Top picks: CL-Sell UPM; CL-Buy Smurfit
Given our negative outlook for pulp and expectations of weak pulp eventually spilling into paper prices, our 2017E EBITDA is -15% vs. Bloomberg consensus for UPM. UPM trades on a 2017E P/E of 14.3x with -4% EPS growth vs. Stoxx 600 on 13.9x P/E and 13.4% EPS growth. While the declining testliner/OCC spread is a near-term risk to earnings for Smurfit we expect the spread to recover in 2H. Smurfit still looks cheap trading on 7.2x 2016E EV/EBITDA.
Cracks appearing in the P&P sector
Pulp prices have inflected (EU hardwood -$81/t ytd) and the record capacity additions over the next five years (10mt) have just begun ramping. We see roughly 4% supply growth vs. 2% demand growth per year with most of the new supply at the bottom of the cost curve. UPM and Stora have both underperformed the STOXX basic materials ytd but still trade 59%/53% above their trough multiples. Investors remain divided about how much of the raw material weakness can be retained in downstream paper and packaging units which we address in this report.