Long thought to be a "steady as she goes" industry with slow growth prospects, with the help of active hedge funds, packaging companies are finding new ways to reward shareholders. Although industry consolidation has done a lot to promote better pricing and improved margins, many of these companies still trade at very attractive valuations.
International Paper is the largest paper company in the U.S. Billionaire and activist Dan Loeb also owns shares of International Paper. Loeb's hedge fund, Third Point, made a sizable investment in the company at the beginning of 2013, noting the company's free cash flow generating capabilities. Loeb believes that as it pays down debt, it'll free up even more cash flow for buybacks and dividends. It already offers a solid near 3% dividend yield.
But Perry believes there's even more value to be unlocked for shareholders. His key thesis? Shares of major paper stocks could easily double if they just adopt a new tax structure. Perry notes that by creating master limited partnerships (MLP) for their paper mills, they could boost earnings. MLPs pay no federal income tax if they distribute the majority of their cash flow to shareholders.
However, the market appears to be underrating this opportunity. When the telco industry said it would be exploring spinning their physical assets into a REIT structured company, shares soared. The likes of Windstream (NASDAQ:WIN) and CenturyLink (NYSE:CTL) are up 11.4% and 8.4% over the last month, respectively. Meanwhile, IP and Rock-Tenn are both negative for the month.
But even if the MLP idea doesn't come to fruition, the major packaging companies could still be worth a closer look.
Last month, IP boosted its share buyback plan by $1.5 billion (good enough to reduce shares outstanding by 7%). IP has also undergone various structural changes to help optimize its operations. It believes it has over $200 million in further optimization opportunities for its North America packaging operations. As well, it can still tap into various overseas markets. Ultimately, IP believes it can get EBITDA up to $5 billion, compared to its current $3.8 billion over the trailing twelve months.
As for Rock-Tenn, it bought up Smurfit-Stone for $4.9 billion a few years ago. This made the company the second-largest domestic producer of corrugated packaging. Then it bought Simpson Tacoma Kraft Paper Mill for $343 million on May 2014. This latest acquisition is expected to boost Rock-Tenn's kraft linerboard capacity and give the company positioning in the West coast.
One stock that Perry missed that could be one of the best investments in the market is Packaging Corp of America (NYSE:PKG). Packaging Corp trades at with a P/E ratio that's above the other two, but factoring in Wall Street's growth expectations and its P/E to growth (PEG) is a low 0.7. It also pays a 2.4% dividend yield.
Packaging Corp bought up Boise for $2 billion last year (Packaging Corp's current market cap is $6.5 billion). Ultimately, the acquisition is expected to boost the company's liner-board capacity by 40% and increase sales by 80% annually. What's more is the deal really made Packaging Corp a global operator and broadened its product line.
All three of the listed paper companies above are worth buying. Perry's sum-of-the-parts valuation puts International Paper's upside to $78 (suggesting 62% upside) and Rock-Tenn's to $170 (75% upside). Meanwhile, Packaging Corp is just too cheap to ignore, with analysts having a mean $75 price target (nearly 15% upside).
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