Industry Reports

Deutsche Bank Reports Summaries

050822 Dr Paper's Pulse on Pricing

Deutsche Bank - Equity Research

MARKET PULP

August prices slipped $5/tonne after Weyerhaeuser lowered its price on NBSK by $10/tonne. Producers announced a $20/tonne increase on NBSK shipments to Asia starting in September; the move signals potential hikes in western markets. Worldwide producer inventories rose 5 days to 38 days of supply in July, comparable to levels seen in July of 2004. July shipments came in at 2.87MM tonnes, down 9.3% m/m and down 1.3% y/y. Prices last rose in February from $650/tonne to $680/tonne. Since then they have gradually eroded.

LUMBER

Lumber prices fell again last week. The framing lumber composite fell $8/mbf to $355/mbf, the lowest levels since November 2004. Earlier this month the ECC rejected the US extaordinary challenge in the lumber dispute. The next step may be an appeal to US federal court. In the meantime, negotiations continue, and the 20.2% duty still gets collected.

PANELS

Prices enjoyed a modest rebound last week. The structural panel composite price rose $4/msf to $354/msf while the benchmark grade of OSB (7/16" in the North Central region) rose $8 to $255/msf. Broad demand helped to drive up prices and order books appear full through Sept 5th. With new capacity in OSB boosting supply by as much as 30% in the next five years, the market seems certain to come under pressure longer-term.

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050819 Dr Paper's Weekly Wrap-up

Deutsche Bank - Equity Research

IP's restructuring begins. IP selling its 50.5% stake in Carter Holt Harvey for $1.16B ­ bit shy of some expectations. IP also moving its HQ from Stamford, CT to Memphis, TN.

July box vol's fell 1.3% y/y on an avg wk basis, but July '04 was +8.2% y/y - toughest comp of the year. With the ISM index up sharply last 2 months & comp's easing, we expect better #'s soon.

Pulp markets starting to rebound? Most producers are out with a $20/mton hike on NBSK in China for September 1. Hike announcements for North America seem likely to follow.

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050817 - IP - Once (They) Were Warriors

Deutsche Bank - Equity Research

International Paper {Ticker: IP, Closing Price: USD 30.99, Target Price: USD 36, Recommendation: Buy}.

"Once (They) Were Warriors": IP Leaving New Zealand

International Paper has announced an agreement to sell off its 50.5% stake in New Zealand's Carter Holt Harvey to the Rank Group for NZ$2.50/share. With nearly 661MM shares of CHH, the deal translates into just over US$1.16B of proceeds (just short of US$2.50 per IP share). IP is suggesting that pretax and after-tax proceeds will be nearly identical. It appears that IP will have a modest book loss on the sale. In US$ terms, CHH had reported EBIT of $38-47MM/yr in each of the past 3 years. EBIT as a % of sales has been approximately 2.5% and as a percentage of assets about 1.2%.

Good concept, poor execution. IP's entrance into New Zealand in the early 1990's with an initial 16% stake in CHH was an interesting strategic move. Carter Holt gave IP a strong position in a Pacific Rim market and some of the world's most sophisticated plantation forestry. Carter Holt also held strong NZ/Australian positions in tissue and corrugated packaging and an enviable (but, indirect) 30% stake in Chile's Copec. The concept was good, IP's execution wasn't. In the midst of the spotted owl "craze" of the early/mid 1990's, IP boosted the size of the CHH stake at peak prices. Sadly, this is a song which IP played repeatedly over the last 15+/yrs. It's been a bankers' dream and a shareholders' nightmare.

IP had been actively restructuring Carter Holt in recent years. The Copec stake was sold earlier this decade. Later, CHH's tissue operations were sold to SCA. Recently, a portion of the NZ forestry plantations were sold. The biggest issue for CHH would appear to have been the sharp drop-off in timberland performance over the past decade. New Zealand's relatively under-developed processing operations left the firm exposed to log exports to Asia and the strong NZ$ reduced their competitiveness in that US$ denominated market. Higher freight & fuel costs also hurt. We think CHH had become a significant management distraction for IP with very little offsetting financial contribution.

The sale isn't a surprise, but the valuation falls slightly short of some analyst's expectations. The deal is a first installment on the asset sale & repositioning program initiated under John Faraci. The goal is a smaller & more focused International Paper - - - no longer, a broadly diversified industry giant. Hopefully, the new IP will be a better IP for investors. IP is currently shopping a host of other assets, including US timberlands, coated paper, and specialty chemicals. We expect the initial proceeds to be applied to debt reduction. In contrast to some on the Street, we're encouraged by most elements of IP's program. The biggest issue for IP remains a sputtering paper cycle. Beyond the cycle, we think the key questions will be how well IP sells the assets and how it opts to redeploy the proceeds.

Our $36 target price implies 1.8x book value, 5.3x peak earnings, 9.6x normalized earnings, 4.3x peak EV/EBITDA, and 6.2x normalized EV/EBITDA. Each of these ratios are about in-line with group averages, except the price/book ratio, which is at a slight premium. Historically, IP tends to trade about in-line with the group average when the paper cycle is weak, rather than commanding its customary premium. We think that conditions are currently weak in containerboard and uncoated free sheet, IP's two largest volume commodities, and we can no longer justify a high premium valuation on IP.

Economic momentum needs to be sustained. We also remain watchful about capacity growth abroad as well as the movement of jobs and manufacturing facilities overseas. Internally, we'd focus on the balance sheet, acquisitions (which have seldom created value in the past), and the need for better disclosure. Other risks include energy costs and currency translation.

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050817 - July Containerboard Monitor & July Containerboard Numbers

Deutsche Bank - Equity Research

HIGHLIGHTS

Yr-yr Box Comp's Still Look Sluggish.

These #'s may be a bit deceptive. This was the toughest comp of the year. July of 2004 box shipments rose 8.2% on an avg wk basis. This yr, July dropped 1.3% y/y on an avg week basis, in-line with the YTD number. July was the fourth straight month with an average week decline. With the ISM index (56.6) up sharply the past 2 mo's and other signs that the industrial economy is regaining steam, we're anticipating some better comp's.

The inventory situation improved markedly.

Total mill & box plant inventories fell 9K tons to 2,549K tons. This compares to a 10-year average inventory rise of 73K tons for July, a positive variance of 82K tons. While the absolute level of inventories is low by historical levels, it remains above '04 levels. With demand struggling, we'll probably need very low inventories to support any price restoration.

Production eased modestly.

We are pleased to see operating rates ease. The July operating rate dropped to 93.7% vs. 95.3% in June and 97.2% in July of 2004. We suspect that a bit more capacity must come out of the market if producers are to regain pricing traction. Based on performance to date in 2005, it would appear that producers have strayed from the "run-to-demand" model in place 3-4 yrs ago.

The stocks?

These numbers ­ mostly the inventory level - look like a mild positive. Positive box comp's might set the stage for an autumn price attempt. As it stands, we'll probably have to wait until late winter. In the meantime, the trade papers trimmed containerboard prices again, taking the linerboard price down $10 to $395/ton. When coupled with a $30/ton reduction in July and a $15/ton reduction in May, reported "transaction" prices are down $55/ton since mid-spring. Box prices are destined to slip in Q3 and Q4.

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050816 - The Rigid Container Market

Deutsche Bank - Equity Research

Can Investors Make Money in Mature Markets? We think so. We recently initiated coverage on Ball Corp. (target $45), Crown Holdings (target $22), and Owens-Illinois, Inc. (target $33) with a Buy rating on each. All three firms manufacture rigid containers and primarily serve food and beverage businesses. The industry has faced the issue of mature domestic markets, restructuring and rationalizing capacity. These operations now generate significant free cash flow. Investment in emerging markets offers solid opportunities for sustained growth.

What can go right?

Faster growth in Europe (all three companies have large European operations) and some easing in energy and transportation costs could benefit all three companies. Away from the economy, we believe CCK offers the best potential for "catalytic events" over the next 6-12 months. These could include refinancing over $2B in high coupon bonds (could yield $70-80MM in interest savings) as well as a potential sale of its closures business. In O-I's case, the key issue is integration of its BSN acquisition. Can O-I hit the upper- end of a Euro220MM synergy target and put the money on the bottom line? The spread between O-I's bottom and top of the synergy range is Euro120MM ­ just over $0.90/share pre-tax. O-I's other big catalyst would be a national asbestos settlement ­ not a development we're assuming. It's harder to spot an immediate catalyst with BLL. With the strongest balance sheet in the group and two large and successful acquisitions under its belt, BLL has indicated it could be an acquirer.

What can go wrong?

Balance sheets are leveraged. All three companies have used debt, but Crown and O-I are especially leveraged. Over time, steady volume and contractual passthrough of costs have produced stable cash flow. Asbestos remains an issue for Crown and O-I. In both cases, annual payments have been declining as the age of claimants continues to rise. Because all three firms have large offshore operations (50+% of sales are offshore for Crown and O-I), currency movements can be important. A strong US$ would reduce offshore sales and income when translated into US$ terms. Conversely, a weak US$ boosts reported sales and earnings. Rising raw material costs (energy, transportation, metals and chemicals) can squeeze margins. Contractual "cost pass-throughs" mitigate, but don't eliminate, this issue. Changing consumer preferences and competition from packaging alternatives are also risks.

Valuation looks reasonable; key risk is acquisition/diversification missteps By most metrics, all three stocks are trading at reasonable levels relative to historic norms. On a 2005E P/E basis, BLL and O-I trade at about 14.6x and 14.4x respectively, a significant discount to the S&P 500 multiple. CCK's 2005E P/E ratio of about 22.3x is above the broad market, but CCK's EV/Sales ratio of 0.8x looks inexpensive, both in relation to its peers and to its own historical range. We believe the companies should get a modest boost with declining metal and resin costs. An asbestos settlement at the Federal level would likely lift CCK and O-I in our view. In addition to possible misuse of cash flow, we cite product substitution, commodity costs and foreign exchange as the key industry-specific risks.

For more information, please click on the attached document.