Profits at paper, packaging and building supply companies are getting squeezed by raw material costs and falling demand for their goods as the U.S. economy and housing market languish.
Even as these companies cut costs by shuttering mills and raise customer prices, it's not fast enough to offset inflation. And if they raise what they charge too quickly, they could see a greater falloff in demand.
With the exception of newsprint and the price of land with timber on it, product prices are struggling to keep up, says RBC Capital Markets analyst Paul Quinn.
"While forest product prices are increasing, these gains are largely the result of capacity curtailments and closures rather than rising demand," he wrote in a July 22 client note.
Meanwhile, companies are still paying for the surging cost of materials like fiber, energy, chemicals and transportation. Take natural gas, both a fuel and a component for plastic packaging makers: In the last 52 weeks its price has shot up about 54 percent, even after the effect of a dramatic sell-off over the past three weeks.
Earnings also are staggering under the worst U.S. housing construction in decades and _ for companies with significant assets north of the U.S. _ a sharp rise in the value of the Canadian dollar against the greenback. Those conditions are freezing up demand for lumber and other goods used in buildings.
"We expect the industry to report aggregate net income of just $37 million for the second quarter of 2008, down 93 percent from the second quarter 2007, despite higher product prices," wrote Citi Investment Research analyst Chip Dillon in a July 21 note.
Among building products, paper and packaging companies that will release second-quarter earnings are Louisiana-Pacific Corp., reporting July 29, and Memphis-based International Paper, reporting July 31.
Analysts polled by Thomson Financial expect, on average, that Louisiana-Pacific will report a wider loss of 38 cents per share, while International Paper will report a smaller profit of 39 cents. Analysts' estimates typically exclude one-time items.
Share prices have declined with the sector's weakened results. In the last 52 weeks, the S&P 500 Paper and Forest Products index has tumbled 34 percent.
"The sector is a long way from a sustained recovery ... significant cost inflation remains the industry's main concern," says Quinn. "On the top line, we see little sustained momentum in commodity pricing, with the exception of newsprint and groundwood paper, offering limited ability to offset higher fibre, chemical, energy and transportation costs," Quinn wrote.
Quinn also said the average estimate of 11 cents per share loss is down from the 10 cents per share average profit seen in the second quarter of 2007, but narrower than the 17 cents per share loss seen in the first quarter of 2008.
Although there is evidence of sequential price increases and sequential improvements in earnings, new threats are looming.
Deutsche Bank-North America analyst Mark Wilde said in a July 21 client note that "reliable trade sources" report Brazilian pulp and white paper producer Suzano Papel e Celulose is considering building a plant on or near the Texas Gulf Coast.
He said as the industry scrambles to close mills and plants in the face of declining demand, "the specter of new capacity coming into the market is troubling."
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