Thu 06/03/2021 10:17 AM
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Relevant Documents:
Lecta Q1 Earnings Presentation
Kloeckner Q1 Earnings
Wepa Q1 Earnings
Progroup Q1 Earnings Presentation

Investors are expressing diverging views on the paper and packaging sector across Europe, sources told Reorg, with names such as Lecta, Kloeckner Pentaplast, and Wepa contending with increases to raw material prices and the continued impact of the Covid-19 pandemic. Continue reading for our EMEA Core Credit team's reporting on the paper and packaging sector in Europe and request a trial for access to the linked documents and reporting on hundreds more stressed, distressed and performing credits. 

Views differ on the merits of shorting the debt of companies in the sector, with some investors anticipating a downturn as increased demand on raw materials is coupled with supply issues and cost inflation. Others, however, say they believe the sector to be more robust and point to an absence of significant triggers to cause a meaningful downturn.

“People in the market are leaning into anything that is low-coupon and paper related,” said one source. “An increase in soft pulp prices is hitting these businesses.”

In contrast, another source said that despite “bits of weakness and high-yield tourists the sector remains a stable one” and that B and BB names will likely endure negative trends. Sources also pointed to the fact that there are “no hard triggers” in the immediate future on many companies in the sector.

German tissue paper manufacturer Wepa is among the names to be hit by raw material cost increases, sources say, with some funds considering shorting its debt. The company’s €350 million senior secured notes due 2027 have fallen just under a point since a month ago to be quoted at 99.10, according to Solve Advisors. The company’s €200 million senior secured notes due 2026 are quoted at 99.44, according to Solve Advisors, compared with about par a month ago.

On the other hand, Spanish paper company Lecta’s 144A notes are currently in the high 70s compared with 72.86 a month ago, according to Solve Advisors.

According to research by BofA Global Research, the price of Kraftliner containerboard is estimated to increase year over year by 16.3% in 2021 while white-top kraftliner is expected to increase by 8.4% in the period. The cost of SC Fluting is anticipated to rise 12.2% in 2021 year over year and Testliner is expected to rise 30.3%. OCC recycled paper is estimated to rise 138.4% in the period while ONP recycled paper is estimated to increase 63.7% year over year.

The paper pulp market has also experienced steep price inflation since November last year, with current pulp prices up by 45% to 50% compared with the 2020 average. As per BofA Global report, softwood and hardwood pulp prices per ton are currently at $1,023 and $1,216 respectively.

The chart below is from Sappi's latest earnings presentation and depicts recent pulp prices trends. The South-African group is one of the largest graphic paper producers, globally, with large production facilities in Europe and North America.

Different names will also have varying scope to control their own prices through their contracts, with those who have shorter contracts better able to pass on the cost to their customers, sources said.

For instance, Lecta, which has limited pulp integration producing only 30% of its own pulp needs, has limited ability to pass through pulp price increases to customers because of its commoditized product offering and Europe’s supply overcapacities. The group does not hedge against fluctuations in the price of pulp.

Lecta’s first-quarter EBITDA fell 61% year-over-year to €9.5 million, with the drop reflecting lower volumes, prices and higher costs. Input costs rose about 20% over the first quarter with the company having limited scope on its own price control, according to sources. The company noted in its first-quarter earnings presentation that “unprecedented pulp increases'' applied to the period. Moreover, there is a time lag of one quarter between cost impact and price increase, which is eroding Lecta’s short-term margins, the company added. Last month, Lecta reported a 15% year-over-year decrease in first-quarter revenue to €270.8 million.

Wepa does not own any mills, and around 70% of its sales volumes are subject to framework agreements without automatic price adjustments, leaving the company exposed to cost-push inflation. Wepa offsets this risk by hedging pulp price exposure through forward contracts for up to two-thirds of its pulp requirements over a 12 month to 18 month period, with the remaining acquired at spot.

Wepa’s revenue fell by 24% year over year to €276.7 million and adjusted EBITDA was down 36% year over year to €34.2 million driven by sales volume decline and recurring time-lags in pricing.

German containerboard and corrugated board producer Progroup is also being monitored by funds, sources said. In its first-quarter earnings, the company noted that strong demand had been offset by increasing raw material costs. The company added that margin was temporarily impacted by the typical time-lag in passing on the raw material price increase to customers. Progroup saw revenues increase 22.7% year over year to €285.7 million in the period while Reported EBITDA fell by 21.2% year over year to €45.5 million.

A comparable company to Progroup, the Italian paper-based packaging producer Pro-Gest also reported rising raw materials costs in the last quarter, with a significant increase in waste paper prices to peak toward April, though the company’s end-markets have stronger fundamentals and selling prices have been accordingly adjusted.

German packaging group Kloeckner too has been hurt by an increase to input costs as resin and chemical prices grow and its debt is being shorted by some investors, according to sources. However, the company’s two term loan Bs due in 2026 have remained unmoved over the past month and are currently quoted at about 99, according to Solve Advisors.

Kloeckner’s food packaging segment saw first-quarter adjusted EBITDA down 3.5% excluding corporate, other expenses, as a result of a compression in price-cost spreads due to steep raw material inflation, timing of price pass-through and negative FX impact. The company stated in its first-quarter earnings presentation that it recorded a raw material inflation of €22 million in the period.

Last month, Kloeckner’s management said about 65% of the group’s business in the first quarter were made with non-escalator pricing contracts, which is a type of contract that adjusts the prices typically every three months, meaning passing the higher material cost to customers is slower. For businesses without such contracts the period to pass through higher prices to customers is 30 to 45 days, while the overall pass-through period was below 60 days. The company also confirmed 2021 guidance of EBITDA at more than €300 million, about 45% of which is forecast to be generated in the first half.

In addition, the company said raw material prices significantly increased at the beginning of the second quarter, and price for polyethylene terephthalate, or PET, may continue to grow, but management forecasts a normalization in the second half of the year.

Resin prices have increased due to shortages in supply following a hurricane season in America, which hit refineries. Moreover, demand has increased in some polymer-based hygiene items, such as gowns and face masks, according to a report in the Financial Times. Below is a table detailing recent changes to resin prices:

A table from research conducted by ICIS tracking changes to the ICIS Petrochemical Index is below:

--Thomas Baker, Cedrick Cassin
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