Transformation of China’s Containerboard Industry: Will Winners Take It All?
China’s stricter environmental policies stimulate the transformation of the containerboard industry, which in turn is leading to industry consolidation. Weakening consumption, however, is enlarging the imbalance between supply and demand, making new capacity additions unlikely in the short to medium term. China’s containerboard producers are implementing integrated strategies in order to stay competitive, focusing not only on securing fiber supply, but also on diversifying their product portfolio and vertically integrating converting plants.
Industry Transformation Leads to a More Consolidated Market
China will continue to implement strict environmental policies. Stricter recovered paper (RCP) policies result in widening cost disadvantages for marginal containerboard producers and eventually forces them to close. In 2017, the government introduced a threshold of 50,000 metric tons of installed capacity for producers to be able to apply for RCP import permits. Also, most of the cheaper imported RCP is being granted to major players (Nine Dragons, Lee&Man and Shanying). So, although the total RCP import quota has gradually declined, the joint quota share of the three major players increased from 44% to 61%, in 2015 and 2019 (first 13 batches), respectively (see Figure 1). By doing this, the Chinese government stimulates the transformation of the industry but also implicitly regulates who the winners will be. According to the National Bureau of Statistics of China, by August 2019, 20% of China’s paper mills operated at a loss, compared to 16% in 2018 and 10% in 2017 (see Figure 2). It’s inevitable that smaller mills will continue to shut down. This lowers environmental impact, as they are often less efficient, and leaves larger producers with a greater market share.
At the same time, from 2015 to 2019, containerboard producers added 7.9m metric tons of new capacity in China, reaching the highest level of total capacity – 59.0m metric tons – by 2019 according to Fastmarkets RISI. This was driven by healthy containerboard demand, uninterruptedly growing at 4.1% CAGR in the period 2015 to 2017. With these investments, the companies were also aiming for better positions on the cost curve and timely modernization in anticipation of stricter environmental policies.
New low cost capacity is forcing the closure of less-efficient producers, and allows big producers to move towards a more consolidated market. Over the last decade, the top-three producers have increased their share of total capacity from 26.5% in 2009, to 34.5% in 2019. Given the announced projects, this market share is expected to further increase to 43.4% in 2021. Less efficient capacity being removed from the market in the short term will outpace new capacity additions, resulting in the decline of total capacity in 2020-2021 (see Figure 3).
Will China Absorb All Additional Capacities?
The CAGR15-19 of 3.6% capacity growth is significant, especially given that changes in China’s RCP policy have disrupted the country's corrugated packaging growth. China’s containerboard demand declined by 7.9% YOY in 2018. Subsequently, China’s containerboard producers faced low operating rates of 76% in 2018. In 1H 2019 the Chinese market remains sluggish, with operating rates below 70%.
The uncertainty about China’s labour market, and the economy in general, might hold back consumer spending, while exports of goods are set to remain subdued due to US tariffs and waning global trade growth. Also, the leading e-commerce and delivery companies are jointly investing in reusable packaging solutions. Therefore, demand for containerboard might remain soft in the foreseeable period. Under such market conditions, together with existing fiber supply issues, some players had to delay, postpone or even shelve new projects (see Table 1).
Diversification and Integration to Stay Competitive
China’s corrugated paper packaging players are likely to continue operating in this challenging market environment in the short to medium term. In our previous report, we discussed various strategies Chinese companies use to secure fiber supply locally and abroad. Simultaneously, to stay competitive, companies are seeking new strategies for achieving healthy and stable growth. These include:
–Diversifying the product portfolio: adding new products to the portfolio (organically or via M&A activities) or expanding into new non-packaging paper businesses. For instance, Nine Dragons recently released new lightweight testliner and recycled medium, targeting downstream off-takers looking for highly cost-efficient products. Nine Dragons also recently bought a warehouse in Wisconsin, which will eventually be used as a corrugated plant. This suggests that the company may have plans to integrate their recently acquired paper mills downstream into US corrugated packaging. Shanying has added kraft and greaseproof paper to its portfolio and by acquiring Nordic Paper in Sweden in 2017, diversified geographically. Lee&Man Paper took advantage of its own pulp and other resources (captive power, water treatment and port facilities), used for containerboard production, to expand its tissue business in Jiangxi in 2019. This has become the new growth engine for the company.
–Vertical integration: leading containerboard producers are entering the converting business to offer tailor-made packaging solutions, to generate downstream synergies, and to enhance their negotiating power. For example, in 2018, Longcheng Paper announced an investment of RMB 320m in building converter plants with an annual capacity of 180m m2, and in 2019, Nine Dragons acquired nine converting plants in China and Hong Kong.
Sink or Swim?
Recent developments indicate that containerboard market consolidation and transformation are accelerating in China. It is questionable whether it’s good timing for producers to invest in new capacity. Despite all of the strategic efforts, China’s producers, also leading ones, are challenged by the imbalanced market, product homogeneity, and shortage of cost-efficient fibers. Also, for the companies that had already planned new capacity additions in the next few years, there will be no access to OCC quotas, given China’s move towards zero RCP imports. All of these factors can hurt margins.