconsin Tissue assets it had acquired from Chesapeake Corp. in 1999. The divestment was a condition imposed by regulatory authorities before the closing its US$ 11 billion dollar deal to acquire Fort James Corp. in 2000. Swedish firm SCA purchased the assets and created SCA Tissue North America in early 2001. The deal cost SCA approximately US$ 850 million for the purchase of four mills, plus converting capacity, and promptly landed SCA the number three spot in the North American AFH market (although its share of the North American tissue market overall is only 7%). The acquired businesses turned out nearly 400,000 metric tons of converted tissue products last year, and have a maximum capacity of 500,000 tons a year.

"For SCA, this was a huge undertaking," said Lee Bingham, SCA Tissue North America's president and CEO. "SCA had a very small presence in North America--less than 1% market share. (After the deal) we have approximately 17% market share (of the AFH market)." In fact, according to data compiled by AF&PA, Bognar Enterprises and G-P internal reports, SCA North America, G-P and K-C together claim a whopping 82% of North America's commercial tissue market; in comparison, Europe's top three tissue players combine for only 42% of the European market.

In late November, 2001, SCA also acquired Encore Tissue in a US$ 92 million deal that adds Encore's 85,000 short tons per year of production. "rowel products account for more than half of Encore's sales, complementing SCA Tissue's product mix and strengthening its position in the AFH market. "(Encore) has an excellent customer base with strong customer relationships," Bingham commented. "The company is strategically located in terms of our production in the U.S."

In spite of the top three companies' domination, the commercial market remains more open than the consumer business in several senses, Thompson noted. "This market still has a number of players in it and less product differentiation than the at-home market. Also, some of the non-big three players in this market have respectable market shares and are tenacious competitors. The away-from-home market still has a way to go to reach the level of consolidation that is now present on the consumer side. It seems to me that, for the big players, participating in (the commercial) market may have a tendency to drag down overall results. I would not be surprised to see the two big players exit this for the same reasons they exited pulp."

An unexpected drop in demand for commercial tissue products was reported following the September 11 tragedies; the sector is sensitive to changes in the food service, hospitality, and travel industries, which all experienced related declines.

AN AMERICAN TALE

Profit margins for the tissue sector are generally higher than other industry sectors, but that doesn't necessarily protect its players from trouble. A case in point is American Tissue, which has filed for bankruptcy despite reporting record earnings for the first quarter of its 2001 fiscal year. The action contributed to the decision by Perry H. Koplik and Sons, a recovered paper trading house, to liquidate its operation after more than 40 years in the industry.

AT's recent buying spree reportedly overextended the company. During 2001 alone, the company acquired pulp mill assets from the bankrupt Ponderosa Fibres, the assets of forms producer CST/Star Inc., the Centennial paper mill from Simpson Paper, as well as two shuttered mills from Georgia-Pacific and one from Crown Vantage, among other deals. In a letter to employees, AT President and CEO Mehdi Gabayzadeh cited the U.S. economic slowdown, AT's overburdened debt structure, and recently discovered financial inaccuracies as factors. "We believe that Chapter 11 reorganization will allow us to restructure our debt and secure additional financing so that we can continue to operate our business," he said.

Though AT had a presence in both the consumer side of the market (for which it produced mostly private-label store brand products) and the commercial tissue market, Thompson doubted that its bankruptcy announcement would have an effect on the North American tissue market as a whole. "First off, American Tissue had many other manufacturing assets than just tissue assets," he said. "Secondly, most of the assets they owned they had purchased in distressed sales, indicating the assets were sub par in one or more vital areas. Third, what tissue assets they had played mostly in the secondary markets, not directly in the top tier consumer markets.

"There are assets in this industry that deserve to die," Thompson continued. "The sooner we can shut them down, rip them out, and replace them with beautiful meadows of fescue and indigenous wildflowers, the better off we will all be, and by we I mean: the consumer (because they will be getting high tech product from efficient, high tech machines), the communities in which these old assets struggled (because they can quit passing out tax abatements for unsustainable businesses), and the people that worked for them (because they will be motivated to find jobs in vibrant industries where they are not constantly asked to give up salary increases and benefits). Also, don't forget the long-suffering investors, bankers, and vendors who lose in disasters like American Tissue."

EUROPE: Not too much to cry about for the tissue sector

Europe's tissue market has been pretty interesting this year. Consumption has remained solid and shown fairly steady growth overall in what is an uncertain market. But that is about the only thing that has remained constant as merger and acquisition rumors have been running rampant and some long-term battles have been getting particularly heated. At the same time, prices and brand names have come under pressure.

Perhaps unsurprisingly, SCA in Sweden has featured heavily in the most significant events across the tissue segment this year. As Europe's largest tissue player, it has been involved in many of the big news items over recent months, including a failed acquisition of Metsa Tissue. The short, terse statement delivered by Metsa Tissue at the time spoke volumes about the group's disappointment that the European Commission had vetoed the deal on antitrust grounds. "Metsa-Serla Corporation has today (31 January, 2001) announced that the decision issued by the European Commission on 31 January 2001 prevents Metsa-Serla's controlling interest in Metsa Tissue from being sold to SCA. Metsa-Serla owns 65.58% of Metsa Tissue's share capital and SCA owns 19.27%," read the company's press release.

As a result, Metsa Tissue had to resort to Plan B. In effect, the company was obliged to make a go of competing with the other main players in the European market--Kimberly Clark, Georgia-Pacific, CartoInvest, Sofidel, Tronchetti, etc.

The group's recent third quarter results suggest that it is indeed getting on track to attain a place as a profitable, dynamic tissue producer in Europe. But even as Metsa Tissue mulls over its future strategy for growth, SCA is less concerned about where its growth prospects lie.

Indeed, just as the Metsa Tissue deal fell through, SCA had just completed the US$ 852 million acquisition of Georgia-Pacific's tissue manufacturing operations in the United States that were part of a joint venture with Chesapeake Corporation--Georgia-Pacific Tissue (see above article). SCA did not stop there though. In November, the group complemented its U.S. tissue operations by snapping up Encore Paper for US$ 92 million on a debt-free basis (see above).

MORE TO COME?

The really interesting move could be set to come closer to home though. Expectations are growing that SCA could launch a formal bid for CartoInvest, a fast growing Italian group. According to tissue industry expert Esko Uutela of EU Consulting, "Metsa Tissue is not going anywhere for the moment, but there are lots of rumors about SCA and CartoInvest. It's possible that we can expect something early this year."

Market rules make it impossible for either SCA or CartoInvest to comment on such speculation, but several observers believe that the two groups may be going through a pre-decision process with the European Commission to establish whether any formal bid would be blocked by anti-trust rules. If such a deal were to go ahead, though, it would propel SCA into the very top tier of tissue producers anywhere in the world--not all that far behind Georgia-Pacific and Kimberly-Clark and ahead of Procter & Gamble. Big stakes indeed.

OVER THE TOP

Given that the make-up of the players are changing rapidly, the next issue concerns what sort of market they can expect to be operating in over the coming years. Industry consultant Jaakko Poyry has just completed a global tissue study suggesting that there are some interesting challenges ahead for European tissue producers. According to report author Pekka Niku, the pace of new capacity additions is likely to generate overcapacity in the sector for some time to come (Table 3). "Depending on how things go, we could be looking at 330,000 metric tons of new capacity coming on stream in the 2001-2003 period with plans in the pipeline for another 140,000 tonnes, so it's a big increase."

Of course there is no way of knowing how the producers will respond to such capacity developments. They may opt to cancel some of the proposed projects, reduce capacity utilization rates or take some of the older, less efficient units out of the equation altogether. But it certainly seems likely from Niku's numbers (Table 2) that prices will come under pressure in the years to come.

Several analysts--including Uutela--concur with Niku's view that Eastern Europe could prove fertile ground for future growth in the tissue market as demand is expected to rise sharply over the coming years. But as the economics of the business make it unrealistic to move significant volumes over any distance, this would only really benefit tissue producers operating inside Eastern European countries or on its close fringes, such as Italy.

ONGOING BATTLES

Aside from the capacity trends, analysts note two other areas where the tissue market is changing. The first of these is in terms of quality. Over the entire European market, quality standards are said to be rising as consumers come to expect more luxurious products. That is not to say that the market is by any means uniform in how it determines quality, but the standards are certainly being raised across the board, fine trend is being driven partly by marketing, but consumers appear to be generating a "pull" effect on quality standards as well.

One curious phenomenon that remains constant is the apparent preference that German-speaking countries have for multiple ply tissue. Three- and four-ply products are the norm for Germany and Switzerland, for example, whereas many other countries are happy to go with single or two-ply tissues. As a result of such consumer preference patterns, it is sometimes difficult to establish exactly what a "European" tissue is in some cases.

Another factor driving quality standards up in Europe is the ongoing introduction of greater numbers of TAD (through air drying) tissue machines. The enhanced strength and flexibility offered by the technology has already prompted several producers to install TAD capacity, but Europe's 8% of installed capacity still lags well behind the united States, suggesting that this trend is set to continue for some time yet.

PRIVATELY OWNED

Another area where Germany and Switzerland are ahead of the European pack is in the battle between private labels versus producer branded products. For years now, the big retailers have been pushing producers to deliver tissue products labeled under the retailer's own brand name--private labels. Typically, such products are priced lower than the big brand names promoted by the likes of Kimberly-Clark, much to the consternation of many producers who see the private labels eating into their market share and margins.

In Germany and Switzerland, private labels 'already account for more than 60% of total sales and the rest of Europe is catching up fast. According to Niku, "The trend makes it difficult for some companies to select a strategy. SCA, for example, is already something like 50% private label, 50% own brand. But with the retail sector still consolidating, they will want to see more private label product."

And as Uutela points out, "SCA and G-P are doing both [private and branded], but Proctor & Gamble and Kimberly-Clark are trying just to do brancks only. They are not 100% brand only though. Even though it goes against P&G's strategy, for example, they are going to do some private label if it keeps the machines running."

Retailer consolidation has given the distribution chains the balance of power in Europe, so it seems likely that private label sales will continue to grow across Europe. However, there are likely to be limits on the private label volumes that consumers will be willing to buy, so branded product sales are likely to decline faster in countries where private label penetration is currently low.

On current evidence, it appears that the battles between retailers and the big producers are likely to continue for the time being.

LOOKING AHEAD

With European consumption set to grow annually by about 3%, most producers would normally be looking forward to the coming years with a degree of anticipation--but it is unlikely to be plain sailing. Tissue producers have benefited from cheaper pulp and reasonably stable prices in recent months, but outside factors have prompted some caution. As Metsa Tissue reports, "Market outlook remains uncertain because of the general macroeconomic development." Even so, the company expects to meet its cash flow and profit targets for 2001.

SCA too, is convinced that demand in the consumer and incontinence segments will remain favorable, although its enhanced exposure to the United States leads it to note that "the weak market for tissue in the Away-from-Home segment in the U.S. is expected to remain for some time."

In short, demand is sound, Eastern Europe is blossoming, consolidation appears to be progressing and quality standards are rising. In other words, things look reasonably good. As such, European tissue producers appear to have their futures largely in their own hands. The only fly in the ointment comes in the form of new capacity. How producers deal with the imminent overcapacity situation is likely to be the key in determining whether the next few years represent a period of growth and prosperity or a cycle of weakening prices and declining profits. Look out for next year's annual reports to see how they are all getting on.

BRAZIL Warning signs: Consumption declines worry manufacturers

With consumption not keeping up with tissue paper production capacity in Brazil, producers are taking steps to cut costs, increase productivity and control output. Suppliers are diversifying product lines as an option to reverse the drop in sales.

Ever feel like everything is going wrong and the whole world has turned against you? This is how the tissue paper sector in Brazil is now feeling. There are several reasons: high pulp prices in 2000, increased informal competition, greater power of retail clients, stagnating consumption, and production overcapacity. With all this, the tissue sector is going through an unusual business phase. Producers see cost reductions and increased productivity, among other measures, as the way out of the current imbalance between increased production capacity and less than forecast consumption.

The sector had 20% idle capacity in 2000; this was expected to rise to 24% in 2001. "We are very concerned," said Ruy Haidar, president of Santher and vice president of BRACELPA (The Brazilian Pulp and Paper Association). The numbers give the reasons for this concern. In December 2000, the sector had an installed capacity of 830,009 metric tons, which should reach 930,000 by the end of the year. For 2002 there are projections of an increase of 40,000 metric tons. Consumption maintained its average historic growth, which is around 1.5 times the gross domestic product (GDP) of Brazil. In 2000, consumption was 600,000 metric tons and should increase by 6% by the end of 2001.

The increase in capacity is the result of two primary factors. First is the maturation of investments made recently: the acquisition of machinery (with a period of 12 months for delivery) and installation of equipment (which takes another six months). Second is the incorporation of more advanced production technology by small and medium-sized producers in the sector. Consumption, on the other hand, did not keep pace with the increased rate of expansion.

The tissue sector had a good performance in the first quarter of 2000, according to Haidar, but not anything on the scale of the Real Plan era during the 1990s. The Real Plan gave increased purchasing power principally to lower income classes. Economic stability gave the tissue sector one of its best periods in history, generating demand increases of 8% per year between 1993 and 1996. During this period consumption grew 26%, reaching 490,000 metric tons in 1996.

The mismatch between production capacity and consumption became serious only in the second half of 2000, and was reflected in company financial performance. From that point on, prices started dropping and manufacturers' inventories increased. To compound the problem, pulp prices had been recovering since 1999, bringing increased costs to tissue producers. When they dropped in the first quarter of 2000, the reduced costs were onset by the rise in the dollar (commodity price quotes are indexed to the dollar). "The great difficulty for the sector is to reconcile rising prices of inputs indexed to the dollar to the sale of products in Real," stated Haidar.

The strategy of tissue paper producers to deal with the temporary mismatch has principally involved cutting costs, increasing productivity and improving product logistics. This is the sound strategy followed by Klabin Kimberly, Melhoramentos and Santher. Klabin Kimberly went further: it closed the Mendes plant in the state of Rio de Janeiro.

INCREASED EXPORTS?

Exports have not traditionally been a priority for the Brazilian tissue sector. The goal has always been to supply the domestic market, exporting only surplus production. The current business scenario could contribute to a temporary inversion of this lone, with the export market becoming more important. "It would be a way of dealing with the current difficulties," said Haidar.

But there are obstacles to overcome: exports of finished products suffer because of high freight costs. For Santher, total exports accounted for less than 10% of the R$396 million of net cash revenue registered in the 2000 fiscal year.

Along with this, export producers must have prices compatible with those charged by their competitors in the foreign market. And, like any other sector, the tissue sector has lost ground compared to foreign competitors because of the "Brazil Cost." A high tax burden, high cost of credit and the weakness of port infrastructure (which is also expensive) harmed business at this level.

With the global economy in the grips of an economic downturn, recovery of the Brazilian tissue sector depends on regional and international economic trends. Like manufacturers around the world, they are looking for signs of renewed demand growth and economic stability.

Table 1: Major players in the North American consumer and commercial
markets.

NORTH AMERICAN CONSUMER TISSUE:
MAJOR PLAYERS

Kimberly Clark        18%
Georgia-Pacific       34%
Procter & Gamble      28%
Others                20%

Note: Table made from pie chart.

Source: Georgia Pacific; F/D/M ACNielsen US F/D/M 52 wks 7/18/01

NORTH AMERICAN COMMERCIAL
TISSUE: MAJOR PLAYERS

Kimberly Clark        23%
Georgia-Pacific       39%
SCA North American    20%
Others                18%

Note: Table made from pie chart.

Source: Georgia Pacific; AF&PA, Bognar Enterprises

Table 3: Tissue Paper Capacity Expansions in Western Europe

         YEAR/                                              CAPACITY
        COUNTRY                      COMPANY               (1000 mt/a)

2001
        Sweden             SCA, Nattraby                      -32.0
        France             Dalle Hygiene, Bousbecque           30.0
        France             G-P, Usine de Gien, Gien            60.0
        France             Lucart France, Trovilliers          30.0
          UK               Leicester Paper, Leicester          50.0
          UK               North Wales Tissue,
                             Oakenholt                         50.0
         Italy             Cartoran Tissue, Sardinia           22.0
         Italy             Kimberly-Clark, Romagnano
                             Sesia                             15.0
         Italy             Cartiera Partenope, Arzano          35.0
         Italy             Imbalpaper S.A.S. di
                             Perini, Valdottavo                38.0
2002
          UK               Deamas Disposables, Redditch        25.0
         Italy             Cartiera Carma, Pietrabuona        -10.0
         Italy             Cartiera Carma, Pietrabuona         18.0

TOTAL DECIDED 2001-2003                                       331.0
TOTAL PLANNED                                                 142.0

         YEAR/
        COUNTRY                 DATE          REMARKS

2001
        Sweden               Late 2001       shut down
        France               Late 2001        new PM
        France               Late 2001        new PM
        France              August 2001       new PM
          UK               2nd half 2001      new PM
          UK                2nd qtr 2001      new PM
         Italy               June 2001        new PM
         Italy             1st half 2001      rebuild
         Italy               April 2001       new PM
         Italy                  2001          new PM
2002
          UK                 Early 2002       new PM
         Italy             September 2002    shut down
         Italy             September 2002     new PM

TOTAL DECIDED 2001-2003
TOTAL PLANNED

Western Europe's decided capacity changes total 330,000 metric tons in
2001-2003, must of it on new PMs. Capacity will increase most in
France, UK, and Italy.

(Source: Jaakko Poyry)