Please ensure Javascript is enabled for purposes of website accessibility
Free Article Join Over 1 Million Premium Members And Get More In-Depth Stock Guidance and Research

Paper and Packaging Stocks Tumble on Pricing Concerns (IP, PKG, GPK)

By Timothy Green - Jan 25, 2016 at 4:07PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Analyst downgrades related to price cuts raised concerns about eroding margins.

Shares of various paper and packaging companies tumbled on Monday following a slew of analyst downgrades driven by concerns over pricing. International Paper ( IP -3.60% ) was down about 10% shortly before the market closed on Monday, while smaller players Graphic Packaging Holding Co. ( GPK -3.99% ) and Packaging Corp of America ( PKG -2.33% ) were down 9.6% and 12.3% respectively. Earlier in the day, Graphic Packaging was down as much as 10.7%, while Packaging Corp of America bottomed out at a 13.1% loss.

What's going on?
International Paper and Packaging Corp of America were hit with downgrades, along with other companies in the same sector. Citi cut its rating for both companies to neutral, and its price target for International Paper stock dropped to $38, down from $45. Macquarie downgraded KapStone Paper & Packaging, while Bank of America cut its rating of WestRock. Both of those stocks also suffered heavy losses on Monday. Graphic Packaging didn't catch a major downgrade, but the stock slumped along with the rest of the sector.

The main concern cited by Citi relates to pricing. In January, kraftliner prices declined by 2.4% to $15 per ton, while corrugated medium prices fell 3.7% to $20 per ton, according to Citi. Given that these products are largely commodities, falling prices could signal that the sector is getting more competitive, which could lead to further price declines going forward.

This downgrade from Citi comes a little more than one month after the firm listed International Paper as a top value stock for 2016. International Paper's revenue has been essentially flat for the past decade, but the company has been generating substantial free cash flow over the past few years. In 2014, the company reported $1.7 billion of free cash flow, up from just $856 million in 2010. The company's operating margin over the past 12 months was 13.3%, well above the 3.3% operating margin the company managed in 2010.

Packaging Corp of America is also coming off of some highly profitable years, with an operating margin of 12% in 2014, compared with 7.6% in 2010. Over the past 12 months, Graphic Packaging has managed an operating margin of 10%, well above its 5.4% operating margin in 2010.

Citi pointed out that during previous periods of price declines, list prices fell in a "disorganized fashion" for months. With profitability for all three companies at high levels, falling prices could lead to margin erosion in the coming months.

Shares of International Paper, Packaging Corp of America, a Graphic Packaging have all slumped over the past year, even before the declines on Monday. For all three stocks, this decline was preceded by substantial multiyear gains, coinciding with increasing profitability.

When considering companies in cyclical, commodity industries, it's always important to understand that profitability can fluctuate from year to year. All three stocks look inexpensive based on forward earnings estimates, but those estimates will likely decline given the current pricing environment. Buying shares of a company based on peak earnings is a recipe for overpaying for the stock.

Predicting where paper and packaging prices will go in the coming months is next to impossible. Further price declines are possible, which could cause margins at all three companies to contract. The most optimistic scenario is that these price declines are a one-off, with prices stabilizing and margins remaining high.

While analyst upgrades and downgrades should always be taken with a grain of salt, the concerns that Citi and other firms have about International Paper, Packaging Corp of America, and the rest of the sector should not be ignored by investors looking for bargains.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

International Paper Company Stock Quote
International Paper Company
IP
$45.52 (-3.60%) $-1.70
Graphic Packaging Holding Company Stock Quote
Graphic Packaging Holding Company
GPK
$19.74 (-3.99%) $0.82
Packaging Corporation of America Stock Quote
Packaging Corporation of America
PKG
$130.59 (-2.33%) $-3.11

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
673%
 
S&P 500 Returns
142%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 12/01/2021.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Our Most Popular Articles

Premium Investing Services

Invest better with the Motley Fool. Get stock recommendations, portfolio guidance, and more from the Motley Fool's premium services.