The print media sector is built on a vast infrastructure of different supplier industries, stretching from the paper manufacturers to paper merchants to reproduction houses to the printers themselves. Yet despite this diversity, there are a few key macroeconomic factors that drive the sector’s overall profitability.
From a structural perspective, the South African printing sector is broadly divided into two main segments: web-based printing and sheet-fed printing. Web-based printing is dominated by two players, Caxton’s CTP and Media 24’s Paarl Web, and has become the preferred option for the larger publishing houses.
The sheet-fed sector is extremely fragmented and has lower barriers to entry. Damon Greville, managing director of Advance Printing, points out that industry players vary from one-man shows to companies that have invested millions of rand in their equipment.
Nonetheless, web-based and sheet-fed printers have a number of common profitability drivers.
At a macroeconomic level, Greville says that the printing industry has always been an accurate barometer of the state of the economy. From a volume perspective the advertising boom of 2004 and 2005 – catalysed by the consumer boom following sharp declines in interest rates – has been a positive factor.
However, the strengthening rand since the beginning of 2002 has undermined this environment by reducing the price-competitiveness of South African exports to international markets. Greville says that exports will not be significant for Advance Printing this year, although they have accounted for as much as 75 percent of turnover in the past.
In addition, imported competition has also increased, partly as a result of the rand’s strength. Greville says that product from Singapore, China, Taiwan and even India is extraordinarily cheap, “which makes things very competitive”.
On the cost side, Stephen van der Walt, CEO of Paarl Media Holdings (which controls Paarl Web and various other Media24 printing operations), says the printing sector has benefited from the stronger rand. As for capital expenditure, the price of printing presses has fallen in local currency terms. Many industry players – including Paarl Media and CTP – have used this window of opportunity to accelerate their capital expenditure programmes.
Van der Walt highlights that cost of sales (COS) is extremely sensitive to the rand. Depending on what products are being printed, he estimates that paper accounts for 70 to 80 percent of COS, ink 10 to 15 percent, and consumables the balance. In addition, ink and consumables are sensitive to the oil price, which increased more than 50 percent in 2005.
David Brennan, a forestry and paper analyst at Andisa Securities, points out that international paper prices have fallen for the last three to four years.
For South African-based multinational paper producers such as Sappi and Mondi, this reduction in their dollar selling price has been exacerbated by the strengthening of the rand since the beginning of 2002. Doug Heger, managing director of printing company PrintAbility, says that the upshot in this for the printers has been extended by the scrapping of duties on paper imported from the EU, although a 5 percent duty remains on all other paper imports.
Yet printers and publishers across the board still believe the local paper companies are profiteering and overstating the profit margin squeeze. As one industry executive points out, both Sappi and Mondi have cheaper fine paper inputs than European producers – particularly in electricity, bagasse and water. As a result, he argues that Sappi’s prices should reflect this economic reality.
In response to profitability pressures, Mondi recently closed its Crystal plant. This has effectively left the South African print media industry with a single source of local supply. As a result, imports are likely to play a bigger role in future, while Sappi’s pricing power has – notionally at least – improved.
Industry criticisms of the paper sector have clearly struck a nerve as Mondi chose not to respond to questions from The Media.
Yet, despite higher volumes and a favourable cost of sales framework, Heger highlights that profitability in the printing industry “is not what it used to be”. He believes margins are tight because of industry oversupply, which has resulted in a price war.
The consequence, as van der Walt points out, has been very low increases in prices charged to the print media industry. Real prices have declined, so printers have to move more tons through the plant to generate the same rand value in turnover.
In addition, van der Walt also emphasises that the capital-intensive nature of the printing industry means that debt should be used judiciously. Printing companies need to generate positive returns on their investment in order to create the capital reserves necessary to carry them through the bad times.
Lastly, van der Walt highlights wage inflation. He says that salary increases have been ahead of inflation for the past two years, and this is likely to continue into 2007 as companies try to retain skills. The industry as a whole has prioritised skills development and committed R70-million to R80-million to training over the next five years, in addition to funding bursaries.
There have been casualties. Greville says that industry consolidation has been ongoing. Membership of industry body Print Industry Federation of South Africa (Pifsa) has dropped from 650 to 140 in the last five years.
But as indicated, while there are specific cost headwinds, the volume outlook across all segments of the print media supply chain is broadly positive.
In terms of the macroeconomic outlook, a Reuters survey shows that economists predict economic growth of around 4 percent in 2006. This is good news for the print industry as it means that volumes should continue to grow, albeit at a slower pace.
As ever, there are two jokers in the pack: the rand exchange rate and international oil prices.
Tony Twine, a senior economist at Econometrix, believes that the rand will weaken on a trade-weighted basis in 2006. Given his view that the dollar is “peculiarly strong for its fundamentals”, he believe it will weaken against the Euro, British Pound and Japanese Yen. As a result, the rand is likely to “tread water” against the dollar and weaken against the three other major currencies. According to Reuters, the consensus forecast is for the rand to reach R7,07: US$1 by the end of 2006.
Given the rand sensitivity of the printing sector’s cost base, this should be negative for margins.
The international oil price is more difficult, given its extreme volatility this year. Some international economists believe it could top US$100 per barrel this year and it seems likely that the average oil price will be higher in 2006 than 2005, which will keep margins under pressure.
Brennan believes that, from a price perspective, the international paper industry is now over the worst. He projects an overall 2,5 to 3,0 percent increase for 2006 in average international paper prices. As the paper companies are running at low margins, even a modest increase in price leverages profitability improvements. He believes this gradual recovery in paper prices will be extended for the next few years, although he cautions that his forecast on international paper prices for 2009/ 2010 will not exceed those levels that prevailed in 2000. However, the difficulty with forecasting paper prices is that they have traditionally been volatile and moved very quickly.
Brennan believes that a combination of higher input costs and tighter supply will allow the producers to push through some paper price increases in 2006.
Sappi has apparently told the printers that next year’s price increases will be a minimum of 5 percent. Tony Walker, managing director of publisher Highbury Safika, comments that right now international paper prices are still soft so this “seems ambitious”. He expresses concern that printers will then source different quality stock internationally, which impacts both consumers and the publishing houses. Whilst higher paper prices will be positive for the profitability of the paper companies, it will squeeze margins for the printers unless they can pass the cost through to clients.
The last factor to consider in determining whether print industry profitability will improve in 2006 is whether the price war in sheet-fed printing will continue.
Heger believes it will until some of the larger industry players are consolidated, or the larger groups instead compete aggressively on service levels, quality and turnaround times and “sanity prevails” in pricing. He says things will remain “tough” from a profitability perspective for at least the next one to two years.