Capacity Calculus for the Converter

March 21, 2022

Even the largest independent converters are pretty small players in the overall world of paper and packaging. The marketplace is dominated by large integrated producers that control enough of all the papermaking resources to be considered an oligopoly. We know this because it seems that we have the ability to measure paper making capacity to the nearest pound. But what about our capacity to manufacture corrugated sheets? What about our capacity to convert corrugated sheets into finished boxes? Can any of this be measured accurately? If we knew how close we were to these capacities, would it affect decision-making?

Last year was characterized by the largest price increases and highest levels of profitability that I have ever seen among independent converters—and I see a lot of data. The key question is whether these levels of profitability are sustainable. In my experience, independent converters always pick up short-term profit gains when the price of paper goes up rapidly, and the past year has been no exception to this rule. Paper prices always seem to backslide when there is a series of rapid price increases, and when this happens, independent converters generally begin to lose margin. Is this what is going to happen in 2022 and 2023? Even in a market dominated by a small number of paper producers, the fundamental laws of supply and demand always seem to have the final say. If we accept the premise that the integrated producers have a vested interest in keeping available domestic supply as tight as possible, then what are the key factors to look at to help us predict future performance and make solid decisions with respect to the marketplace?

Paper Supply and Availability

The overall domestic supply for containerboard is expected to grow by at least 10% over the next few years. Producers have kept supply as tight as possible by exporting tonnage, often at little or no profit. During the past year, export tonnage dropped dramatically, partly because the spike in demand caused a real short-term paper shortage here and partly because new tonnage is coming online rapidly in almost all export markets. In my opinion, the integrated producers will continue to show the discipline required to keep supply tight enough to continue increasing prices.

Demand for Packaging

Demand has been off the charts for the past 18 months, most likely fueled by all of the government stimulus payments, which are ending. It also seems unlikely now that the Democrats will be able to pass any more spending bills that are even close to what they originally proposed, so it is likely that the pace of demand will slow or even backslide somewhat. However, in the absence of an overall recession, there is likely to be continued growth in the demand for consumer products, nondurable goods, and all other sectors of the economy that utilize paper-based packaging.

Continued Inflation in the Overall Economy

The global supply chain problems that we have all been experiencing are real, and there don’t seem to be any quick fixes for them. Here again, the fundamental laws of supply-demand indicate that when supply is limited, prices tend to go up. In addition, with the Federal Reserve planning to raise interest rates, the cost of capital will increase, thus adding fuel to the need for companies to raise prices. I think those of us who lived through the 1970s will tell you that once this pattern starts, it is hard to reverse, so my feeling is that inflation is going to be part of this calculus for the foreseeable future.

Labor Markets

It seems that everyone is having trouble finding qualified employees. COVIDgovernment support payments, almost zero growth in the population of working-age people, and the lack of any cohesive immigration policy have made this a major problem. Many converters tell me that even if they had all of the paper or sheets they need, they would still have trouble meeting customer demands because they don’t have enough qualified people to operate every machine and work every shift.

Investment in Corrugators

There are a lot of new corrugator projects underway across the country at both the integrated and independent levels. However, there are a limited number of manufacturers, and lead times are in the 12- to 18-month area, so it is going to take a while for increased corrugator capacity to affect the markets. This is also a regional issue in that many independent sheet plants still tell me that they cannot get any more footage from the corrugators in their regions, and this has been a serious impediment to their ability to take care of customers and grow. This will continue to be an issue for at least the next 12–18 months and probably longer in some regions of the country.

Investments in Finishing Equipment

While walking the floor at SuperCorrExpo in Orlando, Florida, last summer, I was struck by how few people seemed to be there. There seemed to be far more vendors than potential customers to my eye, yet most of the vendors who I spoke with indicated that they went home with lots of orders and good prospects for more in the future.

Converters are making money and looking to invest in their plants and equipment. Almost every independent that I am involved with has equipment on order or is planning to order equipment in the next year. Some are also increasing their physical plants. All of this equipment will greatly increase their production capabilities and in many cases allow them to increase their product lines. In addition to allowing them to produce more footage per man-hour, much of it will allow them to reduce overall head counts in the plant. Pre-feeders, robotics, palletizers, and an overall increase in conveyorization are all in the plans for most independents in reaction to the continuing labor shortage. However, as with corrugator investments, they are experiencing very long lead times from manufacturers and encountering shipping delays due to the ongoing supply chain .

New Plant Initiatives

While both integrated and independent manufacturers continue to invest in their capabilities, building a new state-of-the-art corrugator plant could cost upward of $50 million, and building a new state-of-the-art sheet plant could cost upward of $25 million. Several integrated companies and a few independent companies are in the process of doing this, but most of them are doing it in response to existing demand or to consolidate existing plants. The notion that someone is going to do this on a speculative basis is highly unlikely. The days of someone buying an old flexo and die cutter and setting up shop in an old building are over. Real estate is way too costly, and good used equipment is hard to find today.

The past 18 months have radically changed the overall market for paper-based packaging. The markets are far less price-competitive than they used to be, and most customers don’t have a lot of good options when it comes to finding new vendors. This is especially true for small and midsized customers, as well as jobbers, brokers, and other resellers. Customers have had to accept longer lead times and higher prices, and based upon the aforementioned factors, this trend is likely to continue for the foreseeable future.

My advice to independent converters, based upon the above capacity calculus and market analytics, is carpe diem. Almost all of the external factors are in your favor, and in the absence of an overall economic recession, they will be in your favor for the foreseeable future. Our papermaking capacities, corrugating capacities, and converting capacities will continue to be tight. New equipment initiatives will take a long time to have an effect on the markets. The labor market will continue to be problematic for you. This is the time to take care of any pricing and other customer . Put your bets on the table for increasing your production capabilities and reducing your labor force. Seize the day, converters.