Paper and Related Products Industry's Near-Term Prospects Dim

The Paper and Related Products industry comprises companies that manufacture and sell paper and paper products. The industry is highly diversified in terms of products which range from graphic paper, packaging paper to absorbent hygiene products.
Graphic papers, which primarily include printing and writing papers, and newsprint, are used for communication purposes. The industry provides packaging solutions for liquid, food, pharmaceutical, beauty, household, commercial and industrial products. It also produces fluff and specialty pulps that are utilized in absorbent hygiene products, tissue and paper products. The participants serve a wide array of industries, ranging from food and beverage, farming and agriculture, home and personal care, health, retail and e-commerce to shipping and transport, among others.
Let us take a look at the three major themes in the industry:

  • The transition to digital media led to declines in the graphic paper segment in the past few years and is a constant threat. Paperless communication, increased use of email, less print advertising, more electronic billing and fewer catalogs have dented graphic paper demand. Consequently, the industry is resorting to machine conversions into packaging and specialty papers.
  • The Paper and Related Products industry will be backed by packaging demand in the days ahead. The global paper & paperboard packaging market, which was worth $175 billion in 2017, is expected to reach $267 billion by 2026, at a CAGR of 4.8%. Growing consumer awareness regarding sustainable packaging, preference over plastic, rising e-commerce activities and increasing demand for hygiene products are some of the factors favoring the market. Per Statista, global retail e-commerce sales are set to grow to $4.88 trillion in 2021 from $2.3 trillion in 2017. Moreover, improving disposable income, especially in developing countries, is one of the primary catalysts.
  • Apart from high raw material costs, the industry has been affected by rising transportation, chemical and fuel costs. The industry players are focused on cost reduction and resorting to digital manufacturing for the same. The paper industry has already incorporating recycled content into its production methods. By maximizing recycling, the industry will be be able to implement  environmentally and economically sustainable production methods. Further, investment in breakthrough technologies will spur demand for high-quality paper products.

Zacks Industry Rank Indicates Dismal Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy prospects in the near term. The Paper and Related Products industry, which is a 16-stock group within the broader Zacks Basic Materials sector, currently carries a Zacks Industry Rank #222, which places it at the bottom 13% of 256 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since the beginning of this year, the industry’s earnings estimate for the current year has gone down 15%.

Our proprietary Heat Map shows that the industry’s rank has remained in the bottom half over the past seven weeks.

Despite the bleak near-term prospects, we will present a few Paper and Related Products stocks that can be retained in one’s portfolio given their long-term prospects. But it’s worth taking a look at the industry’s shareholder returns and current valuation first.

Industry Lags S&P 500 and Sector on Shareholder Returns

The Paper and Related Products industry has underperformed the S&P 500 over the past year. While the stocks in this industry have collectively declined 32.6%, the Zacks S&P 500 composite has rallied 8.3%. Meanwhile, the Zacks Basic Materials sector fell 1.4%.

One-Year Price Performance

Paper and Related Products Industry’s Valuation
On the basis of forward 12-month EV/EBITDA ratio, which is a commonly used multiple for valuing Paper and Related Products companies, we see that the industry is currently trading at 5.6x compared with the S&P 500’s 11.1x and the Basic Material sector’s forward 12-month EV/EBITDA of 7.8x. This is shown in the charts below.
Enterprise Value/EBITDA (EV/EBITDA) TTM Ratio

Enterprise Value/EBITDA (EV/EBITDA) TTM Ratio

Over the last five years, the industry has traded as high as 13.2x and as low as 4.7x, with the median being at 6.3x.
Bottom Line
Despite threat from increasing digitization, rising global demand for paper packaging, tissue papers and hygiene products will help sustain the Paper and Related Products industry. Further, boom in e-commerce and rising demand in developing countries will act as catalysts.
We are presenting two stocks with a Zacks Rank #2 (Buy) and two with a Zacks Rank #3 (Hold) that investors may take a look at.
You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

D S Smith Plc (DITHF): The London, U.K.-based company currently carries a Zacks Rank #2. The Zacks Consensus Estimate for fiscal 2019 has gone up 2% over the past 90 days. The company has a long-term estimated earnings growth rate of 7%.

Price: DITHF

Smurfit KAppa Group Plc (SMFKY): The Dublin, Ireland-based company carries a Zacks Rank #2. The company has a long-term estimated earnings growth rate of 4.5%. The Zacks Consensus Estimate for 2019 earnings has moved up 3% over the past 90 days.

Price: SMFKY

Sappi Ltd. (SPPJY): This Johannesburg, South Africa-based company carries a Zacks Rank #3. The Zacks Consensus Estimate for fiscal 2019 earnings has moved up 4% over the past 90 days. The Zacks Consensus Estimate for 2019 earnings has moved up 4% over the past 90 days, reflecting year-over-year growth rate of 20%.

Price: SPPJY

Domtar Corporation (UFS): The Zacks Consensus Estimate for this Fort Mill, SC-based company has moved 8% upward for current-year earnings over the past 90 days. The consensus estimate reflects year-over-year growth of 18.9%. This stock carries a Zacks Rank #3. The company has a long-term estimated earnings growth rate of 5%.

Price: UFS

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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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