The best time to buy cyclical stocks is often when folks think the industry is dead, and the worst time to buy is when people are feeling chipper again. But what do you do when it looks as though you're in the middle of a cycle? That's the question now for prospective investors in Packaging Corp. of America (NYSE:PKG).
Packaging Corp. is one of the larger producers of containerboard and corrugated packaging -- materials used to package and protect all manner of food, appliances, consumer goods, and so on. Today, its industry inventory levels are at their lowest point in 11 years, and many players in the industry, including Smurfit-Stone (NASDAQ:SSCC), International Paper (NYSE:IP), and Weyerhaeuser (NYSE:WY), have shut down capacity fairly recently.
Hmmm, low inventories and reduced industry capacity . where have we heard this before? Copper? Iron ore? Coal? Every one of those recent upswings started with some of that same basic math.
To be sure, times may be about to get better, but they're not great yet. Sales in the recently announced fourth quarter were down 4%, as weak pricing outweighed a modest increase in corrugated product shipments. Furthermore, net income was far lower than in the year-ago period. On a brighter note, the company still managed to produce a respectable amount of free cash flow for the year.
Analysts have been raising their estimates on Packaging Corp., suggesting that the word is out on an upcoming industry revival -- as if low inventories and recent price hikes weren't enough of a clue. Still, there is the possibility that the upswing will surpass present expectations, as it did in copper, iron, and coal. Should that happen, Packaging Corp. should be well-positioned. It's an efficient operator, geared to use coal and bark for fuel instead of oil and natural gas, which gives the company a little protection from the volatile natural gas markets.
Here you have a stock with an attractive dividend yield, a meaningful operational advantage, and a presence in a cyclical industry on the way up. The only downside is valuation, but I'll be the first to admit that valuation is tricky in these situations. Investors should proceed with caution. But if the containerboard market really does surge, Packaging Corp. should see some real benefits.
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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
