Corporate activity fails to assist paper stocks
European growth is pushing demand and prices upwards in the sector while the weak euro is limiting f...
European growth is pushing demand and prices upwards in the sector while the weak euro is limiting foreign imports. However, some fund managers say stocks are fully priced and there will be no earnings surprises on the upside.
In the 12 months to May this view has been reflected in returns between 22-25% by the top stocks in the sector compared to the Dow Jones Eurostoxx 50, which has grown by 41%.
Ken Baksh, associate director for Europe at L&G Asset Management is positive on paper and forestry companies. He says: "If you go back a bit the sector has been fairly dismal, although part of that is by default with the technology stocks being as strong as they have been. People were ignoring it as a cyclical play, but we feel there is value and we are starting to overweight the sector. There is good volume growth coming as economic growth in Europe continues. Businesses are being enabled to put through quite large price increases into the second quarter."
Baksh believes it is also an industry with very little over-capacity, and high operating rates can be exploited through the position of the weak euro. He says that as a result of enthusiasm for technology in recent months, valuations going into the second half of the year look good whether on P/E ratios, price to cash flow ratio, or dividend yields.
Possible threats to the industry come from a more rapid than expected slow-down in the European economy or further rises in pulp import prices from outside the eurozone. By contrast, Edinburgh Fund Managers hold no European paper and forestry stocks, and believe the sector is close to reaching the top of its cycle.
Fund manager Wendy Cochran says: "The underlying fundamentals are definitely improving. There is stronger demand coming through, the recovery in Asia is helping supply and some of the excess capacity has been driven out by most of the big players. Yet relative to the market there are better opportunities out there."
One downside the group sees has been the negative response to a recent wave of merger and acquisition activity in the sector. She says: "The overall demand for paper is cyclical and moves with the GDP cycle, but is not growing in absolute terms. So the only way these companies can grow their profits is by becoming more efficient and grow the bottom line, or by acquisition."
Acquisition moves by Stora Enso and UPM Kymmene have been greeted with displeasure by the market, which sees very little potential for synergies on offer, and this saw a downturn in stock prices.
Gregor Smith, fund manager at Aberdeen Asset Management, is underweighting the sector after having taken profits in the second half of last year.
Smith says: "We wouldn't expect paper and forestry stocks to do very much during the rest of the year. Most of the companies are pretty fully valued, and we think the upside is limited because the market fully understands the story."
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