+10.7% for Smurfit-Stone's Penny Upside: Are You Kidding Me?

Smurfit-Stone (SSCC), a major manufacturer of paperboard and paper-based packaging (cardboard boxes), reported adjusted Q4 and year-end earnings of $0.09 and $0.17, respectively. Yes, Q4 beat Wall Street estimates -- by a penny. So the stock rose 10.7% before market open.

Are you kidding me?

The bigger picture:

Cash flow concerns: Margin erosion. Though earnings upside came from price increases of 5.7% and 2.4% across its two major product lines, those amounts are below SSCC's main cost imputs -- energy and fiber.

Smurfit's debt situation: My 2008 estimates: Cash flow from operations: $300 million. Capital expenditures: $300 million. Free cash flow: $50 million. Ability to repay additional debt without additional asset sales: Little to none. Should management sell more assets and cut more costs to reduce SSCC's $3.35 billion in debt (a debt-to-equity ratio of 64.3%)? Does the cost-cutting/asset reduction necessity become a liability at some point? I'm not even sure asset sales should be counted as one-time items for this company because they sell assets every year. In 2006, the company sold assets for a total of $980 million. This year it totaled $452 million.

To be fair: Management doesn't necessarily need to reduce debt right now because the next major debt maturity comes in 2012. However, their revolving debt limit is less than $400 million. I need to further examine their covenants as well (with the refinancing they just did).

Quick and dirty valuation: 2008 EBITDA: $800 million. Enterprise value to EBITDA: 6.0x. And we pay an enormous amount for the free cash flow. Cash flow growth rate: none. This is a company that grows revenues by less than the rate of inflation.

Entry point for short: Over $10. With the short squeeze, I believe it will happen soon.

I have personally met with management and respect them. And Smufit was the bearer of some very good fundamental news today. But we must examine the bigger picture: This truly is a commodity business with high fixed costs and substantial inflationary pressures. SSCC's balance sheet carries large amounts of debt and accordingly, the company pays considerable interest expense. Their operating and financial position spell trouble. And their cash flow is unlikely to grow. Once the short squeeze is over, this is a stock to short.