Paper & Packaging
Dr. Paper's Quarterly: Time for
a Rethink?
Mark Wilde
Research Analyst
(1) 212 250 5570
mark.wilde@db.com
Christopher Chun, CFA
Research Analyst
(1) 212 250 8342
christopher.chun@db.com
Debbie Jones
Research Associate
(1) 212 250 2956
debbie.jones@db.com
Is there room for more "rethink"?
With raw material and transportation costs skyrocketing, management responses
have varied. The most aggressive actions has come from O-I, which has shown a
willingness to surrender volume to rebuild margins. Judging from Q1 results,
most paper companies would benefit from some of this discipline.
Deutsche Bank Securities Inc.
All prices are those current at the end of the previous trading session unless otherwise indicated. Prices are sourced from
local exchanges via Reuters, Bloomberg and other vendors. Data is sourced from Deutsche Bank and subject companies.
Deutsche Bank does and seeks to do business with companies covered in its research reports. Thus, investors should
be aware that the firm may have a conflict of interest that could affect the objectivity of this report.
Investors should consider this report as only a single factor in making their investment decision.
Independent, third-party research (IR) on certain companies covered by DBSI's research is available to customers of
DBSI in the United States at no cost. Customers can access this IR at http://gm.db.com, or call 1-877-208-6300 to
request that a copy of the IR be sent to them.
DISCLOSURES AND ANALYST CERTIFICATIONS ARE LOCATED IN APPENDIX 1
Trend Analysis
Top picks
Domtar (UFS.N),USD6.34 Buy
International Paper (IP.N),USD27.81 Buy
O-I (OI.N),USD55.85 Buy
Pactiv (PTV.N),USD24.10 Buy
Rock-Tenn (RKT.N),USD35.69 Buy
Global Markets Research Company
The best case for a “rethink” is among the containerboard producers
The market is characterized by high operating rates, lean inventories, a weak US$,
higher costs on competing forms of packaging and falling industry margins. An IP
mill outage is reducing supply and the merger of Weyerhaeuser’s c’board
business into IP in 3Q should also help. Virtually all factors except demand growth
appear supportive of a price hike.
Pricing developments
(1) Wood products prices are enjoying a belated spring pricing rally , (2) Coated
paper producers are riding a wave created by recent capacity closures and a weak
US$ - - - prices in some coated grades are up by $250/ton in less than 12 months.
(3) Newsprint producers have raised prices sharply since last autumn - despite
continued rapid erosion in consumption. (4) Uncoated free sheet producers have
moved prices upward, but at a very measured pace.
Valuation/risk
Paper companies are trading around 1.4x book value and 7.0x estimated “peak”
earnings, a bit more than half of the historically high “peak” multiple. Packaging
companies are trading around 14.4x our ’08 EPS estimate, with tight variance
within the sector. We value paper companies using different metrics, including
sum-of-the-parts, and historical EV/EBITDA and P/E ratios. Our valuation of
packaging companies is primarily based on historical EV/EBITDA patterns.
EV/EBITDA takes into account varying amounts of debt at each company. The
primary risks involve momentum in the economy, the health of demand within key
grades like containerboard and white paper, and additional energy, chemical, and
freight cost inflation. Companies with significant exposure to the CN$ remain at
risk as DB forecasts a continued strengthening of that currency. Beyond these
issues, we remain watchful about capacity growth abroad (especially in China and
Latin America).

Outlook and review
Time for a rethink?
There’s been some “rethink” taking place among paper & packaging companies. Is there
room for more? With raw material and transportation costs skyrocketing, management
responses have varied. The most aggressive action has come from O-I, the world’s largest
producer of glass containers. O-I's new Chairman & CEO, Al Stroucken, has been outspoken
in his drive to recoup the higher costs that have ravaged margins. The jury is still out, but
early signs have been encouraging. O-I is willing to surrender volume to rebuild margins.
More recently, Ball, Crown and other metal container companies seem to be moving in the
same direction. Judging from Q1 results, most paper companies would benefit from some
of this discipline. Rapidly rising costs produced disappointing results at most paper
companies.
The Best Case for a “Rethink” is Among the Containerboard Producers
Margins at most producers were compressed by rising energy, fiber and transport costs
along with the failure of a spring price hike. The frustration among analysts & investors is
audible. Although box shipments have slowed with the economy, virtually every other
industry indicator appears positive. The market is characterized by operating rates in the
mid/upper 90’s, lean inventories, a weak US$, higher costs on competing forms of packaging
. . . and falling industry margins. If the industry can't generate acceptable margins now, then
when will it??? Perhaps leaders should spend less time wringing their hands over potential
volume losses and focus on generating shareholder returns. It was this same type of shift
that drove O-I's change in strategy. Two other recent developments in containerboard are
worth noting. First, a boiler explosion at IP's Vicksburg, MS mill has removed 560K tons/yr of
linerboard capacity for an indeterminate amount of time (our best guess, 6 months). This
equates to 2% of industry capacity. Operating rates thru April was 96.4%. Second, IP's
acquisition of WY's packaging business has received Dept of Justice approval and could
close in early Q3. When the deal closes, IP will be the world's largest containerboard
producer with over 11MM tons of capacity, almost 30% of North American capacity.

Wood products prices are enjoying a belated spring pricing rally
The upturn owes far more to supply constraints than any fundamental improvement in
demand. While we're skeptical whether this rally will "have legs", its strength through mid-
May appears strong enough to produce a few upside EPS revisions in Q2 estimates. On a
longer-term basis, it appears that some "rethink" will be necessary to adjust the supply side to
a gradual recovery scenario in the housing market. Earlier scenarios which suggested that
OSB producers would merely need to wait for the market to "grow into" a wave of new
capacity didn't assume a simultaneous, deep and protracted drop in new housing activity.
One of the largest OSB producers, Ainsworth, has publicly acknowledged its search for new
equity. Weyerhaeuser has already idled 4 OSB mills. It's not hard to envision another
"strategic review" taking WY out of engineered wood altogether.
Currency & fiber cost remain key issues
The fall-out from a weak US$ and higher fiber costs continues to rock many producers,
especially in Canada and Scandinavia. The most recent shocks came in Canada. A deal to
acquire bankrupt Pope & Talbot's 3 West Coast pulp mills fell through and the mills are
currently idled, eliminating 830K mtons/year of annual capacity. In addition, Neenah Paper
announced a deal to exit its only remaining market pulp mill. Neenah will provide $15-20MM
in transitional payments to the private equity buyers of the Canadian mill. With pulp prices at
their second highest levels in history, it's a telling situation.