Paper Stocks May Go Flat

 | Mar 25, 2013 | 11:03 AM EDT
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Paper and packaging companies have been some of the peppier performers in the U.S. stock market so far this year. I don't think the fun will last.            

At the moment, the paper companies that are doing best are the packaging companies. Rock-Tenn (RKT) of Norcross, Ga., which makes corrugated packaging and folding cartons, is up about 25% this year. MeadWestvaco (MWV) of Richmond, Va., which makes a wide variety of packaging, is up about 15%. So is competitor Sonoco (SON) of Hartsville, S.C.

Among straight paper producers, the picture is more mixed. International Paper (IP) of Memphis, Tenn., is up 13%. Domtar (UFS) of Montreal, which just acquired Xerox's branded paper business, is down more than 6% in an up market.

Straight paper stocks have to fight a perennial headwind: the ever-increasing use of computers and the Internet. I remember a day in the mid-1980s, when I was a writer at Forbes magazine, and the publication installed a word-processing system. "Paper will soon just be a crutch," a Forbes official told me.

His prophecy is coming true very slowly and gradually. Still, it is coming true. And that's one reason I have never loved paper stocks. Another reason is that newspapers are in decline, crippling the demand for newsprint. As a former newspaperman, I regret this, but it's a fact. My children and their contemporaries get their news from the Internet and will not need paper.

It makes sense that in a reviving economy, companies will use more packaging and maybe even more paper, temporarily. But I don't believe the stocks are likely to outperform.

These companies have some weaknesses. Both Rock-Tenn and MeadWestvaco have had so-so profitability the past two years and skimpy pre-tax margins. International Paper has debt equal to 160% of stockholders' equity, which I consider high.

In addition, several of these stocks are pricey. MeadWestvaco, for example, is at 29x earnings, and its 10-year median is 21x. International Paper fetches 19x earnings, compared with a median of 14x.

Finally, these stocks may suffer the curse of high expectations. Analysts adore International Paper right now -- 14 of the 17 analysts who cover it rate it a Buy. But such popularity often comes late in moves, rather than early.

International Paper's shares have returned 750% since Feb. 28, 2009. Back then, with a seven-fold gain ahead of it, the stock was far less popular -- only 31% of analysts recommended it. Popularity is not always a blessing, and unpopularity may be a blessing in disguise.

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