Paper Cuts: BMO Downgrades WestRock, Packaging Corp, International Paper

China-based Nine Dragons Paper Holdings, a manufacturer of containerboard products including lineboard, announced hundreds of millions of dollars in new investments this week that include conversion projects at coated paper mills in Biron, Wisconsin and Rumford, Maine.

The announcement represents a negative catalyst for American-listed paper companies given expectations for a surge in supply, according to BMO Capital Markets. 

The Analyst

Analyst Mark Wilde made the following rating and price target changes:

WestRock Co WRK downgraded from Outperform to Market Perform, price target lowered from $80 to $54.

Packaging Corp of America PKG downgraded from Outperform to Market Perform, price target lowered from $130 to $108.

International Paper Co IP downgraded from Outperform to Market Perform, price target lowered from $66 to $51.

The Thesis

Nine Dragons' investment in multiple coated paper mills facilities in the U.S. comes at a time of rising industry supply and could prove to be the largest capacity surge in more than two decades, Wilde said in a note. (See the analyst's track record here.) 

The announcement follows recent moves from International Paper and Packaging Corp of America, both of which are doing major conversions of their own, he said. WestRock is building a large machine to replace its older equipment in South Carolina, Wilde said. 

It's unclear how all the new capacity will be absorbed, and the analyst's supply-demand model calls for operating rates to fall from 97.5 percent in 2017 to 90.9 percent by 2021.

Demand growth has slowed despite a strong macro economy, and industry leaders will be forced to fight to maintain pricing while protecting market share from smaller players looking to steal small amounts of market share, Wilde said. 

WestRock

Westrock's stock valuation is "not expensive," although the risk of the containerboard market getting more competitive than previously expected should be seen as an overhang for the stock, in BMO's view. The near-term impact could be seen as early as next year, Wilde said; the analyst lowered the 2019 EBITDA estimate from $3.17 billion to $3.07 billion.

Packaging Corp

Despite boasting best-in-class margins and a strong balance sheet, Packaging Corp will still be impacted by the new market dynamics, the analyst said. While the company does have some financial flexibility, the containerboard market will become rougher than expected, and a revision in 2019 EBITDA estimates from $1.57 billion to $1.53 billion is warranted, he said. 

International Paper

International Paper's stock is "not expensive" at 6.4 times 2019 estimated EBITDA, with a 10.7-percent free cash flow yield — but similar to its peers, International Paper won't be immune from the new market dynamics, according to BMO. The firm's 2019 EBITDA estimate was lowered from $4.4 billion to $4.3 billion.

Price Action

WestRock shares were trading down 4.6 percent to $46.87 at the time of publication Tuesday, while Packaging Corporation was down 3.38 percent at $97.95 and International Paper was down 3.21 percent at $45.81. 

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