Paper cuts come in all sizes.
On an industrial scale, paper-products manufacturers have cut,
spliced and suffered over the past decade to consolidate and
streamline. The process netted a leaner, meaner, more competitive
industry. And it concentrated the majority of production in what
had been a vastly fragmented North American market within a
handful of companies in each paper and board segment.
"After this wave of consolidation, paper and packaging
manufacturers have been better able to match supply with demand,
which provides them with a better bargaining position with
customers," said Morningstar analyst Todd Wenning. "They
certainly have a stronger foothold than in the past."
A more disciplined market points to more stability and higher
profitability for an industry that's struggled against poor
returns and over-capacity, adds Vertical Research Partners
analyst Chip Dillon.
Packaging Corp. of America (
) is the fourth-largest producer of containerboard and corrugated
box products in the U.S. Analysts say the Lake Forest, Ill.-based
operation has been a leading beneficiary of the consolidation and
of a more competitive market. In the third quarter, it saw
earnings jump 28%, its second straight quarter of double-digit
profit growth and an acceleration from the prior quarter.
Analysts see that growth accelerating to 55% in the fourth
quarter, although sales growth is seen holding to low-single
The industry began to flex its newfound muscle in the fall,
when top players passed through a hefty hike in containerboard
prices -- their first price increase in 2-1/2 years.
Graphic Packaging Holding (
), a top producer of folding cartons, has also benefited. Its
earnings rose by 22% in the second and third quarters. Analyst
consensus projects a fourfold earnings gain in the fourth
Investors' response to those and other gains have, during much
of the fourth quarter, held the Paper & Paper Products group
in the top 50 rankings among 197 tracked by IBD. The group ranked
No. 58 on Friday.
The industry is not a treasure trove of leading stocks.
Packaging Corp. and Graphic Packaging, among its top performers,
hold 2013 sales growth forecasts of 7% and 2%, respectively.
But the group is a sensitive indicator of economic activity,
and a turnaround story that appears set to exit the recent
economic recession stronger than when it went in.
That story, and Packaging Corp.'s consensus earnings growth
forecast of 35% this year, are drawing in both growth and value
investors, with Vinik Asset Management, Columbia Mid-Cap Value
Fund and Blackrock Master Large Cap Core Portfolio among the
funds to establish or add to holdings in recent quarters.
Packaging Corp. produces corrugated boxes -- everything from
the basic boxes used in moving and shipping to custom-printed
containers and retail displays.
It's the industry's only pure play in the containerboard
segment, says Wenning. Its position as a North American producer
gives it direct access to virgin fiber -- from the tree to the
box, so to speak. That keeps its costs pretty steady, Wenning
In addition, says Jefferies analyst Philip Ng, the company has
squeezed a lot of costs, like energy consumption, out of its
operations. That is part of what has helped boost earnings this
It's a very well run company, says Ng, and it has executed
Wenning expects benefits from the fall price increase to begin
feeding through in fourth-quarter results. It reports on Jan. 22.
Thus, analysts polled by Thomson Reuters see earnings rising 55%
in Q4, and 48% in Q1.
Graphic Packaging, headquartered in Marietta, Ga., makes
paperboard packaging products for the food, beverage and
household products industries. Products include cereal boxes,
paperboard packaging for beer, soft drinks and other beverages.
Major long-term customers includeKraft Foods (
) andGeneral Mills (
Graphic Packaging benefits from the market's built-in demand,
mainly from the food and beverage companies. Also, the company
has been growing market share, executing well, and taking costs
out of its system, says Ng.
"It consistently generates a lot of cash flow," he said.
Graphic Packaging's cash flow-to-earnings was 263% in 2011,
vs. Packaging Corp.'s 105%.
In another segment of the industry,Schweitzer-Mauduit
International (SWM) is the world's largest producer of the fine
paper used in making cigarettes.
The company held an estimated 2.9% of the tobacco paper
product manufacturing market in 2012 based on its U.S.
production, says a report by Caitlin Moldvay, a senior analyst at
market research firm IBISWorld.
But, as in many industries, "declining demand in the U.S. has
hampered the company's growth," she said. "However, demand is
relatively strong in emerging economies." This has led to an
increase in international operations and a decline in its share
of sales in the U.S. market, which now accounts for an estimated
28.2% of revenue.
The company has increased earnings by at least 22% for six
straight quarters. Sales began declining in the second quarter,
and analysts see earnings down 25% on a 1% slip in sales for
U.S. containerboard producers -- including No. 1International
Paper (IP), No. 2RockTenn (RKT), Packaging Corp. and others --
pushed through a price increase of $50 a ton. They also passed
through most of an announced 8% increase on finished corrugated
boxes, says Will Mies, editorial director at RISI, the leading
information provider for the global forest products industry. It
was the segment's first price increase in 2-1/2 years.
What changed to allow them to push through the increase?
Containerboard supply has been tight due to mill maintenance and
project outages, unexpected operational problems at major mills
and some market downtime, says Mies. At the same time,
containerboard inventory levels at box plants and mills have been
at multidecade lows. U.S. containerboard mills have been running
nearly flat out, with capacity utilization rates year-to-date at
around 95%, he says.
"We think the recent price increase from containerboard
producers was a catch-up price increase from the prior two
years," adds Wenning, who sees potential for the industry to
raise prices again in 2013.
"It could be a sign that the industry is getting more
bargaining power because there are fewer producers and supplies
are tighter than in the past."
Certain areas of the paper industry are doing quite well,
including containerboard for boxes, says Wenning.
There's not a lot of innovation going on in the paper market,
It's all about making sure plants are running efficiently, and
not over- or underproducing.
"It seems like the industry has done a better job of matching
supply with demand, particularly in North America," Wenning
Food, beverage and agricultural products account for about 50%
of the end-use markets for containerboard. Year-to-date box
shipments as of Dec. 18 were essentially flat vs. the prior year,
Over the five years to 2012, revenue for the cardboard box and
container manufacturing industry rose at an annualized rate of
0.6% to an estimated $56.8 billion, tallies Moldvay.
Demand for cardboard packaging began to turn the corner in
2010, and has continued to rise through 2012, she says. Steady
demand from food and beverage manufacturers has kept the industry
afloat over the five-year period. In addition, auto manufacturing
has increased since the recession.
Over the three years to 2012, consumer spending is estimated
to have risen an average of 2.1% annually, which has positively
influenced retail sales and, in turn, increased manufacturing
activity in the U.S., Moldvay says. An increase in activity from
these downstream industries has benefited demand for cardboard
packaging during the industry's recovery. She estimates industry
revenue rose 4% in 2012 vs. the prior year. In 2013, revenue is
expected to rise 4.2% to $59.1 billion from $56.8 billion.
When it comes to assessing the climate for the industry, much
depends on the sustainability of the economic recovery.
The industry, says Wenning , has done a better job of managing
supply and getting it closer to demand.
"Going forward it becomes a question of demand," he said.
"They've cut costs, and reduced capacity where necessary, and
they've taken steps to better match supply with demand. There's
only so far they can cut. Demand will have to improve for there
to be outsized growth in the industry again."
Most watchers are cautious about the outlook for the stock
performance of companies in the space.
Dillon says he's upbeat about the year's prospects for Graphic
Packaging and Packaging Corp.
He calls 2012 a "transition" year. Still, he says, a lot of
investors don't appreciate how much these companies have
Wenning concurs he's seen improvement in the industry.
"But we think the market has also noticed it, and the share
prices reflect most of the improvements we see," he adds.
Ng is generally "upbeat" on the companies he follows. He has a
buy rating on Graphic Packaging and a hold on Packaging Corp.