The pulp, paper and packaging sector is often seen as staid and deeply cyclical. However, despite its seemingly unremarkable nature, medium to long-term earnings are trending upwards and global investor interest is on the rise. What is driving this momentum in an industry where companies are often considered price takers, producing commodity-like products?
In a word, sustainability.
The packaging industry, valued at about US$1 trillion, is under increasing pressure due to concerns about waste, climate change, and sustainability. With food and beverages representing over 43% of the global packaging market and other consumer products accounting for 15%, global packaging demand is driven largely by shifts in consumer behaviour and preferences.
Consequently, regulators are acting, and consumer goods companies and retailers are committing to improve the sustainability of their packaging.
This shift, combined with the rise of e-commerce, is driving growth in wood-based consumer and industrial products. The impact on pulp and paper producers and their value chains will be significant. However, not all companies will be prepared for this shift. The sector is notoriously cost-sensitive, and companies that haven’t kept pace with investment may struggle to survive the coming changes.
In addition to these pressures, a return to trend demand growth in market pulp, fuelled in part by the substitution of plastics with fibre – is expected to drive sector profits. Higher pulp prices are positively correlated to sector profit growth.
Global pulp net demand (kt)
Source: RISI Fastmarkets.
The Ninety One Global Balanced Strategy is invested in the sector, holding positions in Smurfit Westrock, Mondi Plc. and Sappi. Each of these companies plays a distinct role: Smurfit Westrock specialises in recycled fibres and corrugated boxes; Mondi is a vertically integrated leader in packaging and sustainable paper solutions; while Sappi is involved in the production of dissolving wood pulp, paper and packaging. All three source woodfibre responsibly from certified plantations and have strict standards in place to ensure that all wood supplied to their virgin fibre mills meets the highest global ethical standards.
While each company is at a different stage in its business life cycle, they share two key factors: we expect single digit earnings revisions for all three over the next one to two years. In addition, we expect EBITDA CAGR to average 14% (with a 11% to 19% range) through to FY26, from a FY24 base.
Of the three, Sappi stands out as the turnaround story. After heavily investing in the graphic paper market, the company had to change course when the rise of digital media led to a structural decline in demand. Burdened by high debt from M&A activity, along with slowing growth, earnings and returns, the stock experienced a significant derating.
In response, Sappi began transitioning away from the declining graphic paper market and it has recently accelerated these efforts. The company closed two high-cost mills in 2023, supporting cost improvement programs and strengthening the cost structures of its legacy business. More importantly, mill conversions and new investments have increased the company’s capacity in packaging, specialty paper and board, and dissolving wood pulp (DWP). Over the past two years, Sappi’s debt burden has been reduced, lowering financial risk.
Sales volumes
Source: Sappi.
Unlike market pulp, a commodity product used mainly in the production of tissue and paper, DWP is a niche product with more promising growth prospects. Sappi holds 16% of the global dissolving pulp market, with capacity to produce 1.4 million tons annually. Of this the majority is absorbed by the textile industry where demand for sustainable fabrics is growing annually by mid-single digits, particularly in the athleisure market.
Dual-listed Mondi, on the other hand, is not as much of a turnaround story, but is likely better positioned to capitalise on the growth trends the industry is experiencing. Specialising in packaging and sustainable paper solutions, Mondi has generated industry-leading returns on invested capital (ROIC) for eight out of the past ten years. This success is due to its low-cost mill system, supported by continuous reinvestment and robust downstream converting operations.
Despite a challenging 2022/23, marked by its forced exit from its low-cost Russian operation and a sharp increase in Central European wood costs (main wood sourcing area for Mondi), the company still achieved a respectable trough ROIC of 8.6% and an EBITDA margin of 16.4% in 2023.
Mondi also benefits from a virgin fibre advantage relative to its Nordic (and in the near term their recycled fibre) peers, with access to in-demand forest land that supports its production of recyclable products. Product innovation and recycling initiatives are expected to further boost growth, potentially adding 2% to demand over the medium term.
This growth is underpinned by rising public awareness and regulatory changes that have intensified the focus on packaging waste, compelling the industry to rethink its approach. As stakeholders across the value chain – from raw material producers to legislators – commit to circular practices and implement new regulations, the industry is set for significant shifts. The new European Packaging and Packaging Waste Regulation (PPWR), effective in 2025, will challenge the consumer packaging industry. Plastics will bear the brunt of these changes, leaving fiber-based packaging, like that produced by the companies in our portfolios, well-positioned to benefit over time.
Source: Mondi, Jefferies.
Smurfit Westrock exemplifies the ongoing consolidation in the industry. The acquisition of US-based WestRock by EU-based Smurfit Kappa in July 2024 positions the combined entity to capitalise on structural growth in demand for sustainable packaging. We think the market is underestimating the company’s financial glide path along with volume growth potential of the industry. Although it will take time and capital to fully realise this potential, the synergies between the two companies are expected to be profit accretive, enhancing their ability to meet the rising demand for eco-friendly packaging solutions.
While the push for sustainable packaging is still in its early stages, paper-based packaging is well-positioned to benefit from this growing trend. The pandemic, coupled with a weak macroeconomic environment and high inflation, has delayed the adoption of sustainable solutions. However, as inflation eases and economic growth prospects improve, we expect the adoption of sustainable packaging to accelerate.
In the Ninety One Global Balanced portfolio, the domestic and offshore assets are managed on a fully integrated basis. Selecting both the domestic and offshore equities gives us a holistic perspective in terms of idea generation and positioning as illustrated in our exposure to the pulp, paper and packaging sector. The domestic opportunities are further enhanced through specific offshore ideas that complement the investment theme which we believe should enhance the portfolio’s risk-adjusted returns. The companies discussed are held across various portfolios and are poised to lead the charge in this evolving market sector.
