Industry Reports

Deutsche Bank Reports Summaries

071214 Deutsche Bank Report - Dr. Paper's Quarterly Wrap Up

Deutsche Bank - Equity Research

* Issues for our companies vary

For lumber & building products producers: when will supply contract enough to allow the market to stabilize? For the commodity paper & paperboard producers: will the benefits of a falling US$ outweigh the dampening effect from a slowing economy? Finally, for the packagers; how quickly can prices be boosted to offset rising raw material costs?

* In paper, slowing domestic economy vs. falling US$

Slower growth in the US almost always means lower paper demand and falling prices. However, a falling US$ typically means rising exports, falling imports, and greater latitude in boosting US$ prices. One additional development over the past 2-3 yrs has been the widespread closure of Canadian pulp, paper, and paperboard mills with CN$ costs and US$-priced sales. In the early stages of its decline, the falling US$ had little impact on either exports or imports. Over the past 12-18 months, the currency effect seems to be "kicking-in."

* In wood products, capacity closures vs. falling demand

It's been a tough year in building materials and there isn't much evidence that 2008 will be any better. Demand has been weak across all types of lumber & building materials. The steep drop in residential housing is being compounded by new capacity additions in many products. These additions have been most notable in gypsum wallboard and oriented strandboard (OSB). With most forecasts projecting lower housing start levels in 2008, relief won't come on the demand side. The real issue will be closure of marginal capacity.

* Valuation/risk

Paper companies are trading around 1.7X book value and 6.9X estimated "peak" earnings, a bit more than half of the historically high "peak" multiple. Packaging companies are trading around 16.1x our '07 EPS estimate, with tight variance within the sector. We value paper companies using different metrics, including sum-of-the- parts, and historical EV/EBITDA and P/E ratios. Our valuation of packaging companies is primarily based on historical EV/EBITDA patterns. EV/EBITDA takes into account varying amounts of debt at each company. The primary risks involve momentum in the economy, the health of demand within key grades like containerboard and white paper, and additional energy, chemical, and freight cost inflation. Companies with significant exposure to the CN$ remain at risk as DB forecasts a continued strengthening of that currency. Beyond these issues, we remain watchful about capacity growth abroad (especially in China and Latin America).