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MAINE PORTFOLIO OF THE FOREST-PRODUCTS INDUSTRY: A COMPARATIVE ANALYSIS OF PERFORMANCE AND PROSPECTS

by Mahmud Rahman, Assistant Professor of Finance, Eastern Michigan University (formerly at the University of Southern Maine), and Mary J. Wilson, Investment Analyst, Wright Express Corporation (formerly at the Mead Corporation)
 

The Forest-Products Industry

The forest-products industry is the single largest business sector in Maine. The paper industry in particular is very large, even by national standards. Approximately 16,000 people are employed just in production facilities in Maine, and the industry directly generates 24,000 additional jobs. The mills in Maine produce 10,000 tons of paper and 7,000 tons of pulp every day, and Maine is the largest producer of printing and writing papers in the nation. In the production of paper products, Maine is second only to Wisconsin in the nation. Table 1 summarizes the major facilities in Maine and their respective locations and ownership.
 
Table 1: Major Forest Products Companies
 
  Ticker Maine Maine  
  Symbol Operations Location (s) Notes
Boise Cascade Corp. BCC N   Only has Office Products Div. in Maine
Bowater Inc. BOW Y Millinocket, East Millinocket  
Champion Int'l CHA Y Bucksport  
Consolidated Papers, Inc. CDP N    
Georgia Pacific GP Y Baileyville  
International Paper IP Y Jay  
Lincoln Pulp & Paper _______ Y Lincoln Privately owned
Fraser Paper _______ Y Madawaska Owned by Noranda Forest Inc. (Canada)
Kimberly Clark* KMB N   Closed Waterville facility
Madison Industries _______ `Y Madison Owned by Myllykowki Oy (Finland)
Mead Corp. MEA Y Rumford  
Potlatch PCH N    
Sappi LTD  _______ Y Westbrook, Skowhegan 2 mills, owned by Sappi LTD (So. Africa)
Union Camp* UCC Y Auburn  
Wausau-Mosinee WMO Y Jay Consumer products
Westvaco W N    
Weyerhaeuser WY N   Sold Westbrook container facility
*Included on list even though they are consumer products companies,
because they have (or until recently had) Maine facilities.
 
As an investment vehicle, forest-products companies are grouped as "cyclicals," a sector which also includes the aerospace, construction, machinery, and metals industries. In general, these industries require large capital expenditures, sell high-value products, compete in a global marketplace, and endure "boom and bust" cycles. The key profit drivers of this sector are strong GDP growth, an ample money supply for investment, and low interest rates. During boom times the industries tend to overbuild capacity, then lag badly until growth catches up with the additional capacity. The cycle starts again as operating rates increase, allowing product prices and profits to move up in response.

This study focuses on the investment results generated by publicly traded U.S.-incorporated forest-products companies, excluding those that derive most of their net income from consumer products. Well-known consumer products companies such as Kimberly Clark, Proctor and Gamble, and Fort James manufacture and sell diapers and personal products, tissue, and disposable tableware. These products have less elastic demand and thus enjoy less cyclicity than do pulp, paper, wood, and board products. Most forest-products companies have investments in a number of related market segments.
 

Maine Portfolio versus All-Companies Portfolio

As an investor, what kind of returns can one expect from investing in this, the largest economic sector in Maine? How do the companies with investments in Maine stack up when compared to the industry as a whole? What has been the return performance of the forest-products industry (Maine and national) compared to popular market indices like the Dow Jones Industrial Average and the S&P 500? By analyzing the financial performance of the companies and their return to investors, we can draw some conclusions about the industry health and the possibilities for continued investments in Maine to modernize facilities and increase capacity.

Table 2 recaps the share price, the yield, and the total market capitalization as well as the price-earnings and price-to-book ratios of these firms (as of May 8, 1998). This table also compares the Beta, market capitalization, and price-to-book ratios for companies with Maine assets to the industry as a whole. Fig. 1 displays the relative market capitalization of all of these companies, including those with Maine production facilities. Table 3 summarizes the earnings per share for the major forest-products companies. The years 1994-1995 were the best financially for this group since the 1980s, but a steep decline in demand and prices started in 1996 and carried over into 1997.

 
Table 2: Vital Statistics of Forest-Products Companies
as of May 8, 1998
 
      Current     Market  Price-to- Price-to-
Ticker Maine Share Capitalization Earnings  Book
  Symbol Investment? Price Yield Beta $mil Ratio Ratio
Bowater Inc. BOW Yes $55.94 1.40% 1.43 $2,255.50 29.91% 1.95%
Champion Int'l CHA Yes $53.31 0.40% 0.51 $5,125.00 N/A 1.30%
Georgia Pacific GP Yes $78.88 2.20% 0.85 $7,270.80 27.10% 1.50%
International Paper IP Yes $52.38 1.90% 1.12 $15,865.70 N/A 1.70%
Mead Corp. MEA Yes $35.19 1.80% 0.93 $3,656.40 23.30% 1.60%
Union Camp UCC Yes $61.88 2.90% 0.77 $4,284.50 52.88% 2.05%
 
Total ME           $38,457.90    
Avg ME           $6,409.65    
Mkt Wtd Avg ME*         0.95 $9,560.17   1.65%
 
Boise Cascade Corp. BCC No* $37.06 1.60% 1.05 $2,083.80 N/A 1.50%
Potlatch PCH No $45.94 4.70% 0.69 $1,332.00 37.05% 1.40%
Westvaco W No $30.31 2.90% 0.93 $3,075.30 19.30% 1.35%
Consolidated Papers, Inc. CDP No $65.50 2.60% 0.01 $2,941.90 24.90% 2.32%
Weyerhaeuser WY No $56.50 2.80% 1.04 $11,219.00 27.70% 2.41%
 
Total All   $59,109.90    
Avg All   $5,373.63    
Mkt Wtd Avg All*   0.92 $12,129.46   1.80%
*The Avg is the arithmetic average. The Mkt Wtd Avg is the weighted average based
on the market capitalization.
 
 
Table 3: Earnings per Share
Public Forest Products Corporations 
as of May 10, 1998
 
            Trailing  
            12-mo. avg.  
            Mar-98 5-Year
1993 1994 1995 1996 1997 1998 Projected
Boise Cascade Corp. -$3.17 -$3.08 $5.93 -$0.63 -$1.19 ____________ $8.47
Bowater Inc. -$1.84 -$0.59 $5.22 $4.55 $1.25 $1.87 $6.88
Champion International Corp. -$1.98 $0.38 $7.67 $1.48 -$5.72 -$5.13 $6.60
Consolidated Papers, Inc. $1.46 $1.97 $5.16 $4.01 $2.63 ____________ $9.60
Georgia Pacific  -$0.39 $3.45 $11.18 $1.71 $0.73 -$0.22 $8.57
International Paper Co. $1.17 $1.43 $4.41 $1.04 -$0.50 -$0.36 $6.88
Potlatch Corporation -$0.41 $1.68 $3.72 $2.01 $1.24 ____________ $8.50
Mead Corporation $1.04 $5.61 $3.17 $1.84 $1.41 $1.51 $9.00
Union Camp Corp. $1.10 $0.72 $1.62 $6.45 $1.23 $1.17 $8.00
Westvaco $1.04 $1.03 $2.78 $2.09 $1.60 $1.57 $7.80
Weyerhaeuser $2.83 $2.86 $3.91 $2.33 $1.71 $2.04 $11.00
 
Average $0.08 $1.41 $4.98 $2.44 $0.40 ____________ $8.30
Weighted by Market Capitalization $0.71 $1.84 $5.17 $2.15 $0.21 ____________ $8.33
 
Table 4 provides a monthly history of the stock prices of the major forest-products companies. Columns 2 and 3 represent all of these companies, first in an equally weighted portfolio, and second in a portfolio weighted by the market capitalization of the respective company. Holding the first portfolio is the equivalent of holding one share of each company. Investing in the second portfolio is the same as buying shares in each company in proportion to the market capitalization they represent in the industry. The market capitalization portfolio enjoyed a slightly lower return over the period than the equally weighted portfolio. This is because the larger companies on the whole had poorer performance. Columns 4 and 5 represent portfolios composed of equally weighted and market-capitalization weighted forest-products companies with Maine investments, respectively. Over the period, the equally weighted Maine forest-products portfolio had the best returns of the four.

The last two columns in Table 4 compare the performance of these portfolio options to the DJIA and the S&P 500 over the same time period. These are two widely followed market indices that returned, on average, nearly four times the forest-products portfolios over the three-year period. Only the metals (various categories) and the pollution-control/waste-management industry segments had worse ten-year returns than this industry did (WSJ, Feb. 26, 1998). Figs. 2 and 3 illustrate the performance of the forest-products industry versus these two market indices.
 
Table 4: Forest-Products Portfolios and Market Indexes
 
  All Forest Portfolio Maine Forest Portfolio Market Indices
  Equal Market Equal Market DJIA S&P 500
Jan-95 38.05 40.07 40.70 42.50 3,843.86 470.42
Feb-95 41.56 43.24 44.39 45.68 4,011.05 487.39
Mar-95 42.56 43.72 45.83 46.76 4,157.69 500.71
Apr-95 42.77 44.45 46.02 47.04 4,321.27 514.71
May-95 43.78 45.38 46.94 47.76 4,465.14 533.40
Jun-95 48.22 49.72 52.32 52.89 4,556.10 544.75
Jul-95 49.00 49.89 52.93 52.99 4,708.47 562.06
Aug-95 49.16 49.93 53.81 53.50 4,610.56 561.88
Sep-95 44.46 41.67 52.82 52.99 4,789.08 584.41
Oct-95 45.88 46.42 49.53 49.04 4,755.48 581.50
Nov-95 44.81 45.53 46.76 47.28 5,074.49 605.37
Dec-95 41.76 42.82 42.96 44.07 5,117.12 615.93
Jan-96 44.07 45.08 46.49 47.41 5,395.30 636.02
Feb-96 40.58 41.19 41.25 41.75 5,506.21 640.43
Mar-96 44.05 44.94 44.67 45.72 5,587.14 645.50
Apr-96 46.57 47.66 47.99 48.61 5,569.08 654.17
May-96 44.38 45.41 45.85 46.72 5,643.18 669.12
Jun-96 42.01 42.88 43.66 44.30 5,654.63 670.63
Jul-96 41.11 42.95 43.67 45.20 5,528.91 639.95
Aug-96 42.42 44.48 45.08 46.53 5,616.21 651.99
Sep-96 44.02 46.54 47.28 49.07 5,882.17 687.31
Oct-96 42.90 45.65 45.60 47.76 6,029.38 705.27
Nov-96 43.32 45.57 46.23 47.53 6,521.70 757.02
Dec-96 42.74 45.06 45.03 46.37 6,448.27 740.74
Jan-97 42.94 45.04 45.50 46.79 6,813.09 786.16
Feb-97 44.21 46.31 47.25 48.43 6,877.74 790.82
Mar-97 42.09 43.98 44.92 45.91 6,583.48 757.12
Apr-97 44.40 46.47 47.78 49.00 7,008.99 801.34
May-97 48.70 51.47 53.21 54.79 7,331.04 848.28
Jun-97 48.60 51.89 52.76 54.78 7,672.79 885.14
Jul-97 54.52 59.14 59.92 62.29 8,222.61 954.29
Aug-97 53.19 56.74 58.19 59.88 7,622.42 899.47
Sep-97 55.69 59.98 61.52 63.84 7,945.26 947.28
Oct-97 48.02 50.37 51.86 53.31 7,422.08 914.62
Nov-97 49.54 52.52 53.94 55.27 7,823.13 955.40
Dec-97 43.86 45.68 45.89 46.56 7,908.25 970.43
Jan-98 45.98 47.29 48.46 48.43 7,906.50 985.49
Feb-98 46.98 48.32 49.97 49.95 8,545.72 1,048.67
Mar-98 49.85 51.16 52.99 52.19 8,799.81 1,093.55
Apr-98 52.11 54.55 55.69 56.59 9,063.37 1,094.63
May-98 51.84 54.35 55.96 56.80 9,091.52 970.43
 
Annual Returns 9.47% 9.33% 9.77% 8.86% 28.65% 23.62%
 
Correlation Factors (to ME Mkt Wtd Portfolio) 0.56 0.56
 

Result

The DJIA and the S&P 500 outperformed all four portfolios (both all companies and Maine companies, and both the equally weighted and the market-weighted versions) hands down. Thus, an investor in any of the four forest-products portfolios would have received lower than the market return during this time period. However, an investor who still seeks a forest-industry exposure in her portfolio would have done better by choosing an equally weighted portfolio (Maine companies, 9.77%; all forest companies, 9.47%) over any market-weighted portfolios (Maine, 8.86%; all forest companies, 9.33%). A correlation of +0.56 between the market-weighted Maine portfolio and both the DJIA and the S&P 500 strengthens the argument for a Maine exposure in any portfolio.

It should be noted, however, that return calculations for Maine portfolios are underestimated by not adjusting for dividends. Since the industry has a high dividend yield, our price performance analysis has limited validity.
 

Implications

The quality and quantity of forest-products investments in Maine are at risk. From this analysis one can conclude that most companies in this industry are not presently earning their cost of capital, and are paying out hefty dividends to stay attractive to their investors. The forest industry needs to make necessary capital investment to meet the challenge of the millennium. If external financing is used, however, the cost of capital for the industry will be increased. Thus, the current high dividend yield may not be sustainable for long.

Shutting down capacity was once unheard of, but low-cost producers with large new machines are making it impossible for facilities to be profitable in commodity grades if they are utilizing older, slower equipment. Quality of product and service also ranks of paramount importance, because end users have become more sophisticated in supply chain management and total quality measurements that demand just-in-time delivery and invoicing. To an ever greater extent, the customers of the forest-products industry measure product quality on the amount of waste generated in their processes.

Marketplace considerations and production efficiency provide the key component to performance, but environmental regulations are also of significant financial consequence to the forest-products industry. Maine production facilities have each spent tens of millions of dollars over the last few years complying with ever more stringent air and water quality regulations promulgated by the EPA. Many of these facilities date back to the last century and face nearly overwhelming costs for cleanup, new controls and equipment, and continued monitoring of processes under the most recent "Cluster Rules." Forestry practices have also come under attack, especially in the northwestern and northeastern parts of the country. Maine has seen two referendums on the issue in two years with no resolution of the issues at hand. Most Maine mills are integrated. That is, they manufacture their own kraft versus buying it on the open market, and wood supply is critical to low-cost operations.

Finally, the industry faces pressure from foreign competition. Asia, with its excess capacity and weaker currencies, remains a potential rival, although for the time being the largest import threat comes from Canada.

Without continued upgrading of facilities in Maine, this important economic sector will continue to diminish as a factor of production and as a GDP contributor. Without corporate restructuring in this industry, its future prospects remain challenging. Given an increasingly global economy, business efficiency -- and not trade protection -- provides the promise of a better future.
 

Sources

Dow Jones. On-line investor services and information for historical measures.

Moody's Industrial Manual.

Morningstar. On-line investor services and information for historical stock prices and financial performance measures, Appendix C.

Standard & Poor's Stock Reports, business summaries (Feb. 21, 1998).

"Business Cycles and Forest Products Industries," Forest Products Journal (April 1997): 23-26.

John Chrysikopoulos, "A Paradigm Shift and the Benefits of Consolidation", Pulp and Paper (April 1997): 160.

"Maine Paper Expo," Maine Newspaper Group (March 16, 1998).

"Shareholder Scoreboard," Wall Street Journal (Feb. 26, 1998).

"Valuation of the Paper and Forest Products Industry," Weekly Corporate Growth Report (Sept. 8, 1997), pp. 9208-09.

Michael Verespej, "Surviving with Low Prices," Industry Week (Dec. 2, 1996): 55-58.

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