Forestry Investment Prospects. Future and Present.
Russian Forestry development represents the overall country economic development and follows the current macro-economic changes. The Forestry is a multi-dimensional economic system therefore the macro economy has different affect on one and the same industries. We may attribute this to significant difference in target sale markets, business processes, business scope, and regional specifics of forestry enterprises. However, we may identify some key factors that will affect the forestry investment opportunity for the coming years. This forestry investment forecast is prepared by National Forestry Agency for Development and Investments (upon LesInvestInform site request).
Forestry development timeline
Retrospective analysis of Forestry investment activity enables us to identify two periods. Period 1 ranges from 2000 to 2014. During the period we note the internal consumption growth, business climate normalization, and ruble strengthening. All these made investment into internal market production more attractable. Here we talk about wood chipboard and fiber board, packing materials, high-quality paper and other products that we used to import by 2000. The growth of buying ability and ruble strengthening attracted foreign forestry players. The foreign companies have started their production facilities in Russia.
Foreign investors choose different ways to enter Russian market depending on business specifics, corporate investment strategy and required investment amount. In the paper mill case, foreign companies preferred purchasing shares in the mills. However, in chipboard and timber sector the foreign players entered the market through direct investment into their private production facilities with subsequent gradual expansion. In many cases, foreign companies first purchased local forestry production facility with financial and/or organizational challenges. Then the companies started direct investments.
This resulted in overall forestry product production increase mainly for the internal market. This also increased the foreign capital share in forestry. Moreover, we note the industry productivity and forestry market monopolization increase. Small and middle companies started to leave the forestry market replaced by vertically integrated companies with existing production, organizational, and financial resources. The production facilities feature modern technologies, low operational costs, and large capacity. These factors together with the developed sales network gradually reduced SMB with outdated production equipment. The trend will continue and the players will repartition the market.
Round timber export quotation is yet another important event. The quota was introduced in 2008 virtually banning all export. This had a positive effect on internal processing of round timber. However, large forestry enterprises experienced significant negative consequences as they failed to survive the changes.
Nonetheless, the stage ended well before 2014 ruble devaluation. Forestry started to suffer structural challenges typical to overall Russian economy. After 2012, we note significant demand decrease for timber as well as decrease of internal timber transportation. Economist explain this by exhausted economy model potential based on oil that led to stagnation and forestry decline. Of course, this decreased the investment activity in the field.
New economy reality prospects.
2014 ruble devaluation makes a new forestry development stage characterized by low ruble cost, internal buying ability decrease, and western financial sanctions. We shall also note the 2014-2015 shocks had little effect on investment activity in the industry. Business rapidly assessed the prospects of ‘cheap’ ruble and tried to benefit from high-yield investment.
The new macro-economic reality has the following trends. Trend 1. Export-oriented companies increase the production volume an export of finished product. Virtually all export-oriented enterprises enjoy the uphill trend and actively expand the production capacities. The situation is most favorable for most paper mills, plywood, export timber, and other product manufacturers.
Trend 2. Internal market oriented enterprises will recover their positions together with the Russian economy. However, not every enterprise possesses the required resources for recovery. Currently some enterprises partially changed their orientation to export market. However, not all the enterprises may implement the change. Moreover, many enterprises produced products for construction industry that is in downhill trend now. This mainly affects shaped timber and plywood segment for internal market, chipboard and fiberboard as well as joinery products and furniture. However, there are some exceptions to the rule. Russian manufacturers of OSB and high-quality paper types demonstrate positive trend due to specific competition configuration of the Russian market. In this case, we benefit from import phase-out.
Trend 3. We note the forestry monopolization increase. We also note limited access of SMB to credit funds. This limitation creates a funding gap that makes the development impossible. Large enterprises and vertically-integrated holdings do not experience such problems as they possess collateral and are able to get loans at minimal interest rate. This makes them more environment-resistant as compared to SMB. Forestry holdings with full or partial foreign participation are able to attract investments using own channels. This ensures a better position on the market.
Western sanctions had little effect on forestry. High interest rate of Central Bank of Russia is a limiting factor as enterprises are not able to take ruble investment loans. Nonetheless, large local or foreign enterprises have no difficulties with attracting funds.
Devaluation, low inflation, and ruble slow growth expectations are yet another positive trend in the new economic reality for forestry. This is the driver for forestry investments as investors expect long-term effect of “cheap ruble”. This enables them to make long-term investment and get ROI. The time will show whether the expectations come true.
Investments into Forestry. Business not for everyone.
Timber harvesting has significantly transformed over the last 10 years. Before 2000 timber harvesting was mostly a profitable business. Currently most timber harvesting enterprises balance on the profitability edge. We may explain this result with several reasons. 1. In 2000-2014 the timber harvesting operational expenses increased in Russia matching the European level. The expense increase shrinked the efficient lever of raw material transportation therefore affecting round timber export profitability. 2. In 2008 the authorities adopted round timber export limitations. This significantly limited external economic activity of forest harvesting companies. 3. Rapid forest harvesting decreased the number of high-quality forest plots. Moreover, the new plot development requires additional investments into forest infrastructure (road, bridge construction, etc.).
The emergence of forest harvesting holdings led to steady decrease of available areas. Currently, we see mainly large timber harvesting holdings on the market. The SMB market share decreases and the trend will continue in the nearest future. Investors will not be interested in forest harvesting as a standalone business due to low profitability, bureaucracy challenges, and low number of available and easy-to-access forest plots, requesting little investments.
However, we anticipate the investment increase into the forest harvesting business by vertical and horizontal integrated forestry holdings. The holdings will expand their role in forest harvesting business to drive down the cost of timber supply to their processing facilities. This approach offers a set of benefits. First of all, large holdings possess sufficient financial resources to set up modern and efficient forest harvesting facilities. Secondly, companies manage to drastically improve their economic efficiency by using end-to-end approach, i.e. harvesting and processing timber within the same company. Moreover, the end-to-end approach in timber harvesting and processing engage forestry companies to receive FSA and PEFC certificates. Furthermore, Russia creates favorable conditions for FSA forest and supply chain certification. Russia rates second after Canada - world leader. The trend is further promoted by foreign investors and external market requirements.
Forest harvesting shifts to monopolization and currently presents oligopoly market structure. Such structure offers significant benefits to forestry. The model of multiple small and independent harvesters competing failed to attract investments and encouraged illegal harvesting.
Paper mills are the key forestry investors both with Russian and foreign capital. With the increase of timber raw material consumption and raw material competition Russian round timber processing companies will be forced to think about timber harvesting as this will be the only way to increase raw material security of any production facility. Therefore, the steady investments flow into forestry will continue in long-term. However, this investment will generate low yield.
Investments into lumber, furniture, joinery production
Lumber production makes a clear representation of the country macro-economic situation. Due to consumers’ demand decline the internal market lumber profitability suffered a significant drop. A great number of sawmills and wood processing companies went bankrupt.
In contrast, export-oriented sawmills enjoy the peak of opportunities. Ruble devaluation promoted their profitability and offered a splendid opportunity to expand the market and production. Many export-oriented enterprises try to use the opportunities and expand their key products range and introduce the production of non-key items. Lumber export share boosted from 63 to 69 over the last ten years. A recent trend - wood pellet production from lumber wastes. This drives the sawmill efficiency up.
Joinery and furniture sales on external markets is a challenging business that requires an extensive sales network. Swedwood (IKEA group) is highly efficient in this field. The Company produces and exports products from its production facilities in Russia or by engaging other Russian sawmills. Solid wood joinery and furniture sales on internal market suffer crisis due to purchase ability decline.
Investments into chipboard and fiberboard production. Is it outdated?
Currently, the chipboard and fiberboard production is one of the most attractive investment areas. Therefore, mostly foreign companies decided to occupy the market segment, generating its rapid development. Chipboard production has increased by 1.45 times reaching the top capacity of 6.72 million m3. (In 2012), and fiberboard production volume (mainly MDF and HDF) totaled at 2.3 million m3 9In 2016), boosting virtually from a 0 value.
Slab production increase was stimulated mainly by foreign investors. We are largely talking about wood slab producers under the Egger, KronOSpan, Kronostar, Kastamonu, and IKEA brands. Their products have filled the DIY market as well as taken a strong position in furniture, door, and joinery product segment.
Foreign companies served as the main boost driver. However, Russian companies have also taken a part in the market shift. Despite the outdated equipment virtually all Russian manufacturers produce high-value-added products - laminboard. A number of national companies have managed to create their own finish product lines (LLC, “Zavod Nevsky Laminat” - Alternative finish range, LLC, “Syktyvkarsky Fanerny Zavod” - Lamarty finish range) as well chipboard products. The market received a higher-end products - Veneer chipboards and MDF/HDF, as well as CPL and HPL and UV-enamel coated boards. However, the purchase ability decline following the 2014 ruble devaluation contracted the said market opportunities.
Chipboard sector currently suffers a significant crisis due to decreased furniture and finish products demand. Crises has more severe consequences as the product has limited applicability and may not be used in other sectors. Therefore, there is limited or no product diversification. Overproduction and entry barriers provoke the EU low export potential of the products. However, local manufacturers managed to settle the overproduction on the Russian market by increasing the export to Central Asia (mainly to Uzbekistan and Tajikistan).
The challenging situation will continue on the market till the internal market demand recovers. This situation may, however, make a great number of manufacturers bankrupt. The Risk Group includes small-capacity companies that operate in the area of large market players.
Therefore, there no reason to expect chipboard investment increase in the mid-term perspective. We do not think the MDF/HDF production will receive investment till the local market consumption pattern starts to steadily increase. Russia launch a number of MDF/HDF facilities before 2014 that failed to expand their potential. In the result the companies stocked their warehouses without being able to sell the inventories.
Plywood and OSB Investment. Steady trend
We review the OSB and plywood market in one segment as both product types relate to construction boards despite the fact the OSB is fiberboard. Both board types have overlapping consumption areas and generate competing environment.
Plywood is product for export. Russian birch plywood is well valued on the global market and gets a high price. Russia produced no OSB board in Russia before 2000 and we initially planned no OSB production.
With the economy growth in the 2000s the market experienced significant deficit of the product on the local market. Therefore, the Russian plywood export dropped from 66% (2000) to 50% (2008) provided the plywood production and OSB import increased. By 2013 the OSB import volume stood at 710 thousand m3, local production generated only 101 thousand m3. In 2012 Russia launched first modern OSB production factory - DOC Kalevala (CJSC “Compact”, Petrozavodsk). During the next year Kronospan Egorievsk (Moscow Region) and Kronospan Mogilev (Belorus) started the production lines.
Ruble devaluation was a real challenge for the Russian construction boards consumers even despite the construction sector decline. Plywood sales on the internal market started to generate less profit. High OSB prices made the import useless. This generated a large lack of boards on the market that pushed the prices up. The product deficit and high prices attracted more investments.
In September 2016 we witnessed the first OSB production commissioning in Tver Region with total capacity of 500 thousand m3/year. Talion Group of Companies launched a modern Dieffenbacher production line. The project will unable to satisfy OSB board demand on the Russian market and will completely replace the imported products of this category. We may easily understand the investors’ desire to occupy the segment as this will permit them to make the best benefits.
Plywood is a bit different story. Ruble devaluation made plywood business a highly profitable one. We currently implement two projects targeted at export. We expect the overall plywood production increase. However, this will not change the product deficit on the internal market at this macro-economic situation.
Investment into papermill. No point of support
Papermill industry is one of the most industry intensive sector. The investments into papermill production exceed the investments in all other forestry sectors. As the production lines of many production facilities have high wear factor the investments aim is to prolong the equipment service life or replace the equipment. In this case, we do not increase the capacity as well as are not able to produce the products of absolutely new quality.
Russian paper mill industry in Russia has overcome several crises. Many enterprises suspended the activity or went bankrupt. However, the recent decade demonstrates some growth of the industry. Local paper mill industry structure exports semi-finished products (mainly cellulose). Nonetheless, the effective demand on the internal market engaged many companies to produce the most demanded paper and cardboard types. We mainly talk about packing paper and cardboard and sanitary and hygiene paper. However, the Russian market is still heavily dependent on import. The complete import phase-out requires significant investments
We need to note the investments into paper mill industry is heavily pressed by the global market. The increased number of digital gadgets decreased the consumption level of printed, writing, and newspaper paper. We may expect the trend will continue. Companies still actively develop new cellulose production technologies using less water, energy, and source material. The current market trend doesn’t make the investors optimistic as investment volume and ROI for paper mill are significant and the market changes too rapidly. Therefore, we will continue to experience investment stagnation at the paper market for quite a while. We do not think the internal and/or external positive stimuli will change the situation.