The gap between Kraft and Testliner prices had grown and hence a narrowing made sense. Foreign Kraft producers found the UK market increasingly attractive…which raised supply. There has been a further switch out of Kraft into the less costly option of recycled liners. In some parts of Europe Kraft consists of only 2% of the containerboard mix…with the UK currently at 20% there would seem to be further scope for substitution into Testliners. Sterling has strengthened against the dollar.
Conversely, recycled containerboard remains in desperately tight supply. European stocks in week 50 of 2013 totalled 436,000 tonnes; 11% lower than the corresponding week in 2012. This is the lowest level seen since the new generation of recycled paper mills came on stream across Europe and well below the 500,000 tonne threshold that signals a shortage. Whereas past years have often seen a £10-15/tonne price reduction during February, this seems unlikely with the supply-demand balance so close to equilibrium.? Perhaps current recycled prices will be tested in late February, but increases of £25/tonne will almost certainly be implemented in April or May. If that doesn't seem like a lot…remember that box and sheet board makers largely absorbed a £15/tonne increase just before Christmas. A cumulative £40/tonne on recycled containerboard will probably trigger a subsequent increase in box and sheet board prices.
With this in mind, start getting your head around the idea of putting up box prices this Spring and / or taking out a rake of costs beforehand.
If you don't have lots of fat to cut, your menu of sustainable options have the benefit of lonely clarity of choice. There are many of you who have repeatedly shied away from approaching certain box buyers regarding a price rise because they keep threatening to move the business away. This will be the year that you'll no longer be able to kick the can down the road; resolve is often easier if you know you're facing delivering at a loss. Put it another way…you've actually reached agreement if they don't want to buy if you put your prices up and you don't want to supply at a loss.
The New Year brings forward the prospect of heightened competition amongst box makers as they seek to outgrow the market following recent investments:
At the continental level, DS Smith is delivering on its stated aim of out-growing the economy by 1%. Whilst Smurfit Kappa Group (SKG) are their only truly pan-European competitor (i.e. in terms of geographic footprint), it was a surprise to hear DS Smith's CEO Miles Roberts openly talking about having taken business from SKG. That's a clear statement of intent. However, SKG are also a class act…and a combative one at that. It's rather like an English sports team deciding to vociferously pick a fight with an Aussie rival; you can be sure that they've got Antipodean-like inner steel and won't yield without a fight. The practical upshot is heightened rivalry between these two market leaders that is helping to whittle some key margin for the circa 25% of corrugated volume that is purchased by pan-European buyers. In the UK, Rigid continue to compete aggressively as they seek to take their new South West box plant to the critical mass required to trigger investment in a new corrugator. As part of an integrated paper and packaging group, they are also seeking to take advantage of the new recycled containerboard capacity coming on stream in their Blue Paper French paper mill.
Sheet feeding is about to witness a step change in competition as CSI enter the UK market, so it's worth reflecting on the likely consequences for key players.
CSI's founding partners are likely to undergo what to them may be an unexpected paradigm shift once the new sheet feeder is up and running. It seems reasonable to assess their early motivation to have been a logical wish to realise more of the added value in their own sales. However, it also seems reasonable to expect their currently single-track loyalties to be divided when they no longer have just a box plant to worry about…but the profitability of a hugely capital-intensive sheet feeder too. Seeing sheet board prices fall off a cliff is in no one's interests…least of all if you're the proud co-owner of a shiny new sheet feeding operation. Competing sheet feeders should take note of this observation.
All the same, despite what I'm sure are the best of intentions from the founding owners there will be market disruption. Recent history can help to illustrate the likely impact of the new CSI capacity. Prowell recently caused a splash in the UK sheet feeder market by introducing 150 million square metres of effective capacity off their BHS corrugator. The subsequent great gales of creative destruction ultimately blew away Western Corrugated, who turned out to be Prowell's weakest competitor at the volume end of the sheet feeder market. The instructive element of this experience is the symmetry of displacement…Western's capacity was circa 150 million square metres.
The new CSI corrugator has a notional capacity of 200 million square metres, although the messy work mix and relatively low average quantity requirements of the typical UK sheet plant in the available market will doubtless cause some diseconomies of scale which reduce CSI's effective capacity to what I estimate to be around 140 million square metres.
The concept of the available market is an important one. We start with a circa billion square metre sheet feeding market and then start to eliminate the parts of the market that are unlikely to be available to CSI:
Logson Group's vertical integration incorporates sheet feeder Board24 as well as the Boxes & Packaging and inspirepac sheet plant groups. Whilst they are run at arm's length from the sheet feeding business and can (and do) buy significant sheet board from outside the group, it seems a safe bet that they won't want to help CSI get started. Don't be surprised if Logson acquires more sheet plants or opts to further diversify by investing again in their trade box making operation. Smurfit Kappa and DS Smith would also seem hugely unlikely to want their sheet plants to source sheet board from CSI. SKG's shrewd recent acquisition of CRP further shrinks the available market. Prowell has a handful of key strategic partners whom it will doubtless fight tooth and nail to retain. You can also be sure that many sheet plants will actually be loyal to their long-standing suppliers. Not all of course…but a significant number all the same.
On the other side of the equation, CSI can rely on its founding co-owners for circa 65% of the volume from the start of sheet board production. At first glance the maths suggest that all CSI need is another circa 50 million square metres of volume from the available market…which surely can't be that disruptive? However, existing sheet feeders will also be losing the circa 90 million square metres of volume I estimate that arises from the founding owners. Whilst this volume will switch relatively smoothly in commercial terms, they'll have to fight hard to win the 50 million square metres that is not within their gift. Assuming a 15% conversion rate, they'll have to quote for 333 million square metres to win 50. Other sheet feeders will have to quote for 600 million square metres to win the missing 90. That's a lot of disruption.
With CSI's necessary focus on the available market and likely targeting of more lucrative added value grades, their introduction to the market is likely to hurt DS Smith to somewhat a greater degree than Board24, SKG or Prowell. DS Smith and SKG are also more limited in terms of their strategic response options because of their overall market leadership in the UK. Unlike Board24 they can't look to diversify by introducing trade case making into their sheet feeding operation lest they cannibalise market share from their own box plants. Also, their high market share makes the acquisition of further sheet plants tricky (although not impossible – depending on where they target) in terms of approval from the competition authorities.
The overall conclusion has to be that sustainable sheet board and box margins remain in everyone's interests. Somebody, somewhere is going to have to take out 150 million square metres of capacity…it can either be relatively painless and proactive or it can be brought to an eventual head after a disruptive, competitive slug fest. As your Editor reads the tea leaves, I'm predicting a blend of:
A UK sheet feeding market that grows in volume by 3% in 2014 (i.e. 30 million square metres), off the back of a UK economy that's growing by at least 2% and a sheet feeding sector that will out-grow the overall corrugated market as a result of what will be artificially low sheet board margins for a period. Distributors will probably lose market share to sheet plants as they did when Prowell first entered the UK sheet feeding market. Importers losing interest in the UK market quite quickly as margins over here head south. The French sheet board market is sufficiently tough that today's UK market seems an attractive proposition. Hence both Prowell and CGW are importing significant tonnage. I estimate 50 million square metres of capacity will retreat from the UK market via this route once CSI are up and running in earnest. Integrated box plants who dabble in sheet feeding may well also be happy to let some low margin sheet volume go. I estimate 10 million square metres of capacity will bow out via this route to market. An independent sheet feeder selling up or losing the good fight. I estimate 60 million square metres will eventually exit the UK market via this route. On current information, the big three existing sheet feeders will see their combined volume drop by some 50 million square metres. However, I'm betting on a strategic initiative or two from one or more of the big three to further inoculate them from the market disruption to come. Expect announcements before the Spring…which may well impact the above forecast implications for the rest of the market.
OK, that covers sheet feeders…what about the likely impact on sheet plants? Our recent experience with the introduction of the new Prowell capacity saw sheet board prices fall to artificially low levels for a while. If you buy sheet board and you have the opportunity to save serious money on your largest single item of cost – it would be an understandable temptation to take advantage; pocket the saving if you must. However, I strongly recommend that you base your own selling prices on sustainable board prices (i.e. not the cheapest board prices but the average of the rest). At some point sheet board capacity will be removed and board prices will ping back up to a more sustainable level. If your box prices are then based on artificially low sheet prices you'll potentially have to ask your clients for a price rise in isolation from the rest of the market, which is what caused a number of sheet plants to go bust (others 'merely' faced huge difficulty before the dust settled after Prowell's entry into the UK market). I don't blame Prowell just as I don't blame CSI…wanting to introduce a new business is fair enough. Keeping a handle on what prices are sustainable is your challenge too.
A number of UK corrugated companies reported record demand in October and November. Indeed, some box plants were oversold by up to 25% in December despite working flat out (including weekends)…although capacity constraints meant that most will have been unable to take anything like full advantage. More than a few saw productivity suffer horribly as they chopped and changed production schedules to try and keep as many clients supplied as possible, meaning multiple set ups eating into potential running time on machines. Juggling part loads on lorries to maintain service levels also led to diseconomies of scale for some in terms of despatch costs. Typically, the most competitive could have sold 10% more if they'd had the capacity to accommodate the volume. Which just goes to highlight the value of having sufficient reliable capacity up your sleeve (i.e. at levels north of peak demand) if you don't want to miss opportunities. If you were offered far more work than you could make in quarter four, perhaps it's time to consider investing in a productivity improvement programme, more shifts or new kit?
