Monday, September 10, 2012

Actionable Call Alert: Containerboard (NYSE:IP, PKG, RKT, KS)

Deutsche Bank's Paper & Forest Products team is making a significant call this morning downgrading their Containerboard space after their checks revealed the widely anticipated autumn price hike may note materialize:

- International Paper (NYSE:IP) to Hold from Buy with $39 price target (prev. $41)
- Packaging Corp. of America (NYSE:PKG) to Hold from Buy with $34 price target (prev. unch)
- Rock-Tenn (NYSE:RKT) to Hold from Buy with $75 price target (prev. $80)
- Kapstone (NYSE:KS) to Hold from Buy with $23 price target (prev. $24)

Over the last 7-8 weeks, the stocks have rallied sharply (up 30-40% in some cases) in anticipation of an autumn price hike. While the market seems to be assuming the hike is a "done deal", the firm notes they are not convinced. They think real questions remain about whether producers can implement & then maintain the increase. If anything, they've become a bit more cautious. Thus, in firm's view, the prudent move is to take a step back from their Buy recommendations.

Since the price hike announcements began to emerge in mid-July, the backdrop for the initiative has gotten murkier

Last week's sub-50 reading on the ISM manufacturing index is a cautionary sign for future containerboard & box demand. At the industry level, the continuing downward drift in old corrugated container (OCC) signals lackluster demand and reduced costs for producers of recycled containerboard. Finally, reports of quiet downtime by at least one major producer raise the question of just "how tight?" the market really is at the moment. While the firm had initially viewed the prospects of a successful hike at 60-70%, they now view the odds at only 50%. A 50/50 handicapping of the price hike is hardly bearish. However, given the optimistic expectations priced into the stocks, it's hard to argue that these stocks need to be our "conviction list".

Unfortunately, they think the Street has placed too much emphasis on this hike attempt as a litmus test of a newly consolidated & restructured industry
As a result, if the price hike fails, the short-term negative reaction in the stocks could prove dramatic. We think the emphasis on & interpretation of the hike is being overdone. While consolidation & more disciplined management should help investment returns over time, they aren't enough to over-ride economic fundamentals. Raising prices in the face of a global economic slowdown, flattish domestic demand and falling costs is a tall order for any industry.

Containerboard price forecasts remain unchanged
As they have not assumed any benefit from the hike in their 2012 estimates, Deutsches's current EPS forecasts remain unchanged. They will continue to monitor supply/demand fundamentals as well as pricing behavior in the market.

Notablecalls: Actionable Call Alert. Most of these names will be down 7-10% on this. Here's why:

- It was DBAB's team that made the initial positive call in the space back on July 10:

A few months back, we didn’t expect to be talking about an autumn price initiative. But, . . . here we go. Over the next several days, DB believes we could hear about containerboard price hike announcements in the $40-60/ton range.
Now let's look at the charts:

- CSFB upgraded the space on August 13 driving the names even higher over the next weeks. The reason for the upgrade? You guessed it. Expected containterboard price hikes!

With DBAB team now coming out saying they are not so sure the price hikes will stick, some of that money put to work in the space will need to reverse. Millions of shares will need to be unloaded. This will take weeks.

Mark Wilde and Debbie Jones from DBAB's Paper & Forest Products team have done wonderful work in the space. Give kudos when it's due. I do!

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