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COLUMN

The Old Economy, including the forest industry, is attracting investor attention 

By John Clarke

In a world of super-heated information technology it had to be an act of high camp recently for Warren Buffett to add underwear to his investment portfolio. What else could it have been but a bit of down-to-earth Buffett humour to bid for the bankrupt Fruit of the Loom- unless it was more of the genuine genius of a very successful multi-billionaire. 

It was quite in character for Buffett to stick mostly to investing in the Old Economy while almost everybody else was riding high on Information Technology (IT) and consigning traditional industry to a deepening sunset. Only a year ago John Roth, the former chief executive officer at Nortel when it was on the crest of the wave, was saying Old Economy resource industries like forestry in Canada were destined to go into decline. 

Demand for their products would recede relative to the New Economy. Finance Minister Paul Martin was on the same wave, insisting that Canada was to become a leading edge IT country, a sentiment shared by former Industry Minister Brian Tobin in his own rush to spend billions on a rural high speed Internet communication system. It apparently has the seductive appeal of a sensuous Rhine maiden, although Tobin had his ardour cooled a bit by a chastened Martin, who's staring at declining government revenue in an economic recession and the need to beef up security in the wake of the World Trade Centre tragedy in New York. 

The great expansion of the Clinton years is now seen as something of a mirage, based as it was on an overindulged image of insatiable IT demand. The economy was changing, to be sure. But the Old Economy suffered investment neglect disproportionately, while IT grabbed the attention. Venerable old companies like Fruit of the Loom fell into bankruptcy and ignominious obscurity until they attracted the interest of people like Buffett and a few others. 

Throughout it all, the Old Economy had its defenders. The British investment giant Schroders PLC has grown into one of the largest private equity funds in Canada by concentrating on more traditional sectors. Not that Schroders was oblivious to the blandishments of IT investment. But after playing around with the idea of putting some money into "those areas," Paul Echenberg, chief executive officer of the company's Canadian arm, Schroders and Associates Canada Inc, said "we decided to leave high tech to the experts who lost their shirts and we'd stay in the real economy." 

Schroders is probably one of the biggest beneficiaries of the flight from high tech by investors who still have some money to spend. So too are the fortunates buying up the fibre-optic equipment Nortel has had to sell off because of a retreat in that business, an event sometimes described in the public prints as a garage sale. As for relative decline, Nortel has dropped in value from about 33 per cent of the Toronto Stock Exchange in the good times to five or six per cent today. According to some financial analysts, forestry in Canada has been making a huge recovery in market value. 

It has particularly been regaining considerable ground against that glamorous IT sector. "If you take Nortel out of the TSE 300," says one official, "the paper and forest index has done very well in the last several months." That vote of confidence in the forest industry is a remarkable expression of returning confidence, notwithstanding the current problems softwood has been having with American import restrictions. 

The recovery is surprising in that it's happening at a time when the industry's fundamentals are uncertain and it means, according to word on the street, investors are looking beyond the current situation. "Over the next few years the prospects of a very substantial improvement in the forest industry are very high," says analyst Ross Hay-Roe, based in BC. "We will see much better profit performance in the current decade than in the 1990s. Investors are beginning to anticipate that. "Even though it is an old industry (or parts of it are over the hill), nevertheless it is going to make a lot of money." 

The profit improvement will come from production control. The industry has traditionally focused on maximizing its output on the premise that by spreading fixed costs over more production you get more profit. But if everybody is doing the same thing, the market gets over-supplied, with obvious downward pressure on price. The thinking of many decades appears to be changing, not overnight, but changing nonetheless. 

An example cited in the current context is the performance of the containerboard market. Demand has been what people in the industry have called ugly, yet prices have been maintained because producers have responded by cutting production. This is truer of the US at present. But the same imperatives are at work in Canada. Old Economy industries have not been taking the massive write-offs common in the IT sector, which is being reflected in stock prices. 

Nortel, which was outrageously overpriced, has declined enough to be considered now at a "normal" level. None of this is to suggest that high tech is or should be in full retreat. It will continue to evolve as the rest of the economy evolves, as a sector fitting into the whole-as will forestry, as well. It is also to suggest that forestry will have to modernize to adapt to changing conditions, to make sure value derives from smart management, not just volume production. 

Retail investors, badly bitten by the IT experience, seem ready to move their money to institutional investors, who will more rigorously insist on real, measurable value in stocks. Forestry can benefit from that kind of discipline, the kind of scrutiny that has kept Old Economy champions like Buffett and Schroders ahead of the game.

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