EUR 850.00 For Business Accounts Only

Morningstar | STERV Updated Forecasts and Estimates from 03 Aug 2018

Despite delivering another quarter of blowout EBIT growth, no-moat Stora Enso shares are trading down sharply, around 10% at time of writing. The company reported second-quarter EBIT of EUR 327 million, up 50% over 2017. Still, this was not enough to meet consensus estimates. More importantly, the outlook for third-quarter EBIT of “in line with the second quarter” was well below consensus expectations. The unusually warm weather conditions in Europe this summer are mostly to blame, although the company also suffered from higher-than-expected maintenance costs and production challenges in consumer board. The warm and dry weather in Europe has led to increased forest fires, primarily in Sweden, which has resulted in lower harvesting and wood shortages for Stora Enso. This will likely continue to affect the company in the third quarter, but eventually the rain will come. A potentially longer-term issue is pricing in consumer board. Around half of the consumer board business is liquid packaging board and food service board, which is sold to a small number of customers under contracts with annual price negotiations. Consequently, Stora won’t be able to offset current rising input costs for these contracts until the new year. We think the drastic reaction in the share price reflects the unrealistic expectations baked in to what remains a highly cyclical business, and we don’t expect to make a material change to our EUR 9.50 fair value estimate. Even after today’s decline, we still see the shares as overvalued.

Containerboard producers like Stora Enso are currently enjoying the best of both worlds, with higher prices and lower input costs. Indeed, second-quarter EBIT in the packaging solutions increased 42% over the prior-year period. Demand is being driven by increasing online retail sales. European online retail sales increased 14.2% in 2017, according to the Centre for Retail Research. We see this as a structural shift supportive of long-term demand for containerboard. On the cost side, prices for a key input, old corrugated cardboard, have fallen due to the ban of waste paper imports to China that was announced in mid-2017, which has led to a glut of the same outside China. We think this will be more of a temporary situation, as final import rules could still be modified and supply chains have not had a chance to adjust, but considerable uncertainty remains. Overall, our view on the segment is more positive.

Pulp prices have risen sharply as well, another consequence of the ban on waste paper in China, but also due to production issues on the supply side. In 2017, a major Brazilian plant was offline due to a malfunction, and in Indonesia, tougher environmental regulations on logging have made it more difficult to secure raw wood. The combination of these factors will likely cause favourable pulp market conditions to continue in the first half of 2018; this was seen in second-quarter EBIT for the biomaterials segment, which increased 76% over 2017. However, we would expect the plant issue in Brazil to be resolved quickly, and large capacity increases are due to come on line in 2018-19.