QFR Paper Manufacturing – 2014 First Quarter

With this post we are initiating coverage of the Census Bureau’s Quarterly Financial Review data for the U.S. paper manufacturing industry. Each quarter the Census Bureau samples a broad array of U.S. corporations to gather a snapshot of business sector health and activity. The program, known as the Quarterly Financial Report, or QFR, survey has been collected and published for over sixty years by various Federal agencies, the Census Bureau being the current administrator of the program. These data provide a standardized and comprehensive look at the financial condition of the industry.

Results from sampled businesses are aggregated and reported by the North American Industry Classification System (NAICS) and by asset size category. There are separate NAICS codes for wood product manufacturing (“321”) and paper manufacturing (“322”). Based upon returned sample surveys, the QFR presents estimated statements of income and retained earnings, balance sheets, and related financial and operating ratios by industry sector and asset size category. What’s reported in this blog is only a snapshot of the other data reported by the QFR survey.

The paper manufacturing data is categorized by asset size: firms with less than 25 million dollars in assets (“small firms”), firms with more than 25 million in assets (“large firms”), and all firms regardless of size. While the data is somewhat dated, it provides a useful perspective on business direction and momentum with respect to the current cycle as well as providing benchmarks for individuals firm’s performance.

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Viewing the 2014Q1 data, the picture that emerges is a gradually improving industry sector that was hampered by adverse 2014Q1 weather conditions, which have been widely reported by the financial media as the principal cause behind 2014Q1's negative real GDP print. Comparisons to the prior quarter (2013Q4) are further complicated by significant non-operating income and a significant federal tax credit received in 2013Q4. Granting these complications to in-depth interpretation of 2014Q1 industry results, probably the most significant observation is although year-over-year industry net sales increased by 5.5%, operating margins fell, dropping from 5.74% in 2013Q1 to 3.49% in 2014Q1. However, despite loss of operating margin, the industry’s focus on asset rationalization has maintained both ROE and ROA in the solidly within the upper quartile of performance relative to the past 10 years.

Selected financial results of paper manufacturers’ first quarter 2014 is summarized in the table shown below. Notable highlights (see table below) include:

• Net Sales – 2014Q1 net sales ($32.9 billion) retreated by 3.2 percent compared to 2013Q4’s net sales, a reduction approximately three times larger (more negative) than the median reduction seen between Q4 and Q1 over the past ten years. Despite dropping from 2013Q4’s sales, 2014Q1’s net sales increased by 5.5% compared to 2013Q1’s net sales level.
• EBITDA – 2014Q1 operating cash-flow, or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), posted 10-year lows for both large firms and the industry.
• Operating Income – 2014Q1 operating income was in lower quartile of last 10 years for industry and both large and small firms.
• Pre-tax Income – 2014Q1 pre-tax income posted significant declines to 2013Q4, dropping nearly 52 percent compared to a 10 year average percentage change between Q4 and Q1 of nearly 12%.
• Net Income – 2014Q1 net income posted significant declines on both a quarter-over-quarter basis as well as on a year-over-year basis. As noted earlier, quarter-over-quarter comparisons are complicated by large non-operating income received in 2013Q4. However, year-over-year comparisons don’t suffer from this issue and point to significant cost structure increases in 2014Q1 vs. 2013Q1: year-over-year sales improved by $1.7 billion while net income fell by $0.9 billion, a combined implied cost delta of $2.6 billion, or 8.3% on 2013Q1 sales of $31.2 billion.
• Operating Margins – 2014Q1 operating margins showed significant erosion across the board on both quarter-over-quarter and year-over-year comparisons.
• ROE and ROA – Despite apparently increasing operating costs both Return on Equity (ROE) and Return on Assets (ROA) posted year-over-year increases and were in the upper quartile of performance relative to the past 10 years.

(For Larger Image Click on Table)

The key unknown for the industry sector is how much of the increase in 2014Q1 operating costs was attributable to the adverse weather conditions that were blamed for the negative GDP change. The fact 2014Q1 sales contracted from 2013Q4’s net sales level by more than the median percentage between Q4 and Q1 over the past 10 years is consistent with adverse weather impacts. However, 2014Q1’s net sales increase relative to 2013Q1’s net sales potentially challenges weather as the principle explanation for 2014Q1’s EBITDA, operating income, pre-tax income, and net income declines. The second quarter data, due to be released mid-September, will provide additional insights into the industry’s trajectory this business cycle.