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|Georgia-Pacific Corp. |(GP-NYSE) |$47.29 |
Note to Readers: This report contains substantially new material. Subsequent reports will have changes highlighted.
Reason for Report: 3Q05 Earnings Update Previous Edition: October 20, 2005
Overview
Headquartered in Atlanta, Georgia-Pacific (GP or the Company) is one of the world's leading manufacturers and distributors of tissue, pulp, paper, packaging, building products and related chemicals. It is also a leading producer of containerboard, bleached paper & pulp and gypsum board. Familiar consumer brands include: Angel Soft, Sparkle, Coronet, MD, Brawny, Quilted Northern as well as the Dixie brand of disposable cups, plates and cutlery. It is one of the leading wholesale suppliers of building products in the country and one of the top manufacturers of structural panels, lumber and gypsum wallboard. In addition, the Unisource Worldwide subsidiary is one of the largest distributors of packaging systems, printing and imaging papers and maintenance supplies in North America, and is the sole national distributor of Xerox branded papers and supplies. With annual sales of approximately $20 billion, the Company employs more than 85,000 people at 600 locations in North America and Europe.
Investors should make an investment decision based on their assessment of the following issues:
|Key Positive Arguments |Key Negative Arguments |
|Favorable asbestos settlement could boost investor sentiment and |The wood products business could witness a slowdown if interest rates |
|improve valuations according to bullish analysts. |in the U.S. rise sharply or unexpectedly and adversely affect home and |
|The acquisition by Koch Industries and GP’s integration with Koch’s |commercial construction activity. |
|earlier acquired pulp mills expected to lead to operational synergies. |GP has a defensive mix of businesses with less leverage to recoveries |
| |according to some analysts. |
|Repayment of high cost, short-term debts and switching over to low |The forest products segment is also expected to be adversely affected |
|cost, long-term loans are expected to result in higher profitability |from interest rate increases due to lowered expected demand for homes |
|and cash flow going forward. |and building products. |
|Recently announced restructuring measures expected to positively impact|A global recession would likely pressure pricing in the Company’s |
|financial performance going forward and to result in cash savings of |commodity grades. |
|$100 million according to analysts. |High net debt-to-capital ratio. |
More information can be obtained from the Company’s website:
NOTE: The Company’s fiscal year ends December 31; all calendar references coincide with the fiscal year end.
Recent Events
On November 13, 2005 GP consented to be purchased by Koch Industries for $48 per share in cash - valuing the Company at $21 billion including debt. There is a $370 million termination fee for this transaction. Koch Industries has interests in petroleum chemicals, energy, pulp etc and expects to operate GP as a privately held, wholly-owned subsidiary of Koch Industries.
GP’s net sales were $4.71 billion in 3Q05 as compared to $4.74 billion in 3Q04. Net income stood at $198 million as compared to $236 million in 3Q04. EPS in 3Q05 was $0.75, down from $0.89 in 3Q04.
Sales
EXPECTED SALES
|SALES |3Q05A |4Q05E |2004A |2005E |2006E |2007E |
|North America Consumer Products |$1,501 |$1,501 |$5,656.0 |$6,017 |$6,252 |$6,530 |
|International Consumer Products |$479 |$520 |$2,072.0 |$2,053 |$2,035 |$2,039 |
|Packaging |$707 |$686 |$2,968.0 |$2,905 |$2,995 |$3,122 |
|Bleached Pulp & Paper |$392 |$431 |$2,230.0 |$1,785 |$1,951 |$1,769 |
|Building products manufacturing |$1,632 |$1,477 |$6,892.0 |$6,368 |$6,237 |$6,290 |
|TOTAL REVENUE |$4,713 |$4,503 |$19,656.0 |$18,633↓ |$18,766↑ |$19,206↑ |
|Digest High |$4,713 |$4,629 |$19,656.0 |$18,830 |$20,455 |$20,897 |
|Digest Low |$4,713 |$4,156 |$19,656.0 |$18,250 |$17,098 |$17,091 |
|Digest Average |$4,713 |$4,503 |$19,656.0 |$18,633↓ |$18,766↑ |$19,206↑ |
GP recorded sales of $4.71 billion in 3Q05. In the quarter, the North American Consumer Products business and Building Products performance improved significantly according to analysts. Prices remained firm across all North American businesses due to the implementation of previously announced increases.
N.A. Consumers Products: The division accounted for 31.8% of sales in 3Q05. Segment sales increased 4.4% year over year to $1.50 billion, partially offset by consumer and Dixie volume declines. Commercial tissue sales increased 9% year over year.
International Consumers Products: The division accounted for 10.2% of sales in 3Q05. Segment sales were $479 million in 3Q05, showing a decline of 3.8% from 3Q04. The shortfall was attributable to both price and volume declines and also due to higher input costs.
Packaging: The division accounted for 15.0% of sales in 3Q05. Segment sales were $707 million, reflecting a decline of 9.6% year over year. Pricing pressures were evident across all the products while higher transportation and maintenance spending led to an escalation of costs according to analysts.
Bleached Pulp & Paper: The division accounted for 8.3% of sales in 3Q05. Segment revenue fell 32.9% year over year to $392 million on account of lower prices and higher energy costs.
Building Products Manufacturing: The division accounted for 34.6% of sales in 3Q05. Segment revenue declined 9.7% to $1.63 billion as compared to 3Q04.
Please refer to the Zacks Research Digest Spreadsheet for more details.
Margins
EXPECTED MARGINS
|MARGINS |3Q05A |4Q05E |2004A |2005E |2006E |2007E |
|North America Consumer Products |15.7% |15.1% |12.9% |14.9% |16.6% |17.7% |
|International Consumer Products |4.0% |5.0% |8.6% |5.4% |6.2% |5.7% |
|Packaging |6.4% |3.2% |9.5% |7.5% |8.3% |9.5% |
|Bleached Pulp & Paper |0.8% |1.2% |1.2% |1.7% |2.5% |2.1% |
|Building products manufacturing |15.3% |10.8% |14.7% |12.8% |8.7% |6.9% |
|Gross |18.8% |17.1% |24.5% |18.6% |16.2% |17.0% |
|Operating |9.6% |7.7% |9.4% |9.3% |8.7% |8.7% |
|Pre-Tax |6.5% |4.6% |5.8% |6.0% |5.9% |6.1% |
|Net |4.2% |3.0% |3.9% |3.9% |3.9% |3.9% |
N.A. Consumers Products: Segment operating profit was $235 million as compared to $212 million in 3Q04, showing an increase of 10.8%. However, manufacturing costs increased, driven by fiber, energy and chemicals, which partially offset price gains according to analysts.
International Consumers Products: Segment operating profit was $19 million against $44 million in 3Q04. The decline in operating profit was attributed to lower local currency prices and volumes, offset by cost cuts that helped mitigate higher cost pressures.
Packaging: Segment operating profit was $45 million, reflecting a decrease of 55.4% from 3Q04. Transportation, fiber, energy and maintenance costs were considerably higher to analysts. Box volumes increased 1.1% as compared to 3Q04.
Bleached Pulp & Paper: Segment operating profit was $3 million as compared to a profit of $22 million in 3Q04.
Building Products Manufacturing: Segment operating profit stood at $249 million as compared to $279 million in 3Q04. Gypsum was strong with volumes rising 8% year over year and prices up 17% year over year. Lumber also reported strong results.
Please refer to the Zacks Research Digest spreadsheet for more details.
Earnings Per Share
EPS in 3Q05 was $0.75, down from $0.89 in 3Q04.
|EPS |3Q05A |4Q05E |2004A |2005E |2006E |2007E |
|Zacks Consensus |$0.75 |$0.49 |$2.93 |$2.82 |$2.82 | |
|Company Guidance | | | | | | |
|Zacks Digest Model Max. |$0.75 |$0.65 |$2.90 |$3.00 |$3.20 |$3.27 |
|Zacks Digest Model Min. |$0.75 |$0.36 |$2.90 |$2.35 |$2.32 |$2.75 |
|Zacks Digest Model Avg. |$0.75 |$0.49 |$2.90 |$2.81 |$2.83 |$2.98 |
The Zacks Digest consensus model projects EPS to be $2.82 for both 2005 and 2006.
Highlights from the chart above are as follows:
• 2005 forecasts (Total 13) range from $2.35 to $3.00; the average is $2.81.
• 2006 forecasts (Total 13) range from $2.32 to $3.20; the average is $2.83.
• 2006 forecasts (Total 4) range from $2.75 to $3.27; the average is $2.98.
Please refer to the Zacks Research Digest spreadsheet for more details.
Target Price/Valuation
Target prices range between $35.00 and $56.00. The consensus average price of twelve analysts with published target prices is $44.19 (↑ from the previous report). The average target price represents a downside of 6.44% from the current price. The estimated highest target price of $56.00 (Prudential) is based on the metric 9.0x FY’06E EBITDA. The analyst with the lowest estimated target price (UnionBankSwitz.) has a Neutral rating on the stock.
|Rating Distribution |
|Positive |30.8% |
|Neutral |53.8% |
|Negative |15.4% |
|Avg. Target Price |$44.19 |
|Analysts with Target Price/Total |12/14 |
Metrics detailing current management effectiveness are as follows:
|Metrics (ttm) |Value |
|Return on Assets (ROA) |2.5% |
|Return on Investment (ROI) |3.0% |
|Return on Equity (ROE) |8.9% |
Please refer to the Zacks Research Digest spreadsheet for more details.
Long-Term Growth
Expected long-term growth rates range from 5.0%-7.0%, the average is 5.7%. The highest projected growth rate is 7.0% (Zacks Investment Research) while the lowest is 5.0% (D.A. Davidson and B. of America).
In the long term, GP’s growth is expected to be governed by: a) demand for tissue paper and wood products, b) prices, c) direction of exchange rate movements, d) cost cutting, and e) asbestos litigation.
GP’s integrated nature of operations puts the Company in an advantageous position compared to its peers according to analysts. Going forward, GP is making large investments to increase capacity in tissue products, which could take time to yield results. Tissue is seen as less susceptible to cyclical price fluctuations than many paper products.
According to analysts, the Building Products division, despite having a leading position, has an unfavorable mix toward plywood and particleboard. These products are expected to lose market share over the longer term to OSB in residential construction. In the Packaging division, demand for boxes and containerboard is expected to improve with higher industrial activity. Overall demand for containerboard is predicted to increase 1-2% to 10-12 million tons. In the Bleached Paper & Pulp division, demand appears to be improving albeit at a modest rate and often in the form of lower y-o-y declines. Aggregate paper demand is stabilizing and is poised to show growth over the next 6-12 months. Analysts believe the combination of rising tissue profits and an extended building products cycle are likely to enable the Company to have a two-year period of peak earnings power.
The Company is reducing exposure to non-core operations and focusing on a better product mix. GP is working on further cost cuts by reducing its stock-keeping units (SKU’s), and closing machines and warehouses to reduce operating expense. Additionally, from 2002 to 2008, interest expense is expected to drop nearly $2.00 per share pre-tax, which would increase net earnings, reduce earnings volatility, and improve the strength and safety of the enterprise according to analysts.
Finally, GP has substantial asbestos claims pending against it. If the much-awaited asbestos bill is passed, it will have a negative impact on GP.
Capital Structure/Solvency/Cash Flow/Governance/Other
GP is in the process of rolling out its new interior DensArmor Plus product, which is a patented gypsum product coated with fiberglass on both sides that can be treated in the same way as regular paper-covered gypsum. It has the benefit of being mold resistant and builds on the existing DensGlass Gold exterior sheathing product already in the market and generates higher margins than traditional gypsum wallboard.
Individual Analyst Opinions
POSITIVE RATINGS
B. of America – Buy – Target $38 – Dated 14th November, 2005 – The analyst has based their valuation on an average of 18.0x FY2005 estimated EPS (offset by a roughly $0.40 deduction for asbestos cash outflow), a 2.0% dividend yield and SOTP model. The analyst opines that major restructuring initiatives announced could generate close to $100 million of cash savings in the future. The analyst has a Buy rating on the stock on account of higher pricing in tissue and strong fundamentals in wood products attributable to Hurricane Katrina. According to the analyst, key risks include volatility in building/wood product consumption, pricing pressures, asbestos litigation costs, and expected increases in environmental costs.
Deutsche Bank – Buy – Target $48 – Dated 14th November, 2005 – The analyst has based their valuation on the metric 7.7x FY2005 EV/EBITDA. The analyst opines that the Koch deal is a testament to GP’s improving balance sheet, strong cash flow, and durability of its earnings from the Consumer Products division. According to the analyst, key risks to the price target include GP’s high net debt to capital ratio of 58%, asbestos litigation, and increasing competition in the end markets.
MorganStanley – Overweight – Target $37 – Dated 13th November, 2005 – The analyst has based their valuation on the metric 7.0x midcycle EBITDA. According to the analyst, the balanced business mix of the Company will help generate robust cash flow and reduce the debt burden. The analyst is concerned that the combination of high gas costs and a softer housing market will weigh down GP’s near-term profits. Key risks to the valuation are rises in asbestos payments, increased competition in tissue, failure in the recovery of commodity prices and rising interest costs which could slow housing demand and depress wood prices.
Prudential – Overweight– Target $56 – Dated 27th September, 2005 – The analyst has based their valuation on the metric 9.0x FY’06 EBITDA. For 4Q05, the analyst expects a $100 million asbestos charge, $15 million restructuring charge in the domestic Consumer Products division, and higher input costs. According to the analyst, key risks are higher input costs, increases in interest costs, and increasing costs of asbestos litigation.
NEUTRAL RATINGS
BMO Nesbitt – Market perform – Target $36 – Dated 27th October, 2005 – The analyst expects a decline in 4Q05 on account of higher energy and transportation costs as well as seasonal weakness in wood products. According to the analyst, key risks are recession in the economy, increasing competition from Kimberly-Clark and Procter & Gamble, and higher than expected litigation costs.
D.A. Davidson – Neutral – Target $48 – Dated 14th November, 2005 – The analyst opines that the Koch deal is a friendly transaction and it is unlikely that a competing bid will materialize. According to the analyst, GP is focusing on consumer products and structural panels. This business mix has enabled the Company to absorb rising energy and chemical costs as its business is less energy intensive than its competitors. The analyst expects GP to continue to generate significant cash in the coming quarters, which will be dedicated to debt repayment and divided payments to shareholders.
Zacks Investment Research – Hold – Target $48.30 – Dated 14th November, 2005
Buckingham – Neutral – Target $48 – Dated 14th November, 2005 – The analyst has downgraded the stock from Buy to Neutral after the Koch offer as the stock has appreciated to less than 1% of the acquisition price. According to the analyst, principal growth drivers are industrial production growth, deleveraging from strong free cash flow, repositioning of North American consumer products business, and passage of asbestos reforms. Key risks include the peaking of wood prices and increasing competition in tissue markets.
J.P. Morgan – Neutral – Dated 15th November, 2005 – The analyst opines that the Company is on track to achieving debt reduction goals as well as its $1.2 billion EBIT target for North American Consumer Products by 2006. They expect a seasonal pullback in wood products demand in 4Q05 offset by increased hurricane driven demand in the South. The analyst is attracted by GP’s continued focus on commercial and retail tissue markets. According to the analyst, key risks are impending asbestos litigation, a deceleration in U.S. residential markets, and slower economic growth.
Lehman – Equal weight – Target $48 – Dated 14th November, 2005 – The analyst believes that after the Koch offer, strategic buyers will not step forward as synergy opportunities of strategic buyers will be trumped by cost of capital advantages of private buyers. The analyst remains relatively cautious on the outlook for the wood business in late 2005/2006 despite surprising near-term strength in GP's wood product business. According to the analyst, GP is examining repatriating foreign earnings of about $670 million. The analyst opines that rising energy and transportation prices will squeeze margins.
UnionBankSwitz. – Neutral – Target $35 – Dated 18th November, 2005 – The analyst has based their valuation on the metric 11x normalized EPS of $3.15. In 4Q05, the analyst expects cost increases in energy and raw materials to be high, building products to be significantly weaker and box prices to be lower. According to the analyst, key risks are weak demand as evidenced by poor economic conditions and increases in supply as evidenced by capacity additions.
NEGATIVE RATINGS
CIBC – Sector Underperformer – Target $48 – Dated 14th November, 2005 – The analyst has based their valuation on Koch Industries’ offer price. After the takeover, the analyst expects the ultimate spinoff of some of GP’s businesses, specially the packaging business. Key risks to the price target are a slower than expected economic recovery, escalating legal claims relating to asbestos and treated lumber liabilities, and management’s inability to effectively manage multiple brands of tissue paper.
Smith Barney – Sell – Target $40 – Dated 21st November, 2005 – The analyst has based the valuation on the metric 5.6x EV/peak EBITDA ratio. According to the analyst, GP’s debt level of about $8.0 billion is high compared to its $6.0 billion book value. The analyst also opines that the Company has significant asbestos claims pending against it. According to the analyst, key risks are a global economic recession, strengthening of the U.S. dollar, and negative impact of asbestos litigation.
NOT RATED
Goldman – Dated 14th November, 2005 – No report at this time.
Copy Editor: Pushpanjali B.
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[pic]Research Digest Research Associate: Raman Marwaha, C.A.
Editor: R.C. Fuhrmann, CFA
Sr Editor: Ian Madsen, CFA;ianmadsen@; 1-800-767-3771; x417
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December 1, 2005
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