Sappi Papering Over Cost Issues

Sappi Ltd. (SPP) reported 3Q08 earnings of $0.10 per ADR, compared to $0.15 per ADR in the prior year period amid high input costs. The company is emphasizing on cost reductions and implementing price increases to offset higher raw material costs.

The industrywide move to reduce North American and European fine-coated paper capacity is taking off the excess supply from the market. As a global leader in fine-coated paper, though, Sappi could shut-in additional capacity but has not laid out aggressive shut-down plans yet. As a result, we expect a slower price recovery.

Moreover, in the near term, continued high raw material and energy prices and a difficult pricing environment in Europe might put pressure on the Fine Paper segment’s margins. Hence, we reiterate our Hold recommendation on the stock.

On August 5, the company announced that it is contemplating to cease production at its Blackburn Mill and from Paper Machine PM5 at its Maastricht Mill in Europe. This will bring down Sappi’s Graphic coated fine paper capacity by 190,000 tons. In addition to a more favorable capacity outlook, the demand picture looks increasingly brighter.

Despite strong demand for coated fine paper, Sappi's earnings remain susceptible to rising energy, high raw material costs and a difficult pricing environment in Europe. A 1% increase in chemical costs would detract almost $0.02 of EPS.

We believe industry pricing condition will improve further (apart from Europe) with the rise in operating rates. At its current price of $11 per ADR, the Sappi stock price reflects the improvement in industry fundamentals. We think the stock has already priced in the expected earnings improvement. Our target price is $11.50 per ADR.

Read the full analyst report on SPP

Read the full analyst report on SPP