EUR 850.00 For Business Accounts Only

Morningstar | UPM 2Q In Line With Our Expectations but Second-Half Outlook Stronger; Shares Overvalued

No-moat UPM reported second-quarter EBIT of EUR 334 million, a 24% increase over the prior-year period but largely in line with our expectations. Higher prices were the major driver, as price increases more than offset input cost inflation in most divisions. Unlike its major peer, Stora Enso, UPM did not report any significant challenges with wood harvesting due to the warm weather in Europe. This may be due to a lower exposure to Swedish forestland than Stora Enso. The company is bullish on the outlook for the second half of 2018, expecting second-half EBIT to be significantly higher than the first half. This is in contrast to our view for a moderation in the second half from lower pulp prices. As pulp prices look poised to remain strong in the near term, we will likely bump up our near-term estimates, which may increase our EUR 19 fair value estimate slightly. At current levels, the shares look overvalued.

UPM communication papers was the most improved division in the quarter, with second-quarter EBIT more than doubling over 2017. A tight market enabled better pricing and capacity utilisation, which ultimately resulted in a sharp increase in margin. With demand for graphic papers continuing to decline at mid-single-digit rates, we wouldn't expect the market to remain tight for an extended period.

UPM biorefining posted another strong quarter, with EBIT up 18% over the prior-year period despite heavy maintenance activity in the quarter. Average pulp sales prices increased 22% for UPM, which more than offset lower volume due to maintenance shutdowns and higher raw material costs.

Both supply and demand issues in the global pulp market have combined to drive prices significantly higher. Demand has risen materially from China due to the surprise announcement in mid-2017 of a ban on the importation of scrap paper. On the supply side, pulp production issues emerged last year in Brazil, owing to a major plant malfunction, and in Indonesia, as 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 throughout 2018. 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. The impact of government regulations affecting the Chinese and Indonesian markets are more unpredictable, as the final rules could still be modified. However, even in the most stringent scenario, we would expect demand to wane from the panic levels in the second half of 2017 as the initial shock wears off and supply chains adjust.