EUR 850.00 For Business Accounts Only

Morningstar | Packaging Corp. of America Reports Robust 2Q; Shares Remain Overvalued

Although shares in Packaging Corporation of America have traded off more than 5% following the release of second-quarter earnings, we believe shares still look expensive. By historical standards, the second quarter was strong, with sales up 12% over the prior year to $1.77 billion and an adjusted EBITDA margin of 21.6% thanks to rising containerboard prices. However, we believe the current stock price of $110.69 at the time of writing assumes a persistence of profitability that will not come to fruition. Over the long run, PCA will face a combination of higher input costs and price pressures from capacity increases amid favorable operating conditions, driving down profit margins. We are increasing our fair value estimate to $79 per share from $78, largely due to the time value of money. At current prices of roughly 40% above our fair value, the stock looks expensive. Our no-moat rating is unchanged.

Packaging segment performance remained a highlight during the second quarter. Adjusted segment EBITDA margins rose 1.1% from the prior year to 24.2% as spring linerboard price increases rolled into contracts and more than offset input cost inflation. One surprise of the quarter was an announced $100 million increase in capital spending for the year, to $530 million-$550 million. The additional spending will mainly be used for incremental projects within PCA's footprint to boost efficiency and capacity to meet future demand growth. We think these projects could stave off margin compression in the medium term, but we remain more pessimistic about the long-term margins for this segment. With PCA's Wallula conversion nearly complete, we wouldn’t be surprised to see additional paper machine conversions in the pipeline. Over time, we think supply will come back into balance with rising demand, pressuring segment EBITDA margins into the high teens.

Adjusted EBITDA margins in the paper segment, a shrinking portion of the business, fell by 2% from the prior year to 15%. As PCA converts more of its paper lines to linerboard, its shrinking mill network appears to be getting slightly harder to manage. Falling capacity to serve existing customers is causing the company to spend more time managing inventories to avoid supply issues during routine maintenance periods. Ultimately, we expect to see additional containerboard conversions of these machines as a way for PCA to boost profits.