The MoneyLetter recently reviewed two CIBC Capital Markets forest products stocks research reports. A reduction in Chinese demand for feedstock in containerboard production favours Cascades Inc. And increasingly shrinking newsprint and specialty paper operations are just a shrinking portion of an otherwise growing Resolute Forest Products.
A possible Chinese policy to restrict paper imports caused CIBC Capital Markets analysts Hamir Patel and Eric Sandher to increase their financial estimates for Cascades Inc. (TSX—CAS). Quebec-based Cascades Inc. and its subsidiaries produce, convert and market packaging and tissue products composed mainly of recycled fibres.
Specifically, the analysts have reduced their input cost assumptions for old corrugated containers (OCC) due to their latest read on the situation in China.
At the same time, they claim containerboard markets “show no signs of slowing down”, adding that they see “an increasing likelihood of another US$50 per ton up 7.1 per cent, spring price hike” by February. In turn, the analysts upgrade their recommendation for the containerboard producer to ‘outperformer’ from ‘neutral’, and increase their price target to $17 from $14.
The analysts say they are increasingly convinced that China is very serious about implementing its proposed restrictions on recovered paper imports (which trade sources indicate may be lowered 20-30 per cent year-over-year in 2018). They claim that this policy will likely result in less North American OCC being shipped to China—thus keeping input costs for Cascades at favorable levels, with more containerboard being imported into China from North America.
The analysts previously anticipated OCC prices would temporarily surge by late December as China came back into the market, but they are less concerned about a near-term rally given the potential increase in OCC inventory levels.
“While we remain cautious on the tissue business (given competitive pressures), we believe our estimates are sufficiently conservative,” say Messrs. Patel and Sandher. They also note that that their trade contacts are now reporting an approximate eight per cent price hike in US retail tissues underway—the first US retail hike since 2011.
“Our trade contacts are also reporting that at least one privately-owned tissue producer operating in the US recently announced a 12 per cent away-from-home tissues (e.g., Kleenex-brand tissues) price hike for January. Both represent potential upside to our tissue segment forecast.”
Cascades is the sixth-largest producer of containerboard in North America, and the fifth largest tissue producer on the continent. The company is the second-largest producer of recycled boxboard in Europe, through a 58 per cent stake in Reno De Medici S.p.A.
Resolute Forest Products
Messrs. Patel and Sandher are also positive on the overall supply/demand picture for North American lumber and global pulp markets. Consequently, the analysts raised their target share price for Resolute Forest Products Inc. (TSX—RFP; NYSE—RFP) to US$11 from a previous US$10 target. The analysts also rate the stock an ‘Outperformer’.
Quebec-based Resolute Forest Products is a global leader in the forest products industry with a diverse range of products, including newsprint, specialty papers, market pulp and wood products.
The analysts note, “Management stresses that Resolute is “not a paper company” any more. With approximately 48 per cent of its reported adjusted last-12-months earnings before interest, taxes, depreciation and amortization (EBITDA) from wood products, and growing demand for lumber, pulp and tissue (collectively 76 per cent of our 2019 EBITDA forecast), Resolute stressed that its newsprint and specialty paper operations represent an increasingly shrinking portion of an otherwise growing business.
The company noted that newsprint and specialty paper represented only about 28 per cent of EBITDA over the last 12 months, down considerably from the 74 per cent share they comprised in 2011.
“While the North American forest products industry has shifted away from integrated models over the last 20 to 30 years, Resolute sees value in its integrated model as it provides an economic outlet for the chips produced by its lumber mills (an increasingly important consideration in Quebec and Ontario where chip prices are facing continued pressure).
“While declines in newsprint and graphic paper demand are expected to continue at the recent pace, with Resolute still buying some chips from other suppliers, its own lumber mills should continue to have a home for their chips in coming years as the company continues to match its paper capacity base to demand.
“Although Resolute is focused on executing on its tissue expansion over the near to medium term, the company has not closed the door on potentially expanding lumber production into the US South over the long term. Only if the economics make sense and such facilities could be fully integrated with the company’s pulp and paper mills in the region. With substantial US tax assets on hand, we suspect the returns on almost all capital projects the company is considering in the US are much higher than for most other producers.
“We believe Resolute has further growth ambitions in tissue and suspect the company could position additional NTT machines in Calhoun over the next decade as the facility has excess slush pulp capacity. Resolute expects industry capacity additions to be offset by yet-to-be announced closures of older technology machines as the industry continues to adjust to increased consumer demand for premium-grade products.”
This is an edited version of an article that was originally published for subscribers in the January 2018/Second Report of The MoneyLetter. You can profit from the award-winning advice subscribers receive regularly in The MoneyLetter.
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