North America Folding Carton Is Ripe for Investments

This discussion focuses on the three grades relevant for food production: solid bleached sulfate board (SBS), coated unbleached kraft board (CUK), and coated recycled board (CRB).

Over the past three years, folding carton grades have experienced a historical surge in prices across the board. Price increases have ranged from 31% to 44% among various grades and have led inflation indexes, while prices of other paper products trended downward recently. The pricing increase goes well beyond adjustments for costs inflation and reflects strong market demand from Covid-related consumption and from substitution for plastics in a consolidated sector. With the recent decline in energy and (recycled) fiber costs, producers have been able to maintain or further expand their profit margins. The market is ripe for new investments, production optimization, and machinery upgrades.

While the closure of older and less efficient mills is expected to continue, the industry is witnessing an intensifying race to add new capacity and flexible capacity that can switch between grades. Additions totaling close to 2m metric tons of folding carton capacity have been announced for the next decade (see Figures 1 and 2), resulting in a net increase of 24% if all projects are completed, a rare number for this industry.

Though future demand is unlikely to support another round of Covid-like price increases, we believe additional capacity will have a limited impact on pricing. Firstly, the sector is consolidated. Secondly, we expect some older capacities to exit and balance out the market. These are typically announced closer to the date.

Looking back ten years, coated unbleached kraft board (CUK) has been the only grade with continuous capacity additions due to strong demand from the beverage carrier and foodservice market, while solid bleached sulfate board (SBS) and coated recycled board (CRB) capacities have been declining (see Figure 1). Covid and the substitution for plastic brought renewed momentum for SBS and CRB, with the potential for efficiency improvements and growth prospects lasting well beyond Covid.

CRB and Efforts To Improve Efficiency

CRB is the lowest-priced folding carton grade, and the outlook for CRB demand from retail and packaged food companies appears stable. While the next two years may be challenging for sales volume due to the macroeconomic environment, the overall impact on consumer staples and packaged food volume will be limited. CRB’s cheaper prices may even attract certain users to switch from virgin grades given the inflationary pressure.

Compared to the other two grades, CRB is currently almost 20% cheaper in terms of the selling price, but its average production cost is at an 8% premium compared to CUK, the lowest-cost folding carton. There’s also a large variation of 34%, or USD 200/metric ton, between the most and least efficient CRB mills, suggesting great potential for cost reduction. Thus, efforts are focused on increasing operational efficiency and integration, optimizing strategic locations, and improving product quality and strength. For example, Graphic Packaging International’s new mill in Waco, Texas, its second major CRB addition in recent years, is expected to lower production costs by as much as a third (see Figure 2). It will also help shift CRB production to the South, providing good access to Graphic Packaging’s network and to recycled fiber, a key raw material for CRB production. Close to 39% of the current CRB mills are located toward the higher end of the cost spectrum. While the current strong retail prices can support profit margins, we would not be surprised to see continued cost-reduction efforts in high-cost mills from other producers.

SBS and the Impact of European Competition

SBS demand has been mildly declining over the last decade (see Figure 1), but producers were able to stabilize pricing with capacity closures in the past. While demand from domestic frozen foods, foodservice, and luxury packaging bounced back after a temporary slowdown at the beginning of Covid, SBS is facing increasing competition from the unbleached grade (CUK) and foreign imports (folding boxboard, or FBB) as substitutions. SBS capacity has been adjusted precisely to match market demand and maintain profitability. Recent investments in the bleached grade mostly focus on converting paper machines to swing between SBS and CUK production in order to match market demand (see Figure 2).

Despite challenges¹, European FBB is becoming increasingly competitive with domestic SBS and exerting pressure on retail prices – currently through imports and soon through local production. Several European producers have been exporting FBB to North America. Now, with lower energy prices, normalizing ocean shipping costs, and improving shipping schedule availability, FBB imports could enter North America at a more competitive price than before and become an increasing threat. European player Billerud announced plans to produce FBB and CUK at its mill in Escanaba, Michigan in the next five to ten years (see Figure 2). If successful, this will make locally produced FBB more accessible to compete directly with SBS.

In general, we expect healthy demand for all folding carton grades, although demand is unlikely to support the continuous price increases seen in the past three years. We expect pricing to stay mildly above inflation in the near future. While all grades could benefit from operational efficiency improvements, CRB and SBS are under the most pressure (from tighter margins and European and CUK competition, respectively). We expect capacity optimization to continue and swing machines that can switch between virgin bleached and unbleached grades to become increasingly popular.

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¹ FBB is the European version of the bleached grade, but it’s cheaper and has a higher yield. Its multi-ply structure also may allow for more technical properties. But integration into the North American system will be difficult and expensive due to dated machines that cannot run multi-ply boards.