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July 7, 2015 Paper & Packaging Chip Dillon, CFA Partner Phone: (212) 257-6159 Fax: (203) 276-5699 [email protected] James Armstrong Analyst Phone: (212) 257-6157 Fax: (203) 276-5699 [email protected] Anna DeGregorio Executive Assistant Phone: (212) 257-6158 Fax: (203) 276-5699 [email protected] Disclosures Analyst Certification Vertical Research Partners analyst(s) whose name(s) appears on the front page of this research report hereby certifies that the recommendations and opinions expressed in the research report accurately reflect the research analyst's personal views about any and all of the subject securities or issues discussed herein. Transacting Disclosures Vertical Research Partners is not a broker dealer, so does not trade or carry proprietary positions with firm capital in any covered or other stocks. 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Vertical Research Partners, LLC recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of a particular investment or strategy will depend on an investor’s individual circumstances and objectives. The securities, instruments or strategies discussed in Vertical Research Partners, LLC reports may not be suitable for all investors. N.C. State University Pulp and Paper Foundation September 12, 2013 Where Will the Best Returns Be Found in Paper and Forest Products? The VRP Team Electrical Equipment & Multi-Industry Jeffery T. Sprague Managing Partner Ryan Edelman Analyst Andrew Noorigan Analyst Jessica Schenendorf Analyst Engineering & Construction Brian Konigsberg Vice President Engineering & Construction Sales Brendan Byrne Instutional Sales Jack Callahan Instutional Sales Chris Donnelly Instutional Sales William Hennig Instutional Sales Will Newell Instutional Sales Operations Nicole M. Parent Managing Partner Rob Wertheimer Principal David Sulpizio Vice President Joe O'Dea Analyst Anna DeGregorio Executive Assistant Paper & Packaging Chip Dillon Partner James Armstrong Vice President Electrical Equipment & Multi-Industry ABB ADT AME ATU DHR DOV EMR ETN GE HON HUB/B IEX IR MMM PH ROK ROP RXN SIE-DE SPW SU-FP TXT TYC UTX WHR Enginnering & Construction BWC CBI CR FLR FLS FWLT GDI ITT JEC KBR MDR PNR SHAW XYL Machinery AGCO ALSN CAT CMI DE ITW JOYG LII MTW NAV PCAR ST TEX WNC Paper & Packaging ATR BLL BMS BKI CLW CCK UFS IP KS KMB LPX MWV NBD OI PKG GLT PCL PCH RYN RKT SEE SLGN SKG ID SON WY Page 4 Coverage List Chip Dillon • Kimberly-Clark (KMB) • MeadWestvaco (MWV) • Packaging Corp (PKG) • Sealed Air (SEE) • Silgan Holdings (SLGN) • Rayonier (RYN) • Rock-Tenn (RKT) • Aptar (ATR) • Sonoco (SON) • Weyerhaeuser (WY) • Potlatch (PCH) • Plum Creek Timber (PCL) • • • • • • • Owens-Illinois (OI) Louisiana-Pacific (LPX) International Paper (IP) Domtar (UFS) Crown Holdings (CCK) Bemis (BMS) Ball Corp (BLL) James Armstrong • PH Glatfelter (GLT) • Norbord (NBD.CN) • KapStone (KS) • Clearwater Paper (CLW) • Smurfit Kappa (SKG.ID) Page 5 Key Points: Containerboard – Paper’s First “Real Business” Since the 1950’s (as long as OCC stays tight). Also sees benefits from (1) recent consolidation and (2) global growth in demand – that has exceeded real GDP. Paperboard – Crosscurrents near-term; US should maintain advantage LT. Market Pulp – North America could see a sustainable advantage in softwood grades. However, hardwood will continue to be pressured by Latin American capacity. One “wild card” in hardwood is currency -- a super-strong Brazilian Real almost eliminated their advantage in Spring 2011. Tissue – Huge secular changes in North America; good with private label. Printing Papers – Continued, gradual slide in uncoated free sheet (-2%-4% per year). Coated paper could fall faster, especially as effectiveness of full catalogs declines. The fate of mass-read magazines long-term is already clear; specialty “rags” will provide some relief. Wood is Good – But timberland is NOT an inflation hedge. Source: AF&PA and Vertical Research Partners Page 6 Containerboard Page 7 US Paper and Paperboard Returns Return on Investment “Better To Be Lucky Than Good” 1950's 1960's 1970's 1980's 1990's 2000's 2010's Page 8 Key Changes We See • Kraft Linerboard is Critical to the Global Fiber System • Kraft Linerboard also Required for Certain Applications (Fruits/Vegetables, High-Value) • OCC Will become More Dear, the Faster Box Demand Grows • No Room at the Inn – The Americas and Europe Win, Asia Loses Page 9 Containerboard Production by Region 160,000 140,000 120,000 100,000 1993 - 2014E CAGR: 4.6% 80,000 60,000 40,000 20,000 0 United States Source: RISI and Vertical Research Partners China Japan Europe Others Page 10 Global Containerboard Capacity 180,000 Recycled Capacity Capacity (000 metric tons) 160,000 Virgin capacity 140,000 120,000 100,000 80,000 60,000 40,000 20,000 0 1999 2000 2001 Source: RISI and Vertical Research Partners 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012E 2013E Page 11 United States OCC Market 35,000 140% Total OCC Collected Exported to China Tons Collected and Exported (thousands) 120% OCC Collected as % of US Production China as a % of Total Collections 25,000 100% 20,000 80% 15,000 60% 10,000 40% 5,000 20% 0 OCC % of US Production and China % of Collections 30,000 0% 2000 2001 2002 2003 2004 2005 2006 2007 2008 Source: Fibre Box Association, AF&PA, US Department of Commerce, Bureau of the Census 2009 2010 2011 2012E 2013E 2014E Page 12 Global Containerboard Supply Chain Unbleached Kraft Pulp Recycled Board Fiber Loss 2.5 MM Tons 99.0 MM Tons 13.5 MM Tons Assum ptions Collection rate: Fiber Loss: 75% 12% Old Board Collected Virgin Board 112.5 MM Tons 48.5 MM Tons Total Supply Theoretical Total Capacity Actual Total Capacity Difference Source: RISI 150.0 MM Tons 173.0 MM Tons Old Board Not Collected 37.5 MM Tons 22.9 MM Tons Page 13 Global OCC Recovery Rates 86.0% 84.0% 82.0% 80.0% 78.0% 76.0% 74.0% 72.0% 70.0% 68.0% Source: RISI Page 14 Recovery Rates of OCC in China as Percent of Production 140% 130% 120% 110% 100% 90% 80% 70% 60% 50% 40% Source: RISI Page 15 German & US OCC Prices in USD $200 $180 US OCC German OCC (In USD) $160 Price Per Short Ton $140 $120 $100 $80 $60 $40 $20 $1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 Source: RISI Page 16 Fiber Cost Per Ton of Containerboard $250 $200 $150 $100 $50 $- OCC Source: Plum Creek, RISI and VRP Estimates Delivered Pulpwood Page 17 Mill Cash Production Cost, Europe vs. ROW 2Q 2011 $500 $450 Other Fiber $450 $400 $400 $350 $350 $300 $300 $250 $250 $200 $200 $150 $150 $100 $100 $50 $50 $- 2Q 2012 $500 Other Fiber $- North America Africa OceaniaEurope Latin Asia America Global Average North America Africa Latin EuropeOceania Asia America Global Average Note: All costs per short ton. Source: RISI Page 18 OCC Imports OCC Imports (Million Metric Tons) 20 18 China 16 Other Far East 14 Latin America 12 10 8 In 2010, North America and Europe equally supplied the Asian shortfall. 6 4 2 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Source: RISI Page 19 Where to Build New Kraftliner? • Canada – Insufficient Fiber, Slow-Growing Trees, Pine Beetle Issue, High Costs • Latin America / Asia – Almost Totally Hardwoodbased (ex. Chile, Southern Brazil and NZ) • Scandinavia/Central Europe – Possible, competing fiber demands (energy), sustained yield • Russia – Clearly part of the Solution, but there are Infrastructure and Capital Constraints • US South – Clearly part of the Solution, but Permitting takes 3-5 Years Page 20 Tissue Page 21 North American Tissue Market Share Market Position 1 2 3 4 5 6 7 8 9 10 Source: RISI Name Georgia-Pacific Procter & Gamble Kimberly-Clark Cascades Tissue SCA Tissue NA Clearwater Paper Kruger Tissue Group First Quality Tissue Irving Tissue Soundview Paper Co. Top 10 total All others Total Tons (000's) 2,556 1,390 1,329 597 521 476 352 243 217 127 7,807 944 8,750 Market Share 29.2% 15.9% 15.2% 6.8% 6.0% 5.4% 4.0% 2.8% 2.5% 1.5% 89.2% 10.8% Page 22 Tissue Capacity Changes in US and Canada Company Location Notes Blue Heron First Quality Tissue Kimberly-Clark Kruger Products First Quality Tissue Georgia-Pacific White Mountain Tissue Clearwater Paper Georgia-Pacific Wausau Paper K.T.G. (USA)/Kruger Tak Investments Irving Tissue First Quality Tissue Confidential Confidential Confidential Procter & Gamble Oregon City, OR Anderson, SC Everett, WA New Westminster, BC Anderson, SC Green Bay, WI Gorham, NH Shelby, NC Naheola, AL Harrodsburg, KY Memphis, TN Franklin, VA Toronto, ON Anderson, SC Confidential Confidential Confidential Box Elder, UT Mill shut down New greenfield TAD mill; first PM Mill shut down PM1 & PM2 closures New greenfield TAD mill, second PM Restart of PM7 at the Day Street mill New PM from ABK Italia New greenfield TAD mill Restart of PM1 New Voith "ATMOS" PM New PM; TAD Rebuild of a free sheet PM to tissue Rebuild to TAD tissue on PM6 (?) New Voith "ATMOS" PM (third PM) New Metso "Advantage DCT 200TS" PM New Metso "Advantage DCT 100+" PM New Metso "Advantage DCT" PM New PM; TAD from Andritz; on hold Furnish Date V&R V V V V V V V V R V R V V V* V&R* V* V 2011:Q1 (32,000) 2011:Q4 70,000 2011:Q4 (208,000) 2012:Q3 (25,000) 2012:Q3 70,000 2012:Q3 35,000 2012:Q4 36,000 2012:Q4 70,000 2012:Q4 25,000 2012:Q4 75,000 2013:Q1 66,000 2013:Q1 70,000 2013:Q3 * 25,000 2014:Q2 * Tons * * * 75,000 * 2014 * 80,000 2014 * 35,000 2014 * 70,000 2014:Q3 * 80,000 * R = Recycled TAD = Through-Air-Dried * = estimated Source: RISI Page 23 North American Tissue Industry 10,000 98% 9,000 96% 94% 7,000 92% 6,000 90% 5,000 88% 4,000 86% 3,000 Overcapacity 2,000 Consumption Producer Price Index 1,000 Operating Rate 0 Source: AF&PA, RISI and VRP Estimates Operating Rate Production ('000 tons) 8,000 84% 82% 80% Page 24 Tissue Private Label Market Share 70% 60% 50% 40% 30% 20% 10% 0% US Source: Company Reports 2005 2012 Europe Page 25 Pulp Page 26 NBSK Price in USD and Euros € 1,100 $1,100 Historical $1,000 Forecast NBSK Price in US Dollars NBSK Price in Euros € 1,000 $900 € 900 $800 € 800 $700 € 700 $600 € 600 $500 € 500 $400 € 400 € 300 $300 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 2012 2014 2016 Source: Bloomberg and Vertical Research Partners. Source: Bloomberg, RISI and Vertical Research Partners Page 27 Pulp Expansion Projects Underway • 2012 Ramp Up • CMPC – 100k Tonnes Softwood in Laja, Chile: 2012 • 2013 Ramp Up • Ilim (IP) – 720k Tonnes Softwood in Russia: 2nd Half 2012 • Eldorado Celulose – 1,500k Tonnes Hardwood in Brazil: 1st Half 2013 • Stora/Arauco – 1,500k Tonnes Hardwood in Uruguay: 2nd Half 2013 • Oji Paper – 350k Tonnes Hardwood in China: CANCELLED • 2014 Ramp Up • Stora/Guangxi – 450k Tonnes Hardwood in China: Delayed Until 2016? • Suzano – 1,300 Tonnes Hardwood in Brazil: 2014 • 2015 Ramp Up • CMPC – 1,300k Tonnes Hardwood in Brazil: 1st Half of 15 • Shandong Sun – 300k Tonnes Hardwood in Laos – Delayed from2013 Source: RISI and Vertical Research Partners Estimates Page 28 Paper Page 29 Uncoated Free Sheet Market Share UFS Market Share - 2000 P.H. Glatfelter 2.3% Fort James 2.9% Appleton Papers 3.6% Fraser Papers 4.2% Domtar 6.1%Willamette Other 14.7% 7.2% Weyerhaeuser 7.4% International Paper 29.8% UFS Market Share - 2013 Boise Cascades 9.0% GeorgiaPacific 12.8% All Other 16% Glatfelter 8% Domtar 32% Georgia Pacific 9% Boise Paper 11% Source: RISI and Vertical Research Partners International Paper 24% Page 30 Coated Free Sheet Market Share Coated Market Share - 2000 Crown Vantage 2.6% Bowater 3.0% International Paper 20.1% Other 20.8% Coated Market Share - 2012 Potlatch 3.2% UPMKymmene 4.1% Repap Enterprises Westvaco 5.7% 4.2% SAPPI 9.3% Mead 11.4% Stora Enso Belgravia 15.6% 3.1% Catalyst Paper 2.9% FutureMark Paper 2.4% Kruger 3.3% Other 3.1% NewPage 35.0% Sequana Capital 4.7% UPM 4.7% AbitibiBowater 8.4% Source: RISI and Vertical Research Partners SAPPI 14.8% Verso Paper 17.5% Page 31 Uncoated Free Sheet Apparent Consumption 16,000 Apparent Consumption ('000 Tons) 15,000 14,000 13,000 12,000 11,000 10,000 9,000 8,000 7,000 6,000 Source: AF&PA and Vertical Research Partners Page 32 Conclusions: Containerboard – Paper’s First “Real Business” Since the 1950’s (as long as OCC stays tight). Also sees benefits from (1) recent consolidation and (2) global growth in demand – that has exceeded real GDP. Paperboard – Crosscurrents near-term; US should maintain advantage LT. Market Pulp – North America could see a sustainable advantage in softwood grades. However, hardwood will continue to be pressured by Latin American capacity. One “wild card” in hardwood is currency -- a super-strong Brazilian Real almost eliminated their advantage in Spring 2011. Tissue – Huge secular changes in North America; good with private label. Printing Papers – Continued, gradual slide in uncoated free sheet (-2%-4% per year). Coated paper could fall faster, especially as effectiveness of full catalogs declines. The fate of mass-read magazines long-term is already clear; specialty “rags” will provide some relief. Wood is Good – But timberland is NOT an inflation hedge. Source: AF&PA and Vertical Research Partners Page 33 Timberland & Wood Products Page 34 Timberland • Not an Inflation Hedge, But a Deflation Hedge • Regions Matter • Outside of Northwestern US Douglas Fir, Plenty of Headwinds Wood Products • Strong Outlook based on Secular Housing Trends • Supply Chain Constraints • Consolidation Page 35 Return on Southern Timberland Price per Acre EBITDA EBITDA 1998 $400 40 35 1999 $1,034 41 36 2013E $1,400 30 25 Current Return 8.8% 3.5% 1.8% 10-Year Bond S&P 500 Yield 8.6% 3.7% 5.2% 1.1% 2.9% 2.0% Source: RISI, Factset and VRP Estimates Page 36 0% 0% -5% 10% -10% 20% -15% 30% -20% 40% Plum Creek Potlatch -25% Rayonier Change in 10-Year Yield Stock Returns Timber REIT Returns and Change in 10-Year Treasury Yield since May 21st 50% Weyerhaeuser 10-Year Yield -30% Source: RISI, Factset and VRP Estimates 60% Page 37 Timberlands Why is Timber Not an Inflation Hedge? - The logic is simple. If the rate of general price inflation rises to 5% from, say, 2%, one would hope and expect average wages to rise at least 5% to allow workers to maintain overall purchasing power. Of course, the prices of goods/services would not all move up at the same rate. For example, the price of corn might rise by 10% while the next generation of laptops or smart phones may fall a bit. What about the price of timber and, by extension, timberland? The short answer is that timberland values would fall sharply, we believe for two reasons. First, the demand (and price) of mature (ready-to-cut) timber and logs would fall as wood products (lumber) demand would likely fall as fewer houses can be afforded and built. To illustrate, consider that most of the cost of a house is the monthly mortgage payment. If 30-year mortgage rates are, say, 4% with 2% inflation, one would expect them to jump to 7% with 5% inflation. This would raise the monthly payment by nearly 40% (to $8,059 from $5,783). With home prices still down quite a bit from levels seen 7-10 years ago - and near replacement costs - we see little room for home prices to decline in a functioning home market. Therefore, assuming flat home prices, 5% inflation (and thus 5% higher average wages), many fewer could afford to buy a house given the 40% jump in monthly payments! This means fewer homes would be built, less lumber would be needed, and thus fewer logs/less timber would be demanded, leading to lower log/timber prices. Second, timberland values would incur a second hit (in addition to lower cash flows from lower log/timber volumes and price): higher discount rates would lower what a buyer of land would pay for those cash flows. Page 38 Timberlands In Fact, Timber is a Deflation Hedge - Until recently, markets were pricing in no inflation and some risk of deflation. During the post March 2009 bull market, the timber REITS, and pure-play Plum Creek in particular, have experienced strong price performance (especially for low-beta "yield" stocks). In a perverse way, this makes some sense. While log prices have remained quite soft (given the undercutting and resulting inventory increases in recent years), the discount rates applied to current and expected future cash flows fell along with long-term interest rates in general. Also, in a deflationary period, buyers hold out for lower prices that are forced upon sellers - especially with perishing goods (food) and services (empty airplane seats). On the other hand, trees can last decades and sellers (not needing cash) can merely wait for better markets before selling. Page 39 Wood Products Page 40 Softwood Lumber Market 80,000 2,500 70,000 2,000 50,000 1,500 40,000 1,000 30,000 Thousands of Housing Starts Thousands of Square Feet 60,000 20,000 500 10,000 0 0 Lumber Production Lumber Imports Lumber Consumption Lumber Exports Housing Starts Sources: Statistical Yearbook of the Western Lumber Industry, Wood Markets: The Solid Wood Products Outlook, Random Lengths, Canada Mortgage & Housing Corp., and Vertical Research Partners Page 41 Panels Market Supply and Demand 50,000 2,500 45,000 2,000 35,000 30,000 1,500 25,000 20,000 1,000 15,000 10,000 Thousands of Housing Starts Thousands of Square Feet 40,000 500 5,000 84% 77% 84% 85% 91% 87% 86% 90% 93% 94% 91% 89% 92% 93% 98% 97% 93% 86% 71% 61% 71% 76% 85% 94% 98% 96% 90% 89% 0 0 Plywood Capacity OSB Capacity Plywood Production OSB Production Housing Starts Source: APA Economics Report E60, Statistical Yearbook of the Western Lumber Industry, Wood Markets: The Solid Wood Products Outlook, Random Lengths, Canada Mortgage & Housing Corp., Vertical Research Partners Page 42 North American OSB Market Share Other 11% Tolko 5% Louisiana Pacific 20% Huber 7% Ainsworth 10% Weyerhaeuser 14% Georgia-Pacific 17% Norbord 16% Source: Norbord 3Q 2012 Presentation Page 43 July 7, 2015 Paper & Packaging Chip Dillon, CFA Partner Phone: (212) 257-6159 Fax: (203) 276-5699 [email protected] James Armstrong Analyst Phone: (212) 257-6157 Fax: (203) 276-5699 [email protected] Anna DeGregorio Executive Assistant Phone: (212) 257-6158 Fax: (203) 276-5699 [email protected]