The Paper and Related Products industry kicked off 2018 on a bright note backed by rising paper demand for use in packaging materials, skyrocketing e-commerce activities and increasing demand for hygiene products. Though rising digitization remains a constant threat, consolidation in downstream businesses, global trade shifts and supply-chain management will be key catalysts.
The Paper and Related Products industry, which comprises various market segments, including paper packaging and tissue, timber and wood products, and market pulp, is highly dependent on the prices of wood fiber, recycled fiber, energy, chemicals etc. According to RISI (One of the leading providers of information and data for the global forest products industry), old corrugated containers have witnessed a price drop so far in 2018 compared to the previous year. This is favorable for containerboard and paperboard producers using recycled fiber as a raw material.
In addition, RISI projects the total value of U.S. carton shipments to be up around 9% from an estimated $8.8 billion in 2018 to more than $9.6 billion in 2021.
Industry Lags on Shareholder Returns
The Zacks Paper And Related Products industry, which is a 19-stock group within the broader Zacks Basic Materials Sector, has underperformed the S&P 500 as well as its own sector over the past year. While the stocks in this industry have collectively gained 12%, the Zacks S&P 500 Composite and Zacks Basic Materials Sector have rallied around 15% and 14% respectively during the same time frame.
This lackluster performance mainly resulted from a shrinking graphic-paper market, higher-than-anticipated freight costs and raw material costs. Also, the recent tariff-related concerns are weighing on the industry. The imposition of anti-dumping duties on newsprint, in addition to softwood lumber tariffs, will likely impede the industry’s performance.
Further, most companies operating in the industry are facing high investments as well as operating costs and strong competitive environment. Strengthening of the U.S. dollar also remains another major headwind for the industry.
One-Year Price Performance
Group’s Valuation Looks Bit Stretched
Regardless of the underperformance of the industry over the past year, its valuation hardly looks cheap now. The Paper and Related Products industry’s valuation could be roughly assessed on the basis of its EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio performance.
The EV/EBITDA multiple is a preferred valuation metric for a capital-intensive industry like Paper and Related Products that have large component of fixed costs. Therefore, even a marginal dip in revenues might affect the bottom line to a large extent, as companies are unable to reduce costs in order to offset the impact on earnings. Thus, the EV/EBITDA multiple is a preferred valuation metric for such industries that have significant fluctuations in earnings from one quarter to the next.
Going by this multiple, valuation for the paper products industry looks a bit stretched, at the moment, when compared to the broader market and its own sector.
The industry has a trailing 12-month EV/EBITDA ratio of 12.0, which is currently above its one-year median of 11.9. However, the industry compares unfavorably with the market at large, as the trailing 12-month EV/EBITDA ratio for the S&P 500 is 11.5 and the median level is 11.4.
Enterprise Value/EBITDA (TTM)
Additionally, a comparison of the group’s EV/EBITDA ratio with that of its broader sector indicates that the group is trading at a premium. The Zacks Basic Materials Sector’s trailing 12-month EV/EBITDA ratio of 10.1 and the median level of 10.3 for the same period are below the respective ratios of the Zacks Paper and Related Products industry.
Enterprise Value/EBITDA (TTM)
Earnings Outlook Paints an Impressive Picture
Companies operating in the Paper and Related Products industry are expected to deliver positive shareholder returns in the near future, driven by a changing industry structure. Also, increasing focus on M&A activities, strategic capital expenditure, substantial restructuring activities by key players, along with productivity improvements, will counterbalance the dreary demand for graphic paper.
But what really matters to investors is whether or not this group has the potential to perform better than the broader market in the quarters ahead. The earlier valuation discussion shows that market participants have been willing to pay up for these stocks already, potentially limiting further upside from the current levels.
One reliable measure that can help investors understand the industry’s prospects for a solid price performance, going forward, is the industry's earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
The Price & Consensus chart for the industry clearly shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018. There is a clear uptrend in both the year's consensus estimates.
Price and Consensus: Zacks Paper and Related Products Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of the aggregate consensus expectations for 2018.
Please note that the $3.18 'EPS' estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Paper and Related Products industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the dollar earnings of $3.18 'per share' of the industry for 2018, but how this dollar number has evolved recently.
Current Fiscal Year EPS Estimate Revisions
As you can see here, the $3.18 'EPS' estimate for 2018 is up from $3.04 reported at the end of March and $2.61 this time last year. In other words, the sell-side analysts covering the companies in the Zacks Paper and Related Products industry have been steadily raising their estimates.
Zacks Industry Rank Indicates Favorable Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates a positive picture for the near term.
The Zacks Paper And Related Products industry currently carries a Zacks Industry Rank #47, which places it at the top 18% of more than 250 Zacks industries. Our back-testing shows that the top 50% of the Zacks ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has been hovering in the top half over the past seven weeks.
Paper and Related Products Stocks Promise Long-Term Growth
The long-term (3-5 years) EPS growth estimate for the industry appears promising. The group’s mean estimate of long-term EPS growth rate has been increasing since October 2017 to reach the current level of 10.4%. This compares to 9.8% for the Zacks S&P 500 composite.
Mean Estimate of Long-Term EPS Growth Rate
One key reason for this long-term EPS growth could be the recovery in top line that stocks in this industry group have been showing since the beginning of 2016 benefiting from the recent surge in e-commerce and packaging.
The global paper industry has already begun to incorporate recycled content into its production methods. By maximizing recycling, the industry will be better able to support rising standards of living worldwide while implementing environmentally and economically sustainable production methods. Thus, an efficient and effective industrial recycling infrastructure will drive the industry’s performance.
Further, investment in breakthrough technologies will spur demand for high quality paper products. Moreover, the industry will ride on efforts to boost paper efficiencies, which can bring many knock-on benefits, as light-weight packaging can drive product sales, reduce breakages and cut transport emissions.
There are many reasons to be optimistic about the Paper and Related Products industry for the near future. Keeping the long-term expectations in mind, it would be prudent to bet on a few stocks in this space that have a strong earnings outlook. However, there remain a few other players that are not attractive investment targets.
Below we have mentioned four Paper stocks. While three of them have been witnessing positive earnings estimate revisions, it’s not the same with the other.
Domtar Corp. (UFS - Free Report) : The consensus EPS estimate for this Fort Mill-based company has moved 10.4% upward for the current year over the last 60 days. This Zacks Rank #1 (Strong Buy) stock has rallied 27% over the past year. You can see the complete list of today’s Zacks #1 Rank stocks here.
Based in Sao Paulo, Fibria Celulose S.A. FBR has been seeing positive revisions in earnings estimates for the past 60 days. Analysts have revised estimates upward by 2.5% for the current year. In addition, this Zacks #1 Ranked stock has surged 88% in a year’s time.
UPM-Kymmene Corp. (UPMKY - Free Report) has been seeing positive revisions in earnings estimates over the last 60 days. Analysts have revised estimates upward by 4.2% for the current year. Further, the Zacks Rank #1 stock has gained 19% in a year.
Neenah Paper, Inc. (NP - Free Report) : The stock of this Alpharetta-based fine paper and packaging products producer has rallied 10% over the past year. The consensus EPS estimate for 2018 has dropped 2.2% in the last 60 days. The stock currently holds a Zacks Rank #4 (Sell).
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