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Stock market problems could hamper forest industry investment

By John Clarke

If it hadn't been for its preoccupations with countervailing and anti-dumping duties on softwood lumber, the forest industry in Canada might have been able to pay more attention to the corporate accounting scandals in the United States. Maybe it's because they're too busy just trying to survive that in the executive offices they're quietly rejoicing that they haven't caught a whiff of the troubles down south. 

Not that Canada is itself lily-white, not when there's a Bre-X in the record. But there have been no improprieties to match the scale of an Enron, a WorldCom or an Arthur Andersen, where corporate highrollers have been taking the Fifth in a scramble to save themselves from prosecution and where others charged with wrong-doing are paraded in handcuffs before the TV cameras to show how America is cleaning up. Although Americans from the White House on down have claimed the scandals involve only a small percentage of total business, the reach of what US Federal Reserve chairman Alan Greenspan calls "infectious greed" is truly breathtaking. Enron and Arthur Andersen are gone. WorldCom is in bankruptcy. 

Executives, who've made huge personal fortunes with the help of accounting manipulations that made their companies look more profitable than they really were, have been disgraced. Thousands of employees have been left with worthless company pension plans destroyed by ruinous stock value declines. Some of the biggest corporations in America have been frantically restating their financial numbers and 700 chief executive officers have been forced into the indignity of certifying that their numbers are authentic, even though there's been no hint that they aren't. 

Nasdaq, the technology-heavy stock exchange, has lost 70 per cent of its value. Billions of dollars have been pulled out of mutual funds, the little man's favourite investment. When Martha Stewart, the queen of the domestic arts, finds herself embroiled in insider trading allegations, the scandals are casting an extraordinarily wide net. According to the most recent polls, two-thirds of wealthy Americans don't trust the managements of publicly traded companies. 

Three-quarters straight out don't believe published financial statements. Corporate Canada may have escaped the calamities in the US. But in the polls, 62 per cent of Canadians say they no longer trust the stock market and 75 per cent of them believe an Enron-type scandal is still possible here. Interest in forensic accounting and "fraud busters" is at an all-time high in Canada. And no amount of assurance of corporate probity has convinced the federal government that all is well. Prime Minister Jean Chretien says he's afraid of the damage the scandals are doing to the Canadian economy. 

So much so that he has Finance Minister John Manley threatening legislation to tighten accounting regulations and financial reporting. Manley wants an assurance of credible audit processes and severe punishment for "breakers of the public trust." So if the forest industry faces a pile of expensive new accounting regulations, it will have the enchantment with EBITDA in so many of the scandals to blame. There had been an emphasis by high-flying companies on Earnings before Interest, Taxes, Depreciation and Amortization figures, when what investors and potential investors really should have been looking at is the net earnings. 

When Salomon Smith Barney analyst Jack Grubman can walk away with a $32-million payout after a string of bad calls on investments that tanked spectacularly, the public is entitled to wonder whether Wall Street really understands. Now the most knowledgeable observers are talking openly about a crisis in confidence in North American capitalism. Superficially the forest industry seems to have survived the scandals and the subsequent stock market meltdown. 

While the TSX as a whole was declining 2.25 per cent at the height of the revelations, forest products were down only 0.7 per cent. According to National Bank Financial analyst Reid Carter, forestry stocks are driven more by the commodity price outlook than by corporate governance. Cyclical momentum is more important than accounting scandals. "For the most part," he says, "what really drives prices is future earnings. People tend to buy 10 to 12 months ahead of expected earnings." 

The industry is regarded as mature enough to manage these recent events because it's been through so many crises of its own. Since the 1980s it has worked hard on its debt-equity ratios and debt servicing will be less of a problem than for other industries. Even so, the stock market problems could make it difficult to find investment money for new, more modern sawmills needed in Quebec and BC. Banks dealing with loan losses and losses in brokerage arm operations in the hundreds of millions of dollars-all as a result of scandal-plagued problems in the economy-will be very cautious lenders for the next while. 

That could make raising debt-for infrastructure rebuilding-difficult, even assuming the companies might be prepared to go that route. Then there are pension liabilities to contend with. "There could be a need to top up pension accruals, as much as $200 million in some of the funds," says Carter. Lumber is worth $10 billion a year in exports to the US, yet it's small enough in the big scheme not to be a significant factor in whatever has come to ail American business. But the industry is far from immune. It can't afford to be distracted by the softwood war. If the crisis in capitalism permanently undermines the culture of business it will have more lasting consequences on the forest industry than the softwood dispute.

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