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Never turn your back on a falling tree

For some time now I’ve been watching in eager anticipation for a certain industry in North America to hit bottom. Although I won’t proclaim that it has hit rock bottom, I am beginning to initiate starting positions in key companies I feel will benefit from the horrific conditions over the past few years.

In any industry, through good times and bad, there are certain pressures exerted on companies to perform, consolidate, trim expenses and become more competitive. A company that competes internationally in a trade business needs not only a superior product, but also the pricing available to make that competitive against foreign pressures.

So what am I getting at? Even with the internet, computers, blackberries and countless other electronics – our economy and world in general still utilizes paper as a resource on a massive scale. We’ve cut back on usage with recycling & initiatives for the environment, but largely our business community, education systems and industries use paper products for a wide variety of products, tools & services. I’m not only talking about the tradition white 8 ½ X 11” paper we see in offices, but also the usage of paper products in developing new technologies for construction & engineering products.

Yeah, I’m talking about paper stocks. The industry still in the doldrums of the market where no one gives respect or takes a moment to think anything will ever change in the future. But in times like this, an industry is forced to become more competitive or risk becoming extinct. I can’t foresee paper becoming obsolete or extinct…so fundamentals tell me I’m on the right track.

There are a few factors beyond valuations that have my interest here:

1. The loonie has had an incredible run…and hurt these companies along the way. Yet, they’re still kicking, still producing and although the next few quarters may be “more of the same”, eventually the dollar will stabilize or decrease. If it has in fact topped around $0.96, then the end shouldn’t be far too away assuming interest rates moderate in the next 12 months.

2. Production is dropping – drastically. These companies are being forced to trim expenses, cut labour & shut down less productive mills. It’s simple supply vs. demand if you look at this product from the view of economics. In any decreasing supply situation, when demand increases prices will skyrocket. True, it will have to be timed appropriately, but it’s inevitable for any industry.

3. Because of #2, consolidation is next. The big boys will eat up the little ones at a premium in order to position themselves for this eventual shift in demand. It’s already starting as many companies look to trim excess fat from their balance sheets. This says two things: either a.) We’re making ourselves more competitive for the future or b.) We’re making ourselves attractive for an eventual takeover.

4. In North America we have the technology, skill & scale to produce these products cheaper than most international competition. Eventually the economies of the emerging markets will out demand local resources and look internationally to solve the issue of price. Why pay X amount per ton in China when you can ship the same product from Canada for half the price?

5. Bugs: the Mountain Pine Beetle & Brown Spruce Longhorn Beetle are causing considerable damage to existing trees – and their infestation no longer is confined to specific species. The bugs are adapting and moving to surrounding trees with startling success. The bugs are underreported, devastating to existing populations and no one as of yet has found an effective means of dealing with the problem. In the past, harvested trees could be stockpiled for later use in future seasons. Infected trees need to be processed in the SAME season. Supply & demand…very simple. Existing production does not have the capacity to process all these trees and with companies cutting production, economic fundamentals seem very favourable. Quality will become more important and those who can provide it will be able to sell at an astounding premium to the market.

This won’t cause an explosion of M&A tomorrow, next month or maybe even this year. But keep in mind that like many industries before this one, something will eventually happen. The major producers will have placed themselves in a position to acquire & grow through acquisitions, while the smaller producers have trimmed their balance sheets, increased their cashflows & look to sell their assets at a large premium.

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{ 2 comments… add one }
  • FourPillars July 23, 2007, 8:14 pm

    Interesting post.

    What companies are you looking at for either being taken over or long term investments?

    Mike

  • Nurse B, 911 July 23, 2007, 9:56 pm

    Hey Mike,

    I posted the watchlist & existing positions over on CB forums in my Value II thread. I’d be interested to hear your thoughts on them over there or here if you get the time.

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