Independent Thinking 101

November 6, 2024

Analysts seem to be able to calculate mill output each year to the nearest ounce of paper, but no one really knows what the potential board output is from in-place corrugators or the potential units of packaging shipped from converters. What we do know is that the income statements of mill-based companies are heavily dependent on the sales price of paper per ton versus the cost of furnish (primarily OCC and pulp). We also know that North American paper supply is currently greater than the demand for it and that mill-based companies have been closing mills and taking lots of downtime to compensate.

Economics 101 dictates that when supply is greater than demand, prices should go down, yet because a relatively small number of manufacturers dominate this market, prices have been going up. So, independent companies have seen the price of raw materials rising, and no end is in sight. That’s because the suppliers want to see their stock prices rise, and the easiest way to do this is to raise prices.

Getting back to corrugating capacity and converting capacity, no one can really measure this effectively for a few reasons:

While mills are limited in number and each mill is designed to run a specific output, there are infinitely more corrugators in the marketplace, and their capacities are more dependent on the technology they employ and the mix of business they run.
Finishing equipment, technology employed, graphic content, design complexity, and other variables relating to the packaging they are manufacturing make this difficult to predict. In addition, the same packaging may be made with different combinations of finishing equipment. For example, a box might be digitally printed, printed using flexography, or labeled. It may be run on a rotary die cutter, a flatbed die cutter, or on a computer-assisted design table. Laser die cutters are even making their way into converting operations.

What we do know is that 2021 and 2022 were profitable years for converters, and most invested heavily in new plants and equipment. New corrugators are generally wider and faster. New finishing equipment sets up and runs faster. So although we may not be able to measure it, we know that converting capacities have increased in the past few years.

What we also know is that box shipments peaked at almost 36 billion square feet in 2021 and 2022 and now are around 32 billion square feet, which is about where the market was in 2019. Similarly, the market for paper peaked at almost 2.9 million tons and is now about 2.5 million tons. During this time, over 2 million tons of new papermaking capacity came into North America, and the integrated companies took over 2 million tons of capacity out of service to keep the paper market in equilibrium. The price for export linerboard has also dropped a few hundred dollars per ton mainly because of new mill capacity in all our export markets, making it unprofitable to export linerboard not consumed in North America.

So, we have large integrated paper companies with stagnant stock prices closing paper mills because new mills have started up, and too much paper is being made in their markets where there is too much converting equipment and sagging demand. If you laid out this fact pattern to any economists, they would say this market should be exhibiting signs of falling prices, but we are seeing exactly the opposite.

Another difficult measure is how much of the roughly 32 billion square feet of corrugated shipments is being made by independents. The rule of thumb has been roughly 20%, but with the copious consolidation over the past 20 years, it may be less.

When I got involved in the industry in the early 1990s, 25 independent corrugators were operating in the New York City area alone. Today, there are three—and probably fewer than 25 independent corrugators in the U.S. Independent converters composed almost entirely of sheet plants compete in the marketplace based on creativity, innovation, quality, and service. Yet when you look at their profit and loss statements, the biggest expense is always paper/sheets, and it looks like the price of that is going to continue to go up, even though it is plentiful. Because of the converting capacity and the lack of growth in demand, the price for packaging should be trending downward.

What I see is that this is true for longer-run commodity-type businesses in which pricing is not contractual. The biggest issue is that most integrated companies and many larger independents have a large percentage of their businesses tied up in supply agreements that have pricing mechanisms. Almost all of these contracts are tied to Producer Price Index (PPI) Pulp & Paper Week pricing. PPI is supposedly reporting on the transacted price of paper, but with fewer than 25 independent corrugators buying paper in the open market, the notion that this index represents a significant portion of the paper transactions stretches the imagination.

What is going on is that for the integrated companies to get price increases in their contracts, PPI has to report that the transacted price of paper is rising. So with respect to contractual business, which is mainly the realm of integrated producers, they must continue to raise the reported price of paper to boost their margins and improve stock prices.

The real issue comes with the business that is not subject to a contractual pricing mechanism, and this is the world most independent converters live in—increased competition from integrated companies looking to fill up their mills and plants and from other independent converters who now have more converting capacity.

As stated, this seems to be occurring in the longer-run commodity-type business that crosses over between the worlds of large independent and integrated producers. However, on the rest of the mix, I am finding that the vast majority of independent producers continue to compete based upon creativity, innovation, quality, and service. They have passed through these continued price increases to their customers and in many cases have improved their margins. The conventional wisdom is that once you reach your break-even point, that contribution from each incremental order will drop to the bottom line, and therefore, you can take incremental orders at lower prices because you know they will generate profits. This does not seem to be the course of action most independent converters I work with have taken. It comes down to what I call independent thinking 101:

Work your niches hard.
Charge a fair price.
Implement a culture of continuous improvement and take care of your people.
Don’t accept marginal business that doesn’t fit your normal criteria just to fill up your plant.
Focus on long-term profitability and growth.

I am proud to say this is what I am seeing from my independent friends in the face of economic conditions that have deteriorated for them over the past couple of years.

Keep up the good work, gang!