Regional Focus Helps KapStone Paper Outpace Industry


It might be a good sign that KapStone Paper and Packaging is coming off one of its best quarters ever, yet management says the company still could have done better.

KapStone ( KS ) makes and sells containerboard, corrugated products and specialty paper products in the U.S. and internationally.

It is the country's largest producer of kraft paper, used to produce bags for agricultural products, pet food, baking products, cement and chemicals, and grocery bags. The company's subsidiaries operate four paper mills and 22 converting plants in the U.S.

KapStone was formed in 2005 and went public two years later. Since then, it has built a record of steady revenue growth and robust profits, with only the occasional hiccup.

The company recently made it onto the IBD 50 list of top-rated growth stocks.

Profit And Potential

Last year the company's annual earnings doubled from the prior year. Revenue grew 44% -- its biggest top-line gain since 2008.

Fourth-quarter results were even more impressive: EPS climbed 221% year-over-year, while revenue increased 87%.

On a Q4 conference call, CEO Roger Stone called it "a great quarter and year" -- just before conceding that "it could have been better.

"Along with two mill plant shutdowns in the fourth quarter, one of our mills experienced serious productivity issues, which have now been resolved," Stone said.

The plant shutdowns were due to temporary operational issues. Another problem, Stone said, was that the company's product mix was "substantially poor." Demand for higher-priced products was low, and KapStone produced a large volume of cheaper unbleached pulp to help fill in the gap.

The good news? "Demand in our mix has returned to normal, and our January prices were actually $23 a ton higher than December's prices," Stone said.

That bodes well for a company that has delivered two straight quarters of triple-digit EPS growth and 74%-or-better sales growth.

KapStone has benefited from industry trends as well as internal decisions, analysts say.

From an industry standpoint, the main growth driver has been rising prices of goods KapStone sells -- particularly containerboard, which accounts for about 63% of the company's business.

"There has been some consolidation in the corrugated box industry, and the industry has been more rational about managing supply and demand," said Al Kabili, analyst at Macquarie Securities. "As a result, the industry has been able to raise pricing for containerboard, which ultimately leads to higher prices for corrugated boxes."

He says containerboard prices have risen nearly 20% since 2012. While industrywide sales volumes have largely been flat over the last year or so, KapStone has managed to deliver volume growth in the mid-single digits.

"KapStone has and will continue to outperform the industry in terms of volume growth," Kabili said.

Regional Strategy

That's mainly because while larger rivals such asInternational Paper ( IP ) andRock-Tenn ( RKT ) focus on large national accounts, KapStone focuses on smaller regional accounts.

These accounts "tend to be the ones that are growing the fastest vs. the national accounts," he said.

Meanwhile, KapStone should get an additional boost from its recent announcement to implement a $50-per-ton price increase on kraft paper, which makes up about 37% of KapStone's business.

"We expect the full benefit of this increase by mid-second quarter 2014, and we expect the annualized benefit from this increase to be approximately $30 million," Chief Financial Officer Andrea Tarbox said on the Q4 conference call.

Analyst Kabili reckons there is still more room to raise prices in coming quarters.

"I don't think we're at peak pricing in the current cycle," he said. "Once volumes pick up for the broader industry, it's logical to think we'll see additional price increases."

KapStone has also benefited from a couple of acquisitions that have worked out well.

In October 2011 it paid $330 million to buy U.S. Corrugated, owner of a 240,000-ton recycled containerboard paper mill in Cowpens, S.C., and 14 converting facilities in the East and Midwest.

More recently, KapStone in July bought Longview Fibre Paper and Packaging from a private equity firm for $1.025 billion in cash. Longview, a maker of containerboard, specialty kraft papers, corrugated containers and other gear, has operations in the Pacific Northwest, helping KapStone expand its operation west of the Mississippi River.

"The Longview deal gave them a West Coast presence, which widens their geographic profile," Kabili said. "Now, for the first time, they have a national footprint."

During its first five and a half months under the KapStone umbrella, the Longview business added $440 million in revenue and $116 million of adjusted EBITDA.

"The Longview Fibre deal continues to be a home run," Steven Chercover, analyst at D.A. Davidson, said in a report. "With only half of the $18 million in synergies recognized so far, operational improvements could yield another $20 million."

During the 2013 fourth quarter, the Longview business produced 28 cents of adjusted diluted earnings per share. Overall EPS for the quarter came in at 45 cents, up from 14 cents the prior year. Revenue gained 87% to $563 million.

Analysts polled by Thomson Reuters expect first-quarter EPS of 45 cents, up from 21 cents a year earlier. Full-year profit is seen rising 61% in 2014 and 10% in 2015.

KapStone stock set a record high of 32.82 on March 6 and currently trades near 30.

International Paper, Rock-Tenn,Packaging Corp. of America ( PKG ) andMeadwestvaco ( MWV ) are the largest companies by market cap in IBD's Paper & Paper Products industry group, ranked No. 37 of 197 groups. KapStone is eighth in size.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ, Inc.

This article appears in: Investing , Investing Ideas

Referenced Stocks: KS , IP , RKT , PKG , MWV

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