The purpose of this report is to analyse the forest and forest product industry and to assess its investment potential. The report also aims at identifying specific companies in the industry that are candidates for investment. These candidates will be analysed in separate more company specific analyses.

To make the industry analysis more specific and relevant, 20 European forest, paper, packaging, wood and tissue companies have been included in the analysis. For natural reasons most of these companies are located in Sweden and Finland. Many of the companies have a global presence and when looking at market specifics and general trends such as ESG (Environmental, Social and Governance), no geographical limitations have been made. 

During the period from 2015 to 2022 the median return on capital for all 20 companies has been 11.9%. The median operating margin (EBIT) has been 10.7%. These numbers thus pass my initial hurdle for investment consideration; long term historical return on capital and operating margin above 10%.

Although the industry is very old it’s going through a transformation as the demand for print paper has been falling for many years. At the same time demand for paper-based packaging material is increasing. To use wood as construction material instead of concrete and steel has a major positive impact on carbon dioxide emission. It’s therefore gaining popularity as a building material. The analysis will among other things look at how these factors are likely to affect the industry.     

The structure of the report is as follow: 

1. The first chapter of the report, after the introduction, is a summary of the main conclusions and recommendations for the industry. 
2. The next four chapters aim to give an overview and better high-level understanding of the industry. First there is an introduction of the 20 companies that are being analysed, including revenue and sales per business unit of each company. After that follows an overview of the industry and its history. This is followed by a high-level overview of the industry value chain as well as the industry financials.   
3. Having given some background and context to the industry there are two major chapters that look at the ESG aspects and the market dynamics and segment specifics. 
4. The conclusions from the analysis are summarised in the final chapter Investment Considerations. In this chapter the rationale for and against investing in the industry is made on a sub industry or segment level. This has led to the identification of one company that is worth analysing more in detail. It’s important to point out that the investment horizon considered in this chapter is long term or at least 5 years.

In order to make the analysis more specific the industry was broken down into categories or segments for many sections of the analysis. These segments are graphic papers, packaging material, wood products, specialty papers, pulp, bio-products and forest.   

The analysis has identified one segment that has the potential to be attractive for investment. That segment is tissues for personal hygiene and health. There are many trends in the society that favour this segment and it has a good growth potential. Essity, the only listed company in the Nordics that has its business in this segment, has demonstrated solid historical financial performance. Essity will therefore be analysed more in depth in a company specific analysis. 

All other segments in the industry have characteristics that make them and the companies that operate in them less attractive for investments, at least at this point of time. The main arguments against investments in these segments are as follows.

Graphic papers: This has been a declining segment for many years. The pandemic has accelerated this decline and it will likely be a race to the bottom for the coming years.  

Packaging material: This segment is expected to perform well during the next 5 years as paper-based packaging materials are riding on a ‘convert plastic to paper’ wave. The increased demand for packaging for delivery of online shopping is also benefiting the segment.

The near future, however, looks quite uncertain at the moment as both Stora Enso and Billerud, two big packaging material producers, have recently issued profit warnings and see weakening demand. This is a stark reminder about the seasonality of the market segment.    

Long term the ESG factors are likely to play against the segment as the sustainable solution to packaging and packaging waste is not to switch from plastic to paper but to reduce, reuse and recycle.

Wood products: Wood and products made from wood have two distinct ESG benefits. Firstly the carbon stored in the tree remains trapped in the product made from the tree. Secondly the manufacturing process of making building material from wood has a much smaller carbon footprint than the process of making concrete or steel.

It’s likely to take several years though before there is any substantial major impact from increased use of wood in construction.

The long-term advantage of building material may also be reduced as both concrete and steel manufacturers are investing huge amounts of money to reduce carbon dioxide emissions in their production processes.  

During the three last years wood has shown strong cyclicality and it’s difficult to make a clear-cut assessment of the future growth potential. Based on the wood producing companies in the analysis there is no evidence in historical data for strong growth.       

Specialty papers: Specialty papers is a segment with several attractive niche products. The only company that has its main business in this segment, Ahlström-Munksjö, was delisted from the Swedish and Finnish Stock exchanges in the first half of 2021 and is therefore no longer available for retail investors.

Pulp: Pulp is very much a commodity product. Prices and margins follow the demand and supply situation. The main drivers for long term demand are paper, packaging and tissue. With paper demand in decline demand for pulp is expected to remain more or less flat for the next 6 years.

Bioproducts (Biofuels, Biochemicals, Bioplastics, etc): These products are a good usage of the various by-products from the logging and following processing steps. With the exception for biofuels most of these products are still in their infancy with the risk that comes with this. The long-term solution to replace fossil fuels is not Biofuels but sun, wind and hydrogen.     

Forest:  The forest provides a stable stream of revenues for its owners but with very low returns. Return on capital is typically in the range of 2.5% - 3% for forest assets. Given the importance of the forest for solving global warming there is a potential risk of more regulated and controlled logging.

The industry in this analysis is defined as companies that own forest and/ or make products based on the trees from the forest. These products are timber and pulp-based products such as paper, packaging and tissue but also biofuels, bioplastics and biochemicals.

The scope of the analysis has been limited to forest products companies based in Europe with a particular focus on Sweden and Finland which is home to two thirds of the companies in the group. This is for natural and historic reasons as these are the two countries with the largest forests in Europe. Around 70% of these countries are covered by forest. As many of these companies are global, the analysis has included the entire company including the business outside of Europe. E.g. in chapter 6 Industry Financials the financial ratios for the entire company have been considered.

The companies included in the analysis are Stora Enso, UPM Kymmene, Ahsltröm-Munksjö, Billerud, Essity, Holmen, SCA, Nordic Paper, Arctic Paper, Bergs Timber, Huhtamäki, Metsä Group, Norske Skog, Smurfit Kappa, Mondi, DS Smith, Navigator, Rottneros, Setra and Södra Skogsägarna. Most of these companies are listed on a stock exchange but there are some exceptions. Södra Skogsägarna is owned by its members, mainly small forest owners. Setra is partly owned by Sveaskog which is a state-owned forest company and Mellanskog which is a forest owner association. Metsä Group is also member owned (forest owners) but one of their businesses, Metsä Board, is listed on the Finnish stock exchange. Ahlström Munksjö was delisted in 2021 due to a buyout by SPA holding (Bain Capital Investors). These companies have been included in the analysis to get a better overall industry understanding and a bigger peer group to assess financial performance.  

All companies have been listed in the table below by size (revenue 2022). The table also shows the amount of forest the company owns.

To make the analysis more specific the industry has been broken down into the following sub industries or categories:

• Forest
• Biomaterials (mainly pulp but also biochemicals, biofuels and bioproducts)
• Graphic Papers (paper for printing, books, newsprint, …etc.)
• Packaging Materials (consumer packaging, transport packaging and different types of boards for packaging)
• Specialty Papers (labels, filters, tableware, etc...)
• Hygiene & Health Tissues
• Timber and other wood products such as plywood 
• Energy

Many of the companies listed above have business operations in several of these categories such as Stora Enso, UPM Kymmene, Holmen and SCA whilst others are more specialised. Essity for instance only makes Hygiene and Health products and DS Smith only produces packaging material.  The % of total sales that the sales of each segment make up have been shown in the graph 1 below. To show the true size of each segment itself no internal sales have been eliminated. A table with the exact percentages per segment can be found in Appendix 1. 

The history of using wood from the forest is as long as the history of humans. Initially the wood from the forest was used for heating, tools, house building and furniture. The use of wood for paper making only started in the late 18^th- and early 19^th- century. Large-scale wood pulp-based paper production started in the 1840s.

As paper consumption steadily increased during the 20^th century, paper production became the main product of the forest industry and papermaking was one of Swedish industries great success stories. Abundance of the spruce with its long pale fiber, that’s ideal for paper making, combined with Swedish technological prowess and cheap electricity made print paper production ideal. If you add the continuously depreciating Swedish krona you could basically turn the papermaking machines into a money printing machine. In the industry’s golden years of the 90s these machines could generate a return on capital above 30% (Lindvall 2020)  

The increased use of computers was expected to do away with papers and already in the 70s the term ‘the paperless office’ was coined. However, the arrival of PCs and easy access to printing had the opposite effect. Employees in offices started printing and copying papers with an unprecedented ferocity. It made the offices overflow with printed papers and huge archives had to be created just to store all the printed papers. ‘Better to make a hardcopy just in case’. It was not until the rise of the internet that the trend of increasing use of paper was reversed. As the penetration of the internet increased, so did the use of electronic information exchange and digital storage of data. This process took quite some time, and it was not until 2007 that global graphic paper production peaked (Tiseo 2021).

As paper use and production gradually decreased the forest industry found a replacement for paper in packaging material. Whilst demand for print paper gradually fell with a couple of percent per year, packaging material kept growing and could allow the forest industry an orderly retreat from print paper to packaging material. Print paper machine capacity could be reduced by the phasing out of old machines or converting them to produce paper board.

This rather pleasant existence ended abruptly with the arrival of the Covid pandemic. With the societies in lock down and the offices closed the demand for printing paper basically went over the cliff. The print paper producers typically saw their sales revenue fall by 15 – 30% in 2020. Although paper demand has recovered somewhat during 2021 its’ pre-Covid downward trend is likely to continue. The more we get used to working without printing documents the less likely it is that we will go back to the old behaviour.

The public perception of packaging is that paper based packaging is better for the environment than plastic packaging. Plastic is considered much harder to recycle than paper and it ends up in our oceans as it’s not degradable. Consumers expect retailers and brand owners to demonstrate that they take sustainability seriously. This has led to a drive to replace plastic packaging with paper-based packaging. The forest product industry is trying to capitalise on this trend by innovating and developing packaging materials for applications that were previously solved by plastic packaging. The industry is also building on another property of trees which is that as they grow, they absorb carbon dioxide from the atmosphere. As paper packaging is made from a renewable material it's part of a circular economy. The narrative of the industry has become that anything that is produced from the tree is good for the environment. Any packaging material that is being made by plastic can and should be replaced by paper to save the environment.

Further to the push to switch from plastic to paper, the other trend that is benefiting the industry is the increase of online shopping. Online shopping has meant an increased use of transport packaging for home delivery. These transport packages have so far mainly been made of paper.

Wood and products made of wood are experiencing a renaissance due to the increased focus on climate change. The great advantage of products made of wood is that the carbon dioxide absorbed while the tree is growing remains trapped in the wood for a very long time. The use of wood as construction material has a much smaller carbon footprint than steel or concrete. These materials are energy intensive to produce and the manufacturing process itself is emitting high amounts of carbon dioxide.   

Another important product group for the industry is health and hygiene tissues. Also this product group is benefiting from current global trends. One trend is that as we are getting older and older, we consume more and more medical care and consequently more medical tissues. The second trend is that as the disposable income and living standard of the developing world is increasing people will want to have more convenience and consume more personal care products.    

Forestry and the various manufacturing processes for the wood-based products generate a lot of by-products. The main use of these by-products is to generate bio energy. As much as 50% of the volume of the logged tree ends up as bioenergy (Freij 2020). Roughly 25% of all energy supplied in Sweden for instance is coming from biofuels (Pelkmans 2021).

Thanks to its carbon dioxide absorbing ability the forest is playing a very important role in preventing global warming and climate change. As the focus and urgency to prevent climate change is intensifying, we may have to consider what is the optimal use of the forest to prevent climate change. This may have a considerable impact on the industry.  

One big disadvantage of the forest industry products is that they are cyclical and many of them show characteristics of commodities. As a consequence demand and supply as well as prices will fluctuate over time.   

Despite the falling demand for graphic paper and the cyclical character of the industry, it shows several potential opportunities, many of them driven by the need to halt climate change and other structural trends in our society. This report will analyse these opportunities more in detail.     

The industry’s high level value chain can be seen in figure 1 below.

After the tree has reached a mature age, it is logged. Some trees are logged earlier due to necessary thinning of the forest. As much as possible of the log is used for sawlogs. The top section of the log and logs from thinning (pulpwood) are used for pulp production. The pulpwood is transported to a pulp mill and the sawlogs to a sawmill. Logging residuals such as branches, and the top of the tree are sent to a bioenergy or bio products plant.  

At the sawmill, the saw logs are turned into timber which can later be used in construction or turned into other wood products such as windows and furniture. In the sawmill several residual products are created. Bark and sawdust are sent to the bioenergy plant and wood chips are used in the pulp mill.    

The pulpwood is converted into pulp, in the pulp mill, which is then used to make graphic paper and other types of paper, paper board, health & hygiene tissues,…etc. The paper board is used for making different types of packaging materials both for product packaging and transportation packaging. 

The residuals from the logging, pulp-making and sawmilling are used as feedstock to produce biofuels, biochemicals and bioplastics 

The industry as a whole had a great year 2022. All companies with one exception, Berg’s Timber and SCA, increased their revenue in 2022. Most of them increased by substantial amounts and on average by 21%! Median operating margins were as high as 17.4% and return on capital employed 16.4%. When looking further in detail to understand the drivers behind this stellar performance one can observe the following:

• The revenue increases are mainly due to price increases. Costs increased as well but several companies managed to increase prices more than the cost increased. 
• The paper companies or paper business units were able to achieve some major price increases during 2022. A company like Norske Skog for instance that is only producing paper saw their EBIT margin go from -1.6% in 2021 to 18.5% in 2022. The reason for the price increases was reduced capacity which in turn was caused by conversion of paper machines to packaging machines, increased energy costs which some mills even stopped production for cost reasons, reduced imports from Russia and strikes.

To get a better understanding of the industry’s long-term financial performance a selection of financial ratios has been calculated for all the 20 companies over an 8-year period, from 2015 to 2022. Tables with all the details as well as calculation methods can be found in appendix 2. This period should be long enough to compensate for the exceptional year 2020 and short enough to make it relevant for giving an insight into the industry’s future potential. 

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Capital Efficiency:

To assess capital efficiency, or how good the industry is at allocating it’s capital, its return on capital employed (ROCE) has been used, see graph 2.

Overall the median ROCE for the industry for the 8-year period was 11.9%. If we look at the industry median ROCE per year (graph 10) we see that there is no real trend and that in a typical year the industry median is in between 11% and 12%. There is quite a big variation between the worst performer, Norske Skog at 4% and the best performer Nordic Paper at 34.5%. As Norske Skog only has a ROCE of 4% is not surprising as they are a pure paper company. Nordic Paper at 34.5% merits some further analysis to better understand why their ROCE has been almost twice as high as that of any other company.

Companies that own substantial amounts of forest such as Stora Enso, SCA, UPM Kymmene and Holmen that own substantial amounts of forests have a big capital base and consequently a lower ROCE. Some of the companies that mainly produce packaging materials such as Smurfit Kappa and Mondi show strong ROCE. It’s also surprising to see paper focused companies like Arctic Paper (16%) and Navigator (17%) having such a strong ROCE. For Arctic Paper it mainly seems to be driven by the exceptional ROCE of 44% in 2022. For Navigator 2022 also had a big impact but they also had very strong performance in 2017 and 2018 which has an impact on the value for the 8-year period. It's also surprising to see that Rottneros, a specialised pulp manufacturer, has such a strong ROCE performance over the period. Pulp is probably the forest product which shows the most commodity behaviour. 

To conclude many of the companies in the industry show historically solid and healthy ROCE. There are variations from one year to another, even when 2020 is excluded, which mainly depends on the cyclical nature of the industry.

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Profit margins:

To assess profitability EBIT% has been used (instead of net profit). As the aim is to try to understand the long-term sustainable profitability of the industry it’s of less interest if the companies are financed by equity or debt. Most companies have very little net debt in any case so it’s less relevant. The use EBIT%. means that non-cash costs such as depreciations or amortisations are included. The rationale for that is that over the long term the capex and the depreciations should more or less balance for a going concern. Any amortisations or write-downs/ revaluations are consequences of good or bad business decisions and have a long-term cash impact.

EBIT margin for the same periods as ROCE have been shown in graph 4.  

2022 was exceptionally profitable for many companies which was already seen for ROCE. When looking at the entire 8-year period the picture is more nuanced. The median for the period was 10.7%.   More than half of the companies have achieved an average EBIT of 10% or more in the period 2015 -2022 but there are also several companies that have an EBIT well below 10%. At the same time there are in total 5 companies who haven’t even reached an EBIT of 8% for the 5-year period prior to 2020.

Overall the operating profitability for the industry is acceptable but there are big variations from one company to another.

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Revenue Growth:

To understand the growth potential of the industry the historic average CAGR for the period 2014 – 2022 for the total business of the 20 companies as well as for packaging only. As can be seen in graph 8 the median revenue growth for total business of the companies in this period was 6.0%. It’s however important to point out that this number will be impacted by the year 2022 where the median growth was 18.3%! As we have already seen the high number for 2022 was mainly driven by price increases. Some of the companies’ high CAGR have been impacted by acquisitions. Billerud for instance increased their revenue in 2022 by 49% mainly due to an acquisition.   

Most of the companies located in Sweden have a high degree of export which has been helped by a weakening Swedish Krona.

The CAGR for companies who mainly produce packaging materials or the packaging business of mixed companies for the period 2014 -2022 have been shown in graph 6. 

The median CAGR of the packaging businesses is 6.5% but is less influenced by acquisitions. Only Huhtamäki and DS Smith have made major acquisitions during the period.

If instead we look at the actual volumes we see a different picture. For the companies that report delivered tons we can see that the volumes have actually decreased in 2022 compared to 2021 for many of their business lines. If we compare delivered tons 2022 to 2014 and estimate average CGAR for the picture do look a bit better for packaging materials. The CAGR in volume is mostly positive and goes as high as 4.7% for Mondi’s Corrugated Solutions business. Typically the CAGR for packaging business is a couple of %. The print paper businesses have a negative CAGR in tons for the period, all over the board.  

Many companies show solid revenue growth during the period 2014 – 2022. When one looks at actual volumes the growth is less impressive. Companies or business units that produce packaging material grow more or less at the rate of the global GDP. Print paper volumes are falling and wood products are more of a mixed picture. E.g. Holmen’s wood business had a CAGR of 2% adjusted for acquisitions and UPM’s plywood business had a negative CAGR.     ‍

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Leverage:

As can be seen in graph 7 the financial leverage is generally low among the companies with a median net debt to equity ratio of 0.2. Most companies have a ratio below 0.5 and Bergs Timber have negative net debt whilst many others are almost debt free.  The outlier is Ahlström-Munksjö with a ratio of 2.1. This does not come as a surprise as they are private equity owned.  

To summarise the industry in general is profitable and many companies generate healthy return on capital employed. Revenue growth is strong but the underlying volume growth is less impressive and at a level of the global GDP growth at best.   

Nordic Paper:
Remains the very high ROCE of Nordic Paper: The concern is that it’s not only driven by high profitability but also by low depreciations and low level of fixed assets which could indicate years of neglected investments. According to Affärsvärlden Nordic Paper already needed investments of approx. 1,200 MSEK (Svensson, 2020) during the autumn of 2020 when they were in the process of going public. That was more than twice the amount of the value of the companies factories, machines and other production equipment on the balance sheet for 2020. Since then an acquisition was made in Canada that added to the assets. One pulp line has been discontinued and investments were made in a new process line to handle external pulp. In other words no major investments since the autumn of 2020.  

Nordic Paper has been analysed more in detail in Appendix 3 and the main conclusions of this analysis are:

1.   The strong revenue growth in the period 2014 to 2022 seems to have been driven mainly by acquisitions and favourable currency and price movements. The underlying volumes or delivered tons have not had the same development. The volumes seem to have decreased in the period between 2016 (earliest delivery data available) and 2022.

2.   Profitability (operating margins) was strong in the period 2015 – 2019 but fell in 2020 and 2021. It recovered in 2022 due to price increases. Part of the strong profitability is driven by the low level of depreciations. 

3.   Although the ROCE has come down somewhat after the Pandemic it’s still high. Even though debt was added in 2020 the capital employed is still at a low level mainly because of the low amount of fixed assets. Based on the information available it looks like the company has been ‘under invested’ for many years.  

4.   The strong cash flow generated seems to have mainly been used to give dividends to the owners instead of investing it in plants, machinery and equipment. To make matters worse the company took a bank loan of MSEK 950 just before the IPO in 2020. Instead of investing this in the company, they paid the owners the entire amount in dividends.  

5. The previous sole owner has maintained a 48% stake in the company and the next 9 biggest owners that together hold 31% are all institutions. The strategy is thus not likely to change dramatically.   

This puts the company’s performance in a whole other perspective. This no longer looks like an attractive investment.  

As we have seen in chapter 4 above the ESG aspects are very relevant for the sector.

The forest has the great property of absorbing carbon dioxide while it’s growing.  It’s therefore an important component in reducing carbon dioxide in the atmosphere and preventing global warming or climate change. The best use of the forest from a climate change point of view would thus be to grow it as much as possible and not to log it. If you do log it, you want to ensure that as much as possible of the carbon remains trapped in the output you produce from the tree and that the method of production uses as little energy as possible.

The forest makes a vital contribution to biodiversity as it is the natural habitat of numerous plants, insects and animals. The life of these inhabitants is affected negatively by industrialised forest growing and logging. The forest also offers a valuable recreational resource for us humans. These are additional arguments for keeping the forest untouched.

When wood from the forest is used in buildings, furniture and other applications the carbon remains trapped for a long time. Wood can also be used as an alternative construction material to steel and cement which are two of the most carbon dioxide generating manufacturing processes that exist. As long as the logged trees are being replanted the use of wood can have a positive impact on carbon dioxide emission.

The issue becomes a bit trickier when one looks at the other main uses of the forest such as paper, packaging, tissue, and bioenergy. The process of converting wood into pulp and then paper, packaging and tissue is energy intense, polluting and consumes a lot of water. In Europe the industry has made a lot of effort over the last years to make these processes less energy-consuming, less polluting and to recycle water. It’s nevertheless the fourth most energy consuming industry in Europe (Odyssee-Mure 2021). For countries like Sweden this is less of an issue as the majority of the electricity is generated from renewable sources or nuclear power but in Germany, for instance, approximately half of the electricity is still produced from fossil fuels.

As for the wood used for construction it’s also important to look at what happens to the carbon dioxide trapped in these other products.

As demand for graphic paper is declining it’s more important to look at the impact of the other three big uses of the wood (packaging, tissue and bioproducts)

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7.1. Packaging

There are two different ESG aspects that are relevant for packaging material. One is the carbon dioxide or the climate change impact and the other is the impact on the environment and our health.

It’s probably the second that has been given the most public attention mainly thanks to David Attenborough, the world renown maker and narrator of documentaries about nature. Attenborough in his absolute brilliance made the harmful impact of plastic on our oceans obvious to everyone in one single documentary, (Blue Planet 2 2017). With one documentary he made the whole plastic industry ‘persona non grata’.

The issue with plastic is that it’s not degradable or only disintegrates over a very long time. It breaks down physically to micro plastics which tend to infiltrate our ground water or end up in the fish if in the oceans. The health risk of this seems, however, to have been blown out of proportion by the press. Scientists such as Professor Tina Murk of the Wageningen university certainly recognise the serious environmental problem that (macro) plastic is causing but are much more cautious about the adverse health impacts of marine microplastics on humans and the environment. In fact according to Tina Murk there are no indications of adverse health effects of marine microplastics for humans nor the environment (Murk 2019).    

The fear of micro plastics drummed up by the press and the Attenborough documentary has played in the hands of the packaging manufacturers as institutions and companies scramble to eliminate plastic or replace it with the ‘natural’ paper and any cost.

When it comes to the climate change impact, the paper packaging manufacturers are promoting the message that paper packaging is part of a circular economy. It’s made from a renewable material and it's recyclable. As trees are renewable and absorb carbon dioxide while they grow, any products made from the trees must be good for the climate and should replace the ‘horrid’ plastics that are made from fossils.

It’s however a bit more complex than the paper packaging manufacturers tend to make it.

The fact that paper packaging is more degradable than plastic means that when it breaks down the carbon that has been trapped in the product risks going back to the atmosphere. Even if you recycle the paper and packaging there is a limit of 5 to 7 times that it can be recycled as the fibers get shorter and shorter (Sinai 2017). After that it can only be used as input material for other products such as tissues, egg cartoons or newspapers. Although less energy intensive than virgin production the recycling also consumes a considerable amount of electricity that risks being produced from fossil fuels.  

Not all paper and packaging are being recycled. Roughly two thirds of paper and packaging in Europe are being recycled (CEPI 2019) and the rest ends up being burned or in a landfill. In a landfill the paper or packaging will disintegrate. During this process methane is being created and emitted into the atmosphere. Methane is a very potent greenhouse gas and has a global warming potential of 84 – 86 times that of carbon dioxide over a 20-year period (UNECE, 2021).  

Plastic doesn’t degrade which means it won’t emit any carbon dioxide unless you burn it. As plastic is cheap but complicated to recycle, plastic tends to end up in landfills or worse in nature or in the oceans. The carbon footprint of making plastic packaging is however smaller than making paper packaging, at least when you consider that you need less of it (Joyce, 2019) for the same use. Plastic has the great advantage that it’s light. If it were recycled it’s often a better alternative to paper packaging (Plastic Has a Big Carbon Footprint — But That Isn't the Whole Story, 2019). A popular example is grocery bags where consumers believe that it is better to use a paper bag than a plastic bag. This is certainly true if the plastic bag is a single use bag that is not recycled but if the plastic bag is reusable and made from recycled plastic the plastic solution is better from a carbon footprint point of view (Plumer 2019 and Ecoenclose 2021). As it can be reused for a long time and then recycled it won’t have to end up in nature or the oceans.  

The rapid expansion of online shopping, fueled by the Covid pandemic has created a new use for paper packaging as most orders seem to be shipped in cartoons and boxes which many times are over dimensioned. This excessive use of paper boxes will have to stop and be replaced with reusable and returnable solutions. An example can be found in the German car industry that introduced reusable plastic containers (a so called KLT or Klein Laden Träger) already in the nineties. The infrastructure and IT solutions to do this on a consumer level may not exist yet but it can be developed and implemented if the urgency is strong enough.

To believe that a wholesale replacement of plastic with paper is the best solution for global warming and to clean up our nature and oceans is an oversimplification.

The best long-term solution to the packaging material problem is not paper or plastic but to reduce, reuse and recycle. This is referred to as the 3R principle. This would reduce both the amount of packaging needed but also reduce the risk of plastic packaging ending up in the oceans and in our food chain. Once the 3Rs really becomes a priority for ordinary people the consumption of packing will likely fall. The only question is how long it will take. Given the sense of urgency to reverse climate change, it may go quicker than we think.

The increased use of packaging in general has also caught the attention of the EU and it has written a proposal to revise the Packaging and Packaging Waste Directive. The aim is to reduce packaging and packaging waste for instance by making all packaging 100% recyclable by 2030 and limiting the size of the packaging in relation to the product it’s protecting.     

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7.2 Tissue

Tissues have very short fibres already and can only be recycled into tissues. The actual process of recycling tissue is complicated and less straightforward than paper for instance. This means that tissue often ends up being burnt and emits carbon dioxide or ends up in a landfill where they will emit methane. The advantage of tissue making is that it can use fibres that are no longer possible to use in paper or packaging production but the products themselves risk ending up emitting carbon dioxide and methane already after the first use.

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7.3 Bioenergy: 

When it comes to bioenergy or biofuels the industry narrative is the same as for packaging material. The biofuels are produced from residuals from the processing of the renewable forest and must hence be ‘green’ and good for the environment. The residuals that are being burnt have been absorbing carbon dioxide over many years and newly planted trees will absorb the carbon dioxide that is being released into the atmosphere.

Various types of bioenergy and biofuels are great usages of the by-products the industry generates. As we have seen in chapter 4, as much as 50% of the volume of the logged tree ends up as bioenergy. Roughly 25% of all energy supplied in Sweden for instance is coming from biofuels.  

No matter how green you try to make the biofuels appear they still emit the same bad carbon dioxide as fossils when burnt in a furnace or when combusted in an engine. If you didn’t cut down the tree in the first place it would continue to keep the carbon dioxide it has absorbed trapped. You can still plant new trees that will absorb even more carbon dioxide as they grow. 

The long-term sustainable solution to reducing fossil-based combustion in transportation cannot be to replace it with biofuels but with electricity and/ or hydrogen. Likewise, the sustainable solution to heating or electricity is not to burn biofuels but to use renewable sources such as sun, wind, water and geothermal that generate close to zero carbon dioxide emission.

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7.4 Bioplastics and Biochemicals

Other new products that are being produced from logging residuals and residuals from the pulp and sawmilling processes are biochemicals and bioplastics. The idea is that these products will replace fossil-based chemicals and plastics.

The industry sector is further making big efforts to use its various byproducts to make bioplastics that will replace traditionally produced plastics based on petroleum. Some of these products show characteristics that allow them to be fully substitutable for plastics. E.g. PEF, Polyethylene Furoate, that is produced from FDCA, FuranDicarboxylic Acid, that in its turn can be made from sugar, has material characteristics that allows it to replace PET, Polyethylene terephthalate (Omnexus, 2022). PET is used to make plastic bottles or what is referred to as PET bottles. PEF is recyclable but not degradable (which means that you face the same end of life challenges as for petroleum-based plastic).

UPM Kymmene is building a factory in Leuna Germany that will produce glycol from thinning, industrial beechwood and residuals from sawmills (UPM Kymmene Corporation, 2020). Glycol is used as a raw material in several products such as plastics, textiles, cosmetics and industrial applications. But making plastic from glycol based on logging residuals instead of glycol based on petroleum will not make the plastic more degradable. The solution to the plastic ending up in the oceans and groundwater will only be resolved through rigorous recycling. 

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7.5 Other considerations:

As we have seen above, the narrative used by the industry to promote its products is that as trees are renewable and absorb carbon dioxide while they grow any products made from the trees must be good for the environment and to counter climate change. There is however one very important aspect that they omit; The tree that is being logged is absorbing much more carbon dioxide than the tree sapling that is being planted in its place. It will take many years for the sapling to absorb the same amount of carbon dioxide as the felled tree. In countries like Sweden, where forestry is regulated and well controlled, the amount of annual growth of the forest is higher than the quantity that is removed through logging (Lantbrukarnas Riksförbund, 2017). Consequently, overall the forest absorbs more carbon dioxide than is reduced through logging. This cannot, however, be an argument for maintaining current logging levels. By logging even less the net absorption of carbon dioxide will be even bigger than now. Increased net absorption is what is needed from a climate change point of view.

The EU Commission has developed a new strategy for biodiversity for 2030. The aim is to legally protect at least 30% of the EU forest areas. Forest owners would need to be compensated for not logging their forest and there is a new concept, Bio credits, under development. Forest owners would get financially compensated for protecting biological diversity and would thus have an alternative to felling the trees, which is the only way they can make money today. This would reduce the amount of forest that is available for production of forest products.     

Another important aspect to consider is dematerialisation. This has been a very strong force for industrial and economic development during the last century. The dematerialisation or ‘make more with less’ in simple terms means that the amount of material in most industrial products has been reduced considerably. It used to be driven by technical development and economic reasons but is now also driven by ESG reasons. This is reflected by Reduce in the 3R principle. Reduce is thus nothing new but its importance will become bigger through ESG forces. 

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7.6 Conclusions

Paper, paper packaging and tissues do increase the number of green-house gases that are in the atmosphere. The production process itself is a big electricity consumer, electricity that risks being produced from fossil fuels. Even if recycled, the products will eventually end up being burned and emit carbon dioxide or disintegrate into methane and carbon dioxide in a landfill. The trapped carbon thus eventually ends up as a greenhouse gas.

The general perception in society is however that packaging made by paper is natural and therefore good for the environment. It’s always better than packaging made from plastic. The shift that this is causing in industry and commerce is likely to have a positive impact on demand for paper packaging, short to mid-term.

As already stated, the most sustainable solution to packaging is to reduce, reuse and recycle. This is likely to have a long-term negative impact on packaging material consumption.

Unless we can find efficient and workable methods to recycle tissues there is likely to be pressure driven by ESG arguments to reduce the use of tissues.

The use of wood in construction and other applications has several ESG advantages. Demand for wood is therefore likely to increase. You can however only get so many square boards out of a round tree. All other parts of the tree need to have a usage as well. The challenge will be to find uses that have a very low lifecycle carbon footprint. It’s not likely that we will make away with packaging and biofuels completely any time soon so there will have to be some of the byproducts used for these purposes for quite some time to come.

As wood has been given a lot of attention lately about its advantage to concrete and steel as a sustainable building material the concrete and steel industry have started taking actions themselves as well. There are two major industry projects in progress in the north of Sweden to produce ‘green’ steel or without emitting carbon dioxide. The concrete industry is also exploring new production methods that will reduce carbon dioxide emissions. 

The forest is very important for reducing greenhouse gases and limiting climate change during the next 10 years. We may therefore have to accept more radical changes. Perhaps we need to reduce the logging much more drastically to further increase the net carbon dioxide of the forest.

After the latest summer in Europe with the record number of forest fires, flooding and abnormally warm seas, the urgency to act has started hitting home even among ordinary citizens and no longer only among the Greta Thunberg followers.

As awareness and sense of urgency increase, we must be willing to accept changes which today or historically may seem unthinkable.

The forest product industry market is generally mature, competitive and cyclical. Many of its products have the characteristics of a commodity. In addition to that the industry is also capital intensive. Based on these characteristics it does not look like a very attractive marketplace to play in. 

The industry recovered well after the pandemic year 2020 and has seen two years with strong demand in several market segments. This is now looking to change as demand has started weakening in several segments. Three of the biggest European players, Stora Enso, UPM Kymmene and Billerud, have recently issued profit warnings indicating lower demand and others may follow. The wood products segment saw the weakening already last year. This confirms the cyclicality of the market.     

Nevertheless as we have seen previously there are some market trends that may have the potential to drive growth in the future and which need to be explored.

Logged trees are mainly used for wood products and pulp. The highest quality trees are turned into wood products to be used for building materials, furniture,…etc. Lower quality trees and byproducts from wood processing are turned into pulp. Pulp is just an intermediary product that is used for producing paper, paper packaging and tissue. 

The wood products market can be broken down in wood processing, manufactured (engineered) wood materials and finished wood products. For the companies within the forest products industry, it is mainly the two first segments that are of direct interest.

Both these market segments have shown strong growth in recent years. The global woods processing market (lumber, boards, beams, timbers, wood chips,…etc.) grew annually with 4.8% in the period between 2017 and 2022 (The Business Research Company, 2023). The global manufactured wood market grew annually with 6.9% in the period 2015 – 2019 (The Business Research Company, 2020). 

Packaging is by far the biggest segment among the pulp-based products. As shown in graph 8 in 2018 it made up more than half of total consumption in tons (55%). Graphic paper made up just below a third (28%), tissue 9% and other the remaining 8%.

The different segments also demonstrated big differences in growth rates (based on metric tons) as shown in table 2 below. As expected, graphic papers show a decline in the period from 2010 to 2018. What is more interesting to note is that packaging is growing at a slower rate for the period 2010 – 2018 than for the earlier period, 1992 – 2007. In fact, both types of packaging boards grew at a slower rate than the global GDP for the period 2010 -2018 (in constant prices 2010). The average global real GDP growth for this period was 3%. It’s only tissue that grew at a higher rate than the real GDP in this period at 3.6%. The total market for pulp-based products only grew by 1% in the period, weighed down by the decline of graphic paper. 

The various segments of the forest and forest product markets have different historical growth patterns and also show quite different market potential over the next few years. They also have different challenges. It therefore makes sense to look at the segments individually when assessing the market potential.

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8.1 Graphic Paper

As can be seen in table 2 the graphic paper segment had been in decline already before the Covid pandemic. The pandemic caused the demand to fall dramatically when people were in lockdown and stopped going to the office. The graphic paper producers typically saw their sales fall by 20 – 30% in 2020. Although paper demand has recovered somewhat when the pandemic is over it is not likely to get close to the levels seen before covid.

From now on it is likely to be a race to the bottom. Some companies like SCA or Stora Enso have already ceased or are in the process of ceasing paper production. Others such as Norske Skog and UPM Kymmene will have to reduce their paper making capacity considerably.

Some companies have converted or are in the process of converting paper making machines to packaging material machines.   

With the exception of 2022 margins in this market have been low due to continuously falling demand. As demand continues to fall and capacity is being reduced there may be periods where capacity is being reduced quicker than demand. This will cause temporary supply shortage with temporary periods of higher prices and margins.  

There are likely to be more mill closures accompanied by write downs over the next couple of years. This will have an impact on company profits as well.

To conclude the graphic paper market segment is not an attractive segment.

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8.2 Packaging Material

According to Statista (Statista, 2023) the size of the global paper packaging market was 264 million tons in 2021. In 2018 it was 240 million tons. This would mean a CAGR of 3.2% for the period 2018 to 2021 of 3.2% which is slightly higher than the period 2010 – 2018. Global GDP grew at an annual rate of 1.7% during the same period. If we look at the entire period 2010 – 2021 the CAGR of global packaging material would be 2.4%. In 2022 the global GDP growth was 3.4%. At the same time we have seen that delivered volumes of packaging material fell for several businesses (business units) during 2022.   

Demand for paper-based packaging both for product packaging and for transportation purposes is expected to show strong growth in the near to midterm future. This segment is expected to grow by 3.7 % annually between 2022 and 2028 (Research and Markets 2023). The main drivers for growth in this segment are the increased use of online shopping and home delivery as well as the replacement of plastic packaging with paper-based packaging. 

Based on available data it thus seems difficult to build a convincing case for a growth rate much above global GDP growth. Given its cyclicality it’s likely to follow any periodical variations in GDP quite closely.   

It is also important to consider the power game in this segment. The customers are typically consumer goods companies, retailers, transport companies and manufacturers of various products. Common for many of these customers is that they are very powerful. Although sales  and prices are typically locked in by contracts the midterm switching costs are low as most packaging have similar characteristics to a commodity.

As e-commerce or online business allow for greater price transparency this sales channel tends to demonstrate lower margins for the retailer and this margin pressure will be felt by the packaging suppliers as well. 

There will thus be continuous pressure on margins and an increasing expectation that the supplier will be innovative and come up with new packaging solution ideas. This will increase development costs.

As manufacturers of graphic paper convert their paper machines to packaging machines, new packaging machines are built, the capacity and supply will increase, which will risk adversely affecting prices and margins in this sector. As with all cyclical products there will be periods where demand surpasses supply with a positive impact on margins. There will also be periods where capacity surpasses demand with an adverse impact on margins.

In the long run the growth perspective of this sector does look less promising. As we have seen under 7. ESG Aspects, the solution from an environmental point of view is not to replace plastic or glass with paper but to reduce, reuse and recycle. The sector may ride on the current ‘convert plastic to paper’ wave for some time but in the long-term the 3R principle and dematerialisation are likely to become the driving forces for how we deal with packaging.

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8.3. Tissue: 

One market segment that looks promising for the future is tissues made from wood fibre. These tissues are used in various hygiene and health products such as kitchen paper, toilet paper, napkins, feminine care, incontinence products, medical tissues, and paper towels.

There are two demographic trends that play to this segment’s advantage; We live longer and longer and people in the developing world are getting more spendable income. As we live longer, we will consume more incontinence and other medical tissue products. As the spendable income in the developing world increases people will want to buy more convenience products for hygiene and personal care. The Covid pandemic has emphasised the importance of keeping good hygiene and health, which will also contribute to the growth in this segment.

Statista forecasts a CAGR of 5.0% for the tissue and hygiene paper market for the period 2023 to 2027 (Statista, 2023). Fortune Business Insights (Fortune Business Insights, 2023) forecasts that the global tissue paper market will have a CAGR of 6.55% for the period 2023 to 2030. In the period 2010 to 2018 this segment was growing by 3.6% per year in million metric tons which was higher than the average global real GDP growth. Essity, the only company in the group that has its whole business in this segment is a bit more cautious in their expectations. In their annual report of 2022 (Essity, 2022) they forecast a CAGR in the range of between 1-2 % for Europe to 6% for Asia, for the period 2023 to 2028.

Also tissue manufacturers are exposed to the cost cutting pressure from the retailers as sales through the retail channel typically make up 60% of total sales (Essity, 2020). A big difference to other forest products is that the tissue products are branded. Consumers will know the Essity products by the Essity brand names. This gives Essity a stronger position as there are likely many consumers that are loyal to the brands.

The other advantage is that many of the products are essential for daily life once you have got used to them. Even when consumers' spendable income gets squeezed through increased cost of living they are still likely to keep on buying tissues and hygiene paper products.

As for packaging this segment shows a risk from an environmental point of view as the recycling of these products is challenging and they tend to end up in landfills or being burnt.

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8.4. Wood Products  

Another promising segment in the industry is timber or other products made of wood. Both these market segments have shown strong growth during the 5 years period, prior to 2020. The global woods processing market (lumber, boards, beams, timbers, wood chips,…etc.) grew annually with 4.3% in the period between 2015 and 2019 and by 4.8% in the period between 2017 and 2021 (The Business Research Company, 2020). The global manufactured wood market grew annually with 6.9% in the period 2015 – 2019 (The Business Research Company, 2020). 

Timber for house building and other products made of wood such as furniture or windows have the great advantage that the carbon dioxide remains stored very long. As long as you don’t tear the house down or throw the furniture away and burn it, the carbon dioxide can be stored ‘forever’. The use of timber in construction has another advantage in comparison to steel and concrete as the production of the two latter is very energy consuming. Also, the processes themselves emit carbon dioxide.

To see the real impact of increased use of wood as a construction material is likely to take several years. Atrium Ljungberg (Ramnewall, June 2023) a major Swedish listed real estate company is for instance planning to start building ‘Stockholm Wood City’ in 2025. This project will be made up of 7,000 offices and 2,000 homes and will be the world’s biggest urban development project in wood.   

After the initial dampening effect of the Pandemic in 2020 the wood products market recovered strongly and remained strong into the first half of 2022. It seems that all the lockdowns gave people extra time and more money for home improvement projects. As people were not able to travel abroad for their vacations they stayed home and spent their money on installing a home office or laying a new deck. This exceptional demand seems to have abated during the second half of 2022.

In addition to this construction and in particular residential construction has slowed down. This is mainly due to increased cost of material and labour which makes builders less profitable and increasing mortgage rates which reduces the ability for individuals to borrow money. The forecast for Europe is that the construction market will look bleak at least this year and next.     

Research and Markets expect the global wood processing market to grow with a CAGR of 6.3% until 2027 (Research and Markets, 2023). The Business Research Company expects the CAGR to be 6.2% during the next 10 years (The Research Company 2023).  The global manufactured wood materials market shows similar growth expectations. Mordor Intelligence expects it to grow annually by 5% until 2027 (Mordor Intelligence, 2023) The Business Research Company expects it to grow by 7.0% during the same period (The Business Research Company, 2021).

These market forecasts are very promising but they’re not reflected in the sales of the companies in our analysis. These companies do the majority of their wood sales in Europe and for the next couple of years the forecast is less optimistic. It’s likely to take several years before we can see any major impact of increased use of wood in construction.

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8.5 Pulp

The production and sales of pulp will very much be driven by demand for end products such as paper, packaging, and tissue. Pulp has the characteristics of an upstream commodity. As such there will be periods of high demand as seen in 2021-2022 that will have a positive impact on prices and margins but equally there will be periods of price pressure and reduced margins. Prices will fluctuate considerably over relatively short periods of time.

To give a flavour of how much prices may fluctuate the Production Price Index for pulp produced in Sweden has been used, see graph 9. The price increased by about 45% between September 2017 and September 2018 when it peaked. It then fell by 34% to January 2021. It recovered a bit temporarily in the beginning of 2020 but continued to fall until the beginning of 2021 when it was at a level not seen since 2016. After that bottom it recovered and gained 104% to peak in October 2022. It is now in a falling trend for the last 6 months. 

An additional complicating factor for European companies, which report in euro or other local currencies, is the denomination of pulp prices in dollars. The fluctuation in the dollar exchange rate also has an impact on the margins.

Several of the companies in the sector have big pulp business units. Except for Rottneros, pulp is only one of several business units and price fluctuations in this business may have a smaller impact on the group results. For a company like Rottneros though, whose pulp business makes up 94% of the total business, a price reduction may wipe out the entire bottom line as was the case in 2020. Meanwhile in 2022 the price increases helped the company achieve a record-breaking year.

Statista forecasts that the global pulp market will only grow with a CAGR of 0.72% from 2022 to 2029 which means that it will more or less stay flat. This seems reasonable as the pulp demand for packaging is expected to increase whilst pulp demand for paper is expected to continue falling.          

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8.6 Bioproducts

There are several different types of bioproducts such as bioenergy including biofuels, bioplastics and biochemicals. Common for all these products is that they are made from the industry’s various by-products. They all also show great growth potential. According to Allied Market Research the global bioenergy market is expected to grow at an average of 7.6% per year from 2021 to 2030 (Dixit & Prasad, 2021). The global bio-based chemicals market is expected to grow by 10.4% per year (Polaris Market Research, 2022). Albeit a much smaller market segment, bioplastics and biopolymers is expected to grow with a stellar 22.7% per year during the same period (Marketsandmarkets, 2020).

Bioenergy is the biggest bioproduct and is typically biofuels used to replace fossil fuels like biodiesel or wood pellets that are being burned for heating. As we have seen in section 7.3 that although bioenergy is classified as renewable it’s still emitting carbon dioxide. As there are other renewable energy sources that generate close to zero carbon dioxide emission it’s likely that these will not only replace fossil energy sources but also much of the bioenergy. The long-term prospects of biofuels therefore seem limited and cannot become more than an interim solution. It is questionable if the segment can really grow at a yearly rate of 7.6%, long term.

The use of renewable materials or feedstock to produce bio-based chemicals and bioplastics will provide a strong selling argument, but the challenge will be the characteristics of these markets. Glycol for instance (that the UPM factory in Leuna will produce) is a commodity product far upstream the supply chain and the market is very competitive. UPM will be competing against some chemical giants such as Azko Nobel, BASF and Dow Chemical. Some of them have already entered the bio-based chemicals and bioplastics markets and they have the advantage of long industry experience, a wide geographical presence and factories across the globe.

Finally a very interesting use of the industry by-products is to make battery anode material from lignin. Lignin gives wood its stiffness but is a waste product when wood is processed into pulp. Stora Enso claims it has a process that can turn lignin into synthetic graphite according to The Economist (The Economist 2023). The battery maker Northvolt is looking at using the material in their battery making.  

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8.7 Energy

Some of the companies with big forests such as Holmen and UPM Kymmene have used their land and water streams to install hydrogen plants and wind turbines. The part of the generated electricity that is not used for own consumption is being sold in the energy market. SCA is subleasing its forest land to various wind turbine operators. Although renewable energy is an exciting business to be in, it's not really a forest industry product and its market has therefore not been further analysed here.

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8.8 Forest

Finally, the source of all these products, the forest itself, makes up an important segment. The beauty of the forest is that it grows on its own. If the projected demand of the other segments materialises the forest segment will see a healthy growth as well. As for any commodity demand may fluctuate on a short-term basis but the long-term growth prospects should be good.

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8.9 Others:

In others we find specialty papers or niche products such as adhesive labels, filters, tape and insulation. Some of these product groups such adhesive only grow with a couple of percent yearly whilst others such as tape demonstrate yearly growth of 3 - 5% (Ahlström Munksjö Annual Report, 2020). Ahlström Munksjö has several interesting niche products with good growth prospects but are no longer accessible for retail investors because of the delisting.

So, with all this in mind should one invest in this industry?

Many of the companies in the sector are solid, well-run companies that have been around for a very long time. Many of them generate healthy margins and good returns on capital. They have limited leverage and are able to distribute a good part of the profits yearly to the owners. Dividend yields in the range of 3 – 5% are not uncommon and currently several of the companies have an even higher dividend yield. With some exceptions though the historical organic growth of these companies has rarely been above the global GDP growth.

To make the characteristics of the industry more visible the information gathered so far has been summarised in an Industry SWOT analysis, see figure 3.  

The industry faces both opportunities and challenges in the future. Many of these challenges and opportunities are segment specific. The investment attractiveness has therefore been assessed per segment

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Graphic Paper:

The demand for graphic paper fell dramatically during the Covid pandemic and although it has recovered some it is likely to continue its long-term downward trend. It’s uncertain where and when it’s going to hit the floor. As production capacity is being gradually reduced there may be the odd year like 2022 where the demand temporarily supersedes the supply but the overall trend is falling sales and low profitability. The companies active in this segment have already been or will be forced to shut down or convert some of their paper making mills.

This conclusion is that this segment should be avoided. Companies that still have big paper making business are Norske Skog (100%), Arctic Paper (73%), Navigator (71%), UPM Kymmene (37%), Holmen (28%), Mondi (18%) and Billerud (22%).      

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Packaging Material:

Paper or paperboard-based packaging material is the biggest pulp-based product. The segment and its players are currently riding on the ESG wave as paper is seen as a more climate and environmentally friendly alternative to plastic. The growth of online commerce is also benefiting this segment. The growth expectations for this segment are high, perhaps even too high. It’s also questionable how long the positive image of paper packaging as ‘climate change savior’ can be defended. As we have seen, paper-based packaging is not necessarily always the most sustainable solution. The long-term sustainable solution to packaging is to Reduce, Reuse and Recycle (3R) and to make more with less. If these principles really take hold, we are likely to see limited or possibly even long-term negative growth in this segment.

The main purpose of the product packaging material is to protect and transport other products. It’s thus more of a ‘secondary product’ or waste and the aim of the users would always be to try to use as little as possible of it. As we have seen above it’s likely to be subject to the 3R and dematerialisation.     

The negotiation power of the customers such as retailers, FMCG (Fast Moving Consumer Goods) companies and other industries is likely to limit the prices and margin attractiveness of the segment. A packaging supplier can be replaced fairly easily.

Like the rest of the industry the products are cyclical and the financial performance will vary depending on where in the business cycle we are. Judging from recent profit warnings we are likely to enter a period of weaker demand.

To conclude the segment has a potential for moderate growth but in the near future growth is likely to be limited. There are also some mid to long-term threats. For other investors the segment is more questionable.

The companies that have big packaging businesses are Stora Enso (36%), Smurfit Kappa (100%), DS Smith (100%), Mondi (82%), Metsä Group (26%), Huhtamäki (43%), Billerud (60%), Holmen (27%), SCA (25%) and Nordic Paper (53%).       

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Tissue:

The difference to the other forest industry products is that it’s a consumer goods and many of its products are a necessity good. The only listed company analysed in this segment, Essity, is more of an FMCG company than a forest industry company. 

There are many trends in society that play in the favor of this segment and it seems to have one of the best growth potential of the analysed segments.

The segment is more questionable from an environmental point of view. It has the advantage that recycled paper fiber that has been recycled too many times for paper or packaging production can still be used as raw material for tissue. The recycling of the used tissue products themselves is however challenging and the products tend to end up in landfill or being burnt after use which means creation of greenhouse gases.

The reduction of tissue use outside of the western world faces some moral challenges. As countries in the developing world and its citizens become wealthier, they tend to want to have the same conveniences as we in the developed world do. It will be hard to create a narrative that justifies depriving them of these conveniences that we have enjoyed for decades.

As demonstrated by Essity this segment has moderate to good growth potential and allows for solid financial performance from its players.

To conclude there are several trends in society that are likely to drive the future growth of the segment. The main risk comes from the negative impact tissues have on the environment as it’s a consumption product that is challenging to recycle. The only company in this segment is Essity that has 100% of its sales from this segment.      

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Pulp:

As we have seen above, pulp is very much an upstream commodity game. In the short horizon demand and prices fluctuate a lot. The long-term underlying demand trend will very much depend on the demand for paper, packaging and tissue. As we have seen above there are some uncertainties about the long-term demand both for paper and packaging. Global demand is expected to remain more or less flat during the next 6 years. 

This segment does not seem very attractive unless there is a long-term continuous structural change in the industry which restricts the output of the forest. This could create a shortage of wood-based pulp in the market.  

The companies who have big pulp business are: Rottneros (100%), Stora Enso (14%), UPM Kymmene (21%), Metsä group (32%), SCA (26%) and Arctic Paper (27%).

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Wood products: 

Wood and products made of wood seems to be another segment with strong potential. Wood products have two distinct ESG benefits:

1. The carbon in the tree remains trapped in the product made from the tree
2. Building material made from wood has a much smaller carbon footprint than the alternative materials concrete and steel.

It’s likely to take several years before there is any substantial major impact from increased use of wood in construction.

It does also have to be pointed out that both the concrete and steel business are making huge investments to reduce their carbon footprint. It will take many years before this has an impact on the ESG advantage of wood.

Also wood products are cyclical, which the last couple of years have bear witness to. The companies with wood business saw a very strong demand and financial performance during 2021 and the first half of 2022. During the second half of 2022 demand cooled off and the prospects of the segment look less promising for this year and next.  

Given the big swings in demand and prices of the segment during recent years it’s hard to assess how strong the ‘ESG induced’ growth is likely to be in the future. It seems prudent to await a normalisation of the demand to assess the long-term sustainable growth potential of the segment.  

Bergs Timber is the only company that has all its sales in this segment and that is also publicly traded. The company’s financial performance during the last 8 years has not been very impressive and their growth is mainly driven by acquisitions.  

Other companies that have a big wood business and that are publicly traded are: Holmen (18%), SCA (25%) and Stora Enso (14%).

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Bioproducts:

Bioproducts such as biochemicals and bioplastics provide a good use of the industry’s byproducts. If these byproducts are an output of a process with low carbon footprint and products with high carbon trapping abilities, they would seem a good solution to reduce the carbon footprint of the entire tree. The objective to replace fossil-based plastic with bioplastics or fossil-based glycol with biochemically produced glycol does, however, risk having the same negative impact on the ecological systems as the fossil-based alternative has. These products may have a good potential marketing value for the buyers but both glycol and plastics are very much up stream commodities in very competitive markets. As several of these products are still in the innovative/ development phase there is a big risk associated with these products as with any new venture. As we have seen from the planned UPM plant in Leuna building a chemical plant requires major investments. UPM is investing €550 million to build the Leuna refinery.

Biofuels are another good commercial solution for the industry byproducts. If the current alternative is to incinerate the byproduct, then it would be better to use it to produce biofuels that can replace fossil-based fuels. The best long-term solution to fossil fuels though is not biofuels but renewable sources such as wind, solar and water. Biofuels can never be more than an interim solution from a climate change point of view.

The revenue of the bioproducts for the industry is so far rather small. Some of the biofuels are used in companies own plants and some of the electricity generated can even be sold back to the national grid.

For an investor who wants to invest in bioplastics it would seem more sensible to invest in a chemical company that has a strong presence in bioplastics such as BASF or potentially in a startup. If the investor wants to invest in biofuels, he or she should consider a specialist biofuels company.      

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Forest:

The interest to invest in the forest has increased during the last couple of years as various funds are looking for alternative investments to low yielding bonds and property. As these funds are buying forest land, the market value of forest land has become more transparent. This has allowed the big forest owners such as Stora Enso, SCA and Holmen to increase the value of the forests on the balance sheets. Consequently, the return on capital employed as well as the return of equity has fallen considerably. Some companies like Stora Enso try to ‘solve this issue’ by reporting return on capital employed excluding forest assets.

The forest can in principle be seen as a real estate asset; Low and fairly stable return, at least over the business cycle, and low risk. The return is a bit less stable than real estate as the prices of wood vary over time. The estimated return on assets for the forest assets in 2022 for the big forest owners was in the range 2.6% - 2.8%. This is not an attractive return. 

There is also the risk that the use of the forest will become more regulated to better optimise its carbon trapping capabilities. If that were the case forest owners would have to be compensated. Such compensation is likely to be low but stable.

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Conclusions:

To conclude:

1. Graphic paper and Pulp are unattractive segments or product groups to invest in
2. Packaging material is questionable as there are both factors that could potentially drive growth and limit growth prospect.
3. The answer for wood products is wait and see. The company that focusses on wood only and is publicly traded, Bergs Timber, does not look very attractive from a financial performance point of view.
4. Tissue is a potentially attractive segment. The segment has more characteristics of FMCG and its main company Essity needs to be further analysed from this perspective.  
5. Forest is not attractive as the return on assets is very low.
6. The answer for Bioproducts is wait and see as well. Bioproducts are made from byproducts from other production processes and the revenue for the companies active in this segment is small. It’s not reported separately and it’s therefore difficult to assess the financial performance of these products.

This means that it’s only tissue and companies in this segment that have the potential to be attractive to invest in at this moment. The only listed Nordic company in this segment is Essity (Metsä Tissue is not listed).

There are two segments that could potentially become of interest in the future. These are wood and bioproducts.

There are several arguments to underpin an investment case for Essity. The company has strong brands. Given their strong brand and the importance of the product for day-to-day life (remember the toilet paper panic buying madness in the beginning of the pandemic 2020) it’s an essential product for supermarkets to have available. Their market segments show good growth potential and their financial performance track record is strong.

The main downside with the company is what happens with their products after they have been used. The products are difficult to recycle and risk ending up in a landfill or being incinerated. The company is aware of the problem and is running pilots to recycle paper towels for instance. It’s likely to take several years though before this becomes a big scale and commercially viable activity.

Essity has very little of its own pulp production and as raw material makes up roughly 40% of operating costs it’s in the company’s interest to reduce material content both from a cost point and carbon footprint of view. So, both cost and ESG objectives are well aligned.

Appendix 1: Percentage each business segment makes up of total revenue.

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Appendix 2: Financial ratios and methods of calculation

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Calculation methods:

1. ROCE, Return on Capital Employed, illustrated for 2022 =
   EBIT 2022/ ((Capital Employed 2022 + Capital Employed 2021)/2)
   Capital employed = (Total Assets - Short Term Liabilities – Deferred Tax Liabilities)
2. ROE, Return on Equity, for 2022 = Net Profit 2022 / ((Equity 2022 + Equity 2021)/2
3. EBITDA = Earnings Before Interests, Taxes, Depreciations and Amortisations. Any non-recurring costs (e.g. restructuring) or non-cash profit (e.g. revaluation of forest assets) are eliminated from the costs/ earnings.  
4. EBIT = Earnings before Interest and Taxes. Major non-cash profits (e.g. revaluation of forest assets) are eliminated from the earnings.

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Appendix 3 – Detailed analysis of Nordic Capital financial performance

Business Units:

1. Kraft paper is used mainly for packaging such as bags. 53% of revenue
2. Grease proof paper for food, e.g., muffins. 47% of revenue

‍

Ownership:  

The company made an IPO in October 2020. Shanying International Holding is the biggest owner (through Sutriv Holding) with 48% of the shares and the votes. The other big owners are all institutional investors such as mutual funds. Prior to the IPO Shanying was the sole owner. They bought the company in 2017 from Holding Blanc Bleu and Petek GmbH.

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Growth:

As seen in table 6 the average growth during the 8 past years has been 9.3%. Revenue fell during the Pandemic year 2020. It recovered a bit in 2021 and increased by 44% in 2022.
In chapter 6 Industry Financials we saw that the industry revenue increase YoY in 2022 was mainly due to price increases. In the case of Nordic Paper there was also an acquisition made at the end of 2021. The acquisition of Glassine Canada Inc. added approx.. 440 MSEK to the revenue in 2022 or roughly 14% of the total revenue increase of 44%.

More than 90% of the company’s revenue is exported. In the period 2016 to 2022 the Swedish krona fell against most other currencies. E.g., the Euro gained from SEK 9.57 in December 2016 to 11.19 in December 2022. That’s an increase of 16% or a CAGR of 2.5% per year.

If we instead look at tons sold the picture is a bit different. In 2016 the sales volume was 263 ktons. In 2022 after the acquisition of the Glassine Canada the sales volume was 285 ktons or an increase with 7.5%. The corresponding CAGR was 1%. If we make a high-level adjustment for the total sales volume in 2022 would be approx. 40 tons less or 245 tons which is less than the volumes in 2016! Volumes have actually decreased.  

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Profitability:  

The operating margin (EBIT) was on average 13.6% during the 8 years period as shown in graph 10.

Overall strong operating margins throughout the period but with quite poor performance during the pandemic years 2020 and 2021.

One contributing factor to the strong operating margins are the relative low levels of depreciations of the assets.     

‍

Capital Efficiency:

‍‍The high ROCE is driven by high operating margin (EBIT) and low capital employed. The capital employed, or the denominator in the ratio, is mainly corresponding to shareholders equity, long-term debt minus cash on hand. There has been very little change in the sum of this three between 2015 and 2019. In 2019 the company had no long-term debt. This changed in 2020 just before the IPO. The company then took a bank loan of 950 MSEK in order to pay the owners a dividend of 950 MSEK. This corresponds to almost 4 times the net result in 2020 or 40% of the market value of all shares. The ROCE has come down since then.  

If we look at the asset side of the equation one can see that the balance sheet value of the fixed assets hasn’t really changed since 2014. At the end of 2014 the value of buildings, land, machinery, equipment and ongoing constructions was MSEK 642. End of 2022 that value was MSEK 742 which includes assets of MSEK 100 though the acquisition of Glassine Canada. The company has only invested enough to cover the yearly depreciations. The value of the fixed assets in relation to the revenue 2022 was 0.17 (742/4440). The same ratio for Billerud is 0.69 or four times higher, as an example. According to an analysis of the IPO document made by Affärsvärlden in October 2020 (Svensson, 2020) prior to the IPO the company had identified a need to invest MSEK 1,200 in one of their factories (out of four). That was twice the amount of the total current value of their fixed assets. This investment hasn’t happened yet. All this points to a business that seems to have been ‘under invested’ for a long time.%. Nordic Paper seems to have prioritised high dividends to the owners and only invested the bare minimum to keep the operations running. This is concerning for the future. The MSEK 950 dividend the owners paid themselves just before the IPO would have been better spent investing in machinery and equipment. It’s also questionable how willing the banks will be to lend more money to Nordic Paper if they just use the money to pay their owners.

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Conclusions:

Nordic Paper has been a veritable cash cow for the owners prior to the IPO. The investments seem to have been neglected as most cash has been distributed to the owners. To make matters worse the company has borrowed a substantial amount of money to pay the owners a huge dividend just before the IPO.

The strong growth rate seen in the period 2014 to 2022 has mainly been driven by acquisition and favourable currency and price movements. The underlying volumes or delivered tons have actually decreased (in the period from 2016 to 2022). The price and currency factors may also act in the opposite direction for the company if the Krona strengthens or prices fall. As a consequence, profitability would take a hit.  

As profitability has been reduced in 2020 and 2021 and debt has been added ROCE has been reduced as well. If one were to add the investments of MSEK 1,200 identified in 2020 to the capital employed the ROCE would fall even further.  

As the previous owner has maintained a 48% stake and the next 9 biggest owners that together hold 31.1% are all institutions the strategy of the company is not likely to change dramatically.

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