As Newsprint Demand Slackens, Paper Companies Feel the Pinch

By: While many U.S. stock sectors have bounded higher by double-digit percentages in recent months and scored big gains for the past year, paper and wood producers have stagnated.

The slowdown in the housing business and a drop in newsprint demand have pulled some of the stocks lower, while speculation about interest in the companies from private equity buyers has helped others advance.

The Dow Jones U.S. Paper Index, which reflects the performance of paper industry stocks, has had a meager rise of just 2 percent over the past year. The stocks of some of the largest paper companies have fallen by double digits over the same period: Abitibi-Price Inc. fell more than 28 percent, Bowater Inc. dropped by about 30 percent and International Paper Co. by 35 percent.

Goldman Sachs Analyst Richard Skidmore wrote in a research note that he sees the greatest risk in newsprint and coated paper products used in publishing. He noted that October data on paper "showed little to suggest markets have sufficiently tightened to support higher paper prices in the near term."

Skidmore wrote that within the industry, he preferred companies with an interest in containerboard. Goldman maintains a "Buy" rating on Smurfit-Stone Container Corp., Temple-Inland Inc. and Packaging Corporation of America.

Georgia-Pacific announced this week it would follow two competitors, International Paper and Weyerhaeuser Co., in raising containerboard prices this January. The three producers, which are second-, third- and fourth-largest in the industry sector, together represent 42 percent of capacity.

Those price hikes can only offset in part the drop in newsprint.

"We have been concerned that, rather than flattening out as some of the trade consultancies and investors believe 'because it's already declined so much,' newsprint consumption in the U.S. and North America would continue to decline at 5 percent or more given the 1 to 2 percent steady circulation declines, 1 to 2 percent ad linage declines and continued conservation efforts by the newspapers," Banc of America Securities Analyst George Staphos wrote in a research report last week.

Staphos wrote in a Tuesday report about the "elephant in the room," or the mergers and acquisitions and private equity market. In recent months, analysts had noted companies' divestitures of non-core assets and paydown of debt as signs some that paper producers might be readying themselves for sale.

Louisiana-Pacific Corp. is the latest subject of such speculation, as industry watchers look to Weyerhaeuser as a potential buyer. Nashville, Tenn.-based Louisiana-Pacific, one of the largest makers of lumber products for new homes and remodeling, is attractive partly due to a large amount of cash on hand.

UBS Analyst Richard Schneider wrote that the company's $1.2 billion in cash could help finance a deal, but he doubted the acquisition would be done. He said Weyerhauser is focused on improving its containerboard business and that pursuing such a large transaction could prove distracting, especially because of Louisiana-Pacific's focus on wood products.

Meanwhile, the broad reach of the housing slowdown has depressed the part of the industry focused on building materials. As developers pull back on new home construction, leading to a decline in demand for lumber, wood manufacturers suffered in the third quarter, with many reporting lower profits.

At least one analyst, though, believes wood product prices appeared to have bottomed out. Prudential Equity Group Analyst John Tumazos wrote in a weekly report that lumber prices "appear to have stopped their year-to-date decline."

Prices for oriented strand board, which is similar to plywood, and traditional plywood appear to have hit a bottom in late September and early October. Both have risen since then.