Paper Stocks Look Dirt Cheap

08/22/2007 12:00 am EST


George Putnam

Editor, The Turnaround Letter

George Putnam, editor of the Turnaround Letter, says weak industry conditions shouldn’t keep contrarians away from paper stocks—precisely because so many investors hate them. 

Just as newspapers have struggled in recent years, so have their suppliers. And, of course, one of the biggest suppliers to newspapers is the paper industry. Moreover, many of the paper companies are being hit doubly hard right now because they supply other forest- based products, such as lumber, to the homebuilding industry.

As if falling demand wasn’t enough, the paper companies have also been hit with rising costs. The papermaking process uses a lot of energy, which has become increasingly costly over the last year or two. Rising energy costs also make it more expensive to transport paper and other forest products to their ultimate destinations.

So why do we find the paper companies interesting? Because most other investors hate them. Many of these stocks are trading near the bottom of their ten-year ranges. Some, such as Chesapeake (NYSE: CSP) and Nashua (NASDAQ: NSHA), are trading near 20-year lows.

While the movement toward more electronic delivery of information will continue to dampen demand for paper, the industry is consolidating, which should reduce capacity and decrease supply. For example, Bowater and Abitibi-Consolidated are working on a merger right now. Also, the cost picture could improve if energy prices level out.

[Here are some] stocks in the paper industry whose prospects we find particularly interesting.

Chesapeake is a supplier of specialty paperboard and plastic packaging. Everything has not been well at Chesapeake as evidenced by the stock recently trading at a 22-year low. Following seemingly endless restructuring efforts, senior management was shaken up in 2005, and a new two-year $25-million global cost-savings program was initiated. Though [the stock is] cheap on a valuation basis, the balance sheet is leveraged, and so Chesapeake should be considered speculative. (The stock closed below $11 Tuesday—Editor.)

Nashua’s stock declined for most of the decade prior to merging with Rittenhouse Paper in April 2000. Rittenhouse’s chief executive officer took charge and began turning operations around at the maker of labels and specialty papers. But the firm’s momentum was stalled in 2005 by excess industry capacity and rising utility and freight rates. Management has responded by selling assets to improve the balance sheet. Though the stock is off its 2001 lows, it is still trading lower than it was some 23 years ago. (It also closed below $11 Tuesday—Editor.)
Avery Dennison (NYSE: AVY) is a global manufacturer of pressure-sensitive and self-adhesive products used in a range of consumer products and labeling systems. It has actually been a beneficiary of the electronic age as it has been able to adapt many of its products to the personal computer. The company has consistently grown revenues and profits, but investors have recently reduced the premium that they were previously willing to pay for it. As a result, the stock now appears reasonably valued. And the company has a strong balance sheet and pays a decent dividend. (The stock closed above $58 Tuesday—Editor.)

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