Who Knew Containerboard Was Such a Great Business?
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Containerboard is the brown box that packages are packed and shipped in. Over the last few years, the industry has consolidated and that lead to a decrease in the number of companies making containerboard. As a result, the industry has been able to increase prices as well as profits.
The consolidation trend started in 2008 when International Paper (NYSE: IP) bought Weyerhauser's packaging business for $6 billion. Since then, other players were bought out, changing the industry in the last five years. Besides International Paper, two other large publicly traded containerboard companies include Packaging Corp of America (NYSE: PKG) and Rock-Tenn (NYSE: RKT).
The largest of the 3
International Paper is a paper and packaging company with operations in North America, Europe, Latin America, Russia, Asia and North Africa. The company employees more than 70,000 people working in 24 countries. Last year, revenue was $28 billion. International Paper is the leading manufacturer and exporter of containerboard and also serves as a packaging company for other companies.
In the first quarter of this year, the company earned $0.71 per share compared to $0.43 per share in the prior year. Net sales improved as well to $7.1 billion from $6.7 billion. The dividend remained the same at $0.30 per share for a yield of 2.5%. The biggest news of the quarter was that Dan Loeb's Third Point initiated a position in the stock. In its quarterly letter, Third Point stated:
International Paper is a core position in our portfolio, which we sized up during the first quarter. [International Paper] has a compelling case for ownership buoyed by excellent sector and secular tailwinds.
Going forward, investors are going to be rewarded with share buybacks and dividend increases. CEO John Faraci is no longer focused on acquisitions, but on improving cash flow and operations. Actually, asset sales are on the table from the Temple-Inland acquisition. International Paper just announced that it's selling the Temple-Inland Building Products division to Georgia-Pacific for $710 million in cash.
The second largest producer
Rock-Tenn is the second largest producer of containerboard in North America after International Paper. The company produces more than 8 million tons annually. It has 14 pulp and paper mills in the U.S. and Canada.
In the second quarter, net sales increased $42 million to $2.3 billion. Adjusted earnings came in at $1.12 per share compared to $0.97 in the prior year's quarter. The company cited higher containerboard and box pricing for the increases. Corrugated packaging shipments increased 28,000 tons due to an increase in U.S. sales.
Going forward, Rock-Tenn will benefit from federal tax and state tax loss carry-forwards and tax credit carry-forwards to the tune of $625 million. This is related to Rock-Tenn's acquisition of Smurfit.
This year, the company forecasts free cash flow available for debt repayment, dividends, and pension contributions to be in the range of $10 to $10.50 per share. The company is expecting further improvement in cash flow in 2014 to be between $14.25 and $15 per share. Free cash flow is increasing as a result of a $50 per-ton increase in containerboard prices being offset by the tax loss carry-forwards.
The smallest producer of the 3
Packaging Corp of America produces over 2.6 million tons of containerboard every year. The company operates four containerboard mills in the United States. Its products are made from renewable fiber and, with few exceptions, are completely recyclable.
Packaging Corp of America just reported record second-quarter earnings. Net income rose to $0.66 per share from $0.46 per share in the prior year. The company benefited from higher prices for containerboard and strong demand from its customers. Net sales increased 12.3% to $800.2 million compared to $712.5 million in the year-ago period. Total shipments increased 6.8% year-over-year. For income investors, the company hiked the dividend by 28% to $1.60 annually. The yield is now 3%.
Packaging Corp of America expects increased containerboard production and lower operating costs in the next quarter. There are no scheduled plant outages. The company anticipates third-quarter earnings to increase to $0.88 per share. To start the third quarter, the company's bookings were up 18% and billings increased 11%. Due to the company's strong results, it will increase capital expenditures by $25 million to $205 million.
Overall, the containerboard business is a boring business, but a profitable one. The industry is benefiting from several tailwinds. One of the biggest tailwinds is the increase of online retailers and the need to ship more packages. The second biggest tailwind is the fact that the industry has consolidated and the producers have more pricing power. Price discounts on containerboard don't appear to be in their vocabulary.
Of the 3 containerboard companies, my favorite would be International Paper. For one, Dan Loeb has it in his portfolio and he has a great track record. Two, International Paper has under-performed the other two stocks in the past year in terms of price appreciation. That has left International Paper as the cheapest with a PEG ratio of only 0.5 compared to Rock-Tenn's PEG ratio of 0.9 and Packaging Corp of America's PEG ratio of 1.2.
Overall, I like the sector and see increased profits leading to further price appreciation and an increase in dividend payouts.
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Mark Yagalla has no position in any stocks mentioned. The Motley Fool owns shares of Rock-Tenn Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!