The Busy Weekly covers paper & corrugated packaging industry this week. This industry is compared to steel industry in this issue.
The paper & corrugated packaging industry is under-studied and little is known about its economy. Therefore, the weekly paper has its own merit being the first formal attempt to help expand our circle of competence.
Unlike the steel turnaround, the weekly paper concludes that Malaysian paper & corrugated packaging companies will not benefit from the changes in China's arena.
It is the objective of this letter to demonstrate the second-level thinking in order to verify that preposition.
其目标包括混合废纸 - 纸和瓦楞纸包装的关键原料。废纸分为三类：旧瓦楞纸箱，旧报纸和混合纸。
The Chinese government has recently banned importation of scrap commodities.
China is targeting mixed scrap paper - a key raw material in making paper & corrugated packaging. Wastepaper falls under three classifications — old corrugated containers, old newspapers, and mixed papers.
This latest environmental initiative by China that was published on July 18 and is scheduled to take effect at the end of the year is nevertheless chilling for scrap paper exporters.
The General Office of the State Council said the goal by the end of 2019 is to “gradually halt the importation of solid waste that can be replaced with domestic resources.” China appears to be moving toward domestically procured recyclables that it can better control.
This is the latest Chinese government effort to crack down on the environmental impact of scrap imports. It follows the 2013 “Green Fence” and this year’s “National Sword” initiatives. China’s goal, as stated in the latest report, is to “ensure the safety of the natural environment by continuously strengthening the supervision and management of solid wastes at the importation, transport, utilization, and other steps.”
The Chinese government’s 'Reform and Implementation Plan to Enhance Solid Waste Import Management System by Prohibiting the Entry of Foreign Waste' could change the landscape of international and national markets.
How would that affect paper & corrugated packaging companies based in Malaysia?
左图 - 当大型出口商停止出口时，其连锁效应的逻辑观点
右图 - 当大型进口商停止进口时，其连锁效应的逻辑观点
Before we attempt to answer that, let's consider the two conceptual frameworks below:
On the left - A logical view on its chain effects when large exporters halt exports
On the right - A logical view on its chain effects when large importers halt imports
供需定律是解释资源供给与资源需求之间的相互作用的理论。 供需法定义了特定产品的可用性和该产品的需求（或需求）对价格的影响。 一般来说，低供应量和高需求量增加价格，而相比之下，供应越多，需求越来越低，价格趋于下降。
Given their separate role (being large exporters or importers), their trade policy has distinctly different impact on the international and domestic suppy-demand dynamics.
The law of supply and demand is the theory explaining the interaction between the supply of a resource and the demand for that resource. The law of supply and demand defines the effect the availability of a particular product and the desire (or demand) for that product has on price. Generally, a low supply and a high demand increases price, and in contrast, the greater the supply and the lower the demand, the lower the price tends to fall.
They look academic. It is necessary to to illustrate these chain effects through real events.
When large exporters reduce/limit/ban exports
Food Price Crisis 2007/08:
- Export restriction/ban => (seemingly) lower inventory in the international market
- (Seemingly) lower inventory => higher trading prices
- (Seemingly) lower inventory => (panic) greater demand from nations
- (Panic) greater demand from nations => higher trading prices
China steel production cut 2017:
- Production & export reduction => (seemingly) lower inventory in the international market
- (Seemingly) lower inventory => higher trading prices
- (Seemingly) lower inventory => intensified demand from nations
- Intensified demand from nations => higher trading prices
When large importers reduce/limit/ban imports
Dairy Price Crisis since Aug 2014:
- Import ban by Russia => inventory glut in the international market
- Inventory glut => lower trading prices
- Inventory glut => more affordable demand from other nations
- Greater demand from nations => (slightly) improved trading prices over time
China: the world's largest importer of wastepaper
Globally, countries imported wastepaper valued at $41,734 mil in 2016.
Approximately 36% of the total import value contributed by China, making it the world's largest importer of wastepaper.
The ban also piles up the inventory of wastepaper in those countries (i.e. USA, Canada, Brazil and Indonesia) China previously sourced from.
As more wastepaper is available in the international market than before, domestic (i.e. USA) wastepaper prices have taken a dip.
It is however too early to draw an inference on the persistence of the downtrend since the Chinese ban on wastepaper has just kicked in.
Paper mills in Malaysia rely on wastepaper imports, largely from USA (31%) and Brazil (12%).
They should face less intense competition in sourcing wastepaper from these countries after the Chinese policy.
由于中国已经缺货，大马公司很可能会转向第二大出口国 - 印尼（即另一方面是第四大废纸出口国）进口纸质和纸板。
However, the scale of the local paper mills is limited and unable to fulfill domestic demand. Malaysian paper & corrugated packaging companies therefore turn to imports.
As China is already running out of stock, the Malaysian companies are likely to source paper & paperboard from the second largest exporter - Indonesia, who on the other hand was the 4th largest exporter of wastepaper to China.
The Indonesian supply is known for its relatively low prices, and that is unlikely to change much since the country is piled with more wastepaper since the implementation of the Chinese policy. It would be a different case when international demand surpasses/catches up the local supply.
Wining recipes for Malaysian firms
We are now highly certain that both China and Indonesia will not dump their cheap raw materials and corrugated packaging products in Malaysia.
If we follow the chronicles of Dairy Price Crisis, the rising international inventory would lead to low international prices if the demand slows behind the supply.
However, it is likely to be a different (or neutral) case since both manufacturing and online shopping segments are growing at the global landscape.
As a result, Malaysia's existing 55 production lines of corrugated packaging are fully operated and, sometimes, unable to fulfill all domestic demand. It is therefore not surprising that all paper & corrugated packaging companies are expanding their production lines.
Nevertheless, the Busy Weekly (資匯) suggests that Malaysian paper & corrugated packaging companies will have to be efficient in sourcing and passing down any increased cost to customers.
When searching for that new equilibrium, they risk losing their customers to competitors who undercut their prices.
In implication, it is not about charging average selling price per se.
What matters most is the intertwined ability to increase average selling price, save cost for customers, maintain/improve product & service quality, and improve operation efficiency for offering better value to customers.
(Un)fortunately, at our best knowledge, PPHB is the only listed company doing just that. Please visit our report on the management interview (click here）to learn how the company comes ahead of its peers in the industry.
The company is now selling at lower valuations than its international peers (ex-China, HK, and Taiwan) and cheaper than its local competitors.
PPHB made RM13.6 mil capital expenditure in FY16, and RM9.1 mil capital expenditure in the first 6-month of FY17 for acquiring plants.
These are so far the largest capital expenditure of PPHB. Its previous capital expenditure was consistently below RM5 mil per annum.
Its cumulative revenue and net profit have grown by 8% and 9.6% respectively at the end of H1FY17. The half yearly performance seems comparable to its 12.3% CAGR of the past 6 years.
If you wish to learn how PPHB meets all Buffett's investment criteria, please visit our compilation (click here）.