One of Russia’s biggest natural resources is also one of its least talked about: its “green gold:” Trees.

The country stretches half way around the world, yet the bulk of the interior is devoid of people and one giant forest. Russia is home to one tree in four on the plant, and also three quarters of the earth’s soft wood that is ideal for making paper. But the business has lain fallow until recently; Russian company Segezha is in the middle of tapping this resource and has already made a Russia a world leader in the paper, pulp and packaging businesses.

“In 2014 Sistema identified forestry as a high potential investment. Russia had not invested into the sector for many years, especially not into soft wood. Sistema set out to build a world-class company,” Segezha’s CFO, Rovshan Aliyev, said in an exclusive interview with bne IntelliNews.

Sistema began to acquire forestry companies and paper and pulp plants around the country, investing over $1bn, with the main facility being the Segezha paper and pulp mill in Karelia in Russia’s north-west.

With the attention slowly returning to the climate crisis, Russia’s wood processing and timber business is coming back into focus, as bne IntelliNews reported in a recent company profile of Segezha, predicting an IPO of the company that is now expected to happen very soon.

Today the company is one of the largest vertically integrated paper, pulp and packaging producers in Russia, and one of the biggest in the world.

Russia is famous for its raw materials production, but while oil, gas, metals and diamonds catch most of the attention, Russia has one further huge reserve of a valuable but under-utilised natural resource: trees.

Segezha is also one of the largest leaseholders of forests, by hectares, in Russia, which is the resource the business is based on. Controlling the paper production process from start to finish gives the company big cost advantages, says Aliyev.

“We have built a company that is both vertically and horizontally integrated,” says Aliyev. “We have everything included – from the forests to the efficient distribution channels – and so we seek to maximise the entire potential of each tree to maximise the profit. There is minimal waste.”

Business lines

Segezha has four main business lines: paper and packaging, forestry and woodworking, plywood and boards and specialist products like construction materials.

The biggest of the four is paper and packaging. Segezha produces its own pulp, then converts that into paper, of which 35% goes into the production of its own packaging. The company is the second-biggest producer of packaging in Europe, with plants in Germany, Italy, Romania, Turkey and elsewhere. It is also the biggest producer of packaging in Russia with more than 60% of the market.

“In 2017 we invested RUB11.5bn [154mn) into a new German paper-making machine that is the best in Europe. It makes very high quality paper,” says Aliyev.

Paper and packaging accounts for 60% of EBITDA. 30-35% of paper produced by the company is converted to packaging, but the company wants to increase this to 50% in the future, says Aliyev.

The next big business segment is forestry and timber. The company produces about 1.2-1.3mn cubic metres of timber in Russia and is also the country's number one sawn timber exporter. 

In the wild days of the '90s the logging for exports was a wildcat business, riven by corruption. Firms could pay bribes to local authorities and fell trees for the cash they earned from exporting them. The game in those days was simply to cut down as many trees as possible and get them over the border for the cash they generated. Things have changed a lot in recent years, as these corrupt schemes have been closed down and the forestry sector is regulated and has been put on a sustainable footing.

Segezha has an annual allowable cut of 8.2mn cubic metres, which is bigger than its international peers, despite the fact that the majority of Russia’s forest resources are still lying fallow.

“We manage all our forest resources and run them on a sustainable basis. For every tree we cut down, we plant a new one,” says Aliyev, who adds that as of year-end 2020 83% of Segezha’s forest assets were Forest Stewardship Council-certified, the industry standard, which is high in comparison to certain global peers. “The problem with the soft wood market is that it can be volatile and is affected by many factors, including weather. Having our own resources means we are insulated to a significant extent against price fluctuations on the international raw timber market and so can protect profits, enabling us to create strong profitability.”

And the business is still growing fast as a result of these investments, which are ongoing. Production in some segments has been growing by double digits in recent years, helped by ongoing investments into efficiency, says Aliyev.

Plywood is another important product, and here Segezha has been investing not only to increase production but also to move up the value chain.

Already in the top five biggest producers of large birch plywood in the world, Segezha started work on a new factory this year that may raise it another two spots in the global production ranking when it is complete. The company focuses on high-quality plywood products that have stronger profit margins, according to Aliyev.

“The question we faced was: should we invest to double the production, but of low-quality plywood, or invest into lower production volume but of higher margin products. Given our cost structure, both options work. But generally we prefer to go after high value-added and high margin options,” says Aliyev.

One of the most important value-added products is cross-laminated timber (CLT) panels, which are used in construction in place of concrete. Segezha has a new CLT plant that has just come online this year.

All in all, Segezha plans to continue to invest in value-accretive projects, and it has delivered an internal rate of return (IRR) of above 25% on all completed investment projects.

“We are still in the main growth phase of the company’s life,” says Aliyev.

Global player

Aliyev says Segezha likes to think of itself as a global company, even if its raw material resource is in Russia.

“About 70-75% of our revenue came from exports in 2019, to over 100 countries, so that makes us a truly international company,” says Aliyev.

The timber business is a global one, as the bulk of the world’s soft wood that is ideal for making paper (the fibres in soft wood are longer than those in the hard wood that is found in Southeast Asia and Latin America).

Russia accounts for 70% of the world’s boreal forests and 25% of the world's entire forest resources with the bulk of the rest found in Scandinavia and Canada.

Segezha competes directly with the Scandinavian companies on the European market, but they have already developed almost all of their available forests, so their resources are tapped out and they are struggling to grow production volumes any more.

Canada is a big player too, with plenty of undeveloped forest in reserve, but as transport costs play a significant role in the paper and pulp business, the companies there tend to focus on the large American market south of the border.

Because of Russia’s size it has several markets that are within easy striking distance, including Europe, North Africa and the Middle East, and on to the whole of China and Southeast Asia – all of which have a strong and steady demand for paper.

The demand for paper is still growing steadily, although the nature of the market is changing fast, driven by the digitalisation of economies around the world.

“Paper is partly a commodities market, but within the business the different grade and quality of paper is also important,” says Aliyev. “We have found that office print paper and newsprint demands have fallen, but demand for kraft paper [paper for sacks] and packaging has gone up… In the last 3-4 years the demand for consumer packaging has gone up enormously.”

As retail is rapidly going online and home delivery is becoming the norm, the amount of packaging in use is soaring. And the same is true in Russia. The demand for packaging started to rise rapidly in Moscow and St Petersburg, but Aliyev says it is now growing rapidly across the whole of Russia. This year, Segezha is building five packaging plants within a 30-km radius around Moscow to cover a large portion of the city’s consumer packaging needs.

“Russia is not the key market for us, but it is our original domicile, and we take pride in servicing it as a leading player in the market for paper sacks, unbleached sack paper and sawn timber here,” says Aliyev. “Russia was behind [the rest of the world in the production of packaging], but now it is growing at an attractive rate.”

The global market demand for pulp is rising at a much more sedate 1.5%-2% a year, but it's a global market, so the volumes are huge. Aliyev estimates the global production of pulp at some 50mn tonnes per year, which means the paper and pulp companies need to add approximately 1mn tpy of paper production capacity. That’s a lot. It requires one new plant each year to produce that much new paper at an investment cost of $1.5-2bn and a timeline of 3-5 years to bring it online. As the Scandinavian production is largely tapped out, that means meeting the bulk of future paper and pulp demand will fall on Russia.

Developing Russia’s forests is now also on the Kremlin’s agenda. Russia signed off on the Paris Climate accord in 2019 and is committed to reducing its emissions, as bne IntelliNews reported in “The Cost of Carbon in Russia”. At a corporate level too, Russian companies are also embracing the rise of environmental, social and governance (ESG), partly as some big Scandinavian institutional investors have begun to ban investments into companies that have poor ESG scores.

In addition to putting regulations and an inspection regime in place under a Federal Forestry Agency, part of the Ministry of Natural Resources & Environment, from January next year the government will ban the export of raw timber altogether.

“There is lots of export [of raw timber], especially to China, but the government wants to incentivise investment into higher value-added products,” says Aliyev, who adds that the cost of leases in Russia represents a competitive advantage for forestry product producers.

IPO plans

The company already issued its first RUB10bn (ca $140mn) bond on the Moscow Exchange (MOEX) in December 2019 with a coupon of 7.1% that was issued in rubles, but then swapped into euros to bring the cost of borrowing down, says Aliyev. “It was cheaper than issuing a Eurobond. The perception is that the cost of borrowing in Russia is very high, but it’s not necessarily true.”

And the company also has a RUB35bn credit line from a consortium of Russian and international banks that it can draw on. Banks are happy to lend to Segezha as, like other raw materials producers, its costs are in rubles but its exports earn foreign exchange revenues, making the company relatively immune to Russia’s perennial crises. Indeed, the shocks that the Russian economy felt in 2020 and the circa 20% devaluation of the ruble that resulted only improved Segezha’s profitability.

The borrowing means Segezha’s net debt-to-LTM OIBDA ratio was 3.3x for 9M 2020, which Aliyev considers is justified and more than manageable given the company’s fast growth rate. 

The company’s financial results are very strong. Sistema reported 10% year-on-year revenue growth for the 3Q20 to RUB185bn ($2.5bn) in 3Q20 under IFRS, with adjusted operating income before depreciation and amortisation (OIBDA) up by 14% to RUB72bn with 39% margin, part of which was due to strong third-quarter 2020 results from Segezha that saw revenues up 38% y/y to RUB19bn ($250mn), and OIBDA more than doubled (106.9%) y/y to RUB5.1bn ($67mn) with a OIBDA margin of 26.7%, an increase of 8.9pp from a year earlier, bne IntelliNews reported in December.

And the next big event will be to float the company. Segezha plans to raise $0.4bn-0.5bn in an IPO planned in Moscow in spring 2021, Reuters reports citing unnamed sources. Aliyev declined to comment on the reports.

However, the shareholders approved a new share issue of 11.94bn new shares last week, which could potentially double the existing share count. Notably, a new legal form as a public joint-stock company has also been approved, which means the company is now technically ready for an IPO.