with Positive View of Containerboard,
Packaging, and Tissue; Avoiding Timber REITs
■ Take your pick—containerboard, glass, or cans. We initiated coverage of the
U.S. Paper and Packaging Industry with a positive bias toward the more
cyclical containerboard names and the more-stable glass and beverage can
players. Positive secular changes in containerboard will soften the 2009-
2010 downcycle and allow for a strong recovery thereafter. In the meantime,
we see the more stable glass and beverage/food can area as attractively
valued in still-uncertain times.
■ Containerboard—a paradigm shift? In previous downturns, which were much
milder economically, containerboard prices quickly fell to the high-cost
producers’ cash cost levels within months. Since last fall, containerboard
prices have gradually declined, but remain at profitable levels. This change
reflects recent industry consolidation with better managers taking the helms.
In the next upcycle (late 2010 to 2013), the U.S. industry should benefit from
its virgin-fiber advantage over other regions.
■ Glass and cans—boring is better. Unlike paper and paperboard, the
beverage/food glass and can business is actually localized, since these
containers cannot travel cheaply. Moreover, people still eat and drink, and
more so at home, in tougher times. In cans, we believe that Crown Holdings
is attractively valued and that it will produce record free cash flow in 2009. In
glass, we see O-I’s volume stumble as temporary and see positive EPS
comparisons returning in the fourth quarter.
■ Cost declines helping tissue. Kimberly-Clark should benefit from belowmidcycle
pulp costs throughout 2010, and benefit from the just-completed
strategic cost initiative. Relative to other consumer plays, KMB has a much
greater exposure to falling or low raw material costs.
■ Don’t climb the trees! We see considerable headwinds for the timber REITs,
as the timber business cycle lags the overall economic cycle. In recent
months, log and chip prices have come under pressure and the torrent of
cash chasing “attractive” 2-4% cash returns in timberland investments
appears to have dried up. These trends could make it difficult for dividends
(which are arguably already a functional return of capital) to be maintained.
We would therefore avoid Plum Creek and Potlatch (both rated
Underperform), and we see limited near-term upside potential in Rayonier
(Neutral).