Stora Enso said its second-quarter operating profit would halve from a year ago, with rising energy, transport and chemical costs set to weigh on second half profits too.

UPM-Kymmene, the world's top magazine paper maker, and packaging maker Huhtamaki also warned that profits in 2008 would be down, citing increasing input costs.

The paper industry has for years suffered from overcapacity which has kept a lid on prices, while increasing costs of wood and energy have eaten into their already low margins.

Stora Enso raised its estimate of overall cost inflation for 2008 to 4 per cent from an earlier forecast of 2.5-3 per cent.

Shares in Stora Enso fell 7 per cent on the news to €6.57, their lowest level since 1998, while UPM shares were 4.6 per cent lower at €11.01 by 1151 GMT.

Shares in Huhtamaki fell more than 10 per cent, to levels last seen in February 1996.

The warnings dragged lower sector shares across Europe, with Norske Skog, Mondi and Holmen all falling more than 3 per cent.

“The bad news keeps on coming from that sector and there is really nothing that could change that sentiment in the short term,” said Swedbank analyst Claes Rasmuson.

“We need to see some more capacity closures for them to balance the market. That's the only thing to hope for,” he said.

Stora Enso said it was looking at further capacity cuts to improve the situation.

“After three quarters of deteriorating performance, combined with the uncertain macroeconomic outlook, Stora Enso is reviewing its plans for production curtailments in the second half of 2008 as well as permanent capacity reductions,” it said.

Prices for most paper grades have fallen in 2008, according to research firm Foex, but prices for key magazine paper grade LWC have increased 2.3 per cent in Europe.

UPM said it was hoping for some help from further price hikes.

Stora said operating profit excluding non-recurring items for the second quarter was expected to be about half the €223-million of a year earlier due to poor performance of the Wood products business, higher raw materials costs and adverse foreign exchange movements.

Analysts had expected the firm to post operating profit of €134-million in the quarter, according to the median forecast from Reuters Estimates, with projections ranging from €108-190 million.

UPM-Kymmene issued its second profit warning in a week and said its operative profitability would fall in 2008 from the previous year due to higher-than-estimated costs of wood fibre sourcing and a poor performance at its sawn timber business.

A company spokesman later explained that the comment meant UPM's 2008 operating profit, excluding one-offs and forest value changes, would fall from around €750-million reached last year. UPM had earlier forecast profits would be flat.

On June 12 it warned that its timber business was likely to perform more weakly than expected.

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