The hits keep on coming for the beleaguered and overleveraged paper industry. On Feb. 18 it was International Paper's (IP) CEO, John Faraci, delivering the bad news, suggesting his company might soon cut its $1 a share dividend. The CEO's musings followed the company's weak fourth quarter results, a surprisingly large $452 million loss announced on Jan. 29 that has pushed International Paper shares down almost 50% in just a few weeks.
The news isn't much better across the rest of the sector. Smurfit-Stone Container (SSCCQ) filed for bankruptcy protection on Jan. 26, and analysts are expecting some of its competitors to follow. Shares of AbitibiBowater (ABH), the result of a misbegotten 2007 merger between two paper giants, have dropped to less than 50 cents on fears the company won't be able to continue servicing its debt.
"Here's an industry where the investment bankers really need to be fired," says Lee Eugene Munson, chief investment officer at money manager Portfolio in Albuquerque, N.M. "The debt these companies took on is killing them."
International Paper CEO Faraci told Bloomberg that his company's dividend, now equal to 15% of the share price, might not be the best use of the company's cash. "Our CFO says 15% dividends don't exist in nature," Faraci told the news service. Paper demand continued to decline by 15% to 20% in January, about the same rate as in the fourth quarter, Faraci also said.
Shares of International Paper have lost 80% over the past year, while Domtar (UFS) is down 85% and AbitibiBowater has lost 96%. The industry has been sapped by falling demand for everything from office paper to the cardboard boxes used to ship goods made in China to the U.S. Overall demand for paper and cardboard declined 19% in December from the same month in 2007, according to the American Forest & Paper Assn.
Despite the depressed stock prices, Munson sees few bargains in the paper industry. International Paper is unappealing because of its balance sheet, loaded down with debt after the $6 billion acquisition of Weyerhaeuser's packaging unit last year, Munson says. Domtar is too reliant on exports, and AbitibiBowater's finances look shaky.
Packaging Corp.'s Cushion
There is one bright spot. Munson's firm has been buying shares of Packaging Corp. of America (PKG), one of the few companies in the industry to report a profit in the fourth quarter. Management has been smartly cutting costs to offset falling demand for boxes while building up cash on the company's balance sheet, he adds. For example, instead of closing its Valdosta (Ga.) plant for eight days and using outside contractors to perform maintenance, as it did in past years, the company is taking advantage of employee downtime and shutting the plant for 16 days to use its own employees to perform the overhaul.
And Packaging Corp. also has no debt coming due in the next five years, a cushion its troubled competitors can't match. "It's the best defensive play in the industry," Munson says.
Still, the company's shares aren't inexpensive. Packaging Corp. trades at over two times its book value and over 20 times expected 2009 profits. International Paper and Domtar trade at a fraction of their book value.