EUR 850.00 For Business Accounts Only

Morningstar | Strong Containerboard Profitability Spurs Additional Capacity Investment by ND Paper

ND Paper's announced capacity expansions in its recently purchased pulp and paper mills sent share prices sharply lower for International Paper, WestRock, and Packaging Corp. of America. The announcement itself doesn't reflect a large capacity increase above the pipeline of projects already in progress. However, it does reflect a potential shift in strategy by ND Paper's parent company, China-based Nine Dragons, to increase North American containerboard capacity. The move is in line with our long-term view that higher containerboard prices would encourage additional supply. Accordingly, our fair value estimates of $49 for International Paper, $53 for WestRock, and $79 for PCA are unchanged, along with our no-moat rating for all three. At current prices, PCA remains overvalued, while IP and WestRock both appear to be fairly valued.

We've long argued that no containerboard operator possesses a competitive advantage. While returns on invested capital can be strong for extended periods, over a full business cycle we believe these businesses merely earn their cost of capital. In recent years, rising containerboard demand has supported price increases and wider operating margins. However, higher prices have spurred numerous mill conversion projects among the companies we cover and increasingly by other companies in the paper industry.

In our view, the incentives to expand capacity are twofold. First, demand for other paper products, such as graphic paper and uncoated freesheet, has been waning, making underutilized assets available for conversion to containerboard production. Second, strong containerboard prices combined with low recycled material prices, which is a containerboard input, have expanded margins and returns on incremental invested capital. As capacity rises, we expect pricing power to wane, margins to compress, and economic profits to fall.