This may not be the sexiest business in the world, but it's earnings statement would certainly make you look twice, notes Timothy Lutts of Cabot Stock of the Month.
Our latest recommendation is a company that makes what is perhaps the most prosaic product possible: cardboard. Yet, it's just beginning a new, major uptrend.
Packaging Corporation of America (PKG) was created in 1959. In the decades since, it’s added many more companies to its stable through acquisition. It’s been swallowed up by Tenneco and spit out again.
Today the company boasts four containerboard mills (in Georgia, Michigan, Tennessee, and Wisconsin), and more than 70 manufacturing locations spread across the US.
Its primary products are corrugated containers and retail packaging and displays, all made to order and printed on the company’s own presses. Exports account for just 10% of revenues, so this is mainly a domestic story—and it’s a simple story.
The first part is growth. Over the past decade, Packaging Corp. has not only succeeded in turning a profit every year, it’s also succeeded in growing revenues in every year but one, 2009.
Given the ups and downs in this industry, that revenue record tells you the company is well managed. And looking forward, the picture is particularly attractive because the company is just beginning what looks to be a powerful turnaround.
The third-quarter report, released two weeks ago, revealed that while revenues inched up 8%, earnings gained 28%! The main reason for the jump was a price hike. After years of sluggish demand caused players in the industry to reduce capacity, a pickup in demand revealed capacity constraints, so management pushed through a $50 per ton hike for containerboard in September.
Going forward, Packaging Corp. expects a similar price hike for its corrugated products in this quarter, and expects the full benefit of these moves to be felt in the first quarter of 2013.
A secondary reason for the jump was increased operating efficiencies, thanks to both lower natural gas prices and process improvements as manufacturing scaled higher.
So even before the price hikes are fully implemented in 2013, management expects the three levers of increased demand, increased prices, and increased efficiencies to boost fourth-quarter earnings more than 50% (which would be the third straight quarter of accelerating earnings growth).
Analysts think earnings will leap to $2.78 per share in 2013, up 34% from 2012. Frankly, we think those estimates are likely conservative, because when industries like this turn up, they usually turn up faster than most expect.
The second part of the story is the stock’s valuation. PKG is currently trading at 19 times trailing earnings, even though the company has grown earnings 26% and 28% in the previous two quarters.
When earnings growth outweighs the P/E by that much, odds are good that the discrepancy will be resolved, by either earnings falling or price rising. The second course is clearly most likely here, because of the earnings growth expected in the coming quarters.
Topping it off is a healthy dividend of $1 per share, for an annual yield of 2.8%, as well as the possibility of a dividend increase or a share buyback—or both—as the cash pours into the company’s coffers.
Technically, PKG’s chart is attractive. It broke free of a multi-year range in July when it crossed above $29, and climbed strongly and steadily until it hit $36 at the end of September. In the month since then, it’s been consolidating that gain, trading quietly between $35 and $37, with minor excursions outside the range. In the meantime, the 50-day moving average has advanced to $34. We recommend buying now.