Are You Missing the Paper Story?

·7-min read

The Paper and related Products industry is undergoing meaningful changes.

Historically, the biggest use cases for paper have been packaging and printing. With the expansion of the digital economy, the printing paper industry went into secular decline. So when the pandemic hit in 2020, paper producers were consolidating operations, shutting down mills and some were going out of business.

At the same time, there was gross underestimation of printing paper demand. These factors combined to create supply-demand imbalance. During the pandemic, there were added supply-side challenges related to raw material and labor availability and shipping bottlenecks. All these served to further constrict supply.

The logistical difficulties were shared by other segments of the paper industry, most notably in the packaging segment. However, environmental factors continue to drive demand for ecofriendly packaging materials, putting paper at the forefront.

Companies are researching paper and related products to replace their dependence on plastic and meet ESG goals. And the pandemic hugely increased demand for ecofriendly packaging because products that were earlier picked up in the store had to be transported in containers of some sort (paper boxes for the most part).

As peoples’ shopping habits change and move online, demand for this kind of packaging will continue to grow. In the stores too, paper bags are increasingly replacing plastic bags. Therefore, this is a large and fast-growing market.

The third segment that continues to emerge is health/sanitation. Use of paper (tissue, wipes, etc) was greatly boosted by the pandemic as hospitals and nursing homes pushed demand. In general it is seen that paper consumption in households in developed economies is higher than in developing economies.

Therefore, it is reasonable to assume that growth in developing economies will continue to boost this demand in the next few years. Since population growth in these countries is also higher, this is a strong secular driver of demand.

Rising disposable income and increasing food consumption away from home in developing economies are also boosting demand.

China is the largest producer and consumer of paper per capita. Therefore, developments in China tend to affect the market as well.

The war in Ukraine is also disrupting the supply chain and impacting raw material supply. Part of the problem is related to the availability of components and part of it is the trade ban on Russia, which is limiting supply.

The above factors indicate that paper demand is likely to be relatively steady even if the economy takes a turn for the worse, which is a recipe for stronger pricing. And this is a good thing because raw material and energy prices are likely to remain elevated in the foreseeable future. Commentary from a number of companies shows that stronger pricing is more than offsetting the higher costs. Therefore, paper stocks are a relatively safe bet in 2023.

Let’s take a look at some examples:

Klabin S.A. KLBAY

The Brazilian company operates through Forestry, Paper, Conversion and Pulp segments. The Forestry segment is involved with the planting and forestry operations of pine and eucalyptus; and the sale of wood logs. The Paper segment produces and sells reels of cardboard, kraftliner, and recycled paper. The Conversion segment is involved in the production and sale of corrugated boxes and sheets, and industrial bags. The Pulp segment produces and sells short, long, and fluffed pulp.

Current drivers of Klabin’s business include strengthening demand in the food and beverage market as well as industrial packaging, as the Brazilian economy continues to strengthen. Higher volumes, a more favorable mix and stronger pricing are contributing. On the third-quarter earnings call, management stated that the average net price per ton was 28% higher than the prior year.

In the last 30 days, analysts have raised Klabin’s 2023 earnings estimates by 27 cents (15.3%).

Valuation based on P/E is low. At a 3.8X multiple, the shares are trading at a 21.0% discount to their median level over the past year and a 78.1% discount to the S&P 500.

Mondi MONDY

Mondi engages in the manufacture and sale of packaging and paper products in Africa, Western Europe, Emerging Europe, Russia, North America, South America, Asia and Australia. It operates in Corrugated Packaging, Flexible Packaging, Engineered Materials and Uncoated Fine Paper segments. It serves customers in the agriculture, automotive, building and construction, chemicals and dangerous goods, food and beverages, graphic and photographic, home and personal care, medical and pharmaceutical, office and professional printing, paper and packaging converting, pet care, retail and e-commerce, and shipping and transport industries.

The company is seeing stronger pricing across segments with volume strength in all except corrugated, which ran into difficult comps.

In the last 30 days, the Zacks Consensus Estimate for 2023 earnings increased 22 cents (7.5%) and for 2024 earnings 10 cents, or a little over 3%.

The shares are trading below their annual high but still at a 33..8% discount to the S&P 500.

Suzano S.A. SUZ

Suzano is engaged primarily in the production and sale of eucalyptus pulp and paper products in Brazil and internationally. It operates through the Pulp and Paper segments. The company offers coated and uncoated printing and writing papers, paperboards, tissue papers, market and fluff pulps; and lignin and its byproducts.

Like Klabin and Mondi, Suzano is also seeing stronger pricing for its hardwood pulp in North America and Europe, where demand is strong as well as in China where demand is stable. While demand was also very strong in South America, new projects saw roadblocks because of European sanctions on Russian wood.

In the last 30 days, Suzano’s 2023 estimates have jumped 29 cents (17.4%)

The shares are trading at a discount to their annual high and also the S&P 500.

Sylvamo Corporation SLVM

Sylvamo produces and supplies printing paper in Latin America, Europe and North America. Some of its offerings include uncoated freesheet for paper products (cutsize and offset paper; pulp, aseptic, liquid packaging board, coated unbleached kraft) and hardwood pulp (bleached hardwood and eucalyptus kraft; bleached softwood kraft; bleached chemi-thermomechanical pulp). It sells through merchants and distributors, office product suppliers, e-commerce channels, retailers and dealers, as well as directly to converters producing envelopes, forms and other related products.

Other than stronger volumes, both price and mix are driving the company’s profitability right now. Pricing in particular is turning out to be better than management’s expectations.

The shares are trading at a slight discount to their median level over the past year and a 69.5% discount to the S&P 500.

Veritiv Corporation VRTV

Veritiv Corporation operates as a business-to-business provider of value-added packaging products and services, as well as facility solutions, print, and publishing products and services in the United States and internationally. The company operates through four segments: Packaging, Facility Solutions, Print, and Publishing and Print Management (Publishing). It serves manufacturing, food and beverage, wholesale and retail, healthcare, transportation, property management, higher education, entertainment and hospitality, commercial printing, and publishing sectors.

Management has talked about slower volumes in the logistics and consumer electronics markets with higher volumes in health-care, manufacturing and e-commerce markets.

While price increases in corrugated and resin have moderated, other segments within Packaging remain strong with elevated prices expected to continue into 2023. In the Facility Solutions segment, the away-from-home verticals like entertainment and hospitality are likely to remain strong (cruise lines and theme parks returning) but offset to an extent by continued softness in offices. In Printing, demand is outpacing supply because of the reasons outlined above, leading to stronger pricing.

The shares are trading at a 9.6% discount to their median value over the past year and a 59.7% discount to the S&P 500.

Wrapping Up

All the above stocks carry a Zacks Rank #1, which translates to a Strong Buy Rating. Moreover, all except Klabin have Value and Growth Scores of A or B. Moreover, as the above examples illustrate, the current story is not reflected in share prices, which continue to represent a slow-growing and mature market with limited pricing power. Therefore, this is a market worth considering.

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