Good Prospects In Paper

Long term societal trends are the meat and potatoes of long term investing. When you identify one that will benefit a particular industry or sector it gives some degree of confidence that, over time, an investment in that industry will pay off, regardless of the short term outlook. When there are several such long term trends that stand to benefit an industry and short term sentiment has resulted in a dip in related stocks, then it is almost too good an opportunity to miss.

I see such an opportunity right now in the paper business. A couple of weeks ago, Jim Cramer, on his CNBC show Mad Money, pointed out one of those trends when discussing the earnings release of and prospects for the industry giant International Paper (IP). Cramer observed that current environmental thinking favors paper packaging over plastic and that trend was confirmed by IP CEO John Faraci, at least in terms of the food service business. That is notable, but there are two other things that I believe will drive sales of paper products over the coming years.

Firstly, the long promised boom in internet commerce is upon us. This chart from the U.S. Census Bureau shows that e-commerce sales continuing to climb at a steady rate since 2005.

When you buy online and have the product shipped nobody asks if you would like paper or plastic. Whatever packaging the product comes in it is placed in a cardboard box for shipping, and that simple fact means increasing sales for paper companies as a whole over time.

Another factor that will drive long term paper demand is the world’s aging population. This may seem like a tenuous link, but anybody who has ever cared for an aging relative, particularly one with any form of dementia will tell you that they get through an awful lot of paper products. In Japan, for example, sales of adult diapers are set to exceed those of infant diapers by 2020. As the incidence of dementia grows with advancing average age, so that demand will continue to increase.

When taken together, these three trends will cause, at worst, steady growth in paper demand over the next few years and, barring any massive global slowdown, rapid growth is likely. It would be reasonable, then, to expect the earnings multiples of the major paper companies to reflect that seemingly inexorable rise in demand; reasonable, but wrong.

Weakness in Europe combined with fears about global growth combined with some slightly disappointing results from individual companies compared to last year has caused stocks in the paper industry to lag the broader market over the last few months. It would seem then that there is value to be had, but, as always, the question remains; how best to play the idea?

Spreading an investment between three of the major U.S. listed companies that supply the paper market would be my favored play. Investing in three companies reduces the company specific and execution risk that would be inherent in just picking one, but won’t dilute any particularly good performance by one stock too much.

International Paper (IP), as the largest player, is the obvious first choice. As I mentioned above, IP released earnings a couple of weeks ago. They beat EPS estimates ex-items, with earnings of $0.95 per share versus expectations for $0.83, but the stock fell sharply as revenues missed. This short term reaction to news, however, just makes the stock more attractive to long term investors. The company has undergone some restructuring recently but may be placed to take advantage of growing demand and a forward P/E of around 12.5 certainly looks cheap enough.

Rock Tennessee (RKT) is another company where, despite beating estimates in terms of EPS and, in this case, revenues, last quarter, the stock fell, presumably as the result of a similar year on year decline to that experienced by IP. The whole point here, though, is that these declines are most likely to be a temporary set-back, so once again, at a bargain P/E of around 12.0, RKT looks cheap.

Domtar Group (UFS) has seen a more sustained and spectacular decline in the stock price which has fallen from a March high of $57.87 to below $36. In this case too, the focus has been on year on year declines in sales and profits, but that just makes for better value in the stock if you believe that the problems in the industry are temporary. In any event, a P/E under 10 for a company with an earnings yield over 10 percent and forecast growth of around 17 percent certainly doesn’t look expensive.

There are long term shifts in demographics and consumer behavior that will benefit paper companies over the coming years, but short term pressures have led to stocks in the business being relatively cheap. That, my friends, is when those with an eye for value step in.

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

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

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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