Since the Internet bubble burst, you might have earned more as a paperboy than as an investor in the newsprint industry. The dot-com craze spurred tremendous spending on advertising and classifieds; in turn, the demand for newsprint grew well above trend line in 1999 and early 2000. Since the dot-bomb dropped, however, the demand for newsprint has collapsed, with consumption likely to plunge 10% or more this year.
The fact that newsprint prices are likely to fall further makes
an interesting pick right now. Abitibi's shares are off 23% so far this year, compared with a 3.4% move up in the Dow Jones Forest Products index.
Newsprint prices tend to lag behind pulp prices, yet the stocks usually move well before prices do (for details, see my
recent column on pulp). For patient investors, Abitibi's turn will come. In the meantime, this is a very cheap stock, selling at close to a recession-level valuation, with little downside risk. If you had bought Abitibi's shares at the trough of the last recession at the end of 1990, for example, within six months you would have gotten almost a 50% return.
Buying Canada-based Abitibi is one of the best ways to pick up some exposure to newsprint. The company is the largest newsprint producer in the world, with 29% of the North American market and 14% of the world market. Two-thirds of the company's EBITDA (earnings before interest, taxes, depreciation and amortization) are derived from newsprint, and the remaining third is mainly from pulp and paper.
Because most of its costs are based in cheaper Canadian dollars, Abitibi could now be the world's lowest-cost major newsprint producer, with EBITDA margins of 28.8% for the first nine months of this year. That's the highest in the industry.
Despite its bleak near-term outlook, the newsprint industry -- and Abitibi in particular -- is well-situated to surprise on the upside coming out of the current recession. Here's why:
- The newsprint market is already well-consolidated, with the two largest newsprint players, Abitibi and
Bowater( BOW), representing 45% of the North American market.
Both Abitibi and Bowater have been very disciplined in this downturn about reining in capacity, which should help support a stronger recovery in earnings and return on capital when the cycle turns up.
Abitibi, for one, has limited its capital spending to just 50% of its depreciation and amortization expenses this year, or less than $300 million. The company has sold two high-cost mills and shut high-cost machines at three mills. Analysts estimate that from early 2000 to the end of this year, North American newsprint capacity will have dropped about 5% (including six Abitibi plants), and could be down another 1% in 2002.
Newsprint inventories are in fairly good shape as well, thanks to the discipline that many producers have had in curtailing capacity. This has helped operating rates stay relatively high -- in the low 90% range. Any improvement in demand could drive inventories down even further, helping operating rates and setting the stage for a recovery in prices.
Abitibi is positioning itself to emerge a stronger player when the recovery materializes. For example, last year Abitibi acquired Donohue, a smaller but very efficient newsprint producer, galvanizing its position as market leader. Abitibi is targeting $250 million in cost savings from merging Donohue's operations with its own by the end of this year. So far through the third quarter, the company had already achieved $223 million toward that goal. Abitibi has another cost-reduction program for 2002 that should generate additional savings of $100 million.
Some might quibble that Abitibi has a somewhat leveraged balance sheet, with a debt-to-capital ratio of 62%. But its interest coverage ratio of 2.2 (meaning cash flow covers interest expense 2.2 times) is manageable at this stage of a downturn. The risk, of course, is the length and depth of this cycle. If no recovery materializes by the end of next year, the company may need to consider reducing its dividend.
The main problem for the newsprint companies, as I suggested above, is demand. But the good news is that comparisons are starting to get a little easier. In fact, the year-over-year declines in newsprint demand are now in the single digits -- better than the nearly 15% drop posted in the first quarter of this year. As a result, consumption has been below trend line for most of this year already.
Another caveat: Don't look for a recovery in newsprint prices until late next year. After being up about 11% in 2000, prices are likely to be down 15% year over year to $520 per metric ton in both the fourth quarter of this year and the first quarter of next. It's not until the fourth quarter of 2002 that prices may actually be up on a year-over-year basis. But if history is any guide, Abitibi's stock price will move up well before newsprint prices do.
So, while there may still be some pain left in the newsprint world, Abitibi's stock price is clearly already reflecting much of it. Abitibi is one of the most undervalued stocks in the North American paper group, selling at an enterprise value (that's equity market value plus net debt) to EBITDA ratio of just 5.2, and a price-to-book value ratio of just 1.3. If the recent move up in some pulp and paper stocks is any indication that the pulp industry is bottoming, it's Abitibi's turn next.
Odette Galli writes daily for TheStreet.com. Before coming to TSC, Galli was a writer at SmartMoney Magazine. Prior to that, she worked as a senior manager at Ark Asset Management where she managed $3 billion in institutional assets. In addition, Galli was a senior vice president at J & W Seligman. She has also served as a research analyst for Morgan Stanley.
In keeping with TSC's editorial policy, Galli doesn't own or short individual stocks, although she owns stock in TheStreet.com. She also doesn't invest in hedge funds or other private investment partnerships. She invites you to send your feedback to