In a stunning about-face for US trade policy, the US Department of Commerce has just imposed countervailing duties on the imports of coated free sheet paper from China. This could be a warning shot of more to come on the protectionist front.
We aren’t big fans of protectionism, and Morgan Stanley’s article appears concerned about the issue. However, we are big fans of profit opportunities, and we smell what could potentially be a big one for the leading coated paper manufacturers. Consider what happened when the Bush administration imposed steel duties in 2002. Prices went up:
The pricing power for coated paper has withered away, but we think that will reverse due to the duties imposed:
The question then becomes whether there are stocks that will benefit. The suit that led to the current duties on coated paper was brought by a private company, which does us little good. However, the remaining publicly traded coated paper manufacturers should also benefit. Although it is certainly not a truly clean play, specifically we were thinking of Abitibi (ABY) and Bowater (BOW). The stocks have underperformed due to the poor market for their main product, newsprint, as can be seen from the chart below.
About a third of Bowater’s sales in 2006 were derived from coated and specialty papers. According to the company’s 10K, Bowater is a leading producer of coated and specialty papers and newsprint. It controls 13% of the North American capacity for coated papers, 14% of the capacity for specialty papers and 20% of the capacity for newsprint. It is also a leading producer of paper pulp.
Abitibi, meanwhile, does not produce coated paper but could restart at least one idled mill to produce lightweight coated paper. But in January they agreed to merge with Bowater. According to the Paper Trader:
This union will lift the new company to the position of largest global producer of newsprint in terms of capacity with Norske Skog slipping to second place. AbitibiBowater will command 15% of global newsprint capacity and 47% of North American capacity. This jump in market share could present the first hurdle for the merger to overcome when the companies apply for the required regulatory approval.
The same publication notes:
Although an acceleration in conversions to other paper grades in 2007 is an option, any significant rise in uncoated market share would likely raise concerns with regulatory commissions since Abitibi-Consolidated and Bowater combined already hold a 40% share of North American uncoated mechanical capacity.
That suggests they may move further into coated papers. To be sure, we would rather see more exposure to coated papers and less to newsprint for this play to work. However, the combined companies expect to produce $250 million in cost efficiencies and by concentrating the market share for newsprint may be able to stabilize prices there. If that is the case, the benefits could be two-fold: gains in coated paper as discussed above, and gains in the main newsprint business from consolidation.
Abitibi appears slightly undervalued relative to its share of the combined company. However, Bowater is the company with the coated paper exposure, and the risk of the deal collapsing seems higher than the small discount for Abitibi would make worthwhile.