When people want to express a lack of enthusiasm about something, they sometimes compare it to cardboard.
We've all heard someone say something like "This cereal is so bland, I might as well be eating cardboard," or "This movie is about as exciting as a cardboard box."
But after I've told you about one company that produces cardboard boxes and other types of packaging, you may see these sorts of products in a whole new light. Indeed, they could be among the most lucrative investments you ever encounter.
The firm I'm referring to is the fourth-largest player in the U.S. containerboard and corrugated packaging industry, with a 10% market share. Its products come in all shapes and sizes from big shipping containers and multicolored boxes to retail displays and food packaging.
The company also produces white paper, newsprint and wood pulp. It has 15,000 customers in many industries like food and beverages, retail, and appliances. Production capability is about 3.4 million tons of containerboard and 46 billion square feet of corrugated products annually.
Bored yet? Then consider this: The firm's stock is up fivefold in the past five years. And it could triple again during the next five years.
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That's because the company, Packaging Corp. of America (NYSE: PKG), is apt to outperform the competition and sustain fast earnings growth while maintaining a low-cost structure -- just like it has been doing.
Annual revenue grew at a healthy 14.6% clip during the past three years, rising from $2.4 billion in 2010 to $3.7 billion currently. Earnings per share (EPS) expanded by a whopping 31% a year during the same period, spiking from $2 to $4.47.
The low costs I mentioned were a big factor in PKG's exceptional profit growth. For instance, total operating expenses (consisting mainly of sales, general and administrative costs) have barely budged in three years. At $386 million, they're only 11% above the 2010 level of $347 million. That's an annual growth rate of 3.6% -- far lower than the pace of revenue expansion.
Controlling costs for product inputs (mainly wood fiber) is tougher for PKG since it doesn't dictate raw material prices, which are trending upward. However, the firm has still managed to keep its cost of goods sold growing slower than sales by about 1% a year for the past three years.
|Packaging Corp. of America has 15,000 customers in many industries like food and beverages, retail, and appliances. Production capability is about 3.4 million tons of containerboard and 46 billion square feet of corrugated products annually.|
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It accomplishes this in a couple of key ways, and one is by using mainly virgin wood fiber in its products instead of recycled materials. Not only is virgin fiber cheaper now, but analysts see an even wider cost advantage in coming years because recycled material supplies are tightening.
The other big cost-saving measure is using machinery that can accommodate a variety of fiber types and run on different fuels (like natural gas, electricity, or even production byproducts). This usually enables PKG to manufacture with whichever fibers and fuels are cheapest at the time. Most competitors, on the other hand, haven't yet converted to the more flexible machinery. So they're often stuck with the fuels and fibers their machinery can handle -- no matter the price.
With its lower costs, PKG boasts operating and net margins of 13% and 12%, respectively, compared with the industry averages of 8% and 5%.
Another margin booster is the company's focus on a much more diverse regional and local clientele as opposed to more concentrated national accounts (the firm derives two-thirds of revenue regionally and locally). Smaller customers tend to carry higher margins because they don't have the ability to influence product prices the way much larger customers can.
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With the economy slowly coming around, I like PKG's prospects for more fast growth. Since the performance of the company (and its competitors) typically varies with the shipping needs of other industries, I suspect quick-rising sales and profits at PKG are very good signs of things to come -- especially since analysts commonly use the containerboard and corrugated packaging industry as an indicator of overall economic activity.
The acquisition of competitor Boise Inc. last November for just shy of $2 billion should help PKG keep up with rising demand. The deal improved PKG's containerboard production capacity by 42% and gave the company a much larger presence in the western U.S.
Considering all this, PKG is capable of meeting EPS growth estimates of 27% a year for the next five years (after maintaining a 32% growth rate during the previous five years). Assuming its price-to-earnings (P/E) ratio remains in line with the historical average of 15, the stock could more than triple from the recent price of about $69, climbing above $220 sometime in 2019.
Risks to Consider: Containerboard and corrugated packaging are highly commoditized, so customers base buying decisions mainly on price. If PKG loses its production cost advantage, margins could suffer because the firm probably wouldn't be able to raise prices to compensate. Prospective investors should also be aware of a pending class-action suit against PKG and eight other industry participants on allegations of price fixing. The suit is still in the discovery phase, so it's much too soon to estimate how much it could ultimately cost PKG.
Action to Take --> PKG may be a boring stock, but it can provide exciting returns. With a P/E of 15.5, shares look cheap next to the S&P 500's earnings multiple of 18. When you factor in PKG's high rate of projected growth and 2.4% yield, the stock appears to be an even better value.