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Packaging Corporation of America Downgraded: What You Need to Know

Investors in (NASDAQ: BABY) stock awoke to a shock this morning: Their stock has just been initiated with a rating of "strong sell."

Cardboard boxes might not seem like the sexiest place to invest in the stock market. But boxes can contain big surprises -- such as the surprise success of cardboard box company Packaging Corporation of America (NYSE: PKG) , whose stock is up 33% over the past year, six times better than the performance of the S&P 500.

Packaging Corp stock has worked out pretty well for banker BMO Capital, which recommended the stock to its clients back in July 2015. But today, BMO has had a rethink about Packaging Corp stock, and just downgraded the stock from outperform to market perform.

Here are three things BMO says it doesn't like about the stock.

Should you stock up on Packaging Corp stock? BMO Capital thinks not. Image source: Getty Images.

1. The U.S. dollar

The first thing BMO doesn't like about Packaging Corp stock is...the U.S. dollar. As reports, BMO worries that a strong U.S. Dollar is bad news for U.S. companies doing business abroad. But if you ask me, this is a trumped-up worry.

According to data from S&P Global Market Intelligence , Packaging Corp actually gets only about 3% of its annual revenue from foreign sources, with the bulk of its business being done right here in the U.S. of A. While foreign exchange headwinds might affect the business somewhat, I don't think this should overly concern investors.

2. Pricing power

A second concern BMO raises is Packaging Corp's ability to stick its customers with a $50 increase in the price of containerboard. In a still-iffy economy, that could be a concern. One thing that's reassuring, though, is the fact that $50 price hikes have gone into effect pretty much across the (container) board.

In September, Midland Paper confirmed that "major containerboard producers" including not just Packaging Corp, but WestRock (NYSE: WRK) , Georgia-Pacific, and even International Paper (NYSE: IP) all instituted $50/ton increases in the price of their containerboard products last month -- the first such wide-scale increase in nearly four years. While it's still early innings in the effort to make this price hike stick, the widespread support for the price increase among so many competitors suggests no one is breaking ranks and trying to fight a price war. That increases the chance that the price hike will stay.

3. Valuation

BMO's third objection to Packaging Corp stock -- and the one I actually agree with -- is the valuation of the stock. While BMO calls Packaging Corp "best-in-class" for its profit margins, and praises the stock's balance sheet as "strong," BMO worries that "the stock [is] trading within 3.5% of our price target," and sees little room for it to grow past this.

And that's the most important thing

On this point I agree. Priced at more than 18 times earnings, and 15 times free cash flow, Packaging Corp doesn't look drastically overvalued. Rival International Paper sells for more than 22 times earnings after all (and 16.5 times free cash flow). WestRock stock costs only 13.7 times free cash flow, but is GAAP-unprofitable and carries a debt load roughly twice as large as Packaging Corp's.

Viewed in this context, Packaging Corp appears to be valued more or less in line with its peers. Nonetheless, the stock's slow projected growth rate (just 8% compared to International Paper's 10%) doesn't seem to me fast enough to justify Packaging Corp stock's P/E or price-to-free-cash-flow ratio, either one.

At the same time, Packaging Corp's 2.9% dividend yield seems a bit stingy in light of the better yields available at its competitors -- 3.2% at WestRock, 3.9% at International Paper. All things considered, I have to agree with BMO Capital on this one: There are better places to put your money than in Packaging Corp's box.

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Fool contributorRich Smith does not own shares of, nor is he short, any company named above. You can find him onMotley Fool CAPS, publicly pontificating under the handleTMFDitty, where he currently ranks No. 314 out of more than 75,000 rated members.

The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days . We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy .

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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