BEDFORD, MA, Sept. 13, 2013 (RISI) - International Paper recently announced the closure of its large paper mill in Courtland, AL, which will remove 740,000 tons of uncoated freesheet and 116,000 tons of coated freesheet capacity from the North American market. This mill's uncoated freesheet production costs were firmly entrenched in the first quartile, so its candidacy for shutdown was not immediately apparent when solely analyzing the strength of the machines. However, there are various other important company-level factors that we consider in our forthcoming risk study on freesheet paper production around the globe, and we indeed measure International Paper as presenting the highest company-level strategic threat of any uncoated freesheet producer in North America.
First, International Paper's status as the second largest producer of uncoated freesheet in North America will leave it with ample capacity at its four other mills, which may benefit from an improved demand/supply balance. This move will improve industry operating rates and allow an internal shift of production to higher-margin grades, as the Courtland closure will better match the company's supply to demand. International Paper's strong motivation for improving its paper margins can be seen in its latest financial report; operating income for the North American printing paper segment dropped to an $8 million loss in the second quarter of 2013, compared to earnings of $63 million in the first quarter of this year and $69 million in the second quarter of 2012, although the second quarter result does include a non-recurring charge of $28 million due to a customer's bankruptcy and some downtime expenses.
Even though Courtland will remove 23% of International Paper's North American graphic paper capacity, improved margins at the remaining mills and a more profitable grade mix could actually help this closure have a positive effect on earnings thanks to the size of the company's uncoated freesheet business. International Paper CEO John Faraci mentioned the resulting improved grade mix as a motivating factor in a September 12th presentation, citing the value-added production at the higher cost capacity of Georgetown, SC, and Ticonderoga, NY, as advantages for these mills.
It is also important to consider the coated freesheet production and relative corporate significance of this mill, which was International Paper's only non-bristol coated freesheet capacity. Unlike the uncoated business, coated freesheet accounts for only a very small portion of the company's total revenues, so this production was considered a high strategic risk. In fact, even uncoated freesheet production is becoming less strategic. Faraci estimates that the North American printing paper business has fallen from a 20% share of EBITDA to a level of 7-8%, illustrating the company's increasing focus on its large packaging footprint, which has become even more essential thanks to the ongoing retreat of paper demand. The small impact of the Courtland mill's closure on total revenues makes its closure much more palatable for the company.
Finally, International Paper is operating with a fairly high degree of leverage, which, along with the stronger grade mixes at other uncoated freesheet mills and general retreat of paper demand, makes the Courtland mill a less attractive candidate for major investments to keep it viable. International Paper has previously shown a preference for large closures over gradual curtailments, as seen in its 2010-2011 shutdown and subsequent conversion of the Franklin, VA, mill to fluff pulp.
In summary, although the Courtland mill's low costs did not mark it as an obvious choice for closure, International Paper's choice to proactively close freesheet capacity was not surprising due to its large uncoated freesheet market share, the declining importance of paper production to its overall business and the company's high degree of leverage. It is important to not only consider a machine's relative position on the cost curve and other characteristics when assessing risk, but also the threat posed by the ownership's position and strategy.