Gunns squeezed by credit crunch

Twelve months ago, Tassie timber giant Gunns was ramming its proposal for the world’s largest pulp mill through at top gear on all fronts.

Premier Paul Lennon had forced approval of the mill through state parliament. In Canberra, Environment Minister Malcolm Turnbull worked his hardest at looking the other way.
And Gunns’ boss John Gay was announcing plans to break ground before Christmas.

What a difference a year makes!

The worst credit crisis since last century’s Great Depression and a deteriorating domestic economy may have prevented the pulp mill project getting off the ground this year, if ever.

In January – to the amusement of some commentators – I flagged the combination of the credit crisis and the ongoing anti pulp mill campaign as a looming impediment to Gunns’ efforts to secure financing for the project.

Environmentally-inclined economists watched with interest just two months later in March as Gunns announced its half yearly results. These revealed a balance sheet lacking transparency but nevertheless coming under pressure from higher debt levels, arising from the acquisition of mainland plantation specialists, Auspine.

More recently – amidst direct campaigning by grassroots Tasmanian groups, GetUp and The Wilderness Society – it transpired that ANZ, Gunns’ long-term bankers, declined to head the banking consortium, after due diligence. Word on the street has it that John Gay has been talking up the pulp mill in Europe with the aim of finding funding.

However, with only $500 billion in losses announced from the subprime crisis and at least another $500 billion to be announced and written off the already fragile balance sheets of US and European banks, it would seem liquidity conditions will remain tight for the foreseeable future.

Now, barely half way through August, Gunns has flagged full year 2008 earnings after tax of just $67m. This falls well short of investment bank Credit Suisse’s most recent forecast of $101m. Worse than that – for Gunns – they are even below last year’s full year result of $73m.

Full details, along with a pulp mill update, are to be announced on August 28. Albeit without the benefit of that information, my analysis leads me to believe Gunns has experienced a downturn in demand for domestic timber as a result of a slowdown in the housing market; more dramatically, interest costs have also blown out substantially, leading to unsustainable debt levels for the company.

Gunns’ current proposal to sell $170m of very valuable plantations, potentially those same ones needed for the proposed pulp mill, completely defies logic – unless they are strapped for cash (liquidity).

Adverse stock market conditions have seen Gunns’ share price fall 55 per cent since December 2007. This now means the cost of raising equity has risen too high, even if the market would facilitate an equity issue – which would seem unlikely at this rather parlous stage of the bear market cycle.

So, the only option for Gunns to keep its bankers happy and the cash flow humming might be a speedy asset sale, like flogging the crown jewels – its plantations.

With a tumbling stock market capitalisation having fallen to around $960m and a much-weakened balance sheet and earnings that have gone backwards, it seems unlikely bankers in the current financial market would contemplate putting $2 billion worth of financing together for a controversial carbon-intensive project proposed by a company struggling to meet existing debt obligations.

Unless they’re bankers hoping to end up owning the world’s biggest pulp mill.

I believe the pulp mill project will not get off the ground, for the simple fact it is not financially viable. Then again, I may be forced to eat humble pie on August 28, so I wait with interest.

Danielle Ecuyer is a former investment banker.