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Financial State of the Forest Industry and Delivered Wood Cost Drivers

III The Financial State Of The B.C. Forest Industry

A. Purpose

The purpose of this section is to put the analysis of logging cost drivers in the context of the overall financial state of the forest industry in recent years. As indicated in the Approach and Workplan section, we reviewed the "Industry on the Brink" presentation material and concluded on its plausibility, with respect to the information set out below.

B. Contribution of the forest industry in B.C.

In 1995, the forest industry was the province’s largest industrial employer accounting for 18% of total provincial employment or about 100,000 direct and 200,000 indirect jobs. It supported directly about 116 dependent communities throughout the province. Forest products accounted for 57% of manufacturing shipments and 63% of provincial exports in 1995. The industry directly paid $2.8 billion to government (federal, provincial and municipal) and, additionally, direct industry employees paid $1.9 billion, for a total of $4.7 billion.

C. 1992 to 1996 financial results

During the period 1992 to 1996, industry sales increased from $11 billion in 1992 to almost $18 billion in 1995 before falling to about $16 billion in 1996. During that period, net earnings ranged from a loss of about $250 million in 1992 to net earnings of about $1.3 billion in each of 1994 and 1995 before turning to an estimated loss of $250 million^[1] in 1996.

Cash flow from operations was negative $700 million in 1991 and rose to $2 billion in 1996. Capital expenditure ranged from $900 million in 1992 to $1.3 billion in 1995. Over the five year period, cash flow exceeded capital expenditures by $700 million.

In terms of return on capital employed, the average return over the period 1986 to 1995 was about 7.6% and over the period 1992 to 1995 was about 4.5%. In 1996, the estimated return on capital employed was about 0.2%.

Industry presents the case that an average return on capital employed of 11% is required to maintain investment, based on the following calculation:

Type of Capital	% of Total Industry Capital	Less Tax	Weighted Cost

Debt @ 9% return	41 %	@40%	2.2
Equity @ 15% return	59 %	-	8.8

Total	100 %		11.0

The financial results within the industry have varied considerably by product market and geographical area of operation. Pulp and paper production has generated net losses in each year since 1990, except for profits earned in 1995 when pulp prices hit a historic but short-term high. The average return on capital employed from 1991 to 1996 was negative.

Plywood and veneer has been profitable since 1986, with the exception of small losses in 1990 and 1991 and has had an average return on capital above the 11% rate. Interior lumber has come close to the 11% rate of return over the past 10 years and has exceeded it since 1992. In 1996, Interior lumber earnings represented more than an 11% return. Coast lumber has also come close to the 11% rate over the past 10 years and has exceeded it since 1992 but 1996 will show negative net earnings and a negative return on capital employed. Lumber prices are currently at or near historic highs.

It should be noted that pulp and paper and lumber are interdependent products because chips are an important by-product of lumber manufacturing and these chips make up a large proportion of the raw material requirements for B.C.'s pulp and paper industry. As a result, when pulp prices are low as they are at present, chip prices are also generally low and overall lumber revenues are reduced by reduced chip revenues. Thus, 1996 net earnings from lumber were impacted by the effect of high lumber prices and relatively low chip prices.

The profitability and return on capital for the industry are affected by a large number of factors including delivered wood costs, manufacturing costs, distribution and sales costs and the value and volume of products sold. Changes in all of these areas have affected financial performance over the past several years. It is clear that one of the most significant factors has been the substantial increase in delivered wood costs, which is examined in detail below. Delivered wood costs to all sectors have increased by about 80% in the Interior and by about 70% on the Coast from 1992 to 1996.