Pair Trade: Paper and Paper Products

For my explanation on pair trading, please see here.

Paper & Paper Products Industry

The paper products industry covers the manufacture of paper and paperboard from wood pulp. The industry also includes the production of finished paper and cardboard products, such as paper bags, paper boxes, stationery, tissues, and envelopes. Packaging products represent a significant portion of the industry. The US share of this global market is shrinking as competition from Europe and Asia heats up. There is a huge motion politically and economically to go “paperless”, and although this can never happen, the move towards this will continue to hurt the paper product companies. Production costs are subsiding as fiber and energy costs come down, which could provide some short-term relief for many of these companies. The slowing economy hurts demand across all segments of the industry, and FedEx is a great indicator of this, as global shipping figures have come down substantially. The brighter outlook is that online shopping is seeing growth which does help the paper industry due to more shipping in paper boxes required.

Long: Glatfelter (GLT), $10.2: Glatfelter shares have lost 37.38% this year and although the outlook for the paper product industry is not exactly bright, it should outperform its peers based on valuation. Glatfelter is in the specialty paper group as it makes paper for book publishers, credit card receipts, shopping bags, tea bags, and bottling labels. Glatfelter recently put in a solid quarter, beating expectations, and shares are still very cheap relative to the industry. Shares trade at a 9% discount to book value, 0.38x sales, and pay a very solid 3.53% dividend yield. Operating margins of 11.49% and a ROE of 17.93% are at the upper echelon in the industry consisting of 11 major companies.  Also, nearly 4% of the company’s value is in cash on the balance sheet and the liquidity situation is not worrisome. 

As a fast grower in the group and a stock that trades at cheaper relative multiples, Glatfelter is the standout in this group. The $10 level is a major support level from 2004 and the recent trend is strengthening as shares move higher near the $13 resistance level.

Short: Wausau Paper (WPP), $8.61: Wausau Paper is also in the specialty paper group, and main line of business is the backing paper for “peel and stick” labels, but also produces some paper products for tissues and towels. Wausau shares are only down 4.97% for the year, we can expect to see further moves lower with all signs of a major business slowdown. Wausau’s customer base that includes hotels, restaurants, schools, and the consumer are all cutting back on spending and this fall in demand will impact earnings more than the declining pulp and energy costs. 

Wausau is also wildly overvalued with the recent 30% plus run-up. Management efficiency rates are very poor and it trades at a much higher price/book and EV/EBITDA ratio than its peers, including Glatfelter. Margins are also negative and falling rapidly and there is no relief in sight for this sticky situation. There is a double bottom at the $7 mark, and a break through that area could send shares much lower, to all-time lows.

Correlation: GLT has 86.47% correlation with WPP over the last 3 months.

Fight Card:

The Trade

GLT: Long 1 April ’09 Vertical Call Spread $10/$15 for a debit of $1.25

WPP: Short 1 April ’09 Vertical Call Spread $7.5/$12 for a credit of $1.45

Disclosure: none