An Obituary for the Paper Industry

Paper companies have been struggling in these difficult times. Not only do they have to deal with the recession, but they have to deal with fairly dramatic changes in their markets. In paper, the business market has been moving increasingly toward a paperless environment. Most documents are now sent by email; and/or they are stored on disk. Most are never printed on paper. Even newspapers have gone paperless. The Wall Street Journal is “Online”. Ditto the Investors Business Daily, and many if not most daily newspapers. Of course, most of these still publish a paper version, but the circulations of those paper versions has been falling for many years now. The fall in circulations is noticeable in the fall of newspaper stock prices. Additionally, International Paper (IP) still has lawsuits pending over a Mississippi plant explosion which killed one and injured about 2 dozen others. These lawsuits will likely continue to hurt profits over the near term.

Even though paper equities are over the long haul trending downward, they can still make you money. In the latest 50+% run up from the march lows, the general recovery euphoria became so strong that even these struggling stocks benefitted. Some are significantly over valued at present. You can make money by shorting them as they likely retreat from their current price levels. Plus in late Sept. 2009, three US paper companies filed an antidumping complaint against Chinese and Indonesian paper makers. It takes a while for such a complaint to move through the Federal system. There won’t likely be any action in the immediate future. This means that the paper companies not only have to contend with declining markets and low prices, but unfair trade practices as well. In the short term the Chinese and Indonesian dumping has to hurt IP on the bottom line. It will be months before tariffs may be applied, if they are granted by the Obama administration. With a general market retracement trend seemingly in place now, paper company equities are likely to decline rapidly in the near term.

A general market down trend has started recently. This trend should help paper companies go down. This new trend can be seen in the chart of the SPY shown below:

You can see that a noticeable down trend started in early to mid Sept. The Money Flow chart indicates that money is still moving out of the SPY (which I am using as an indicator of the general market). The Relative Strength Index shows that this down trend is not very close to bottoming out. The Volume chart shows that the SPY is moving down on good volume. The fundamental fair value for the SPY is in the $85 to $88 range, so it has a fair ways it can move downward for fundamental reasons. All of these things are good signs if you are planning to short the market or a particular stock.

IP is one of the paper companies that will likely do poorly in the near term. Both the 3 month chart, which shows the near term down trend, and the 2 year chart, which shows the longer term down trend, illustrate that this stock should outperform to the downside in a market retracement.

The 3 month chart is most important for our purposes. It shows IP declining consistently near term. The Money Flow Index and the RSI are declining with the stock price. The Williams %R shows that IP is currently oversold, but the Relative Strength Index shows that it can remain over sold for quite some time yet. IP is right at the point of crossing its 50-day SMA line. This is a very bearish signal. It should be able to run a ways down from that point. That would be a normal expectation, especially in a declining market. Some possible support points are the 100-day and 200-day SMA lines. Plus if you look at the 2 year chart, you can see major support points at $18-$19, at $13-$16, and at $8-$9. IP bottomed at a little less than $4 in March.

That was then. This is now. The possibility of helpful tariffs looms in the future. The possibility of a recovery from the recession is much more real now. Bernanke has said the recession may be technically over. All this means that it is unlikely that IP will again go down to $4 near term. My first target would be about $19. The current price is $21.39. If IP breaks below $19, especially if it breaks below the 100-day SMA line, my next target would be approx. $16. At that point I would be getting out. The two legged climb from $4 to approx. $16 was rapid. The subsequent climb to approx. $25 was much slower. This shows that the upside push was tiring. IP is more likely to lose this reluctant price increase than the prior rapid increase.

IP is currently predicted to make money in 2010 and 2009. It deserves some respect. However, its general statistics do make it a candidate for a short. For instance, it has no TTM PE. The 2010 PE is over 22, and even this is above the long term average PE of approx. 15 for this industry. This stock is over priced even on a forward looking basis. It should move downward near term. Fundamentally a fair value in a recession recovery market might be a PE of 15 for 2010. If you adjust the stock price for the current FPE and the fair value FPE, you might say a fair stock price would be about $7 less than the current $21.39. Since there is good support at about $16, that might be a less risky place to exit a short position. However, if the general market reverses its trend due to earnings beats and positive economic news, I might think seriously about exiting a short position at $19 instead of waiting for $16. IP's Beta of 2.4 should also help it to move down quickly as the overall market moves downward. For more fundamental details about IP please see the table below.

Stock Name	International Paper (IP)
Price at close 10/2/09	$21.39
PE (TTM)	NA – negative earnings TTM
2009 PE	33.42
2010 PE	22.28
Beta	2.4
% Held by Institutions	80.44%
Short Interest	2.67
Price to Cash Flow	34.67
Price to Book	1.91
Debt to Capital Ratio	68.25%
Quick Ratio	1.35
Return on Equity	-17.5%
Return on Investment	-5.2%
EPS Growth (MRQ)	-40.74%
EPS Growth (TTM)	-237.16%
Revenue Growth (MRQ)	-.09%
Revenue Growth (TTM)	8.61%
Dividend Yield	0.47%
Net Profit Margin	-4.83%

Notably IP has some cash flow problems. The PCF number is poor. The Price to Book ratio is also higher at 1.91 than the industry median of 0.86. The ROE, ROI, and EPS Growth numbers are bad, although going forward these should improve. The Net Margin number is bad. With China and Indonesia apparently dumping in the US, this number seems likely to continue to be a problem in the near term. In sum the prospects of this stock’s price rising demonstrably in the near future are poor. The prospects of IP’s stock price falling are good. The imminent cross of the 50-day SMA line is very bearish. The apparent retracement mode of the S&P500 is helpful to a down movement in the IP stock price, especially given its 2.4 Beta. The dumping is helpful to a short position.

I currently do not have a position in IP stock. I may establish one soon (perhaps Monday). If you elect to pursue this trade, pay close attention to any announcements about tariffs. I do not expect any in the next month. I expect instead this trade to be over within the next month. IP reports earnings on 10/28/2009. You may wish to be out of this trade before then in order to decrease you risk.

Disclosure: No positions.

Comments

[BRUCE E. W.]

The American Free Press as an extension of the checks and balances of our United States Constitutional Government is a vital part of the American Republic and its Democratic Foundation. The desparation of its industrial struggle on paper is a technological drag in the process of retooling. The more critical question is wheather this struggle to survive will lend itself to a perverted incentive to maintain profits at the cost of its greater role in our democracy. Tne basic market incentives have distorted the news on television and radio to a substantial degree. A good deal of investigative reporting is either career makers or liabilities that go punished by political and economic ostracisizing; or, in other words...market exile and atrophe. The most revealing risk takers have been essentially underground or alternative:
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NATIONAL AFFAIRS
Wall Street's Naked Swindle
A scheme to sell fake stocks helped kill Bear Sterns and Lehman Brothers — exposing the counterfeit nature of our entire economy. By Matt Taibbi

Coming Soon Video: Matt Taibbi breaks down his argument.

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So what if the real defense of our Democracy was now left to the Free Press? Would it stand the "stress test" of truth when the truth itself is mostly all in advertising? Painful thoughts: but the question still needs to be asked "what price freedom?" If the "free press" is merely a paper manifestation than perhaps its all been fiat all along.

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2009 Oct 04 11:49 AM

[Andrew Shapiro]

the author ought research and learn about and then add that IP's earnings benefited from a one time windfall from the black liquor tax subsidy this past year that expires at end of the year.

2009 Oct 04 02:00 PM

[Econ 101]

What about IP as a real estate play??? Arent they one of the largest land holders in the USA????

2009 Oct 04 06:48 PM

[David White]

lawndale1: you make a good point.

For those who don't know. The black liquor tax subsidy is a federal tax credit for using biofuels in conjunction with carbon based fuels (fossil fuels). The paper companies were already using a pulp makings byproduct called black liquor to generate electricity. They started using diesel in conjunction with this, so they could qualify for the tax break. It's something of a lawmaking boondoggle. This legislation is set to expire at the end of this year (2009).

"The total fiscal-year windfall for IP will be an estimated $1.27 billion, about one-third of its market value, according to the April 5 report by Deutsche Bank Securities analysts." (Bloomberg) When this law expires at the end of 2009, IP will have just that much more trouble being profitable in 2010.

However, this does not weaken the short play unless you believe this law will be renewed. This law was enacted in 2005. A renewal of this law is probably something else to watch for. Somehow I think the lawmakers may improve the law this time, so they don't pay to encourage the use of fossil fuels (as they have in this case) instead of discouraging their use as the law was intended to do.

This means IP faces unfair competition via dumping. Plus IP is losing approx. $1.25B in subsidy monies. Plus the price of pulp has dropped considerably.

2009 Oct 04 08:15 PM

[David White]

Sorry I don't have the actual current status of the law, but I hope the following will help:

"Because the payouts are more than expected, the Obama administration has rewritten the alternative fuels provision to exclude the paper industry for the fiscal year 2010 budget proposal. If approved by Congress, the provision will take effect Oct. 1, 2009, though if the law is changed and the tax credits expire at the end of this year, some members of Congress have said pulp and paper companies would receive some other form of relief." (Jim Tierney)

2009 Oct 04 08:29 PM

[David White]

Latest on Oct. 5, 2009:

"The United Steelworkers (USW) has filed comments strongly opposing a Senate Finance Committee staff draft of legislation that if enacted would specifically target the pulp and paper industry for repeal of a vital tax credit."

They argued, “This tax credit is encouraging paper companies to make greater use of biofuel, and in the case of one Maine producer, Old Town Fuel & Fiber in Old Town, it’s allowing this company to pursue a project to produce jet fuel in addition to pulp,” says USW President Leo Gerard. “In addition, it is saving thousands of Steelworker and other jobs.”

The above information was posted on packaging-online.com with a date of Oct. 5, 2009. My conclusion is there has been no decisive action taken on this issue yet. However, the clear inclination of the Senate subcommittee is to close this loophole.

2009 Oct 04 08:39 PM

[Buckoux]

"What a load of commie BS!"...General Buck Turgidson.


On Oct 04 11:49 AM BRUCE E. W. wrote:

> The American Free Press as an extension of the checks and balances
> of our United States Constitutional Government is a vital part of
> the American Republic and its Democratic Foundation. The desparation...[ yada..yada..yada ]....

2009 Oct 05 10:28 AM

[Windsun33]

First of all, IP is not "the paper industry". It is one player (and not a very good one) of many in that industry. BZ for example appears to be doing quite well, and also own millions of acres of tree farms.

Second, most paper is used in packaging and containers, not for documents or printing.

2009 Oct 05 10:28 AM

[Annualgain]

i second what windsun has to say. There is no "paper industry" per se, but rather there's a dozen sub industries making free sheet, corrugated, wall board, newsprint, etc. Each has its own set of dynamics - newsprint is by far the hardest hit by secular trends away from paper. Check out abwtq.pk.

2009 Oct 05 10:56 AM

[The Geoffster]

Good news for the spotted owl.

2009 Oct 05 11:13 AM

[Wizler]

what about the upside from printing all the new $$'s?

2009 Oct 05 11:16 AM

[Windsun33]

That is all electronic money, and uses recycled electrons. My main complaint with BZ is that I bought a few 1000 at 14 cents, and sold @ just under $1..


On Oct 05 11:16 AM Wizler wrote:

> what about the upside from printing all the new $$'s?

2009 Oct 05 11:30 AM

[David White]

Explanation: The fundamentals of the paper industry (virtually all types) are very negative. These seem to be deteriorating at the moment. The paper industry benefits to the tune of $6+B from the black liquor tax subsidy this year. It will likely be gone next year. There is increasing competition from abroad. In fact there is dumping apparently. Plus most of the paper industries are using less paper. The USPS is laying off workers. The newspapers are downsizing or failing outright. The recession has added even further downward pricing pressures to the industry. Amazon has the Kindle. Apple is following suit. You won't have to worry about packaging to ship books that will no longer be shipped.

There are always companies that manage to compete better than others. I mentioned IP specifically because it looked like a safe short bet. Why would I pick the strongest paper company to short? Still the fundamentals for the overall industry do seem to be deteriorating (with light at the end of the tunnel as yet). That is part of what makes IP a good short.

2009 Oct 05 03:49 PM

[bob adamson]

From the perspective of the Canadian forest products industry, this has the taint of underlying protectionism.

2009 Oct 05 04:59 PM

[Windsun33]

I would question that it is the strongest paper company - biggest perhaps. While paper overall has not done good as a sector, and probably will lag the rest of the economy, there are some companies that are still doing pretty good.

On a side note, it appears that the paper recycling companies are doing even worse.

On Oct 05 03:49 PM David White wrote:

> Why would I pick the strongest paper company to short? Still the
> fundamentals for the overall industry do seem to be deteriorating
> (with light at the end of the tunnel as yet). That is part of what
> makes IP a good short.

2009 Oct 05 09:52 PM

[Karldean]

As usual, I find a lot of truth in the well meaning comments. I used to work in a plant that recycled paper to make shingles, it was interesting to watch the contents they put in the vat, paper, cloth, and wood chips mostly. Sludge was sprayed on cloth screens and shaken onto driers to form rolls 6 feet in diameter, tar sprayed on paper and granules imbedded in the hot tar and on to the shingle cutter. Long story short we will always need paper, American paper, because when you wipe your ass you don't want to get a splinter from the Chinese stuff.

2009 Nov 15 03:29 PM