Thaw elusive for snowbound paper sector

A log mover prepares to grab a load of trees from a storage pile at the UPM paper mill in Kajaani July 21, 2008.

HELSINKI (Reuters) - Last month, when there was talk across various industries of "green shoots" of economic activity poking up from the recession, Chief Executive Jouko Karvinen of top European papermaker Stora Enso weighed in with his view.

"In the forest industry I would dare to say there is about half a meter of snow on top of them," he said.

It has been a gruelling eight years for the global paper industry, which has suffered from overcapacity, soft demand and resulting low prices, with a flow of weak earnings often punctuated by sharp restructuring costs and lay-offs.

In the current global downturn, the demand for basic materials, including paper, has further eroded as print advertising has dropped steeply.

"From a credit perspective, most of the rated companies in Europe were already very weakly positioned in their rating categories in advance of the current period of demand," said analyst Christian Hendker at Moody's.

The latest blow came on Wednesday, when Stora (STERV.HE) said it would close mills in Finland, slash up to 1,100 jobs and book an almost 600 million euro ($854 million) charge as it tries to align production with flaccid demand.

The latest sector job cut news sounded an ominous note as the industry heads into the autumn and a ninth grim year beckons.

The outlook for demand and capacity cuts will be a key focus at the Reuters Paper and Packaging Summit being held next Monday and Tuesday in Helsinki, Stockholm, Oslo and Johannesburg.

"Others must follow the example of Stora Enso to rectify the (demand-supply) balance situation," said analyst Claes Rasmuson at Swedbank.

Ratings agency S&P added: "We believe that capacity closures across the industry could contribute to a better supply and demand balance and price formation, but recognize that the industry is facing a severe headwind."

PRICING PAIN

The immediate outlook remains gloomy, though firms have indicated the worst drop in demand is likely over, as paper purchasers have now burned off inventories.

But even as demand steadies, analysts warn that continued excess capacity in the industry will pressure prices, noting there are many small loss-making mills that must churn out paper, regardless of the price, to try to cover some costs.

The world's top magazine paper maker, Finland's UPM-Kymmene (UPM1V.HE), said this month that while second-half paper deliveries would be higher than in January to June, the average price for paper deliveries in euros is expected to fall.

"Demand is likely to come back to a certain extent in some grades, but there will likely be capacity additions in other parts of the world," Swedbank's Rasmuson said.

The outlook for newsprint in particular looked bad, analysts said, as electronic publishing takes off and newspaper circulation continues its steady slide, with 2010 contract talks between paper buyers and sellers likely to be bruising.

"Newsprint has suffered and will continue to suffer," said analyst Mikael Jafs at Cheuvreux.

UPSIDE POTENTIAL

Amid the overall gloomy sector news, analysts said there were still some reasons for optimism.

"Looking at the fundamentals today, things look bleak. But things never remain the same," Jafs said.

"If Stora's closures are followed by others, and the economy turns around, then the current market situation could change for the better rapidly," he said.

A Stockholm-based analyst added: "What it comes down to at this point is that everybody knows the outlook for the market is extremely challenging, and that is discounted in the share prices. If you restore balance ... the upside can be huge."

There has already been some rebound in beaten-down share prices of late, with International Paper (IP.N) and UPM rising some 45 percent and Stora around 40 percent in the last six weeks, although all shares remain well below year-ago levels.

And some companies, seeking to reduce their dependence on paper, have started to branch into new business areas, although these may not offer immediate relief in the downturn.

Both Stora Enso and UPM are involved in projects to see how waste wood can be converted into biofuels, and Sweden's Holmen (HOLMb.ST) has said it aims to generate considerable wind power from turbines on its land.

($1=.7028 Euro)

(Reporting by Brett Young; Editing by Hans Peters)