Key Takeaways
- We see the pulp and paper sector as having above-average environmental risks, compared with other industries. The forest industry itself we see as having average exposure.
- However, we consider environmental risk factors for the pulp and paper industries higher because of the high water- and energy-intensive nature of the production processes. Pollution and quality of water and air quality are also very important, given the extensive use of chemicals.
- The forestry sector, in contrast, is most exposed to sustainable forest management (land and biodiversity) as well as to physical climate (potentially affecting forest health) and severe weather risks (e.g., fires). Forestry companies are less exposed to carbon emissions, thanks to the carbon capture & storage capacity of forests.
- We see social risks as above average for the pulp and paper industry, stemming mainly from community interactions, health and safety standards, particularly in automated processes. Sensitivity to communities stems from the need for paper mills to focus on the quality and smell of the water and the air discharged during the paper production process.
- Customer behavior may see an increasing focus on certified forest and paper, and benefit from an ongoing switch to plastic-free and recyclable packaging solutions, but demand could equally be negatively influenced by rising environmental concerns and increased recycling, as paper use is an important source of waste and emissions.
- The main credit negative for the sector, however, is the secular decline in paper consumption that stems from digitalization, which we see as a general sector trend rather than environmental, social, and governance (ESG) driven.
Analytical Approach
Environmental, social, and governance (ESG) risks and opportunities can affect an entity's capacity to meet its financial commitments in many ways. S&P Global Ratings incorporates these considerations into its ratings methodology and analytics, which enables analysts to factor in short-, medium-, and long-term impacts--both qualitative and quantitative--to multiple steps of their credit analysis. Strong ESG credentials do not necessarily indicate strong creditworthiness (see "The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis," published Sept. 12, 2019).
Our ESG report cards qualitatively explore the relative exposures (average, below, above average) of sectors to environmental and social credit factors over the short, medium, and long term. For environmental exposures, the chart shows a more granular listing of key sectors and (in some cases) subsectors reflecting the qualitative views of our analytical rating teams. This sector comparison is not an input to our credit ratings and not a component of our credit rating methodologies; it is based on our current qualitative, forward-looking opinion of credit risks across sectors.
In addition to our sector views, this report card lists ESG insights for individual companies, including how and why ESG factors may have had a more positive or negative influence on an entity's credit quality compared to sector peers or the broader sector. These comparative views of environmental and social risks are qualitative and established by analysts during industry portfolio discussions, with the goal of providing more insight and transparency.
Environmental risks we considered include greenhouse gas (GHG) emissions, including carbon dioxide, pollution, and waste, water and land usage, and natural conditions (physical climate, including extreme and changing weather conditions, though these tend to be more geographic/entity-specific than a sector feature). Social risks include human capital management, safety management, community impacts, and consumer-related impacts from customer service and changing behavior to the extent influenced by environmental, health, human rights, and privacy (but excluding changes resulting from broader demographic, technological, or other disruptive industry trends). Our views on governance are directly embedded in our rating methodology as part of the management and governance assessment score.
The list of entities covered in this report is not exhaustive. We may provide additional ESG insights in individual company analyses throughout the year as they change or develop, with companies expected to increasingly focus on ESG in their communication and strategy updates.
Environmental Exposure
We see the forestry sector as having average environmental risks, notably resulting from sustainable forest management, as well as to physical climate and severe weather risks. The majority of issuers we rate with forest assets are large groups in South America, North America, or Northern Europe. Forests are subject to extensive land use laws and regulations designed to preserve sustainability, biodiversity, and air and water quality. Violating these laws could result in material fines or liability and could restrict our rated issuers' harvesting rates and profitability. Forest practices that are detrimental to forest health could bring about adverse publicity, boycotts, and regulatory scrutiny.
Forest companies are exposed to environmental factors that could affect wood supply and profitability. In tropical climates, for example, harvesting rates are higher. Forest companies are also exposed to event risk, such as fires or pest infestations. Reducing carbon emissions is less of a concern, as forests act as "carbon sinks" meaning they don't generate but instead absorb carbon dioxide emission.
As for the pulp and paper sector, environmental risks are above average, given the high water and energy intensity. Hence the largest pulp and paper manufacturers tend to be vertically integrated into energy, which is a key competitive advantage. Typically, the energy would be generated from forest-based biomass or another renewable source (such as wind power from wind turbines located on their land). The use of chemicals (such as chlorine, paper dyes, fungicides) in the production process also means the industry needs to closely monitor water quality.
Recovered paper prices have been low since the end of 2017, when the Chinese government implemented import restrictions on waste paper. Although this has been a key challenge to Chinese paper producers, it lowered input costs for containerboard producers worldwide and increased the demand (due to substitution) for virgin pulp. Any material change in Chinese government policies will likely affect global recovered paper prices.
Social Exposure
Social risks in the sector are typically average for forestry, while above-average for pulp and paper and mainly center on community impacts and investments in health and safety procedures as well as labor relations.
Pulp and paper mills tend to focus on the quality, smell and preservation of water as well as on the quality and smell of the air discharged during the paper production, conversion and transportation process. This makes the industry as sensitive to community interactions. Health and safety are also key considerations in the industry, particularly for wood manufacturers, owing to the highly automated nature of sawmills.
Customer behavior may see an increasing focus on certified forest and paper, and benefit from an ongoing switch to plastic-free and recyclable packaging solutions, but demand could equally be negatively influenced by rising environmental concerns and increased recycling, given that paper use is an important source of waste and emissions. The main credit negative for the sector, however, is the secular decline in newsprint and graphic paper consumption stemming from digitalization, which we see as a general sector trend rather than ESG driven.
ESG Risks In Forest And Paper Products
| ESG Risks In Forest And Paper Products | ||
|---|---|---|
| Company/Rating/Comments | Analyst | |
| Celulosa Arauco y Constitucion S.A.(BBB-/Negative/--) | ||
| We view Chile-based Arauco's exposure to environmental factors as similar to that of its sector peers. Arauco benefits from favorable climate conditions that underpin its competitive position. The efficient and fast-growing nature of its forest assets, sustainable forest management practices, and well-invested asset base support the credit rating. With planted forests of radiate, taeda, and elliotti pine and eucalyptus in Chile, Argentina, Brazil, and Uruguay, the company benefits from high harvesting yields and stands among the lowest-cost (in terms of cash) producers in the world, only behind Brazilian ones. The company's EBITDA margins are also supported by its 100% energy self-sufficiency. On the one hand, Arauco is one of the largest nonconventional renewable energy producers in Chile and sells excess capacity to the national energy grid and expects to be certified as the first carbon neutral company in the sector in 2020. On the other hand, its Chilean forests are exposed to wildfires that have caused considerable losses in the past. For instance, a massive fire in Chile in 2017 destroyed about 7% of Arauco's planted area, but the operational and financial impact did not cause credit metrics to materially deteriorate. The company subsequently launched a forest renovation plan in Chile and strengthened its insurance coverage and its fire prevention and suppression programs. These investments did not have a material impact on its profitability. | Amalia Bulacios | |
| Domtar Corp.(BBB-/Stable/--) | ||
| We see environment risk management and exposure for North America-based Domtar as comparable with that of its industry peers, because it sources wood from responsibly managed forests and all of its pulp and paper facilities are certified to chain-of-custody standards. The company's credit quality has not benefitted from its low-cost asset base and ability to convert paper assets to growth segments. Domtar is subject to strict environmental regulations. It has reduced its greenhouse gas emissions and the amount of waste (boiler ash) sent to landfills by converting six coal-fired power boilers to natural gas. The energy used in its mills is 72% from biomass (mostly wood residuals and pulp byproducts). The company treats and returns 90% of the water it uses in the pulp and water production process to the local watersheds. It also focuses on safety and injury prevention and has a track-record of improving the safety incident rate. We believe it will achieve its target (0.50) by 2020. | Phalguni Adalja | |
| Empresas CMPC S.A.(BBB-/Stable/--) | ||
| We view Chile-based CMPC's exposure to environmental risks as fairly aligned with the pulp and paper industry. Favorable climate conditions in Chile and Brazil support its high harvesting rates and above-average profitability. On the other hand, summer wildfires are frequent in Chile and have caused meaningful damage in the past. In 2017 a fire destroyed nearly 4% of CMPC's forest assets in Chile. That did not lead to a rating change, but remains an environmental risk we are monitoring. The company manages its forest base in a sustainable manner and all its forest plantations in Chile and Brazil are certified by the Program for the Endorsement of Forest Certification (PEFC) and Forest Stewardship Council (FSC; a certification from the leading independent third-party certifiers for sustainable forest management). CMPC also generates renewable energy from biomass, achieving up to 80% of self-sufficiency. We view CMPC's management and governance as fair. In 2017, after self-reporting the matter, the company had to make restitution of $150 million to Chilean consumers and will have to pay a $15 million fine for fixing the price of tissue paper with another player between 2001 and 2011. Although this highlighted shortcomings in its internal controls and governance, the fine and restitution had a limited impact on liquidity and credit metrics. CMPC has since replaced top-level executives and implemented several measures in line with guidelines provided by the Free Competition Defense Court. | Amalia Bulacios | |
| ENCE Energia y Celulosa S.A.(BB/Negative/--) | ||
| We believe that Spain-based hardwood pulp producer Ence is exposed to financial risk associated with a potential early termination of the concession extension at the Pontevedra mill, which currently represents 40% of its pulp production. However, we believe that Ence's upcoming investments could mitigate the financial impact. These investments include Ence's renewable energy business and a swing line at its pulp mill in Navia. The 2016 extension of the concession to operate the mill in Pontevedra until 2073 is currently facing legal challenges. These are largely driven by concerns from local organizations (Pontevedra City Council, the Association for the Defence of the Ría de Pontevedra, and Greenpeace) around industrial activities in Pontevedra. We understand that Ence is fully compliant with environmental regulation. Legal proceedings are likely to last four to six years. We don't think it probably that ENCE's credit metrics will be unaffected by these legal proceedings in the medium term, but they do represent a long-term risk. Ence has an environmental and social budget of up to €140 million for 2019-2023 (12% of its total capital expenditure planned). The budget will target investments in energy efficiencies, a reduction in waste water and carbon emissions, and improvements in safety measures. The group also seeks to enhance the welfare of local communities and to minimize noise pollution and potential unpleasant smells from its plants. Ence sources its wood from sustainable forest sources. Over 82% of the wood it uses in its pulp production is certified by sustainable forestry schemes like the Forestry Stewardship Council (FSC). FSC is a certification from the leading independent third-party certifiers for sustainable forest management. Ence has achieved an above-average recycling rate, at around 98% over the past three years, and targets a recycling rate of 100%. Ence also focuses on reducing its carbon emissions and minimizing its energy use, which is largely achieved via the cogeneration of energy at its pulp plants and supported by its biomass energy division. The Spanish government's long-term goal to generate all its energy from renewable sources by 2050 supports Ence's investments in renewable energy (40% of the group's 2019 estimated EBITDA). | Divyata Ved | |
| Klabin S.A.(BB+/Stable/--) | ||
| In our view, Brazil-based Klabin's overall ESG exposure is in line with that of industry peers. Environmental considerations are important to the sustainability of Klabin's business since sustainable forest management and obtaining the appropriate certifications are highly scrutinized by clients. Brazil, where the company's eucalyptus and pine trees are located, benefits from very favorable climate conditions, which result in high harvesting rates, particularly compared with European or North American pulp producers. Klabin's high degree of energy self-sufficiency (currently about 740%), results in a very competitive cost structure. The company is currently investing in paper packaging operations, which we expect to represent 350% of net revenue in 2023. A higher contribution from this segment would reduce exposure to the more volatile pulp segment, which would in turn reduce cash flow generation volatility. In the medium to long term, paper packaging would increasingly substitute plastic packaging, supporting continuous volume growth perspectives in the long term. | Felipe Speranzini | |
| Mondi Group(BBB+/Stable/--) | ||
| We view environmental and social risk factors for U.K.-listed Mondi, as similar to that of its sector peers. Mondi focuses on sustainable forest management; around 24% of its managed forests has been set aside for conservation purposes. All of its forests have certifications from the leading independent third-party certifiers for sustainable forest management. South African and Russian forests are all FSC certified. Its Russian forests are also certified by the PEFC. Wood sourced externally is either certified or from a controlled wood source (i.e., legally harvested, not genetically modified, etc.). Cost reduction is key to remaining competitive, since many of the products are standardized. As part of its ongoing efforts to streamline costs, Mondi seeks to reduce its energy consumption, in addition to reducing its carbon, greenhouse gas, and malodorous gas emissions. Biomass-based renewable fuels now account for about 64% of its fuel consumption. Mondi also focuses on waste reduction and limits its level of air and water pollution. In the medium to long term Mondi's cash generation could also benefit from the ongoing switch to paper-based and recyclable packaging solutions. | Desiree Menjivar | |
| PotlatchDeltic Corp.(BBB-/Negative/--) | ||
| We view the credit quality of North American PotlatchDeltic as more exposed to long-term environmental factors than other forest product companies. This is because climate change has brought about increased risk of catastrophic infestation and disease (as occurred with the pine beetle in Western Canada), fire, and potential long-term impact on growth rates of certain species. The health and sustainability of its forestlands is heavily regulated and core to the company's business, given its need for a reliable source of timber for many decades into the future. PotlatchDeltic has successfully managed its forestland health risks through the use of established silviculture practices, longer-term planting and harvesting plans, active management of the lands (thinning and building roads for access) and geographic diversity of its holdings. All of PotlachDeltic's land management units are certified to the Sustainable Forestry Initiative (a sustainability standard met by only 10% of the world's forests) or the FSC standard. The company owns nearly two million acres of timberland, harvests timber, and manufactures wood products in the U.S. The company's operations are subject to numerous environmental, land use, and safety regulations designed to preserve biodiversity, air and water quality, and wildlife. | Pablo Garces | |
| Pro.Gest SpA(B/Watch Neg/--) | ||
| We view Italian packaging group Pro.Gest SpA as less favorably positioned on environmental factors than other companies in the sector. The jurisdictional and political landscape of Italy also leads to a higher degree of regulatory uncertainties. Pro.Gest's containerboard mill in Mantova was initially due to start operations at a capacity of 200,000 tons per year from July 2018. However, local authorities have so far not granted the mill the environmental impact assessment ('EIA'; a tool used to estimate the induced effects of the mill on the surrounding environment) and they ordered the suspension of its operations in May 2019. The company submitted an amended EIA application, which now excludes its original request for a waste incineration plant. Management is hopeful that the mill will reopen in 2020 but further regulatory delays cannot be ruled out. The mill's €16 million inventory build-up in the first half of 2019 was one of the factors that led to the large working capital outflow in the first half of 2019. Our assessment of the company's management and governance as only fair also reflects the €47.5 million fine inflicted by Italian antitrust authorities in 2019 for the company's alleged participation in an industrywide price-fixing cartel. We understand that payments relating to this fine will kick in from February 2020. | Desiree Menjivar | |
| Rayonier Inc.(BBB-Stable/--) | ||
| We view Rayonier Inc.'s credit quality as more exposed to environmental risks than other forest product companies, because of long-term still unknown impact of climate change. Changes in average temperatures, precipitation and/or frequency and severity of drought, storm, etc. may impact growing cycles and rate. Also, recent history has shown the impact of catastrophic infestation and disease (such as the pine beetle in Western Canada, which has severely impacted harvesting there. Preservation and sustainability of its forests assets are critical to Rayonier's future operating viability as it requires a long-term, predictable supply of timber decades into the future. The company manages risks to its forestlands by following established silviculture practices, active health management of its timberlands, long-term harvesting plans, and spreading the risk through geographic diversity. In the U.S., Rayonier's timberlands are certified by the Sustainable Forestry Initiative and in New Zealand by the FSC and the PEFC). The company is also subject to extensive land use laws and regulations designed to preserve the environment. Rayonier owns and manages 2.6 million acres of timberlands in the U.S. and New Zealand. As a "pure-play" timber REIT with no wood product manufacturing, we believe Rayonier faces fewer safety risks than most manufacturing or industrial companies. | Pablo Garces | |
| Rayonier Advanced Materials Inc.(B-/Stable/--) | ||
| Environmental and social factors are key to Rayonier Advanced Materials Inc. (RYAM). The company operates four pulp plants, sawmills, produces paper-based packaging (containerboard) and newsprint, and manages forestlands. Its operations are subject to extensive land use laws and regulations designed to preserve sustainable forests and the environment. Violation of these laws could result in material fines or liability for remediation, and could restrict the company's output. RYAM also operates several cogeneration plants at its facilities, which rely on renewable biomass. It meets 42% of its electricity needs internally and 81% of the energy it uses comes from renewable resources. Formal programs are also in place to manage and monitor safety. The company manages more than 25 million acres of forestlands in Canada (owned by the provincial government) and supplies fiber to the company's lumber, paper, cellulose, and pulp operations in Ontario and Quebec. These lands are managed in accordance with FSC standards to ensure sustainability and preservation of land resources and wildlife. As a publicly traded entity with an independent board and long management experience in its core businesses, we believe RYAM maintains a proper balance of stakeholder and public interest. | Pablo Garces | |
| Sappi Ltd.(BB/Stable/B) | ||
| We view South-Africa based Sappi's ESG exposure as broadly in line with industry peers. Forests are subject to extensive land use laws and regulations designed to preserve sustainability, biodiversity, and air and water quality, while paper mills focus on quality of water and air discharged. Sappi has no history of significant environmental incidents, and focuses on renewable inputs (energy and pulp) and recyclable products. All of Sappi's forests are FSC-certified, 46% of the energy it uses is renewable, and 95% of water is returned to the environment (this is broadly in line with its large peers). Reducing greenhouse gas emissions (partly offset by carbon sequestration in forests), energy efficiency, and waste management are greater challenges. Furthermore, environmental regulations, in particular controls on emissions, are tightening in South Africa, which introduced carbon tax legislation effective June 1, 2019 (although some transitional arrangements are in place). In terms of social factors, Sappi focuses on a good health and safety track record, solid support of employment equity targets in South Africa, and good relations with unions and employees. | Omega Collocott | |
| Suzano S.A.(BBB-/Negative/--) | ||
| We believe Brazil-based Suzano's overall exposure to environmental and social risks is comparable with that of other pulp producers. Suzano has a good track record in sustainable forest management and achieving energy efficiencies, currently generating about 90 MW of annual surplus electricity. The company benefits from ideal climate conditions for pulp planting and harvesting and has a solid forestry research and development, which positively affect its operating efficiency through the industry price cycle when compared with higher cost producers in other regions. Suzano is expected to generate considerable synergies in the next few years related to the combination assets, given the acquisition of Fibria, which should reduce distance from forest to mills. These initiatives lead to high forest yields and short harvesting periods, and support the company's above-average profitability, with pulp cash cost. | Felipe Speranzini | |
| UPM-Kymmene Corp.(BBB/Stable/A-2) | ||
| We believe that Finnish UPM's exposure to ESG factors is similar to that of other companies in the sector. The group focuses on sustainable forest management and plants about 50 million trees every year. All of UPM's forests are certified and 85% of the wood it uses comes from certified forests (i.e., it meets the requirements set by an independent third party for sustainable forest management). Wood harvesting levels remain exposed to changes in weather conditions. The company increasingly focuses on developing renewable and recyclable materials (including fuels and chemicals) from bio-based materials. UPM also focuses on using a higher portion of recycled content and energy efficiencies via the production of hydro power, nuclear power, and biomass-based energy at its mills. UPM has a leaner cost base and lower waste, partially because 70% of the energy it uses is renewable. | Desiree Menjivar | |
| West Fraser Timber Co. Ltd.(BBB-/Stable/--) | ||
| Environmental and social factors are key considerations in assessing North American West Fraser's operating performance and we view them as generally in line with those of its industry peers. The company's operations depend on a reliable and consistent supply of wood fiber. West Fraser follows sustainable forest management practices (certified by independent auditors) in Canada. The mountain pine beetle infestation materially affected its operations in western Canada (30% of production) and we expect this to reduce the current and future timber availability. The company as a result has announced several temporary and permanent curtailments at its British Colombia (B.C.) sawmills to align production with timber availability. We believe this could affect employee morale, but the company expects to mitigate the impact by offering employees opportunities to work at other operations. In addition, caribou preservation plans in Alberta could also reduce timber supply. To offset these issues, West Fraser has reduced its exposure in B.C. and increased its presence in the U.S. South. West Fraser is one of the lowest-cost producers in the industry and has the ability to absorb the fiber escalation costs, without affecting our issuer credit rating on the company. To maintain its low cost position, the company has rebuilt sawmills, added continuous kilns, and focused on reducing its greenhouse gas emissions. Its energy cogeneration facilities use sawmill residuals and waste biomass to produce electricity. The company has invested in excess of US$500 million to improve the safety and competitiveness of its mills. | Phalguni Adalja | |
| Weyerhaeuser Co.(BBB/Negative/A-2) | ||
| We believe North American Weyerhaeuser's credit quality is more exposed to risks from environmental factors than the broader industry, due largely to potential long-term effects of climate change on the company's 12 million acres of timber assets. Maintaining healthy and sustainable forest lands is core to Weyerhaeuser's viability to ensure a reliable permanent source of timber. The company's timberlands are also heavily regulated to preserve sustainability. Long-term climate change could affect growing rates, lead to more insect infestation (as occurred with the pine beetle in Western Canada) and may increase the risk of catastrophic fires. Weyerhaeuser mitigates climate and environmental risks through active health management of its forest assets, following established silviculture practices, having fully developed long-term harvesting plans, and diversification of its holdings over a wide geographic area. All of the company's timberlands are certified to the Sustainable Forestry Initiative. Weyerhaeuser's operations are subject to extensive land use laws and regulations to preserve green spaces, wildlife and the environment. Legal violations carry material fines, potential liability for remediation and the risk of curtailed future operations, although no major restrictions have occurred in recent years. We view Weyerhaeuser's operations as relatively low risk to the environment compared with other industrial and manufacturing companies, that is, its operations do not produce high levels of pollutants or potential environmental damage. We view Weyerhaeuser's management and governance as in line with other large public companies. It was one of the first companies to establish sustainable forestry practices. | Pablo Garces | |
| Ratings as of Feb. 10, 2020. | ||
This report does not constitute a rating action.
| Primary Credit Analysts: | Desiree I Menjivar, London + 44 20 7176 7822; desiree.menjivar@spglobal.com |
| Donald Marleau, CFA, Toronto (1) 416-507-2526; donald.marleau@spglobal.com | |
| Amalia E Bulacios, Buenos Aires (54) 11-4891-2141; amalia.bulacios@spglobal.com | |
| Secondary Contacts: | Divyata Ved, London + 44 20 7176 7637; divyata.ved@spglobal.com |
| Thomas J Nadramia, New York + 1 (212) 438 3944; thomas.nadramia@spglobal.com | |
| Felipe Speranzini, Sao Paulo (55) 11-3039-9751; felipe.speranzini@spglobal.com | |
| Phalguni Adalja, CFA, Toronto + 1 (416) 507 3212; phalguni.adalja@spglobal.com | |
| Omega M Collocott, Johannesburg (27) 11-214-4854; omega.collocott@spglobal.com | |
| Pablo A Garces, Dallas + 1 (214) 765 5884; pablo.garces@spglobal.com |
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