The paper sector has not exactly been the epitome of growth lately, as the digitization of commerce in countless areas has generally cut down on overall paper demand. According to data provider IBISWorld, global industry sales have been fairly flat, rising 0.4% for the twelve months ended August 2013.
On the upside, economic growth requires more containers and boxes to transport products, providing a source of potential growth. Given the price-taking nature of the industry, with roughly 570 companies competing for market share, an efficient scale of operations is a primary determinant for success in order for smaller competitors to match prices with industry giants, like International Paper and Georgia-Pacific. So, which companies are making the right moves for investors?
Focus on boxes
Packaging Corporation of America (NYSE:PKG) has ridden three straight years of annual top-line growth by concentrating its efforts on the corrugated box segment, currently generating almost 10% of the industry's domestic production.
The company has cultivated a strong supplier position to the agriculture sector, which accounts for 52% of its sales, by providing a growing assortment of wax boxes, meat boxes, and custom containers. It also benefited from a 2012 retreat in wood fiber prices, its largest raw material cost, which led to a five-year high in its operating margin.
In fiscal year 2013, Packaging Corporation has continued its strong operating performance, aided by industry growth of approximately 5% in the corrugated box segment. For the period, the company registered a top-line gain of 12.4%, with its increase in corrugated volumes outpacing the industry average.
More importantly, higher demand for boxes allowed it to use more of its linerboard production internally, roughly 83%, which positively affected its overall profitability.
Fueling its growth
Packaging Corporation's strong operating margin has provided solid operating cash flow, $404 million in its latest fiscal year, allowing management to pursue its growth ambitions. Case in point is its recent acquisition of regional competitor Boise (UNKNOWN:BZ.DL) for approximately $1.3 billion.
While the purchase adds a large, weakly performing freesheet paper business, it also brings economies of scale by adding Boise's 26 paper conversion facilities to Packaging Corporation's existing network of 71 facilities.
In FY 2013, Boise has underperformed its larger competitor, notching a 4.2% decline in revenues and a steep drop in operating income. Its results were hurt by margin compression in its freesheet paper segment, due to lower newsprint prices, as well as the costs of closing plants and reducing its capacity.
However, Packaging Corporation should be able to wring cost savings out of the combined enterprise and enhance Boise's profitability by refocusing its plant capacity and associated product mix on the corrugated box segment.
Another player to watch
Also finding growth in the current operating environment is KapStone Paper & Packaging (NYSE:KS), an acquisition-prone company that primarily built its capacity through purchases of ancillary plants from International Paper and MeadWestvaco in 2007 and 2008, respectively. Like Packaging Corporation, KapStone sees its future in the corrugated box segment, acquiring U.S. Corrugated and its fourteen plants in 2011 for roughly $330 million.
While KapStone is only a fraction of Packaging Corporation's size, with 6.2 billion square feet of production capacity, it is not afraid to leverage itself for growth, recently completing its acquisition of privately held Longview Fibre for roughly $1 billion.
In FY2013, KapStone has continued to generate top-line growth, with a 6.6% increase in revenues and a slight widening of its operating margin. While the company is still heavily skewed toward being a supplier of base linerboard to other box producers, accounting for 77% of its production, KapStone's purchase of Longview positions it for greater market share in the higher-margin corrugated box segment.
More importantly, the addition of eight plants and roughly twelve billion square feet of production capacity should enhance its profitability, with management forecasting a future operating margin in the mid teen range.
The bottom line
While the growth of online activities has incontrovertibly reduced the nation's freesheet paper needs, it has also increased the need for a variety of boxes and containers that can transport the purchases from online commerce. The companies that have efficient operations and are well positioned in this segment should be able to continue to grow by taking market share from less efficient competitors in this fragmented business. As such, Packaging Corporation and KapStone are the industry operators for investors to watch.
Robert Hanley has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.