Industry Reports

Deutsche Bank Reports Summaries

080521 Deutsche Bank Report - Dr. Paper's Quarterly

Deutsche Bank - Equity Research

* Is there room for more "rethink"?

With raw material and transportation costs skyrocketing, management responses have varied. The most aggressive actions has come from O- I, which has shown a willingness to surrender volume to rebuild margins. Judging from Q1 results, most paper companies would benefit from some of this discipline.

* The best case for a "rethink" is among the containerboard producers

The market is characterized by high operating rates, lean inventories, a weak US$, higher costs on competing forms of packaging and falling industry margins. An IP mill outage is reducing supply and the merger of Weyerhaeuser's c'board business into IP in 3Q should also help. Virtually all factors except demand growth appear supportive of a price hike.

* Pricing developments

(1) Wood products prices are enjoying a belated spring pricing rally, (2) Coated paper producers are riding a wave created by recent capacity closures and a weak US$ - - - prices in some coated grades are up by $250/ton in less than 12 months. (3) Newsprint producers have raised prices sharply since last autumn - despite continued rapid erosion in consumption. (4) Uncoated free sheet producers have moved prices upward, but at a very measured pace.

* Valuation/risk

Paper companies are trading around 1.4x book value and 7.0x estimated "peak" earnings, a bit more than half of the historically high "peak" multiple. Packaging companies are trading around 14.4x our '08 EPS estimate, with tight variance within the sector. We value paper companies using different metrics, including sum-of-the- parts, and historical EV/EBITDA and P/E ratios. Our valuation of packaging companies is primarily based on historical EV/EBITDA patterns. EV/EBITDA takes into account varying amounts of debt at each company. The primary risks involve momentum in the economy, the health of demand within key grades like containerboard and white paper, and additional energy, chemical, and freight cost inflation.

Companies with significant exposure to the CN$ remain at risk as DB forecasts a continued strengthening of that currency. Beyond these issues, we remain watchful about capacity growth abroad (especially in China and Latin America).