Looking for Paper Profits?
By Michael Jaffe
Standard & Poor's Focus Stock of The Week is Boise Cascade (BCC ), a leading forest products company which makes paper and wood products, and distributes office supplies and building materials. Boise carries S&P's highest investment recommendation, 5 STARS (buy).
We at S&P believe that the shares are poised for a significant near-term upturn, as Boise's currently soft business trends reach a cycle low in the first half of 2002. We expect strength in its office products segment (45% of 2001 sales) and its paper segment (25% of sales) to more than offset the continued sluggishness that we anticipate in the company's building products division (30% of sales).
Our positive outlook for the company stems largely from our belief that the domestic economy will bottom over the next few months, with the labor market also improving over the course of the year. In light of that forecast, we believe that the company's focus on products used in offices leaves it very well-positioned. We expect demand to start recovering for the business paper and office supplies produced and distributed by the company. With more goods likely to be shipped in a better economy, demand for Boise's corrugated products should also improve.
Boise's paper division, which ranks as North America's third largest maker of uncoated free sheet paper (market share of about 10%) and is a smaller producer of corrugated products, recorded much weaker profits in 2001. The soft domestic economy, customer inventory workdowns and high import levels related to the strong U.S. dollar reduced demand for the company's uncoated paper. Economic woes also softened shipments of corrugated products. With that situation lowering prices for uncoated and corrugated products, and with the division also impacted by higher energy costs, margins narrowed significantly.
However, in light of our expectation of better economic trends over the course of 2002, the likely completion of customer inventory reductions and ongoing industry capacity shutdowns, we see the uncoated and corrugated sectors firming up as 2002 goes on, with a true revival taking place in 2003. We see sector margins aided by the upturn in demand, benefits of the company's cost cutting initiatives and lower energy costs.
The office products segment, which is the principal driver within the paper division, had a promising operating performance in 2001. Although sales fell in the segment, as the difficult economy reduced demand for paper and other office products, significant cost cuts enabled the division to record modestly higher profits.
Based on our expectation of more favorable business trends over the next year, Boise's business customers will likely begin to replenish their labor force during the next 12-18 months. This scenario should start to boost demand for the paper, office products, computer supplies and office furniture offered by the division. This increased order flow, combined with gains in operating efficiency, should translate to moderately improving profitability in 2002, with much stronger gains likely in 2003.
A more cautious outlook remains for Boise's building products division, which has been hurt by lower wood products prices stemming from excess industry supply. With panels markets suffering from overcapacity, and lumber markets likely to be limited by high levels of Canadian imports, we expect results in this division to remain weak for the foreseeable future.
On balance, however, S&P sees an expected improvement in Boise's office products, paper and packaging businesses more than offsetting the difficult results that we envision for the building products area. This scenario should allow the company to post gradual earnings gains during 2002, with increasing strength in 2003.
We forecast earnings per share of $0.90 in 2002, up sharply from the depressed $0.57 Boise recorded in 2001 (before one-time items). With industry fundamentals on the mend, we project EPS to jump to $2.35 in 2003.
Trading at a modest valuation of 15 times our mid-cycle 2003 EPS forecast, S&P believes the shares are attractively priced. Assuming even modest p-e expansion on our 2003 EPS forecast implies that the shares could reach $45 over the next 12 months -- representing potential capital appreciation of almost 30% from current levels.
Jaffe is an equity analyst covering the forest products industry for Standard & Poor's