presentation to: paper industry management association · china 1. world’s largest consumer of...
TRANSCRIPT
2006 PIMA Conference
Presentation to: Paper Industry Management Association
May 24, 2006
State of the Industry
Peter Ruschmeier, Senior VP
Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be
aware that the Firm may have a conflict of interest that could affect the objectivity of this report.
Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies
covered in this report, at no cost to them, where such research is available. Customers can access this independent research at
www.lehmanlive.com or can call 1-800-2-LEHMAN to request a copy of this research.
Investors should consider this report as only a single factor in making their investment decisions.
PLEASE SEE ANALYST CERTIFICATION AND IMPORTANT DISCLOSURES BEGINNING ON PAGE 51.
Outline
� Economy – Strong Growth Moderating Due to Higher Rates
� Key Themes
– Commodity Prices
– China is Driving Higher (and Lower) Prices
– Timber – Change in Ownership Continues
– U.S. and Global Supply/Demand is Favorable
– Financial Returns – Better, but Further Improvement Needed
� Summary
2
Economy
� Global economic growth is strong, but moderating.
� Interest rates are low, but rising.
� Interest sensitive sectors like housing are feeling the pinch.
� Twin deficits (budget/trade) may keep pressure on rates.
� The dollar continues to slide.
3
EconomyGlobal economic growth is strong but moderating…
Composition of Global GDP and GDP Growth
Asia
Europe
$0
$5
$10
$15
$20
$25
$30
$35
$40
$451
97
0
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
E
Tri
llio
ns
of
US
$ (
20
06
)
0%
1%
2%
3%
4%
5%
6%
7%
GD
P G
row
thLatin America
North America
Composition (left scale)
Source: DRI/McGraw Hill, International Monetary Fund, Lehman Brothers Estimates
GDP Growth (right scale)
4
Economy
� Between 1968 and 2003 there was negative GDP somewhere in
the world every year (looking at largest 47 economies of the
world).
� For 2004, 2005, and 2006E, we’ve enjoyed synchronized
growth with all of the 47 largest economies showing positive
growth.
Sources: International Monetary Fund, McGraw Hill/DRI.
5
EconomyEconomic growth has been supported by low interest rates…
10-Year Treasury Yield
2%
4%
6%
8%
10%
12%
14%
16%
18%D
ec
-79
Sep
-81
Ju
n-8
3
Ma
r-8
5
De
c-8
6
Sep
-88
Ju
n-9
0
Ma
r-9
2
De
c-9
3
Sep
-95
Ju
n-9
7
Ma
r-9
9
De
c-0
0
Sep
-02
Ju
n-0
4
Ma
r-0
6
2%
4%
6%
8%
10%
12%
14%
16%
18%
Source: Bloomberg
Current Rate as of 5/23/06 = 5.07%
6
EconomyBut the Fed is worried about signs of inflation…
Consumer Price Index (including food and energy)
0%
1%
2%
3%
4%
5%
6%
7%
Dec-9
0
Dec-9
1
Dec-9
2
Dec-9
3
Dec-9
4
Dec-9
5
Dec-9
6
Dec-9
7
Dec-9
8
Dec-9
9
Dec-0
0
Dec-0
1
Dec-0
2
Dec-0
3
Dec-0
4
Dec-0
5
0%
1%
2%
3%
4%
5%
6%
7%
Source: Bloomberg
7
EconomySo the Fed continues to raise short-term rates…
Fed Funds Target Rate
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
Jan
-85
Jan
-87
Jan
-89
Jan
-91
Jan
-93
Jan
-95
Jan
-97
Jan
-99
Jan
-01
Jan
-03
Jan
-05
0%
1%
2%
3%
4%
5%
6%
7%
8%
9%
10%
Source: Bloomberg
8
EconomyAnd 10-Year Treasury Yields are finally rising…
10-Year Treasury Yield
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%Ju
n-0
3
Au
g-0
3
No
v-0
3
Ja
n-0
4
Ap
r-04
Ju
l-0
4
Sep
-04
De
c-0
4
Fe
b-0
5
Ma
y-0
5
Ju
l-0
5
Oc
t-0
5
De
c-0
5
Ma
r-0
6
Ma
y-0
6
3.0%
3.5%
4.0%
4.5%
5.0%
5.5%
Source: Bloomberg
Current Rate as of 5/23/06 =5.07%
Rate on 6/13/03 = 3.10%
9
EconomyHome prices are responding to higher interest rates. A soft landing would help avoid a consumer-led recession.
YOY % Change in Average 12-month Median
Price of New Homes Sold
-5%
0%
5%
10%
15%
20%
1984
1985
1986
1988
1989
1991
1992
1993
1995
1996
1998
1999
2001
2002
2003
2005
-5%
0%
5%
10%
15%
20%
Source: U.S. Census Bureau.
10
EconomyBut housing starts are beginning to correct…
NAHB Index vs. U.S. Housing Starts
0
500
1,000
1,500
2,000
2,500
1975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
Th
ou
sa
nd
s o
f S
tart
s,
SA
AR
0
10
20
30
40
50
60
70
80
90
NA
HB
Ho
us
ing
In
de
x
NAHB IndexHousing Starts
Source: U.S. Census Bureau; National Association of Home Builders
11
Economy
US Budget Deficit as % of GDP
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
1950
1953
1956
1959
1962
1965
1968
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
-3%
-2%
-1%
0%
1%
2%
3%
4%
5%
6%
Source: Lehman Brothers and Bloomberg
Unfortunately, the “Twin deficits” (budget and trade) could further pressure interest rates upward…
12
EconomyWith the U.S. trade deficit near a record $65 BB per month, the
U.S. is borrowing more than $2 BB every day.
US Trade Deficit (Monthly)
-$80
-$70
-$60
-$50
-$40
-$30
-$20
-$10
$0
$101992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Bil
lio
n $
US
-$80
-$70
-$60
-$50
-$40
-$30
-$20
-$10
$0
$10
Bil
lio
n $
US
Source: Bureau of Economic Analysis, Lehman Brothers and Bloomberg
13
EconomyAmong other factors, twin deficits are contributing to a weak $…
Exchange Rate Movements USD/Currency
50
60
70
80
90
100
110
120
130
140Jan
-99
Jan
-00
Jan
-01
Jan
-02
Jan
-03
Jan
-04
Jan
-05
Jan
-06
50
60
70
80
90
100
110
120
130
140Brazilian Real
Japanese Yen
Chinese Yuan
Euro
Canadian Dollar
Source: Bloomberg
14
Commodity Prices
� Commodity prices continue to pressure input costs.
– Oil prices are up 7X from the lows.
– Natural gas prices are up 4X from the lows.
– Caustic soda prices are up 4X from the lows.
– Transportation (freight) cost index up 2X since 2001.
– Fiber – we expect fiber costs to rise further.
15
Commodity PricesOver the past decade paper/forest product prices have lagged…
Indexed Commodity Prices
0
100
200
300
400
500
600
700
800
900
Ma
r-9
5
Ma
r-9
6
Ma
r-9
7
Ma
r-9
8
Ma
r-9
9
Ma
r-0
0
Ma
r-0
1
Ma
r-0
2
Ma
r-0
3
Ma
r-0
4
Ma
r-0
5
Ma
r-0
6Source: Bloomberg, Industry Sources, Lehman Brothers
Natural Gas 3.9X
Oil 3.6X
Copper 2.8X
Gold 1.9X
Ethylene 1.6X
Caustic Soda 1.6X
Wood 1.1X
Pulp & Paper 1.0X
Paperboard .99X
Steel 1.5X
16
Commodity PricesYear to date, paper prices are rising as most wood prices fall…
Sources: FOEX and Random Lengths
Particleboard (US) +73%
Linerboard (Eur) +19%
Pulp (US) +9%
C Free Sheet (Eur) +9%
Newsprint (US) +4%
Lumber (US) -9%
Plywood (US) -12%
OSB (US) -28%
U Free Sheet (Eur) +12%
Weekly Commodity Price Index in US Dollars
(1/3/06 = 100)
60
80
100
120
140
160
180
Jan-06 Feb-06 Mar-06 Apr-06 May-06
17
Commodity PricesNewsprint prices higher in US $ but flat in C$ terms…
Newsprint Prices - 30lb East Coast Delivery Quarterly, In U.S.$ and Canadian$ per metric tonne
$300
$400
$500
$600
$700
$800
$900
$1,000
$1,1001980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Pri
ce
/to
nn
e i
n C
an
ad
ian
Do
lla
rs
$300
$400
$500
$600
$700
$800
$900
$1,000
$1,100
Pri
ce
/to
nn
e i
n U
.S.
Do
llars
Newsprint - 30lb East Coast C$/tonne
Newsprint - 30lb East CoastUS$/tonne
Source: Pulp & Paper Week; Bloomberg; Lehman Brothers.
18
Commodity PricesStrong C$ is reducing newsprint imports from Canada…
Newsprint - Canadian Imports as % of US
Consumption & US/Canadian$ Exchange Rate
40%
42%
44%
46%
48%
50%
52%
54%
56%
58%
60%
Jan
-02
Ju
l-02
Jan
-03
Ju
l-03
Jan
-04
Ju
l-04
Jan
-05
Ju
l-05
Jan
-06
Imp
ort
s f
rom
Can
ad
a
0.55
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
US
$ v
s.
C$
Canadian Imports % US Consumption
US$ vs. C$
Imports trending down
Source: Pulp & Paper Products Council and Bloomberg.
19
Commodity PricesLumber prices above trough in US $, but at 14-year lows in C $...
Lumber Prices, Quarterly In U.S.$ and Canadian$ per thousand board feet
$100
$200
$300
$400
$500
$600
$700
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
Pri
ce/t
on
ne
in
Ca
na
dia
n $
$100
$200
$300
$400
$500
$600
$700
Pri
ce/t
on
ne
in
US
$
Lumber C$ Lumber US$
Source: Random Lengths
20
Commodity Prices
Strong C$ is reducing lumber imports from Canada…Lumber - Canadian Imports as % of US Consumption &
US/Canadian$ Exchange Rate
24%
26%
28%
30%
32%
34%
36%
38%
40%
Ja
n-0
2
Ap
r-0
2
Ju
l-0
2
Oc
t-0
2
Ja
n-0
3
Ap
r-0
3
Ju
l-0
3
Oc
t-0
3
Ja
n-0
4
Ap
r-0
4
Ju
l-0
4
Oc
t-0
4
Ja
n-0
5
Ap
r-0
5
Ju
l-0
5
Oc
t-0
5
Ja
n-0
6
Imp
ort
s f
rom
Ca
na
da
0.60
0.65
0.70
0.75
0.80
0.85
0.90
US
$ v
s. C
$
Canadian Lumber Imports % US Consumption US$/C$Source: Western Wood Products Association and Lehman Brothers estimates.
21
Commodity PricesPulp prices higher in US $ but flat in Canadian $...
Northern Bleached Softwood Pulp Prices
Quarterly, In C$'s per metric ton
$400
$500
$600
$700
$800
$900
$1,000
$1,100
$1,200
$1,300
$1,4001
98
0
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
Pri
ce
/to
nn
e in
Ca
na
dia
n $
$400
$500
$600
$700
$800
$900
$1,000
$1,100
$1,200
$1,300
$1,400
Pri
ce
/to
nn
e in
U.S
. $
NBSK Pulp C$/tonne
NBSK Pulp US$/tonne
Source: Lehman Brothers Estimates
22
China
1. World’s largest consumer of steel by a 3-1 factor.
2. Second largest consumer of paper and paperboard in the world (for
now) behind the US.
3. Large labor cost advantage (per capita income is 1/40th US).
4. Lower energy costs, coal vs. natural gas.
5. Willingness to tolerate lower returns.
6. Ambitious plans for capacity growth.
Top Reasons to Watch China Closely
23
ChinaIn just a decade, China’s consumption of paper & board has increased from less than 1/3 the size of the U.S. market to 2/3.
Ratio of Chinese Consumption of Paper &
Paperboard to U.S. Consumption
0.20x
0.30x
0.40x
0.50x
0.60x
0.70x
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Rati
o o
f C
hin
a-t
o-U
.S.
Source: Lehman Brothers Estimates, AF&PA, China Paper Association
China's CAGR = 8.4% (1994-2005)
24
ChinaAs China industrializes, China’s paper industry could match the U.S. by 2011 and become double the size by 2022.
Est. Consumption Growth of Paper &
Paperboard of U.S. & China 2005 - 2022
0
50
100
150
200
250
300
350
400
450
500
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
(Millio
n m
etr
ic t
on
nes)
0%
50%
100%
150%
200%
250%
Ch
ina C
on
su
mp
tio
n a
s a
%
of
U.S
.
Est. Chinese Consumption Growth = 8.4%
Est. U.S. Consumption Growth = 1.5%
China as a % of U.S.
Source: Lehman Brothers Estimates, China Paper Association
25
ChinaWith 53% of U.S. wastepaper exports now going to China…
U.S. Wastepaper Exports to China
0
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,0001975
1977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
000 S
ho
rt T
on
s
0%
10%
20%
30%
40%
50%
60%
% o
f U
.S.
Exp
ort
s G
oin
g t
o C
hin
a
Total All AreasChinaChina % of Total
Source: Lehman Brothers, American Forest & Paper Association, RISI
Wastepaper exports to China have increased
more than 70x since 1990 (CAGR = 35%). 53% of
all U.S. wastepaper exports in 2005 went to China.
26
ChinaWe continue to believe in an eventual “boom” in fiber costs…
Old Corrugated Container #11 Costs
$0
$40
$80
$120
$160
$200
$2401980
1982
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
$ P
er
Sh
ort
To
n
$0
$40
$80
$120
$160
$200
$240
1980-1989 Avg = $48/ton
Source: Pulp & Paper Week
1990-1999 Avg = $59/ton
2000-2006 Avg
$71/ton
27
ChinaChina’s demand for pulp is also booming, supported by growth in paper supply and an upgrade to higher-quality pulps.
China Pulp Imports as a % of Global Pulp
Shipments
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
% o
f G
lob
al S
hip
men
ts
0
1,000
2,000
3,000
4,000
5,000
6,000
7,000
8,000
Imp
ort
s in
000 M
etr
ic T
on
s
China Imports of Pulp, CAGR = 23%
China Imports as a % of Total GlobalShipments
Source: Lehman Brothers, Pulp & Paper International, PPI Asia News.
28
ChinaRatio of Pulp Shipments to Capacity by Region
Ratio of Pulp Shipments to Capacity by Region
0.08
0.55
1.48
3.24
0.270.44
2.38
0.76
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Canada Latin
America
Oceania Eastern
Europe
United
States
Western
Europe
Asia &
Africa
Japan
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
Source: Lehman Brothers and Pulp & Paper Products Council
Pulp Buyers
Pulp Sellers
29
Timber
State/Region Total Acres Price/Acre State/Region Total Acres Price/Acre
(000's) (000's)
Pacific NW (West of Cascades) 2486 $2,151 South 9435 $876
Washington (coast) 1004 $2,011 Oklahoma 260 $635
Oregon (coast) 653 $2,659 Texas 1085 $667
California (coast) 830 $1,919 Arkansas 517 $940
Louisiana 1797 $952
Pacific NW (East of Cascades) 3503 $760 Mississippi 968 $768
Washington (inland) 903 $845 Alabama 1774 $799
Oregon (inland) 1794 $646 Georgia 915 $932
California (inland) 134 $1,555 Virginia 212 $1,100
Idaho 627 $780 North Carolina 172 $841
Montana 43 $906 South Carolina 685 $1,116
Nevada 2 $1,520 Florida 724 $1,229
Tennessee 325 $420
Central 1308 $450
Wisconsin 815 $448 Northeast 7617 $271
Michigan 184 $424 Maine 5900 $227
New Hampshire 738 $225
Vermont 112 $218
New York 484 $582
West Virginia 357 $541
Maryland 25 $1,500
Total U.S. 24,350 $777
Source: Lehman Brothers and Industry Sources
Timber transactions vary by region.
30
TimberTax and capital structure arbitrage is allowing private buyers to pay up for timberlands…
Indexed Avg. Price of U.S. Timberland Transactions
78
88
118
103
89 89
10196
106 104
129
60
70
80
90
100
110
120
130
140
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
60
70
80
90
100
110
120
130
140
Source: Company reports, industry sources and Lehman Brothers.Note: Trailing 10-year average timberland value = 100.
31
Timber
Source: Timber Mart South
Prices vary greatly depending on the diameter of the log….
Southern Stumpage Prices by Diameter Class
0.00
0.50
1.00
1.50
2.00
2.501977
1979
1981
1983
1985
1987
1989
1991
1993
1995
1997
1999
2001
2003
2005
$ p
er
Cu
bic
Fo
ot
0.00
0.50
1.00
1.50
2.00
2.50
8 18 12
Note: We estimate the price for the 12 inch diameter classes based on the cross section
area of the log. We assume the 8 inch and 18 inch diameter classes are equal to pine
pulpwood and pine sawtimber, as reported by Timber Mart-South.
32
Timber
Estimated Southern Stumpage Prices by Diameter
Class
$0.00
$0.50
$1.00
$1.50
$2.00
$2.501977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
$ p
er
Cu
bic
Fo
ot
6
8
10
12
14
16
18
Note: We estimate the price for the 6, 10, 12, 14 and 16 inch diameter classes based on the
cross section area of the log. We assume the 8 inch and 18 inch diameter classes are equal to
pine pulpwood and pine sawtimber, as reported by Timber Mart-South.
Estimated prices of 7 diameter classes…
Source: Timber Mart South
33
Timber
Pulpwood prices are below trend level in the U.S. South…
Softwood Pulpwood Stumpage Prices
$0.11$0.13 $0.13
$0.14 $0.15 $0.15 $0.15 $0.15 $0.16 $0.16 $0.16 $0.16
$0.18
$0.33 $0.33
$0.00
$0.05
$0.10
$0.15
$0.20
$0.25
$0.30
$0.35
$0.40
NC TN SC
GA
Pac N
W A
vg.
Southea
st A
vg AR AL
MS LA VA FL TX
Nort
heast
Avg
.
Lake
State
s A
vg.
$ p
er
Cu
bic
Ft.
* Average prices for the Pac NW, Northeast, and Lake States regions are estimated based on data from the International Woodfiber
Report. Data for the Southeast region and states are from Timber Mart-South.
Trend Price Level
34
TimberAt $19/cord, pulpwood is priced to yield energy at an estimated cost of less than $4 per MMBtu…
Pulpwood and Natural Gas Cost Comparison
$0
$2
$4
$6
$8
$10
$12
$14
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
E
$ p
er
MM
Btu
$0
$2
$4
$6
$8
$10
$12
$14
Natural Gas
Pine PulpwoodDelivered
Source: Timber Mart-South, Bloomberg and Lehman Brothers.Note: We assume a 75% wood-burning efficiency ratio and 8,500 Btu's per air-dried lb. of pulpwood.
35
Supply/Demand
� U.S. demand growth is slowing, but supply is contracting much
faster.
� Global trend demand growth also exceeds supply growth.
� U.S. trade flows are improving as exports rise and imports
decline.
36
Supply/DemandU.S. capacity growth remains the slowest in decades, but demand is also noticeably lower…
Yr/Yr Capacity Change, Total U.S. Paper &
Paperboard
-2%
-1%
0%
1%
2%
3%
4%
5%
1971
1974
1977
1980
1983
1986
1989
1992
1995
1998
2001
2004
2007E
Year-
over-
Year
% C
han
ge
-2%
-1%
0%
1%
2%
3%
4%
5%
Year-
over-
Year
% C
han
ge
Source: AF&PA and Lehman Brothers estimates
U.S. capacity declined for four years in
a row for the first time on record.
Demand
CAGR = 2.5%Demand
CAGR = 2.4%Demand
CAGR = 2.1%
Demand
CAGR = 0.6%
37
Supply/DemandSupply discipline and capital spending discipline both started for the first time in 1998…
Capital Expenditures vs. Depreciation - Lehman Brothers Index
0
2000
4000
6000
8000
10000
12000
19
72
19
74
19
76
19
78
19
80
19
82
19
84
19
86
19
88
19
90
19
92
19
94
19
96
19
98
20
00
20
02
20
04
20
06
E2
00
8E
Millio
ns o
f D
ollars
0
2000
4000
6000
8000
10000
12000
Millio
ns o
f D
ollars
Capex D&A
Source: Lehman Brothers and company reports. Lehman Brothers estimates for 2006-2008.
Capital Spending
for the U.S.
Industry remains
significantly below
D&A levels.
38
Supply/DemandWe believe global demand growth exceeds global supply growth by a healthy margin.
Year-over-Year Capacity Growth, Global Paper & Paperboard
-2%
0%
2%
4%
6%
8%
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006E
2007E
2008E
Yr/
Yr
% C
han
ge
-2%
0%
2%
4%
6%
8%
Yr/
Yr
% C
han
ge
Source: 1989 - 2002 PPI International Fact & Price Book; 2003 - 2007 Lehman Brothers estimates.
CAGR = 2.6%
39
Supply/DemandU.S. imports are beginning to decline as exports rise, leading to a 350 basis point improvement in trade flows vs. consumption.
U.S. Total Paper and Paperboard - Import and Export Trends
800
1000
1200
1400
1600
1800
2000
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
20
05
20
06
Imp
ort
s a
nd
Ex
po
rts
('0
00
ton
s)
12
-mth
. M
ov
ing
Av
g.
0%
2%
4%
6%
8%
10%
12%
Ne
t Im
po
rts
as
a %
of
Co
ns
um
pti
on
Net Imports as a % of Consumption (Right Scale)
Exports - 12 mth. moving avg. (Left scale)
Imports - 12 mth. moving avg. (Left scale)
Source: Lehman Brothers and Industry Sources
40
Supply/Demand During 2006, we estimate operating rates will rise to levels notseen since 1972-1973…
US Paper and Paperboard Operating Rates
75
80
85
90
95
100
19
70
19
73
19
76
19
79
19
82
19
85
19
88
19
91
19
94
19
97
20
00
20
03
20
06
E
Source: Lehman Brothers and Industry Sources
41
Financial Returns
� Ebitda margins for the industry are near the bottom quartile.
� But unlevered cash flow yields are near a 25 year high.
� While the industry’s WACC is near a 25 year low.
� Yet returns still fall short of cost of capital.
� Including current cash flow and current unit growth, the industry is
earning cost of capital for the first time in at least 25 years.
� Cost of equity vs. after-tax cost of debt is at an all-time high.
� Which is attracting significant interest from private equity investors.
� Capital discipline, free cash flow and operating rates are improving.
42
Financial ReturnsEBITDA margins are near the bottom quartile of their historic range.
EBITDA Margins
7%
9%
11%
13%
15%
17%
19%
21%
23%
1972
1975
1978
1981
1984
1987
1990
1993
1996
1999
2002
2005
2008E
7%
9%
11%
13%
15%
17%
19%
21%
23%
Source: Lehman Brothers E ti t
43
Financial Returns10-year rolling unlevered free cash flow yields are near a 25-year high while WACC is near a 25-year low.
Lehman Paper & Forest Index: 10-Yr Unlevered Free Cash Yield on Adjusted Enterprise
Value (with Actual Capex) vs 10-Yr WACC
0%
2%
4%
6%
8%
10%
12%
14%
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
E
0%
2%
4%
6%
8%
10%
12%
14%Cash Yield WACC
Source: Company reports and Lehman Brothers Estimates.
44
Financial ReturnsIncluding 10-year unlevered free cash flow yield AND organic growth rates we estimate the industry can sustainably earn cost of capital for the first time in 25 years.
Lehman Paper & Forest Index: 10-Yr Unlevered Free Cash Yield on Adjusted Enterprise
Value (with Actual Capex) & Growth vs 10-Yr WACC
0%
2%
4%
6%
8%
10%
12%
14%
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
E
0%
2%
4%
6%
8%
10%
12%
14%Cash Yield Growth Rate WACC
Source: Company Reports and Lehman Brothers estimates.
45
Financial ReturnsCost of equity is historically expensive relative to debt…
Lehman Paper and Forest Index:Blended 10-YR Weighted Avg Cost of Capital
0%
2%
4%
6%
8%
10%
12%
14%
16%
18%
19
81
19
83
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
20
07
E
Co
st
of
Cap
ital
1.0
1.5
2.0
2.5
3.0
Rati
o o
f C
ost
of
Eq
uit
y t
o D
eb
t
Cost of Equity
After-Tax Cost of Debt
Ratio of Cost of Equity to Cost of Debt
Source: Lehman Brothers and company reports. Lehman Brothers Estimates for 2005-2007.
46
Financial ReturnsInterest from private equity investors is up sharply…
� Texas Pacific Group is acquiring Smurfit-Stone Container’s
consumer packaging business for $1 billion. Lehman Brothers is acting as financial advisor to Texas Pacific Group on the acquisition of Smurfit-Stone's consumer packaging segment.
� Private investors are acquiring over 5 million acres of timberland
from International Paper for $6 billion.
� Koch Industries spent $21 BB to acquire Georgia-Pacific.
� Madison Dearborn Partners acquired Boise Cascade.
� Cerberus Capital acquired GP’s building products distribution
business and MeadWestvaco’s coated paper business.
� Kohlberg & Co. acquired IP’s specialty papers business.
47
Financial ReturnsRelative Performance of Paper & Forest Products Index
Daily S&P Paper/Forest Products Index
Relative to S&P 500, (9/27/00 = 100)
100
120
140
160
180
200
220
240
9/2
7/0
0
12
/22
/00
3/2
3/0
1
6/2
0/0
1
9/2
1/0
1
12
/18
/01
3/1
9/0
2
6/1
4/0
2
9/1
1/2
00
12
/06
/02
3/0
7/0
3
6/0
4/0
3
8/2
9/0
3
11
/25
/03
2/2
5/0
4
5/2
1/0
4
8/1
9/0
4
11
/15
/04
2/1
1/0
5
5/1
1/0
5
8/0
8/0
5
11
/02
/05
2/0
1/0
6
5/0
1/0
6
100
120
140
160
180
200
220
240
Since the trough in September 2000, the
S&P Paper & Forest Index is up 70%, while
the S&P 500 is down 8%.
Source: Lehman Brothers and FactSet.
48
Summary
ECONOMY:
� Solid growth, but interest rates are a concern.
� Interest rate sensitive areas like housing feeling the pinch.
� Twin deficits may keep pressure on the dollar
COMMODITY PRICES :
� Exchange rates often impact trade flows and commodity prices.
� Chronically high input costs likely to continue, especially in
upstream commodities that China lacks.
� Most wood prices are down YTD, while paper prices are up.
49
Summary
CHINA:
� Driving upstream commodities up (pulp, wastepaper, timber),
while driving labor-intensive downstream products down (finished
consumer goods).
� Chinese paper industry could match size of U.S. industry by
2011 and grow to 2X our size by 2022.
TIMBER:
� Ownership structure is changing.
� Tax and capital structure arbitrage allows private buyers to pay
more for timberlands.
� Timber prices are trending higher.
50
Summary
Supply/Demand:
� U.S. demand growth is slowing, but supply is contracting faster.
� Global trend demand growth also exceeds supply growth.
� U.S. trade flows are improving.
Financial Returns:
� Returns are still low, but getting better.
� Cost of equity is historically high vs. cost of debt.
� Private equity investors are active in the industry.
51
Important DisclosuresAnalyst Certification:
I, Peter Ruschmeier, hereby certify (1) that the views expressed in this research email accurately reflect my personal views about any or all of the subject securities
or issuers referred to in this email and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views
expressed in this email.
Important Disclosures
Lehman Brothers does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a
conflict of interest that could affect the objectivity of this email communication.
Customers of Lehman Brothers in the United States can receive independent, third-party research on the company or companies covered in this report, at no cost to
them, where such research is available. Customers can access this independent research at www.lehmanlive.com or can call 1-800-2-LEHMAN to request a
copy of this research.
Investors should consider this communication as only a single factor in making their investment decision.
The analysts responsible for preparing this report have received compensation based upon various factors including the Firm’s total revenues, a portion of which is
generated by investment banking activities.
Stock price and ratings history charts along with other important disclosures are available on our disclosure website at www.lehman.com/disclosures
And may also be obtained by sending a written request to: LEHMAN BROTHERS CONTROL ROOM, 745 SEVENTH AVENUE, 19TH FLOOR NEW YORK,
NY 10019
Guide to Lehman Brothers Equity Research Rating System
Our coverage analysts use a relative rating system in which they rate stocks as 1-Overweight, 2- Equal weight or 3-Underweight (see definitions below) relative to
other companies covered by the analyst or a team of analysts that are deemed to be in the same industry sector (“the sector coverage universe”). To see a list of
companies that comprise a particular sector coverage universe, please go to www.lehman.com/disclosures.
In addition to the stock rating, we provide sector views which rate the outlook for the sector coverage universe as 1-Positive, 2-Neutral or 3-Negative (see definitions
below). A rating system using terms such as buy, hold and sell is not the equivalent of our rating system. Investors should carefully read the entire research
report including the definitions of all ratings and not infer its contents from ratings alone.
Stock Rating
1-Overweight - The stock is expected to outperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.
2-Equal weight - The stock is expected to perform in line with the unweighted expected total return of the sector coverage universe over a 12-month investment
horizon.
3-Underweight - The stock is expected to underperform the unweighted expected total return of the sector coverage universe over a 12-month investment horizon.
RS-Rating Suspended - The rating and target price have been suspended temporarily to comply with applicable regulations and/or firm policies in certain
circumstances including when Lehman Brothers is acting in an advisory capacity on a merger or strategic transaction involving the company.
52
Important DisclosuresSector View
1-Positive - sector coverage universe fundamentals are improving.
2-Neutral - sector coverage universe fundamentals are steady, neither improving nor deteriorating.
3-Negative - sector coverage universe fundamentals are deteriorating.
Distribution of Ratings:
Lehman Brothers Equity Research has 1832 companies under coverage.
43% have been assigned a 1-Overweight rating which, for purposes of mandatory disclosures, is classified as a Buy rating, 32% of companies with this rating are
investment banking clients of the Firm.
40% have been assigned a 2-Equal weight rating which, for purposes of mandatory disclosures, is classified as a Hold rating, 6% of companies with this rating are
investment banking clients of the Firm.
17% have been assigned a 3-Underweight rating which, for purposes of mandatory disclosures, is classified as a Sell rating, 61% of companies with this rating are
investment banking clients of the Firm.
This material has been prepared and/or issued by Lehman Brothers Inc., member SIPC, and/or one of its affiliates (“Lehman Brothers”) and has been approved by
Lehman Brothers International (Europe), authorized and regulated by the Financial Services Authority, in connection with its distribution in the European
Economic Area. This material is distributed in Japan by Lehman Brothers Japan Inc., and in Hong Kong by Lehman Brothers Asia Limited. This material is
distributed in Australia by Lehman Brothers Australia Pty Limited, and in Singapore by Lehman Brothers Inc., Singapore Branch. (“LBIS”). Where this
material is distributed by LBIS, please note that it is intended for general circulation only and the recommendations contained herein does not take into account
the specific investment objectives, financial situation or particular needs of any particular person. An investor should consult his Lehman Brothers’
representative regarding the suitability of the product and take into account his specific investment objectives, financial situation or particular needs before he
makes a commitment to purchase the investment product. This material is distributed in Korea by Lehman Brothers International (Europe) Seoul Branch. This
document is for information purposes only and it should not be regarded as an offer to sell or as a solicitation of an offer to buy the securities or other
instruments mentioned in it. No part of this document may be reproduced in any manner without the written permission of Lehman Brothers. With the
exception of disclosures relating to Lehman Brothers, this research report is based on current public information that Lehman Brothers considers reliable, but
we make no representation that it is accurate or complete, and it should not be relied on as such. In the case of any disclosure to the effect that Lehman Brothers
Inc. or its affiliates beneficially own 1% or more of any class of common equity securities of the subject company, the computation of beneficial ownership of
securities is based upon the methodology used to compute ownership under Section 13(d) of the United States' Securities Exchange Act of 1934. In the case of
any disclosure to the effect that Lehman Brothers Inc. and/or its affiliates hold a short position of at least 1% of the outstanding share capital of a particular
company, such disclosure relates solely to the ordinary share capital of the company. Accordingly, while such calculation represents Lehman Brothers’
holdings net of any long position in the ordinary share capital of the company, such calculation excludes any rights or obligations that Lehman Brothers may
otherwise have, or which may accrue in the future, with respect to such ordinary share capital. Similarly such calculation does not include any shares held or
owned by Lehman Brothers where such shares are held under a wider agreement or arrangement (be it with a client or a counterparty) concerning the shares of
such company (e.g. prime broking and/or stock lending activity). Any such disclosure represents the position of Lehman Brothers as of the last business day of
the calendar month preceding the date of this report.
53
Important DisclosuresThis material is provided with the understanding that Lehman Brothers is not acting in a fiduciary capacity. Opinions expressed herein reflect the opinion of Lehman
Brothers and are subject to change without notice. The products mentioned in this document may not be eligible for sale in some states or countries, and they
may not be suitable for all types of investors. If an investor has any doubts about product suitability, he should consult his Lehman Brothers representative. The
value of and the income produced by products may fluctuate, so that an investor may get back less than he invested. Value and income may be adversely
affected by exchange rates, interest rates, or other factors. Past performance is not necessarily indicative of future results. If a product is income producing, part
of the capital invested may be used to pay that income. © 2006 Lehman Brothers. All rights reserved. Additional information is available on request. Please
contact a Lehman Brothers entity in your home jurisdiction.
Lehman Brothers policy for managing conflicts of interest in connection with investment research is available at www.lehman.com/researchconflictspolicy. Ratings,
earnings per share forecasts and price targets contained in the Firm's equity research reports covering U.S. companies are available at
www.lehman.com/disclosures information on companies covered by Lehman Brothers Equity Research is available at www.lehman.com/disclosures.
54