Tuesday 11th July 2000
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That's news Carter's shareholders are keen to hear. As chairman Wilson Whineray admitted in the last annual report, "the closing years of our first century have been difficult. We have not achieved an acceptable financial return."
Big understatement from the big former All Black. For the year ended March, Carter produced an operating profit of $91 million (not including the $248 million one-off gain from the sale of its Chilean assets and other unusual items). That's up from last year's $36 million, but it represents a return on shareholders' funds of just 1.8%. Compare that to Telecom (40%) or Baycorp (47%), and ask yourself if you would invest in this company.
The market's answer is fairly easy to interpret: investors are looking for a company that can offer consistent long-term growth, and Carter doesn't look like it. At around $1.80, the share price is at half the level at which US giant International Paper (IP) bought in back in 1991. And immediately after the latest profit result, it shed $0.15, wiping $250 million off the market value of the company. Partly this was due to disappointment that Carter didn't hand out some of the $2.4 billion it got from selling the stake in Chilean forest products group Copec. But it also partly reflects the market's perception of the forest products industry. "Basically," says one analyst, "people don't like companies like Carter having that much cash."
That's because of its rotten track record investing it. The demand side hasn't been a problem - wood products consumption has risen fairly consistently by about 3% over the past decade. The problem has been massive oversupply. In the words of investment bank Merrill Lynch, the global pulp and paper industry has been "one of the great serial global capital destroyers".
"The main reason for that," explains Liddell, "is that during periods of strong prices people tended to reinvest the large amount of cash they got ... in creating new capacity."
Demand for wood and paper products rises and falls with the global economy as building work waxes and wanes and newspapers, for instance, experience stronger or weaker demand for advertising space.
For forest products giants like IP, Canada's Abitibi, South Africa's Sappi or Norway's Norske Skog, the pressure has been on to grow bigger and globalise. When prices were good they reinvested their big cash flows buying production assets. When building became cheaper than buying they built, adding yet more capacity that would sit idle when the cycle turned down.
It's a dymanic that pesters all commodity industries. But things are getting better with industry now disciplining its expansion, protests Liddell. "The amount of new capacity that's coming on in the global industry is virtually nil in most grades."
Merrill Lynch analyst Simon Gresham agrees the picture looks good. Pulp and paper capacity growth is at only 0.5% to 1.5% in most sectors - well below the 3% growth in demand. Trouble is, as New Zealand wool growers well know, demand can fall. What's more, says Gresham, if growth continues there is little doubt companies will start building plants again. "That will happen but it hasn't started yet."
All these things conspire to make Carter look like it is caught on a commodity treadmill, with huge amounts of capital tied up making products whose prices it can't control. And who'd want to be in that kind of business these days?
Into the woods
Well, Carter, actually. Were it not for two global crises of the past decade, it could have been on the treadmill, riding high by now. The company took first place among New Zealand forestry companies in 1990 with the $1.2 billion acquisition of Elders Resources NZFP (the ailing Forest Products company) but ran into trouble a year later when the Gulf War spooked banks and created a downturn in confidence. The banks insisted Carter quickly repay huge chunks of debt and Brierley Investments (BIL) took the opportunity, gaining control. BIL flicked the shares on to IP, which installed David Oskin as chief. At that time, says Cavill White analyst John Cairns, there was no urgency to cut costs and lift productivity because by 1995 commodity prices were at the peak of the cycle, with Carter booking a $445 million profit and earning a reasonably respectable 9.9% return on shareholders' funds.
Then came the Asian crisis. Log exports virtually disappeared as demand plummeted. Last year the return on shareholders' funds was just 1.3%.
The accompanying chart shows that, while earnings per share have been an up-and-down affair, the long-term trend has been sideways. And, over time, the company hasn't earned its cost of capital - it has been destroying value.
Cairns says Carter had already realised the error of its ways before the Asian crisis bit. "The cost base was too high relative to the margin they were extracting across the cycle. They needed to lift the level of productivity and the whole way the company was run," he says, meaning basically, it was spending too much.
Thus was born "Project Genesis", a three-year earnings improvement drive, started in 1998 under the reign of Carter's second IP chief, John Faraci - a much underrated man, according to Cairns. Faraci was called home to the US early in 1998 and was replaced in May last year by Liddell - a former investment banker with CS First Boston.
The new mission
With costs now firmly in hand and the timber cycle on the up, Liddell has the unenviable job of driving growth. The challenge, as he sees it, is two-fold.
First, he has to shift the whole earnings trend line higher, so that Carter returns more than its cost of capital over the whole of the boom-bust cycle. Second, he has to tilt the trend line upward to achieve consistent profit growth.
To get the first bit right, Carter has been taking a long, hard look at where its money is invested and where it's making its best returns.
Its cost of capital (that is, the interest bill on CHH's debt plus the cost of its shareholders' funds) is around 11% of total assets, so only one of the five main businesses is in the black - tissue, which is returning 13%. Wood products breaks even on 11%. Packaging and distribution (7.5%), pulp and paper (5%) and forests (4%) come nowhere near the grade.
Improving these figures is what Liddell means when he talks of "industry leadership". One initiative is simple asset-switching, like the move out of Chile and into Australia. "It's about investing in businesses we think we can be winners in and getting out of others."
But Liddell says there is a much more fundamental shift afoot within the company. Basically, it means thinking less about Old Economy drivers like machines and manufacturing plants and more about using New Economy principles like branded products and getting the best out of people. "Traditionally we've taken a capital-intensive way of solving problems - spending more money, buying more assets, getting bigger. Now we have a change in the way people think about value," he says. "We need to not only keep good things but reorientate from a tangible asset mentality to an intangible asset mentality. So things like brands, intellectual property, networks, the development of e-commerce, other new business ventures that might be relatively capital-light but value-heavy."
That all sounds right, like a good textbook should. Ask Liddell to go deeper than rhetoric and, to his credit, he can supply concrete examples.
Thinking smarter Take Carter's decision to stop clear-pruning its trees. Clear-pruning produces clear wood for appearance, but it isn't cheap and there wasn't enough demand.
"If you want a nice-looking table you make it out of MDF [medium density fibreboard] and put a clearwood veneer on top ... If you're in the wealth bracket that insists on solid wood, you'll probably buy mahogany or rosewood, not radiata pine."
Anyway, liddell explains everybody else was doing it - the company would be able to buy all the clear wood it needed.
Adding value Carter is building a $110 million LVL [laminated veneer lumber] plant in Whangarei that will turn low-value logs into solid beams that are stronger than the initial log. It's a strategy that appeals to ABN Amro analyst Dennis Lee. "In future, demand for wood products will be driven more by wood technology than wood quality," he says.
People focus Carter has instituted an annual "culture survey" in which all employees - anonymously - get to say what they think about the company, and the boss. Lee says focusing on people will be crucial. "Competitive advantage of any company actually comes from human resources. In commodity industries your capacity to differentiate your products is quite limited ... Carter has to manage its human resources in such a way that it identifies and pursues profitable opportunities that flow down from the core business."
Liddell agrees. "It's my belief, what we do on the people side in terms of leadership and culture, there's absolutely as much upside in that as in anything we've done in [Project] Genesis."
Rewarding ideas Carter is also introducing a programme called "i2b" [ideas to business], an internal competition in which people submit ideas. The promising ones will get the resources to develop a business plan, and the best of these will be launched as business ventures.
"We're saying to people, 'If you come up with great ideas, here's a non-traditional way to promote it without going through five layers of decision-making,'" says Liddell.
"It's how we hope to attract people who would otherwise see us as a traditional company chopping down trees and making commodity products."
Examples range from the very simple to the relatively high-tech. Carter makes cardboard boxes with slits around the base and corresponding lugs around the rim so they can be stacked in more stable piles. It's licensing the idea around the world.
Instead of selling builders beams and boards it's offering a complete flooring system with the beam construction already figured out. And it's adding value to basic LVL by supplying architects and builders with CD-Roms giving engineering specifications for size and load-bearing capacity.
Venture investing Backing the i2b concept is the $15 million venture capital fund announced in May. Liddell says it will serve several purposes. "When you talk about tilting the line it's by creating whole new entities that might take some aspect of expertise that's buried in the industrial structure we have."
A low-tech example is in forestry management. Carter has forests around the country and sees an opportunity to manage estates for smaller owners, harvest their trees and use its distribution and marketing infrastructure to take the wood to end-users.
Offshore investment Liddell sees big opportunities in Australia, which has always had a wood deficit and has never exported radiata pine. "That'll turn around in the next few years. Most plantations are government-owned and there's virtually no expertise in exporting and the associated logistics. There's huge potential for us and these things don't require a lot of capital."
E-commerce aware And the company's ready - nearly - for the onslaught of e-commerce, Liddell says. "Promising to deliver electronically is one thing, actually being able to do it is another." He sees threats and opportunities in the technology. Manufacturing has been put on to an SAP platform across the company. And he's not worried about e-procurement meaning business just goes to the lowest-cost supplier. For one thing, Internet shoppers will look at the quality associated with a brand name as well as price, he says. For another, "Our market shares in this part of the world are such that whichever markets we join, we're almost certainly going to be winners by virtue of critical mass.
"There's no doubt e-markets will cannibalise some of our businesses but we're a hell of a lot better off doing it to ourselves than having somebody else do it to us."
Not yet out of the woods
So can Carter turn itself from a lumbering commodities price-taker into a high-margin innovator? Liddell certainly talks the talk, but the jury's still out on whether he can walk the walk.
There's still that $2.4 billion wad of cash burning a hole in the company's pocket. It's earmarked for investment in "core segments in Australasia", but will it create value? An analyst with Salomon Smith Barney, Stephen Hudson, thinks so. He describes the logic for this strategy as "compelling". Hudson argues Carter's forest estate, which makes up half of his $4.5 billion gross asset valuation of the company, hasn't yet reached full maturity and hasn't been fully integrated into downstream processing - in other words, it's still making low-margin log sales and it'll soon have a lot more logs.
"Further investment along the lines of the [Whangarei LVL plant] has to be made in order to capture the full potential of this resource," Hudson says.
Another question mark for investors is the attitude of Carter's 50.3% owner, IP. A combination of a bombed-out share price and a 15-year low for the New Zealand dollar means it has never been cheaper for IP to buy the rest of the shares. On the other hand, the low exchange rate has eaten into IP's already paltry recent returns, prompting speculation it could be thinking of selling out.
John Faraci, now IP's chief financial officer, says neither is the case. "Carter is a strategic business to IP. We don't have to own 100% to participate in the developing and growing Asian markets ... More-over, Carter's financial position is improving. It still has a way to go to meet the criteria shareholders expect. But we are comfortable with IP's shareholding at its current level."
The dire performance of the share price suggests other investors aren't so comfortable, even if the analysts are. "This is like a child who's done something naughty," ruminates Neil Paviour-Smith, head of research at sharebroker Forsyth Barr. "As a parent you ask yourself, do they know they've done something wrong, and will they do it again?"
The market will probably wait to see if Liddell's "disciplined spending" mantra is more than just talk. If he gets that right, Carter's second century in business will be off to a great start.
Nick Stride is business editor at the National Business Review and a regular contributor to Unlimited
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