Goldman Sachs Paper & Forest Products: Global pulp inventories down 1 day mom and -18 yoy, to 26 days

Ship-to-cap ratio at 95%; does any other commodity have this ratio?

Global pulp inventories down 1 day mom and -18 yoy, to 26 days The Pulp and Paper Products Council (PPPC) released global market pulp statistics for September 2009 this morning (October 22), which we believe was another positive statistic for the sector and will support recently announced eucalyptus pulp price increase for November. Inventories fell
further to 26 days, down 1 day mom (in line with the seasonal pattern) and 18 days yoy. Global pulp producers’ inventories are well below the historical average of 33 days of supply. Global market pulp production may have reached 3.4 mn tons in September, or flat mom, and 11% below the peak level reached in 2008. We estimate global pulp inventories at 3.1 mn tons, which is the lowest level since May 2007 and 0.8 mn tons below the normalized level (assuming 33 days of current pulp shipments).

Higher shipments to Western Europe offset lower China ; world shipments +10.3% yoy
Global pulp shipments were down 1.3% mom and up 10.3% yoy. The highlight was the rebound of pulp shipments to Western Europe , the largest market globally, which increased 11.4% mom and was just 6.5% lower on a yoy basis. September shipments to W. Europe were the highest level since October 2008. Shipments to China remained highly volatile, falling 23% mom but doubling yoy. We expect monthly shipments to China in the short term to be very volatile, but at a much higher level than in recent years.

Pulp prices could be on their way to US$800/ton level in W. Europe
We believe if pulp traded on the LME and had high liquidity, future contracts would likely point to hardwood pulp prices above US$800/ton in 12 months. All the drivers for sharp pulp price increase are aligned: (1) all published inventories around the world are at low levels, (2) ship-to-cap ratio is 95%, (3) paper-to-pulp price spread is still above historical average, (4) China ’s economic performance remains very strong, (5) USD remains weak. An important difference from recent cycles is a lack of pulp mill start-ups until 2013; we estimate additional capacity of 1.9 mn tons vs. forecasted pulp demand growth of 4.1 mn tons (2010-2012). In our view the world will have to rely in the next 3 years on the restarting of old/inefficient pulp mills, which have very high production cash costs and will set the base price for pulp globally. We believe investors should have overweight exposure to pulp stocks vs. other commodities stocks that have worse global supply-demand balance and are trading at a premium to mid-cycle. Top pick is Fibria (VCP).