Overly Pessimistic Outlook for Newsprint & Under appreciated Sustainable Export Story: As a result of the secular decline in North American newsprint demand accompanied by the step-function loss of demand experienced during the financial crisis, much of the North American newsprint industry found itself in financial distress over the past couple of years. The industry responded by dramatically reducing North American capacity by in excess of 25% since 2009. This reduction of capacity has caused a spillover effect which has increased the cash costs for newsprint manufacturers outside of North America and thus, shifted the cost curve in favor of the North American producers (who are currently the low cost producers in the world). This dynamic stems from North American producer’s outsized reliance on virgin wood fiber as its key raw material, relative to Asian and European producers who rely much more heavily on recycled newspaper (ONP – old newsprint). Historically, ONP was in plentiful supply and thus, its cheap cost accompanied by a production process that was less energy intensive allowed ONP mills to produce newsprint on the lower end of the global cost curve. As a result, almost all of the European and Asian mills built over the past two decades have been ONP based and most do not have the equipment or the wood supply to produce newsprint using virgin wood fiber. ;This has come back to bite them, as ONP can only be recycled 4 times before the fibers breakdown and Asian producers must source ONP in North America (which they then have to ship back to Asia) because of its high virgin fiber content. Due to the rapid decline in North American production of newsprint, unsurprisingly recycled newsprint has become increasingly tight (and is expected to remain tight) – driving up the cost for ONP to in excess of $100 per ton relative to $50 two years ago. Additionally, the current low cost of natural gas in North America has reduced the energy cost advantage of the ONP production process.
As a result, North American producers currently have ~$150 cash cost per ton advantage over Asian producers. Meanwhile, European producers would not be competitive until the Euro was sub $1.20, a situation which seems less likely every day. All of the aforementioned factors have created a huge export story (ABH is currently exporting over 50% of its production and is turning down export orders) allowing North American producers to operate at 100% utilization ratios and thus, creating pricing momentum. Despite the continued secular decline in North American newsprint demand (which is expected to continue to decline at 5-6% per year), the rest of the world is actually growing - Asian demand is expected to increase in excess of 500k tons per year through 2014 (more than offsetting the decline in North American demand, as the base of North American demand is already extremely low) as literacy rates increase in emerging markets. Therefore, we expect ABH will maintain their ability to generate meaningful cash flow from newsprint operations into the foreseeable future, as it exports more of its production into the Asia and Latin America.
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