Embed Size (px)
Citation preview
Packaging Corporation of
America
Valuation Analysis
Jacob Finley, Ryan Gerton, Nick Ham, Jason Najm
12.7.2014
Table of Contents
Executive Summary ................................................................................................... 1
Industry Overview.................................................................................................. 2
Five Forces Model .................................................................................................. 2
Accounting Analysis ............................................................................................... 3
Financial Analysis ................................................................................................... 4
Valuation Summary ................................................................................................ 8
Overview of the Firm ............................................................................................... 10
Rivalry Among Existing Firms ................................................................................... 11
Industry Growth .................................................................................................. 12
Concentration ...................................................................................................... 15
Differentiation ...................................................................................................... 16
Switching Costs ................................................................................................... 16
Scale/Learning Economies .................................................................................... 17
Fixed and Variable Costs ...................................................................................... 18
Excess Capacity ................................................................................................... 18
Exit Barriers ......................................................................................................... 19
Conclusion ........................................................................................................... 19
Threat of New Entrants ........................................................................................... 19
Scale Economies .................................................................................................. 20
First Mover Advantage ......................................................................................... 21
Distribution Access ............................................................................................... 21
Relationships ....................................................................................................... 22
Legal Barriers ...................................................................................................... 22
Conclusion ........................................................................................................... 23
Threat of Substitute Products .................................................................................. 23
Relative Price and Performance ............................................................................. 24
Buyers’ Willingness to Switch ................................................................................ 25
Conclusion ........................................................................................................... 26
Bargaining Power of Buyers ..................................................................................... 27
Switching Costs ................................................................................................... 27
Differentiation ...................................................................................................... 27
Importance of Product for Costs and Quality.......................................................... 29
Number of Customers .......................................................................................... 31
Volume per Customer ........................................................................................... 31
Conclusion ........................................................................................................... 32
Bargaining Power of Suppliers ................................................................................. 32
Switching Costs ................................................................................................... 32
Number of Suppliers ............................................................................................ 33
Conclusion ........................................................................................................... 33
Key Success Factors for the Industry ........................................................................ 33
PKG’s Competitive Advantages .............................................................................. 34
Economies of Scale & Efficient Production ............................................................. 34
Simple Product Design ......................................................................................... 35
Tight Cost Control ................................................................................................ 36
Lower Input Costs ................................................................................................ 37
Accounting Analysis................................................................................................. 37
Identify Key Accounting Policies ............................................................................ 37
Type One Key Accounting Policies ......................................................................... 38
Economies of Scale .............................................................................................. 38
Low Input Cost .................................................................................................... 39
Simple Product Design ......................................................................................... 40
Tight Cost Control and Low Distribution Cost ......................................................... 40
Type Two Key Accounting Policies ......................................................................... 41
Goodwill .............................................................................................................. 42
Defined Benefit Pension Plans ............................................................................... 43
Assessing Accounting Flexibility................................................................................ 44
Actual Accounting Strategy ................................................................................... 44
Goodwill .............................................................................................................. 45
Operating Lease Obligations and R&D ................................................................... 45
Conclusion ........................................................................................................... 45
Quality of Disclosure ............................................................................................... 46
Quality of Disclosure of Economies of Scale ........................................................... 47
Quality of Disclosure of Tight Cost Control ............................................................. 47
Quality of Disclosure of Low Input Costs ............................................................... 47
Quality of Disclosure on Simple Products ............................................................... 48
Conclusion ........................................................................................................... 48
Identify Potential Red Flags ..................................................................................... 49
Operating Leases ................................................................................................. 49
Goodwill .............................................................................................................. 51
Research and Development .................................................................................. 53
Conclusion ........................................................................................................... 54
Financial Analysis .................................................................................................... 54
Liquidity and Operating Efficiency Ratios .................................................................. 54
Current Ratio ....................................................................................................... 55
Quick Asset Ratio ................................................................................................. 56
Inventory Turnover .............................................................................................. 57
Days Supply of Inventory ..................................................................................... 58
Accounts Receivables Turnover ............................................................................. 60
Days Sales Outstanding ........................................................................................ 61
Cash to Cash Cycle .............................................................................................. 63
Working Capital Turnover ..................................................................................... 64
Liquidity Analysis Conclusion ................................................................................. 65
Profitability Ratios ................................................................................................... 65
Sales Growth Percentage ...................................................................................... 65
Gross Profit Margin .............................................................................................. 66
Operating Profit Margin ........................................................................................ 68
Net Profit Margin.................................................................................................. 69
Asset Turnover .................................................................................................... 70
Return on Assets.................................................................................................. 71
Return on Equity .................................................................................................. 73
Profitability Ratio Analysis Conclusion .................................................................... 74
Capital Structure Ratios ........................................................................................... 74
Introduction ........................................................................................................ 74
Debt to Equity ..................................................................................................... 74
Times Interest Earned .......................................................................................... 75
Altman’s Z-score .................................................................................................. 76
Internal Growth Rate ........................................................................................... 77
Sustainable Growth Rate ...................................................................................... 79
Capital Structure Conclusion ................................................................................. 80
Financial Forecasting ............................................................................................... 80
Introduction ........................................................................................................ 80
Income Statement ............................................................................................... 80
Dividend Forecasting ............................................................................................ 82
Balance Sheet ...................................................................................................... 85
Statement of Cash Flows ...................................................................................... 88
Cost of Capital Estimation ........................................................................................ 91
Cost of Debt ........................................................................................................ 91
Cost of Equity ...................................................................................................... 92
Backdoor Cost of Equity ....................................................................................... 94
Weighted Average Cost of Capital ......................................................................... 94
Conclusion ........................................................................................................... 96
Method of Comparables ........................................................................................... 96
Price to Book Multiple ........................................................................................... 97
Price to Earnings (Trailing Twelve Months) ............................................................ 97
Price to Earnings (Forward) .................................................................................. 98
Dividend Payout Multiple ...................................................................................... 99
P.E.G. Multiple ..................................................................................................... 99
Enterprise Value/EBITDA .................................................................................... 100
Enterprise Value/FCF .......................................................................................... 101
Enterprise Value/Sales ........................................................................................ 102
Conclusion ......................................................................................................... 102
Intrinsic Valuation Models ...................................................................................... 103
Discounted Dividends Model ............................................................................... 104
Discounted Free Cash Flow Model ....................................................................... 105
Residual Income Model ...................................................................................... 107
Abnormal Earnings Growth Model ....................................................................... 108
Long-Run Residual Income Model ....................................................................... 110
Final Recommendation .......................................................................................... 112
Appendix .............................................................................................................. 113
Works Cited .......................................................................................................... 129
Page | 1
Executive Summary
Analyst Recommendation: Sell (Overvalued)
November 1st 2014
2008 2009 2010 2011 2012 2013
Score 2.73 3.31 3.32 3.07 4.03 2.42
As-Stated Restated 44.41$
15.97$ N/A 108.43$
37.67% N/A 66.33$
10.88% N/A 7.49$
147.76$
Adj. R^2 Beta 90.65$
3 Month 60.7% 1.41 77.50$
1 Year 60.7% 1.41 48.29$
2 Years 60.7% 1.41
7 Years 60.8% 1.41
10 Years 60.8% 1.41
Valuation Model
Backdoor Ke 13.20% 23.69$
WACC BT 10.14% 34.11$
WACC AT 9.88% 41.65$
Published Beta (Yahoo Finance) 1.29 61.61$
16.29$
Cost of Equity (Ke) 10.52% 12.39% 14.26%
Size-Adjusted Ke 11.42% 13.29% 15.16%
Shares Oustanding
Observed Price (11/3/2014)
52 Week Range
Revenue
Market Cap
Packaging Corporation of America- NYSE 11/1/2014
15.16%
15.16%
Cost of Capital
2 Factor Ke
15.16%
15.16%
15.16%
Book Value per Share
Return on Equity
Return on Assets
71.77$
$ 57.06 - 78.50
5,630,000,000$
7,580,000,000$
97,170,000
Result
Comparable
EV/FCF
EV/EBITDA
P.E.G.
Dividend Payout
P/E Froward
P/E Trailing
Fairly Valued
Long-Run Residual Income
Abnormal Earnings Growth
Residual Income
Discounted Free Cash Flows
Discounted Dividends
Lower
Bound
Expected
Value
Upper
Bound
Method of Comparables Valuations
Altman's Z-Score
Intrinsic Valuation Models
EV/Sales
Undervalued
Undervalued
Overvalued
Fairly Valued
Undervalued
Overvalued
Overvalued
P/B
Result
Page | 2
Industry Overview
Packaging Corporation of America (PKG) is a multinational corporation, which
specializes in the containerboard, corrugated products, white paper, and newsprint
industries. A complete analysis of the mentioned industries shows low product
differentiation with high competition. Supply and demand is the main determinant of
price. Firms are slightly able to differentiate themselves by producing high quality
products, but cost leadership is the main competitive strategy. We analyze the five
competitive forces below to see what drives the competitive corrugated packaging and
paper industry.
Five Forces Model
Industry Profitability
(LOW)
Bargaining Power of Suppliers
(MODERATE)
Few Suppliers
No Substitutes
Bargaining Power of Buyers
(MODERATE)
High Switching Costs
Little Differentiation
High Number of Suppliers
Threat of New Entrants (LOW)
Very Mature Industry
Capital Intensive
Legal Barriers
Threat of Substitute Products
(LOW)
Virtually no Substitutes
Substitutes too Expensive
Rivalry Amongst Firms (HIGH)
Nigh Overcapacity
Economies of Scale
Low Concentration
Page | 3
There is a moderate threat of bargaining power of suppliers. Since there are no
substitutes for the materials like wood pulp, the suppliers have a high level of control
on pricing, but there are alternatives like plastic shipping, which the industry could use
if prices rise too much. There is also a moderate threat of bargaining power of buyers.
There are few firms in the industry that make virtually the same products. The buyers
have power over which firm they choose, but each firm has its own specialization and
niche customers. There is a very low threat of new entrants into this industry because
the cost of capital is extremely high, expensive environmental and legal barriers, and
the industry is mature so the existing firms are not going anywhere. The threat of
substitutes is very low for the packing industry because the only true alternative is
plastic products, but those are way more expensive and do not offer any extra benefits.
The threat of substitutes for the paper industry is low, but in the future eBooks could
start to disrupt the industry because of its ease of use. The rivalry amongst firms is
high. PKG and the industry utilize economies of scale to keep costs low.
Using the five forces model we conclude that industry profitability is low. Firms
use the cost leadership strategy to compete for the lowest price. The industry all uses
the same raw materials, so firms that have the most efficient production methods will
have the lower price.
Accounting Analysis
For a complete analysis of a firm, it is necessary to analyze the accounting
policies of the firm. Analyzing the accounting policies can show a more accurate value
of the firm. Firms accounting policies can affect future forecasted earning. GAAP is
flexible when it comes to how firms show certain activities on their financial statements.
When a firm has low disclosure, then they are most likely hiding things that will hurt the
value of their company. High disclosure means that the firm discloses all relevant
information, whether it will create or destroy value. Accounting policies fall into two
categories: Type one and type two.
Page | 4
Type one accounting policies show the connection between the key success
factors. Type one accounting policies reveal how PKG and the industry are performing.
Type one accounting policies include economies of scale, low input costs, tight costs
control, and simple product design. Analysis of these accounting policies and their
quality of disclosure in the financial statements shows that PKG has an average quality
of disclosure.
Type two accounting policies included very flexible accounting procedures that
can be used to mislead investors. Type two accounting policies include capital operating
leases, goodwill, R&D expenses, pension plans, and foreign currency risks. Our analysis
of the accounting policies led us to conclude that the quality of disclosure PKG offers is
above industry average. After our analysis, none of these accounting policies met the
minimum requirements for financial restatements and disclosure of potential red flags.
Through our accounting analysis, we conclude that PKG has a medium quality of
disclosure related to its 10-Ks. Potential red flags were not a concern, therefore
restatements are not necessary because the effect of type two accounting policies are
very minor. PKGs true financial standing is accurately portrayed in their 10-Ks.
Financial Analysis
The next step in finding PKG's true value is to perform the financial analysis. The
financial analysis involves reviewing the financial information of a firm and its
competitors to measure their performance over time. This includes analyzing financial
ratios, forecasting the firm's financials, and estimating the firm's cost of capital. For this
reason, it is a key component in the valuation process. As the first step in this process,
we will analyze PKG’s liquidity and operating efficiency, profitability, and capital
structure using ratio analysis.
The liquidity and operating efficiency ratios that were analyzed consist of the
following: current ratio, quick asset ratio, inventory turnover, days’ supply of inventory,
accounts receivable turnover, days sales outstanding, cash to cash cycle, and working
capital turnover. Liquidity ratios are important as they provide a method for analyzing a
firm’s financial health and determining their capability to satisfy debt obligations with
Page | 5
their current assets. Typically a higher degree of liquidity is preferred, but an excessive
amount of liquidity may suggest poor management. Looking at PKG’s liquidity analysis
they have generally performed well, but due to their recent acquisition of Boise Inc.,
have decreased in relation to their industry peers, but generally appear to be
recovering.
The profitability analysis examines a firm’s ability to generate earnings in excess
of costs. Our analyst team examined the following ratios: sales growth percentage,
gross profit margin, operating profit margin, net profit margin, asset turnover, return on
assets (ROA), and return on equity (ROE). All of these ratios are imperative in
determining the overall performance of the industry, as well as the firm. Looking at the
ratios, PKG’s profitability is outperforming its competitors. Their success in
outperforming their competitors is largely attributable to the acquisition of Boise Inc.
Although they are currently outperforming their competitors, it is unlikely for PKG to
maintain this trend. Overall, PKG and its management have been effective and efficient
at maintaining competitive profitability levels.
Ratio Performance Trend
Current Ratio Average Stable
Quick Asset Ratio Average Stable
Inventory Turnover Underperforming Decreasing
Days Supply of Inventory Underperforming Increasing
A/R Turnover Underperforming Decreasing
Days Sales Outstanding Underperforming Increasing
Cash to Cash Cycle Underperforming Increasing
Working Capital Turnover Underperforming Decreasing
Liquidity and Operating Efficiency Ratio Analysis
Page | 6
The capital structure of a firm portrays how its operations are being financed.
The analysis a firm’s capital structure ratio effectively will allow the analyst team to
understand how the firm is procuring its funds. This is important because there are
multitudes of ways a firm may finance its operations; all of which come at different
associated costs. Our analyst team analyzed the following capital structure ratios: debt
to equity, times interest earned, Altman’s z-score, internal growth rate, and sustainable
growth rate. The packing industry generally has a higher percentage of invested capital
to debt. This is evident in looking at PKG’s debt to equity ratio. Although they are
currently underperforming compared to the industry average, they appear to be
improving, and have the second best average within its peer group for debt to equity
ratio of 1.75. Another important capital structure ratio is Altman’s Z-score. Altman’s Z-
score is used to measure the possibility that a given firm will declare bankruptcy, or the
firm’s credit risk. Typically a score below 1.8 suggests that a firm has a substantial risk
of bankruptcy. If the score is above 3.0 then the chances that the firm will go bankrupt
are very minimal. PKG’s average z-score is 3.15 and well above the industry average,
but has recently decreased. This is likely due to their acquisition of Boise Inc.
There are two growth rates analyzed when looking at the capital structure of a
firm: internal growth rate and sustainable growth rate. A firm’s internal growth rate
(IGR) is the maximum asset growth a firm could achieve by reinvesting cash flows from
operations less any distributed dividends during the period. A key characteristic of the
IGR is the assumption that the firm isn’t receiving any funds from outside sources. In
general, a higher growth rate is favorable as it shows that a firm is capable of growing
Ratio Performance Trend
Sales Growth Percentage Outperforming Increasing
Gross Profit Margin Average Stable
Operating Profit Margin Average Volatile
Net Profit Margin Outperforming Increasing
Asset Turnover Outperforming Increasing
Return on Assets Outperforming Volatile
Return on Equity Outerforming Volatile
Profitability Ratio Analysis
Page | 7
via assets already on its books. PKG had experienced a consisted drop in IGR until 2012
where it experienced an increase. Overall, PKG’s average IGR has outperformed its
industry peers. The second metric utilized in measuring the firm’s growth is the
sustainable growth rate (SGR). A firm’s SGR is the upper limit at which a firm can grow
without changing its capital structure. Unlike IGR, sustainable growth allows a firm to
use leverage to grow. Therefore, SGR is always higher in magnitude than IGR. Typically
an overall growth rate is reasonable when it lies between the IGR and SGR. PKG and
its industry peers recognized similar activity in the values of SGR as they did with IGR.
Therefore, PKG had a consistent decrease in SGR until 2012 where it had an increase.
Overall, PKG’s SGR is outperforming the industry average consisting of its peers.
Following the financial ratios, it’s now possible for the analyst team to forecast
the future growth and financials for PKG. Forecasting the financial statements is an
integral part of the valuation process, as it lays the foundation for the valuation models.
Fundamental analysis is utilized to analyze the ratios and historical trends for PKG and
the industry. Educated and conservative assumptions are then made, in conjunction
with the available data, to predict the future performance of the firm. It’s important to
note that because the resultant forecasts are based off of current available data, the
forecasted duration is critical in determining the accuracy. Therefore a longer period
would likely yield a less accurate forecast due to having less available data to make
future predictions. Information was utilized from PKG’s income statement, balance
sheet, and cash flow statement to forecast the coming ten years of financial data.
Ratio Performance Trend
Debt to Equity Underperforming Volatile
Times Interest Earned Outperforming Volatile
Altman's Z-score Outperforming Decreasing
Internal Growth Rate Outperforming Increasing
Sustainable Growth Rate Outperforming Volatile
Capital Structure Ratio Analysis
Page | 8
The final step in the valuation process is to assess PKG’s cost of capital.
Imbedded within the cost of capital is the cost of debt and cost of equity. The
information is then utilized to calculate the weighted average cost of capital (WACC),
which is the average cost for a firm to obtain capital from both debt and equity sources.
The WACC is important as it serves as the discount rate for the analyst team to
discount certain financials. In computing the cost of capital, the cost of debt was first
calculated. The cost of debt (KD) is the effective rate that the firm pays on its current
debt. It’s important to note how the cost of debt and associated risk are positively
correlated. Therefore, as the cost of debt increases, so does the associated risk of the
firm. To calculate the KD all non-current and interest-bearing liabilities are taken into
account. For PKG, the weighted average of the interest-bearing liabilities was calculated
to be 2.52%. Next, the cost of equity was calculated. The cost of equity (KE) is the
required rate of return shareholders require on their investment. It’s important to note
that the capital asset pricing model (CAPM) is utilized to calculate the cost of equity.
The CAPM approach takes into account the time value of money with the risk-free rate
(rf) and associated risk with an investment with beta (β). The risk-free rate was
calculated using regression analysis of the ten-year treasury rate. While conducting the
regression analysis, a 95% confidence level was utilized yielding a two-factor KE of
13.29%. Lastly, the WACC was calculated on a before-tax basis (WACCBT) and after-tax
basis (WACCAT). Our analyst team has calculated a WACCBT of 10.14% and a WACCAT of
9.88%.
Valuation Summary
Once the 5-forces analysis, cost of capital estimates and forecasts had been
performed, we were able to conduct a valuation analysis for PKG. The valuation process
will allow us to determine rigorously if PKG stock is over, under or fairly priced. We
used two methods of valuation: comparable methods and intrinsic valuation models.
The comparables method utilizes industry average ratios to diagnose how a firm is
performing relative to its peers, and how the market values that performance. This
process is simplistic, but it provides a quick and objective valuation. The most relevant
Page | 9
comparable when valuing PKG is the forward P/E multiple, as it uses future earnings
rather than historical performance. This multiple allows the growth due to the
acquisition of Boise to be considered when valuing PKG. Overall, this multiple has
determined that the stock is fairly valued at $66.33/share, but this value is too close to
the lower boundary of the fair value range to be definitive.
Intrinsic valuation models, however, provide a more thorough and accurate
valuation than comparables. The intrinsic valuation models we used were the
Discounted Dividend Model, Discounted Free Cash Flow Model, Residual Income Model,
Abnormal Earnings Growth Model and Long-Run Residual Income Model. Our team will
use a 10% boundary approach when valuing PKG; if the share price derived by these
models is 10% higher or lower than the observed share price, then we can conclude
that the stock is not fairly valued. Our team will base our final recommendation on
these models. It is important to note that the valuation date of this report is 11/01/14;
our team, however, was unable to retrieve the November 1st share price, so we used
the close price of $71.77 on Monday, November 3rd as a proxy in our valuation models.
The results of our intrinsic value analysis are as follows:
The RI and AEG models provided the most explanatory power when valuing
PKG’s stock. The RI model showed without question that the stock is overvalued; the
AEG model indicated that the stock is overvalued at the cost of capital our team
estimated, and the price plummets with any increase in the cost of equity. Our
recommendation is for PKG stock holders to sell; holding this stock would be risky due
to its sensitivity to changes in cost of equity.
Model Results
Discounted Dividends Overvalued
Discounted Free Cash Flows Inconclusive
Residual Income Overvalued
Abnormal Earnings Growth Inconclusive
Long-Run Residual Income Overvalued
Summary Results of Intrinsic Valuation
Page | 10
Overview of the Firm
Packaging Corporation of America (PKG) was formed in 1959, in a merger
between Central Fiber Products Company, American Boxboard Company, and Ohio
Boxboard Company. PKG participates in the corrugated packaging and paper products
industry. Packaging Corps three main branches are raw containerboard, finished
corrugated products (boxes), and white paper. PKG produces a wide variety of
corrugated packaging products, including conventional shipping containers used to
protect and transport manufactured goods, multi color boxes and displays with strong
visual appeal. In addition PKG is a large producer of packaging for meat, vegetables,
processed food, and beverages (PKG 10-K). The majority of PKG’s raw materials can be
broken down into two categories: fiber supply and energy supply. Fiber supply is the
main input of PKG’s manufacturing as well as the main price input. PKG is an active
participant in the Sustainable Forestry Initiative, which has goals to preserve the long-
term health and conservation of forestry resources. Energy supplies of PKG include
natural gas, electricity, oil, and coal.
The primary end-use markets in the United States for corrugated products are shown below as
reported in the 2012 Fiber Box Association annual report:
Food, beverages, and agricultural products 42 %
Paper products 21 %
General, retail, and wholesale trade 18 %
Petroleum, plastic, synthetic, and rubber products 8 %
Miscellaneous manufacturing 6 %
Appliances, vehicles, and metal products 3 %
Textile mill products and apparel
www.packagingcorp.com
Firms in this industry compete primarily on being able to offer the lowest price.
Most of the industry customer base is located in North America, other than International
Paper who is the largest firm in the industry. PKG is the fourth largest producer of
containerboard in the United States. PKG mains competitors are International Paper
Page | 11
Company, Rock-Tenn Company, and KapStone. PKG has operations in 32 states and
additional operations in Mexico, Europe, and Canada. Packaging Corp operates 5
containerboard mills, 3 white paper mills, 98 corrugated manufacturing plants, and 7
sheet plants. For the purpose of this analysis, our analysis team will use past financial
statements and 10-Ks for PKG and its competitors.
Rivalry Among Existing Firms
Competition within an industry can affect the profitability of a firm. It is
important to identify and analyze the competitors in the industry to better understand
how a firm’s profitability reacts to increases or decreases in competition. The
competitive strategy a firm chooses depends on the industry, but will result in the firm
being a price setter or a price taker. Firms that are price setters can demand a premium
for their products, while price taking firms must set their prices based on supply and
demand. Price setters focus on creating differentiated, unique products that will set
them apart from the industry. Price takers can choose to have tight cost control to
increase market share.
Rivalry amongst firms in the corrugated packaging and paper industry is very
high. Sales within the industry are dependent on fluctuating manufacturing costs, which
causes price competition amongst the firms. The nature of this highly competitive
industry results in the firms being price takers. The many factors that determine the
level of rivalry in an industry include, industry growth, concentration of competitors,
level of differentiation, fixed-variable costs, excess capacity, and exit barriers.
Page | 12
Industry Growth
The first part of analyzing an industry is to analyze its past and future growth. By
analyzing the industry growth we can determine the relative performance of a firm. In
periods of slow growth, firms must rely on cost leadership or differentiation to maintain
or gain market share. From a buyer’s standpoint this can be advantageous as price
wars lead to lower prices. During periods of high growth firms can expand and increase
sales.
In the chart below, our analysis team compared sales throughout the industry,
and concludes that this industry is in a growth cycle. Sales have steadily increased for
the majority of the firms, and increased every year for the industry. This is causing the
industry to expand as firm go through acquisitions and expansion. Though this industry
is negatively impacted by economic slumps, natural disasters, and raw materials pricing.
In the annual reports for the industry, weather was blamed for slowing production and
halting shipments causing sales growth to decrease. Wood pulp prices have remained
stable since recovering from the 2008 financial crisis; therefore, we conclude there is a
high potential for sales growth.
Page | 13
Corrugated Packaging Industry- Containerboard Shipment (In Thousands of Tons)z 2008 2009 2010 2011 2012 2013
Tons Shipped 2,353.0 2,258.0 2,443.0 2,449.0 3,348.0 3,354.0
Percent Change -4.21% 7.57% 0.24% 26.85% 0.18%
Tons Shipped 609.4 848.7 955.6 3,256.4 7,109.9 7,193.0
Percent Change 28.20% 11.19% 70.65% 54.20% 1.16%
Tons Shipped - - 650.20 730.10 1,073.90 1,449.70
Percent Change 12.29% 32.01% 25.92%
Tons Shipped 2,305.00 2,258.00 2,458.00 2,371.00 3,228.00 3,273.00
Percent Change -2.08% 8.14% -3.67% 26.55% 1.37%
Total Volume 5,267.40 5,364.70 6,506.80 8,806.50 14,759.80 15,269.70
Change in Sales 1.81% - 26.11% 40.33% 3.34%
Packaging Corporation
of America
Rock-Tenn Co.
Kapstone Paper and
Packaging Corporation
International Paper
Inc.
Page | 14
Kapstone did not produce containerboard prior to 2010, because that is
when the firm acquired new manufacturing equipment. In 2011 they
acquired U.S. Corrugated Inc. which caused the large increase in production.
Corrugated Packaging Industry- Net Sales Analysis (In Millions)2008 2009 2010 2011 2012 2013
Net Sales 2,360.5$ 2,147.6$ 2,435.6$ 2,620.1$ 2,843.9$ 3,665.3$
Percent Change -9.91% 11.82% 7.04% 7.87% 22.41%
Net Sales 2,838.9$ 2,812.3$ 3,001.4$ 5,399.6$ 9,207.6$ 9,545.4$
Percent Change -0.95% 6.30% 44.41% 41.36% 3.54%
Net Sales 524.5$ 632.5$ 782.7$ 906.1$ 1,216.6$ 1,748.1$
Percent Change 17.08% 19.19% 13.62% 25.52% 30.40%
Net Sales 24,829.0$ 23,366.0$ 25,179.0$ 26,034.0$ 27,833.0$ 29,080.0$
Percent Change -6.26% 7.20% 3.28% 6.46% 4.29%
Total Sales 30,552.9$ 28,958.4$ 31,398.7$ 34,959.8$ 41,101.1$ 44,038.8$
Change in Sales -5.22% 8.43% 11.34% 17.57% 7.15%
Packaging Corporation
of America
Rock-Tenn Co.
Kapstone Paper and
Packaging Corporation
International Paper Inc.
Page | 15
Concentration
Concentration refers to the amount of competition within an industry.
Competition between firms can be greatly affected by the number of companies within
an industry. In the corrugated packaging and paper industry there are few firms that
have the ability to compete with PKG and its main competitors. Even though there are
around 570 companies in this industry, most are small and lack the production capacity
to be considered a threat. In situations where a large number of firms are operating in
an industry, profits can be hard to come by. The high concentration makes it very hard
to gain market share creating a very competitive industry. Large majorities of market
share in the packaging and corrugated products industry is held by a handful of
companies. Smaller companies do play a large part however, driving up competition in
regional sales areas, which account for a large portion of industry sales.
Page | 16
Differentiation
Differentiation refers to the uniqueness of products throughout the industry.
Through product differentiation it is possible to reduce the amount of competition
and/or gain a competitive advantage. Firms that can achieve high levels of
differentiation can set themselves apart from the industry, and attract new customers
and gain market share. Industries with high levels of differentiation, prices wars are
avoided because each product offers unique benefits.
In the case of the packaging industry we conclude there is little differentiation,
so price is the determinate for most buyers. Although each firm in the industry has a its
own specialization, the overall differences between products is minimal. For example, if
PKG invents a new design, competitors can reengineer it quickly. This gives the
customer the ability to choose the cheapest producer at their convenience and greatly
increases competition. Containerboard can be made from virgin wood fiber, recycled
fibers (old corrugated containers or OCC), or a combination of both. These different
inputs however still create a relatively undifferentiated product. OCC occasionally can be
inferior however due to the high recyclable life cycle that wears down the fibers with
each reuse. OCC product prices can also fluctuate and rise more than virgin wood fiber.
Many companies with low OCC levels have a competitive advantage when OCC prices
are high.
Switching Costs
Switching costs arise from the transformation of a company’s current
assets or operations to create new uses or expansions into different markets. Average
contract length in the packaging industry is 15 years. Therefore opportunity costs
associated with switching costs are high because the length of time the machines
cannot be converted to make more profitable products. The industry is mature and
running out of new markets for expansion. The most popular option now is for firms to
convert idle newsprint machines into machines for containerboard production. Many
companies within the industry have begun conversions, including Packaging Corporation
Page | 17
and Rock-Tenn. Not all companies within the industry have the ability or capital to make
these conversions, leaving the companies who can with the opportunity to increase
production and sales while saving on costs arising from unused equipment.
Scale/Learning Economies
Economies of scale refer to a firm’s ability to be able to increase production and
lower costs. In economies of scale the goal is to lower the ratio of fixed to variable
costs. Firms that can operate in economies of scale have an advantage over other firms
because they can out produce them, and take over market share. In this industry
economies of scale exist. The more firms produce the lower the average cost per unit
produced is.
0.00%
2.00%
4.00%
6.00%
8.00%
10.00%
12.00%
14.00%
16.00%
18.00%
Packaging Corp ofAmerica
Rock Tenn Kapstone International PaperCompany
Operating Margins
2012
2013
Page | 18
Fixed and Variable Costs
Costs associated with businesses come in two forms, fixed or variable. Fixed
costs are costs that are incurred regardless of sales volume and production, like rent
and installations. Variable costs are costs associated with each unit of production, like
raw material costs and distribution costs.
This industry tends to have very high fixed costs due to the high demand of
resources used in production. It is usually common for costs per unit to decrease as
the production output increases. Knowing this, in order for a company to keep the
lower fixed costs, it is usual for companies to agree to low price contracts to increase
sales and therefor production. Another way this can be done is by closing certain plants
for a given duration of time in order to stimulate more production. This also ensures
that there will not be too much product entering the market, driving sales prices down.
Variable costs for the packaging industry are also highly susceptible to high fluctuating
prices for resources and energy. Many companies are trying to avoid these costs by
leasing or owning their own farming land and increasing the amount of vertical
integration within the production process.
Excess Capacity
For increased sales during times of excess capacity, companies tend to lower
prices. However the packaging industry prices are already at the lowest and companies
cannot afford to decrease them any more. Many companies within this industry will
focus on reducing and sometimes even halting production in order to reduce inventory
instead of prices. According to PKG’s 2013 annual report companies within the
containerboard and corrugated products industry actively trade excess inventories
working almost in collaboration benefitting both parties involved. This is only made
possible due to the very low level of differentiation of the products.
Page | 19
Exit Barriers
Sometimes firms are failing or do not produce enough profit and exiting that
industry can sometimes be a smart option. Typically when an industry has a lot of exit
barriers that means it is highly competitive. Since the containerboard and corrugated
products industry heavily depends on equipment and natural resources, companies
typically have a lot of money invested. Many producers either own or lease timber
rights for a long period of time to avoid fluctuating prices. Equipment used for the
manufacturing of these products cost millions of dollars and most often firms have high
levels of debt to pay for them. Recently with slowed growth in the industry, mergers
and acquisitions have become common and many firms are willing to buy out struggling
firms in order to grab more market share. In conclusion the high exit barrier cost
prevents companies from leaving and discourages new entrants.
Conclusion
Overall, our analysis team concludes that the industry is highly competitive with
low concentration. The products produced by the different firms are very similar so, the
firms are price takers and compete primarily on low prices. The result of creating the
large economies of scale in the packaging industry has resulted in the industry using
the price taking strategy and cost control. The high exit barrier makes the industry
more mature because it would be too expensive for firms to cut back, therefore the
industry competitors will not back out within the foreseeable future.
Threat of New Entrants
The threat of new entrants refers to the chances of a new firm disrupting the
industry. There are five important areas to focus on while determining the threat of
new entrants. Starting with scale economies, this refers to producing more to lower
individual unit costs. Second is the first mover advantage, which are the advantages
that the first firm in the market has. Next is distribution access, which is basically how a
Page | 20
product gets delivered to the buyer. The fourth area is relationships, referring to the
relationships that the firms have with their suppliers. The last area to focus on is the
legal barrier to entry, which is patents, copyrights, and trademarks that a new entrant
would have to overcome. A new entrant into the marketplace would drive profit margins
down and prices down.
Scale Economies
When firms have a higher output it spreads the costs over a larger number of
products, which makes the individual units, cost less. In the corrugated packaging and
paper industry this is a very important part of cost cutting. The industry produces more
paper so they can compete on price. The few firms that are in this industry cut freight
costs by building plants in close proximity to the buyers (PKG 10-K, RT 10-K, IP 19-K).
When firms operate in economies of scale it acts as a barrier to entry because new
firms are unable to achieve the production capacity that allows the main firms to
compete on low prices.
The corrugated packaging and paper industry is mature. The firms in the
industry have been in it for many years. It takes a lot of capital to enter this industry
because it requires paper mills, land leases, and wood pulp to get started. Graph 2
shows the total assets of some firms in the industry. The main competitors in this
industry have billions in assets that enable them to produce their products at a
minimum cost. This would be a huge barrier for a new firm to overcome.
2009 2010 2011 2012 2013
Packaging Corporation of America 2,152$ $ 2,224 $ 2,412 $ 2,453 $ 5,199
International Paper 25,548$ $ 25,368 $ 27,018 $ 32,153 $ 31,528
Rock-Tenn Company 2,884$ $ 2,914 $ 10,566 $ 10,687 $ 10,733
KapStone Paper and Packaging 669$ $ 720 $ 1,124 $ 1,136 $ 2,652
Total Assets (in millions of $)
Page | 21
First Mover Advantage
When a firm is a first mover it allows them to have more bargaining power with
suppliers and buyers. A firm that is the first one in a market, and sets the industry
trends are usually considered the first mover. The first mover can employ cost saving
strategies first and save more money than the other firms while they copy the first
mover’s strategies. In the corrugated packing and paper industry there is a slight
advantage to being a first mover. The industry is so competitive that if a firm were to
discover a new process that lowered costs, the other firms would no longer be able to
compete since the industry is based on lowest prices.
An important aspect we analyzed is the first mover having the first opportunity to
wholly own a distribution channel, such as International Papers’ XPEDX distribution
business. This segment of International Paper now accounts for 19% of their total
revenues, and they’re continuously growing this channel through mergers (International
10-K). Since this newfound growth opportunity is one-fifth of International Papers’
revenue, our analysis group expects the entire industry to follow them.
Distribution Access
Having a good distribution strategy is essential for firms in the corrugated
packaging and paper industry. Most of the firms ship products to the buyers straight
from the mills. This saves the extra transportation costs to a storage facility and saves
the costs associated with operating a warehouse. Cardboard and paper are durable
products, therefore there is a low chance of them being damaged during delivery to the
customer. The main distribution channels in the industry are rail and semi trucks for
domestic customers, but for shipments headed outside of the U.S. the products are
shipped to the nearest port by rail then shipped by cargo ships (KapStone 10-K). Rail
represents about 60% of the tons shipped, and the remaining 40% of the tons is
shipped by truck (Industry 10-K’s). Those two channels are the most cost effective way
of delivering products. It would be difficult for a new firm joining the market to
coordinate its distribution systems. The trucks that the industry uses in the shipping
Page | 22
process are a combination of dedicated 3rd party fleets and trucks owned by the
company (KapStone, International, Rock-Tenn, PKG 10-K’s). If a new entrant were to
join the industry then they would need to find a fleet of trucks that isn’t already being
used by one of the main firms. Also the cost of purchasing semi trucks is extremely
high. A new entrant would need a combination of owned trucks, as well as 3rd party
trucks, to be able to deliver the amount of tons that the other firms in the industry are
shipping.
Relationships
Maintaining good relationships with suppliers is important to controlling inventory
and ensuring lowest prices possible. Firms need to know if their suppliers can meet
their production demands. The only way they will know is by communicating effectively
and working together. In this industry suppliers could easily undercut you and start
doing business with the competition if there is a lack of trust and everyone being on the
same page. If a new firm comes in they will have no relationships with the suppliers, so
the suppliers could charge higher prices and creating an additional barrier to entry.
Having a positive relationship with customers is equally important. Contracts in
this industry are long. Customers need their demands met on time, with quality service
and products. If a firm underperforms in the contract, the customer will go to a
competitor. Since the contracts in this industry are about 15 years on average (PKG 10-
K), and the customer base is established, a firm trying to enter the market will find it
very difficult to make sales.
Legal Barriers
In this industry the biggest legal barriers would include environmental
regulations from the EPA, Clean Air/Water Act, and the Toxic Substance Control Growth
to name a few. These are government regulations that Packaging Corp must follow or
they are subject to fines. In 2014 Packaging Corp estimates $35 million in
environmental capital expenditures to comply with the regulations (PKG 10-K). New
firms would struggle with environmental expenditures being that high. Following these
Page | 23
regulations is very important in this industry. If a firm does not follow the regulations
they will not be able to continue operations.
Conclusion
Overall the threat of new entrants is low. It takes too much capital to start
producing goods and it is a highly regulated industry. Because the industry is so
mature, the big firms that currently serve the market already have the customers
locked in and have established good relationships with their suppliers and customers. In
an already competitive market, a new entrant would ultimately drive prices down along
with profit margins.
Threat of Substitute Products
The threat of substitutes is a key factor in determining the intensity of
competition in an industry. A substitute product can be defined as an alternative
product that has similar, if not the same, functions and provides the same benefits, but
at a more reasonable price. If there is a substitute product that serves essentially the
same functions, but has a lower price, consumers will buy the substitute. If a product
has a substitute, then the price of the product is mainly determined by the price of the
substitute. Firms in an industry that has product substitutes primarily compete on the
basis of price. Again, substitute products that make other products inferior, will
negatively impact an industry and decrease prices. For firms in the corrugated
packaging industry there is virtually no substitute for cardboard boxes. As for firms in
the paper industry, their biggest threat is the rise digital media: eBooks and online
subscriptions.
Page | 24
Relative Price and Performance
A key measure to determining if products are considered substitutes is the
relative price and performance of the two products. When an alternate product exists
that serves a similar function, then price become the primary deciding measure. Prices
come into play even more when a substitute provides the exact same function, but
more efficiently. For example, there is not a better, cheaper solution to packaging
containers and cardboard boxes. A customer could use packaging peanuts and plastic
wrap to secure their shipments, but it would cost more. There are no substitutes in the
foreseeable future for cardboard containers and boxes.
As for white paper, there is a very direct threat from media that is going digital.
EBooks now account for about 20% of publisher’s sales (USA Today). EBook sales have
been climbing rapidly in the past couple of years but have recently slowed down as
represented in Graph 1. According to digitalbookworld.com, eBook growth is no longer
in its explosive growth stages due to the market reaching its maturity and technological
innovations have slowed (Yahoo Finance). Consumers that are willing to change to
digital version have already done so. It is very likely that eBook sales will remain
constant over the next couple of years. Print books are still around 80% of publishers
revenue source. There is still a very high demand for print books, and that demand will
remain constant over the upcoming years as a result of a lack of substitutes.
Page | 25
The threat of substitutes in the corrugated packing industry is very low and the
threat of substitutes in the paper industry is low. Customers choose between the two
products based on preferences. Once a customer goes digital, there is a very small
chance of them coming back into the print editions. Packaging Corp is in the newsprint
business too, but will be exiting the newsprint market in September of 2014, due to an
even more rapid growth of consumers turning to digital newspapers.
Buyers’ Willingness to Switch
A buyer’s willingness to switch to a substitute product is primarily based off
price. In the corrugated packaging and paper industry however, a buyer’s willingness to
switch could be price, but even more so based on preference. An eBook is cheaper but
it also requires the consumer to purchase an ereader such as an iPad or Kindle. As the
population ages the generations who grew up reading print books will be replaced by
younger generations who will be more willing to switch to digital products. This could
pose a great threat to the paper industry in the long term. In the corrugated packaging
Page | 26
industry there are no efficient substitutes. A buyer could switch firms, but contracts in
the paper industry are long and there is high differentiation between cardboard
products made between firms. Packaging Corp is geographically spread out over the
US. This “local” factor could be a reason why buyers decide to do business with them.
As illustrated in Graph 3, the correlation between paperbacks bought and eBooks
bought is -1 when looking at the increasing price of an ereader. The threat of eBooks to
the white paper industry is minimal until the technology that ereaders use is
significantly cheaper, or improved significantly.
Conclusion
We have come to the conclusion that the overall threat of substitutes in the
corrugated packaging and paper industry is low. There are very few alternate products
to paper based products that provide the same benefits with a low cost. Paper has
existed for thousands of years, and there has never been a close competitor. Since
production of paper has been mastered, and there is differentiation between the
products made by the firms; firms must find ways to cut costs to be able to effectively
compete on price.
Graph 3 – Source (Hui Li)
Page | 27
Bargaining Power of Buyers
Powerful buyers can pressure a firm to reduce prices or offer special services.
Firms in the packaging products industry maintain high fixed costs; these firms are
under pressure to make enough sales to cover these fixed costs. As a result, overall
buyer power is increased. The five determinants of buyer power are switching costs,
firm differentiation, the importance of product cost and quality, the number of buyers
and the volume of sales per buyer.
Switching Costs
Switching costs, or switching barriers, reflect the costs or penalties a company
could face when switching to a new supplier. The output of the packaging products
industry is standardized; if a buyer is unsatisfied with the price or quality of a product,
then that buyer would have little difficulty finding an alternative supplier to buy from.
Although a firm could easily identify an alternative supplier that offered better prices,
the firm still might be hesitant to make a transition. A firm could encounter a gap in
production unless that firm can guarantee a constant flow of inputs while transitioning
from one supplier to another. Also, some buyers have contractual obligations with their
suppliers; the penalties involved in breaking such contracts could discourage a firm
from changing suppliers, even if the current agreement is unfavorable. Large national
firms are also limited to suppliers with similarly large distribution capabilities. For large
firms, the switching costs could lower bargaining power, but for small firms, the lack of
switching costs could raise bargaining power.
Differentiation
Firms in the packaging products industry must compete by meeting the needs of
specialized areas of the industry and by offering value-adding services. If a firm does
not differentiate, than it is forced to compete on price alone. One way to observe
differentiation is by comparing the markups different firms charge over their production
costs. This illustrates the extra value customers place on their product because firms
Page | 28
with high markups face the high demand for their products. Graph 5 illustrates the
markup each firm charges over its cost of goods sold for all of their goods in aggregate.
KapStone leads the industry in markup; overall, the firm is better than its competitors at
creating value for its customers. International Paper’s customers pay above-average
markups, but their markups have remained constant over the past three years,
indicating that the firm is not increasing its value to customers. Packaging Corporation
of America charges below-average markups; the firm is a low-cost provider, but the
slight upward trend in markups indicates that it is slowly increasing the value its
products provide to its customers. Rock-Tenn is the low cost competitor in the industry,
but it is increasing value. Overall, this graph indicates that firms are clearly able to
differentiate themselves from one another, but all firms’ markups shift according to
demand. The demand for boxes is increasing, allowing firms to compete less on price
and more on quality.
While the above graph illustrated firm-level differentiation, the industry segments
experience different amounts of differentiation. All firms produce raw containerboard,
and each firm’s production is indistinguishable from the others’. Firms in this industry
Page | 29
even exchange output with other firms in order to reduce transportation costs (PKG 10-
K). Customers of raw containerboard can seek out the firm with the best price and
suffer no decrease in quality or utility. In the finished boxes segment, all firms offer
engineering, testing, design services, but each firm offers a unique good or service.
Rock-Tenn offers just-in-time delivery and automation solutions (Rock-Tenn 10-K). PKG
specializes in radio-frequency identification tracking and value chain audits; the firm
also offers Hexacomb, a lightweight honeycomb material used for specialized
applications (PKG 10-K). International Paper specializes in packaging for tobacco
industry, and it offers SpaceKraft, a container designed for holding large amounts of
liquids (IP 10-K). KapStone offers the highest strength to weight ratio in the industry,
and the firm focuses on using less fiber and producing a clean, consistent product
(KapStone 10-K). In terms of specialized products and services, no two firms offer the
same thing; this gives customers less power to demand a lower price. The lack of
differentiation in the raw containerboard segment gives customers more bargaining
power, while the relative lack of differentiation among firms in the finished boxes
segment gives customers less bargaining power.
Importance of Product for Costs and Quality
Boxes and containerboard are not luxury goods. Customers of finished boxes
require a product that guarantees safe shipment of their goods at a low cost. Similarly,
customers in the raw containerboard segment require a product which meets minimum
specifications. Economist Diana Weiss conducted a study of the growth of shipments of
both durable and non-durable goods that use corrugated packaging. The results are
shown in graphs 5 and 6:
Page | 30
Shipments of delicate durable goods, like electronics, glass, and petroleum have
decreased, and they are forecasted to decrease for the next two years. This shift
indicates that an increasing share of this industry will require lower quality, lower cost
packaging. In the food and beverage industry, the largest growth is in shipments of
beverages, fruit, dairy, and meat; these shipments require higher-quality packaging to
protect products from damage during transport. This shift indicates that an increasing
share of customers in this segment will require higher quality, higher cost packaging.
Page | 31
The PKG 10-K stated that 42% of end users of corrugated products are in the food,
beverage and agriculture industries; the net trend will be a shift to higher cost, higher
quality boxes (PKG 10-K). The bargaining power of customers of boxes will decrease
slightly, but it will still be moderate; the bargaining power of customers of raw
containerboard will remain high.
Number of Customers
If the demand for a product is spread out among many different buyers, then no
one buyer has enough influence to affect prices. There are thousands of consumers of
packaging products and paper, and all of them are too small to make affect the
economic stability of the large suppliers. This large number of buyers lowers the
bargaining power of each firm.
Volume per Customer
In an industry serving tens of thousands of customers, no one customer
purchases enough to potentially put one of the largest vendors out of business, but
large customers can still negotiate prices. Rock-Tenn states that its top ten customers
per segment account for 17% and 29% of corrugated packaging and consumer
packaging respectively (Rock-Tenn 10-K). PKG states that no one customer accounts for
more than 10% of net sales and 2/3 of corrugated product sales are to regional and
local accounts (PKG 10-K). Even though customers of the packaging products industry
incudes large national brands, the industry itself is so large that no one customer can
dictate the prices of the industry. Some customers are large enough to warrant special
attention from firms, but the majority of customers do not purchase enough volume to
exert downward pressure on prices. The low volume per customer lowers the
bargaining power of customers as a whole.
Page | 32
Conclusion
Our team has determined that the market for packaging products is moderately
vulnerable to the bargaining power of customers. The large national customers may
face high switching costs, but small regional customers can be flexible when prices
change. The moderate level of differentiation in the finished boxes segment, and the
growing focus on quality over cost shit bargaining power away from customers; the lack
of differentiation and the focus on costs over quality in the containerboard increases the
power of customers. However, the large number of customers, and their relatively small
size in relation to total sales, reduces this power of customers to force prices down.
Overall, the power of negation remains with the customers; the packing products
industry is composed in a way that forces sellers to work hard to attract and retain
customers, who are inclined to seek out the supplier with the best prices. The power of
customers is moderate, as customers are likely to change suppliers if costs are lower,
but these customers are unable to force large price decreases.
Bargaining Power of Suppliers
The packaging and corrugation industry is highly competitive. Throughout the
industry, it is difficult for companies to differentiate themselves to gain an edge in
customer base. The packaging industry has three main suppliers due to the high
demand of their products. The three main suppliers are the commodities market, timber
from land leased by the firm, and trading with other firms in the industry.
Switching Costs
The costs associated with switching suppliers would come from the volatility of
the commodities market. If wood pulp prices to rise then it would be cheapest to
harvest the wood on the land the firm owns. Although doing so would increase the
costs of related activities, like transportation of wood to the mill, so it would likely cost
Page | 33
just as much. Therefore switching costs associated with switching suppliers is less
significant than buyers switching costs.
Number of Suppliers
Suppliers for the industry are mainly commodities market, leased timberland, and
temporary trading with other firms. The corrugated packaging and paper industry has
few suppliers. Firms in this industry historically owned most of the timberland they were
harvesting. In 2012 firms sold the land to pay off debts and eliminate land management
costs (Industry 10-K’s). Now land is leased for around 15 years on average, and is used
when the companies need to meet increases in demand. Temporary trading is the least
common of the supply forms. Companies use this when there is a sudden increase in
demand and there is no time to convert timber into wood pulp. One company simply
borrows the refined wood pulp from another company, and replaces it in the future.
Wood pulp obtained from the commodities market is probably the most risky because of
the risks of open market trading. If a firm could properly hedge the costs of wood pulp
on the market, it could lead to higher profitability.
Conclusion
We conclude the bargaining power of suppliers is moderate in this industry.
There are only a few suppliers but there is not a big pricing difference between them.
The products offered by the suppliers are essentially the same so switching costs are
low. Therefore, the industry is indifferent about which supplier is used.
Key Success Factors for the Industry
Profitability of a firm can be determined by the strategies it uses regarding its
position in its industry. Firms have two choices when it comes to competitive strategy,
cost leadership and differentiation. Costs leadership is the best choice in this industry. It
focuses on lowering unit costs. Cost leadership can be implemented by using economies
of scale, efficient production, and simple product design. Firms that use differentiation
Page | 34
as their competitive strategy use brand image, unique products, and quality to set them
selves apart from the industry. For a firm to gain a competitive advantage using
differentiation they must have unique products and high quality.
This industry relies heavily on cost leadership to remain competitive. Key factors
in this industry will be economies of scale and efficient production, simple product
design, and tight cost control. Companies cannot however, ignore the benefits of
differentiation. If a firm in this industry can provide a unique product or service can still
create a significant competitive advantage over the competition. This industry is highly
competitive and firms need to find the best mix of strategies to create the biggest
competitive advantage.
PKG’s Competitive Advantages
Firms in the packaging products and paper industry face heavy competition; they
must find ways to streamline production and reduce costs or see their margins shrink.
PKG has developed a competitive advantage in this industry through controlling input
costs, utilizing economies of scale, and simple product design. The designs are simple,
therefore, the process to create the designs has minimal costs. Packaging corporation
states in their 2013 10-K that it faces large competitors who “may have greater
manufacturing economies of scale, greater energy self-sufficiency, or lower
manufacturing costs,” but this statement is conservative. Due to its relatively small size,
PKG lags behind its two larger competitors in terms of manufacturing costs and
economies of scale, but the firm is making investments to move forward and decrease
this gap in performance.
Economies of Scale & Efficient Production
Firms in the packaging products and paper industry must take advantage of
large production capabilities and efficient production in order to mitigate huge fixed
costs. PKG does use the same economies of scale as its larger competitors. The firm is,
however, consolidating its operations and making strategic acquisitions to increase its
capacity and lower manufacturing costs. In 2013, PKG acquired Boise, a private
Page | 35
company which specializes in producing containerboard –a critical component in PKG’s
production process. By reducing dependence on outside suppliers, PKG has insulated
itself from price fluctuations of this essential production component. With the
acquisition of Boise came the Tharco product line of stock boxes designed for
“customers who do not require custom packaging solutions,” this will add capability to
produce more efficiently and without delays (PKG 10-K). Finally, when PKG acquired
Boise, it received $1.59 billion in property, plant and equipment which will enable them
to boost production and reduce per-unit costs. PKG already uses flexible milling
machines which can shift between fiber input sources depending on price changes of
these fibers, which allows PKG to keep costs low (PKG 10-K). Overall, PKG is positioning
itself to take advantage of increased economies of scale and production efficiency,
allowing the firm to stay competitive as it grows its market share.
Simple Product Design
A firm must stick with what it knows best. In this case, it’s important that
Packaging Corp focuses more on it corrugated packaging because that’s where most of
its revenues come from. According to Packaging Corp. of America’s 10-K most
corrugated products are manufactured to the customer’s specifications and corrugated
producers generally sell within a 150-mile radius of their plants and compete with other
corrugated producers in their local region. The markets in which Packaging Corp. of
America’s paper segment competes are large and highly competitive. Commodity
grades of white paper are globally traded, with numerous worldwide manufacturers,
and as a result, these products compete primarily on the basis of price. In general,
paper production does not rely on proprietary processes or formulas, except in highly
specialized or custom grades. Shifting priorities to their white paper segment could
minimally increase that segments revenue but in the long run it would decrease the
firms overall revenue. Designing and selling corrugated packaging products is their
biggest strength. Packaging Corp is the only firm in the industry that has a design
center in Asia to help contribute to the best designs possible.
Page | 36
Tight Cost Control
Tight cost control relating to distribution costs is important in maintaining a
competitive advantage. This industry is so competitive that even the smallest advantage
gives the firm an upper hand in determining prices and expanding its customer base.
Some examples of costs that the industry can have a tight control over are: fuel,
freight, storage, and shipping costs. Cardboard boxes are light and cheap so it is ideal
to ship as much as possible in one load. Shipping small amounts can lead to an overall
loss on that sale because it is not economical.
Having a tight control over costs is a key factor for success in the corrugated
packaging and shipping industry. Firms that can actively control their costs and keep
them at a minimum are the industry leaders. Many firms in the industry do not ship
straight from their production mills. Instead, they ship to a warehouse or another
central location, and then ship to the customers from there. These extra shipping costs
are a big expenditure to these competing firms. Packaging Corp ships from their mills,
or they temporarily rent a storage facility to ship large orders in one load. According to
PKG’s 10-K corrugated products plants tend to be located in close proximity to
customers to minimize freight costs. The U.S. corrugated products industry consists of
approximately 570 companies and 1,240 plants.
With Packaging Corps geographically spread out customers, Packaging Corp
must have mills within a 150-mile radius to keep these distribution costs as low as
possible. The entire industry is practically a vertical structure, meaning that the firms
lease the land for timber, produce the pulp, and make and ship the products. Vertical
integrations make it easy to keep costs down, by having the ability to keep their own
supply themselves and monitor the distribution of materials. Packaging Corp and its
competitors give detailed information about their facilities including: location, types of
products, types of wood pulp used, and production capacity.
Page | 37
Lower Input Costs
In industrial applications, input costs account for a large portion of product costs,
and a firm which fails to manage these costs will see reduced margins. In the packaging
products and paper industry, wood fiber and energy are the largest inputs, and the
prices of both fluctuate heavily. PKG has created a competitive advantage by taking
steps to control input costs. Firstly, PKG has negotiated long-term contracts with
suppliers to insulate themselves from, or delay, fluctuating input costs. PKG also uses
byproducts of the production process as fuel; almost 64% of the energy consumed was
produced using mill byproducts, with the other 36% coming from purchased fuels (PKG
10-K). Unlike their largest competitors, PKG leases timberland which they use to
produce wood fiber. PKG leases 99,000 acres of timberland, and own the cutting rights
and leases 9000 acres for a fiber farm; this reduces uncertainty and guarantees
constant flow of inputs (PKG 10-K). Unlike its competitors, PKG does not use recycled
materials heavily in its products; recycled fiber accounted for less than 15% their mills’
fiber requirement in 2013 (PKG 10-K). This is advantageous because recycled fiber is
more expensive than virgin wood fiber. All of these factors combine to give PKG more
control over their input costs relative to their larger competitors.
Accounting Analysis
Identify Key Accounting Policies
When valuing a firm, it’s imperative for the analyst to determine the type of
accounting policies utilized. This is because firms are permitted material leeway in their
choice of policies, which implicitly affect the value. The analyst should identify these
policies as either type one or type two key accounting policies prior to performing the
value analysis. Type one policies explore the link between key success factors and how
the firm’s operations account for them. Type two policies involve the accounting
Page | 38
methods of items that may substantially affect the value of the firm. The following
portion will initially discuss type one accounting policies, which include economies of
scale; low input cost, simple product design, and tight cost control. Secondly, type two
accounting policies will be discussed, which include goodwill and defined benefit
pension plans.
Type One Key Accounting Policies
Economies of Scale
Economies of scale are reductions in per unit cost that arise from large volume
production. The price reduction typically results from the ability to spread fixed costs
over a larger number of units. Scale economies exist in the packaging industry but are
limited by raw material supply. To achieve efficient production in an industry with
economies of scale, a firm must either use fewer inputs to achieve the same end
product or use the same amount of inputs to produce a superior product. Below is a
table showing industry fixed-asset turnover. The higher the fixed-asset ratio turnover,
the more effective the company was in using investments in fixed-assets to generate
revenues.
The packaging industry inputs consist mostly of raw materials with fluctuating
prices. A producer’s ability in this industry to invest in assets for maximum vertical
integration that allows the company to best cover losses from fluctuating prices or
decreased demand will give that company a higher fixed-asset turnover ratio. As you
Year 2009 2010 2011 2012 2013
Packaging Corp.
of America1.05 1.11 1.13 1.17 0.96
Rock-Tenn Co. 0.95 1.04 0.8 0.87 0.89
Kapstone Paper
and Packaging
Corp.
0.91 1.13 0.98 1.08 0.92
International
Paper Company0.89 0.99 0.99 0.94 0.91
Fixed-Asset Turnover
Page | 39
can see from the data, PKG has the best fixed-asset turnover ratio among its industry
peers. This is due to their recent investments in plants and equipment that can produce
containerboard or paper depending on the current market pricing and needs.
Low Input Cost
Containerboard is primarily made from fiber. To be competitive in the packaging
industry, firms must have the ability to acquire timber at the lowest cost possible. Firms
in the industry commonly purchase or lease land for harvesting fiber. The land
purchased typically has a useful life of 10-15 years. Firms can also acquire the materials
needed for production from recycled fibers (OCC). Prices for recycled fibers however
have been increasing for the last two years. They also require firms to use machinery
dedicated to recycled fibers.
Due to the rise in OCC prices, firms who did not switch to accommodate recycled
fibers are achieving a competitive advantage over those who did. In the packaging
industry, Packaging Corporation has the lowest OCC use.
Page | 40
Simple Product Design
A firm must stick with what it knows best. In this case, it’s important that
Packaging Corp focuses more on it corrugated packaging because that’s where most of
its revenues come from. Corrugated products need to be able to get the shipped
product safely to the customer. Corrugated packaging is simply cardboard boxes.
Therefore, it is not necessary to have complex and expensive designs, because in the
end the cardboard will be disposed of. According to Packaging Corporation of America’s
10-K most corrugated products are manufactured to the customer’s specifications and
corrugated producers generally sell within a 150-mile radius of their plants and compete
with other corrugated producers in their local region. The markets in which Packaging
Corp. of America’s paper segment competes are large and highly competitive.
Commodity grades of white paper are globally traded, with numerous worldwide
manufacturers, and as a result, these products compete primarily on the basis of price.
In general, paper production does not rely on proprietary processes or formulas, except
in highly specialized or custom grades. Shifting priorities to their white paper segment
could minimally increase that segments revenue but in the long run it would decrease
the firms overall revenue. Designing and selling corrugated packaging products is their
biggest strength. Packaging Corp is the only firm in the industry that has a design
center in Asia to help contribute to the best designs possible. A simple, perfected design
can prevent overuse of materials during production. It can also prevent PKG from
purchasing too much raw materials that they may not use and cause a waste of money
and resources.
Tight Cost Control and Low Distribution Cost
Tight cost control relating to distribution costs is important in maintaining a
competitive advantage. This industry is so competitive that even the smallest advantage
gives the firm an upper hand in determining prices and expanding its customer base.
Having a tight control over costs is a key factor for success in the corrugated packaging
Page | 41
and shipping industry. Firms that can actively control their costs and keep them at a
minimum are the industry leaders.
Many firms in the industry do not ship straight from their production mills.
Instead, they ship to a warehouse or another central location, and then ship to the
customers from there. These extra shipping costs are a big expenditure for the
competing firms. International Papers 3rd party distributers were so expensive, that IP
decided to acquire distribution companies in order to eliminate the extra costs of paying
someone else for the service. Packaging Corp ships from their mills, or they temporarily
rent a storage facility to ship large orders in one load. According to PKG’s 10-K, the
U.S. corrugated products industry consists of approximately 570 companies and 1,240
plants. Corrugated product plants tend to be located in close proximity to customers to
minimize freight costs.
Some examples of costs that the industry can have a tight control over are: fuel,
freight, storage, and shipping costs. According to PKG’s 10-K, PKG applies the use of
rail cars to bring in coal, chemicals, fuel, pulpwood, and recycled fiber. These same rail
cars ship 60% of containerboard produced in their mills with the remaining 40%
shipped on trucks. The leasing of these rail cars and the decision to have production
plants within 150 miles from customers, we conclude that PKG distribution system
allows PKG to drive costs down in places other companies in the industry have yet to
consider, giving them a considerable competitive advantage.
Type Two Key Accounting Policies
Type two Key Accounting Policies reflect items on a firm’s financial statements
which could potentially distort an investor’s valuation of the firm. In the packaging
products industry, type two KAP’s include goodwill accounting, operating leases and
R&D expenditures. This section will analyze PKG’s treatment of these potentially
misleading items and determine if an alteration to the financial statements is required
to fairly represent the firm.
Page | 42
Goodwill
Goodwill is an intangible asset that is associated with the acquisition of a
company. When a company is acquired, if the purchase price is above book value, the
difference is accounted for by goodwill. Reasons for a premium purchase price can
include: company brand, customer base, patents, or a competitive advantage. Goodwill
is reported in the asset portion of the balance sheet, even though goodwill is not a
physical asset. Impairment tests can be performed annually or more often depending
on financial events. Goodwill has flexible rules when reporting, and can be manipulated
more easily than other assets on the balance sheet. Below is an industry overview for
goodwill in the corrugated packaging industry.
Corrugated Packaging Industry - Goodwill in thousandsYear 2009 2010 2011 2012 2013
Goodwill
Reported38,854 38,854 58,214 67,160 526,789
% of
Total 1.80% 1.75% 2.41% 2.73% 10.13%
Goodwill
Reported736,400 748,800 1,839,400 1,865,300 1,862,100
% of
Total
Assets
25.53% 25.69% 17.41% 17.45% 17.35%
Goodwill
Reported544,900 481,000 2,371,930 2,262,890 5,285,150
% of
Total
Assets
0.81% 0.67% 21.10% 19.92% 19.93%
Goodwill
Reported2,290,000 2,308,000 2,346,000 4,315,000 3,978,000
% of
Total
Assets
8.96% 9.10% 8.68% 13.42% 12.65%
Rock-Tenn Co.
Packaging
Corp. of
America
Kapstone Paper
and Packaging
Corp.
International
Paper Inc.
Page | 43
PKG has goodwill balances than its competitors in the industry. Packaging Corp
did not have significant goodwill stated on their balance sheets until they acquired
Boise; PKG’s goodwill increased in 2013 by almost $500 million as a result of the
acquisition. If impairment tests conclude goodwill has broken the threshold, then
restatements will have to be made. Our valuation team will determine if these
restatements need to take place later on in this evaluation.
Defined Benefit Pension Plans
Pension plans are utilized to provide firms with a future stream of cash flow
payments for employees when they choose to retire. When selecting a pension plan,
firms have two options: a defined benefit pension plan, or a defined contribution plan. A
defined benefit pension plan uses variables pertaining to employees to pay them with a
structured monthly payment. Variables used as determinants include the employee’s
age, responsibility, and pay structure, as well as other factors. Within a defined benefit
plan, the cumulative assets of the benefactors are pooled together in investments,
which are then redistributed depending on the aforementioned variables. To ensure
proper fund levels, the firm must forecast expenses that may be incurred. The accuracy
of the prediction is imperative in forecasting, but is largely dependent on a discount
rate that is created by the firm. If the applied discount rate does not properly represent
the needs of the firm’s employee base, then the funding of the plan will consequently
reflect the error. Similarly, a firm may utilize a defined contribution plan. In a defined
contribution plan, individuals’ investments are separately invested contingent on their
preferences. This allows the firm to more accurately forecast, because of knowledge of
their payments into the employees’ individual retirement accounts.
The discount rate used in forecasting will largely influence the amount of
liabilities the firm is expected experience in the future, and often raises red flags in the
valuation process. If the firm chooses an aggressive approach, they may utilize a lower
discount rate, which results in higher future liabilities. Conversely, if the firm chooses a
conservative approach, a higher discount rate will be utilized, which results in lower
future liabilities. Dependent on the firm’s stance, they may grossly over- or under-state
Page | 44
liabilities of present value. At year-end 2013, PKG recognized the unfunded status of
the benefit plan to be $929.82 M.
As represented in the table below, PKG has chosen a conservative stance relative
to its industry competitors. They have attempted to reduce future liabilities by
increasing the discount rate, when most competitors have taken an aggressive stance
by decreasing their discount rate.
Assessing Accounting Flexibility
Accounting flexibility reflects the conventions of an industry and the goals of
firms’ management. GAAP sets minimum standards for accounting disclosure, but these
rules rely heavily on estimates. This flexibility in disclosure can work in favor of
investors when companies provide extra information and analysis, but accountants also
have the opportunity to misrepresent the health of a business. In this section, we will
analyze Packaging Corporation’s accounting policy regarding accruals, goodwill and R&D
and determine that Packaging Corp has limited flexibility due to the relatively small
presence of accounts that are subject to manipulation.
Actual Accounting Strategy
There are two main types of accounting strategies: conservative and aggressive.
A conservative approach focuses on maximizing transparency and providing full
disclosure. An aggressive approach focuses on maximizing firm value through
manipulative accounting strategies. A firm’s managers ultimately decide which strategy
to use. Both strategies must comply with at least the minimum requirements of GAAP,
Page | 45
the guidelines for financial statements reporting. In the corrugated packaging and
paper industry, accounts like goodwill, operating leases, research and development and
pension plans that need to be further analyzed. Analyzing these accounts can have a
significant effect on the value of a company, so it important for investor to not overlook
these.
Goodwill
Compared to the rest of the industry, Packaging Corp has had no Goodwill up
until 2013 when they purchased Boise, Inc. Other firms in the industry appear to enter
mergers and acquisitions more frequently. Therefore there is no reason to restate
goodwill because it will have such an insignificant effect on the financial statements.
Operating Lease Obligations and R&D
Operating lease obligations make up .02% of total liabilities for Packaging Corp.
Therefore it is also insignificant to capitalize and restate the financial with respect to the
operating lease obligations. Competitors disclose little to no information about capital
operating leases. Research and development refers to spending capital to develop new
products or services, for the future benefits of increased profits. Research and
development also plays a very small role in the financial statements of Packaging Corp.
There is no reason to restate R&D, as it would have no effect on the valuation.
Conclusion
Packaging Corp has a good accounting strategy compared to its competitors. It
discloses all the information that it necessary for analysts to perform a complete
valuation. Packaging Corps management has been consistent with their accounting
disclosure policies.
Page | 46
Quality of Disclosure
Analyzing the quality of disclosure is an important part in evaluating a company’s
financial situation. Companies and their managers have many tools at their disposal to
present what material information they want. The consequences and nature of the
material the present in the financials can have a positive or negative effect on the
valuation of the firm. The quality of a valuation is directly tied into the quality of
disclosure in the firm’s financial statements.
Our analysis team will review the quality of the firm’s financial statements in
order to create an accurate valuation of the firm. Some firms choose to disclose the
minimum amount of information that will satisfy the Generally Accepted Accounting
Principles (GAAP), which are the guidelines for financial accounting standards.
Sometimes this leads firm to leaving out material and relevant information that occurred
during the time period of the financial statements. It is important to determine if a firm
has a high or low quality of disclosure because this will ultimately determine the quality
of the valuation of the firm.
A firm faces advantages and disadvantages based of the amount of disclosure
they provide in the financial statements. Managers for the firm can have incentives that
are based on the performance of the financial reports of the firm, which can lead them
to misrepresent the balance sheet and earning. This can lead investors to a false
valuation, and can mislead creditors to the conclusion that the firm is more credit
worthy than they really are. If managers conservatively state the financial, as in
reporting the financials as honest as possible, then creditors and investors can properly
valuate the firm. Conservative reporting can lead to either good or bad changes in the
stock price.
Packaging Corporation discloses a large amount of information, but some of the
information is irrelevant to performing a valuation. The managers also hide expenses
and depreciation in accounts such as Capital Operating Leases and Goodwill. For
example Packaging Corp covers its R&D in a paragraph that’s separate from the income
statement, while other firms in the industry discuss it as a line item in the income
Page | 47
statement. Packaging Corp also covers in its 10-K the “tons shipped” per period, while
other firms do not discuss this in detail. This information can be useful in determining if
the industry is growing or if prices and costs are increasing. In general the entire
industry reports, in the notes sections, about the accounting methods used for specific
line items. The industry as a whole has a high transparency with its financial
statements.
Quality of Disclosure of Economies of Scale
The industry is relying on economies of scale to drive costs down. If a firm
cannot create an economy of scale then they will become uncompetitive and be forced
out of the industry. This industry requires a lot of property, plant, and equipment to
create an economy of scale. The 10-Ks of Packaging Corp and its competitors clearly
give the location of its facilities, and the output per facility. Depreciation of equipment is
clearly stated in the financials along with which facilities are under construction, or
being upgraded to improve production capacity.
Quality of Disclosure of Tight Cost Control
Packaging Corp and its competitors clearly state the risk associated with
transportation cost. Increases in the cost of fuel are a great threat to its distribution
costs. Industry 10-Ks do not go into detail about the actual costs of each shipping
expense. If these details were disclosed it would be easier to determine the real risk of
rising fuel costs would have. Also disclosing if they are hedging fuel costs would be a
huge benefit to help in creating an accurate valuation. Our analysis team concludes that
the quality of disclosure on tight cost control systems in low.
Quality of Disclosure of Low Input Costs
Input costs control is important for firms in an industry, like the corrugated
packaging and paper industry, which compete on low prices. Unfortunately, Packaging
Corp gives low detail on its input costs. This industry has three ways of receiving wood
pulp, and in the financial it does not say when and if they utilized the one with the
Page | 48
lowest price. It would be crucial to know whether they were producing their products
using wood pulp bought in the open market, made themselves, or bought from another
competitor to be able to tell if the really were trying to keep their input costs down.
Packaging Corp also does not disclose that the price of wood pulp has been greatly
fluctuating over the past 10 years.
Quality of Disclosure on Simple Products
Cardboard packaging is simple. Some products, like wine and glassware, need
specialized shipping containers to keep them from breaking during transit. It is
important to develop a design that can meet the standards and needs of the customers.
Most customers just need a simple box to ship their products in. It is important for a
firm to figure out where there strengths are and stick to them. For example if Packaging
Corp were to only focus on selling the simple designs they would lose the high profit
margins of the customized shipping containers. At the same time though most of their
revenue comes from the more simple designs. The industry needs to be sure they
balance out the designs and cardboard type customer base to maximize their margins.
The industry discloses that they have just a small customer base that desires highly
specialized cardboard designs, so they focus more on simple design which are easier to
mass produce.
Conclusion
Our analysis team concludes that Packaging Corporation of America has a
medium quality of disclosure relating to their financial statements. Packaging Corp
provides plenty of quality information in their financials for our investment team to
create a detailed analysis.
Page | 49
Identify Potential Red Flags
When preforming an accounting analysis, a common approach is to look for “red
flags” that point to questionable accounting. These red flags do not always represent a
definite occurrence of financial statement fraud. They signal that further research must
be conducted to assess the validity of the financial statements. Common red flags
include unexplained changes in accounting, unexplained transactions that boost profits,
unusual increases in accounts receivable and inventories in relation to sales increases,
and large fourth-quarter adjustments. All red flags have multiple interpretations
therefore it is best to use red flags as a starting point for further investigation.
Potential accounting red flags include operating leases, inflated goodwill and
overstatement of research and development expenses. In this section, we will analyze
Packaging Corporation’s financials with respect to these potential red flags and conclude
that there is no need for restatements.
Operating Leases
When firms lease fixed assets, they can utilize either capital or operating leases.
This is a significant decision for the firm as both have different effects on the financial
statements. When utilizing a capital lease, the lessor transfers some risk of ownership
to the lessee, which ultimately affects both the balance sheet and the income
statement. Operating leases, however, allow firms to recognize only the current portion
of the lease expense on the income statement as an operating expense; the operating
lease does not appear to be part of the firm’s capital. Firms using a significant amount
of operating leases may need to have their financial statements restated, which will
allow the analyst to better understand the firm’s future obligations.
Neither Packaging Corporation nor its competitors utilized a meaningful amount
of operating leases to require the restatement of the financial statements. Compared to
long-term liabilities, the operating leases if capitalized would not reach the threshold to
substantially alter the debt to asset ratio. The threshold utilized in analysis was to verify
that operating lease obligations did not increase long term liabilities by more than 20%,
Page | 50
as seen below. Graph 3 below shows the spread between total non-current liabilities,
the 20% ceiling lease liabilities can reach before they are considered material and the
amount of Packaging Corporation’s undiscounted lease liabilities.
Operating lease liabilities have remained flat from 2008 to mid-2013; the
acquisition of Boise in late 2013 increased lease liabilities by almost 40%, but the
acquisition also doubled non-current liabilities. Packaging Corporation is not at risk of
carrying excessive operating lease obligations. Graph 4 provides a closer look at the
margin of safety between the undiscounted operating lease liabilities and the 20%
ceiling for materiality.
Page | 51
At their highest point, the operating lease liabilities do not even exceed 15% of
non-current liabilities. The large increase in non-current liabilities due to the Boise
acquisition has diluted the significance of the lease liabilities. Packaging Corporation’s
lease obligations are fairly represented on the financial statements.
Goodwill
If a firm fails to impair goodwill, they are potentially holding on the books an
asset that has no future benefit. We have conducted impairment tests of goodwill under
the assumption that goodwill has a three year life due to the short-lived nature of
competitive advantages in the packaging products industry. Our first test for the
requirement of restatement analyzes the effect goodwill impairment would have on
operating income. Our threshold for restating the value of goodwill is if the impairment
of goodwill reduces operating income by more than 30%. Graph 5 illustrates the
potential for an impairment of goodwill to reduce operating income.
100.0
150.0
200.0
250.0
300.0
350.0
400.0
450.0
500.0
2008 2009 2010 2011 2012 2013
Mill
ion
s o
f D
olla
rs
Year
Goodwill Impariment Reduces Operating Income by Less Than 30%
Operating Income BeforeImpairment
30% Income Reduction Floor
Operating Income AfterImpairment
Page | 52
The uppermost line is operating income at stated; the line below that represents
operating income after impairment to goodwill; the lowest line represents the lowest
operating income could fall before a restatement would be required. Operating income
after goodwill impairment is well above the minimum threshold for restatement, so this
first test shows that a restatement may not be required.
We conducted a second test to check if goodwill accounted for more than 30%
of net property plant and equipment. A firm which exceeds this threshold would be
unfairly stating on their balance sheet a large asset which has a limited potential to
create future value. Graph 6 illustrates the relationship between goodwill and fixed
assets.
Goodwill accounts for less than 30% of net PP&E; the second test shows the
same result: impairing goodwill would not have a material effect on the financial
statements of Packaging Corporation. A restatement is not required.
-
500
1,000
1,500
2,000
2,500
2008 2009 2010 2011 2012 2013
Mill
ion
s o
f D
olla
rs
Year
Goodwill Acocunts for Less Than 30% of Net PP&E
Net PP&E
30% Threshold
Goodwill
Page | 53
Research and Development
Research and development is an investment, but GAAP does not allow R&D
expenses to be capitalized. Firms with substantial R&D are not accurately represented
unless these expenses can be translated into assets. Our threshold for capitalizing R&D
is if the related expenses reduce operating income more than 20%. Beyond this point,
the value and future benefit of R&D is not fairly reflected, and it should show up as an
asset. The graph below illustrates how R&D expenses reduced operating income.
The uppermost line represents operating income before R&D was expensed; the
middle line represents operating income as stated; the lowest line represents the lowest
operating income could fall (due to R&D expense) before a restatement would be
required. In Packaging Corporation’s case, R&D expenditures did not have a material
effect on the income statement. Restating the financials to reflect the capitalization of
R&D expenses would not have a material effect on the representation of Packaging
Corporation.
Page | 54
Conclusion
Our team has performed an analysis of Packaging corporations potential red
flags, and we have determined that the potentially misleading areas of goodwill,
operating leases and R&D all fall within the tolerable limits. The financial statements are
an accurate representation of the obligations, assets and expenses of Packaging
Financial Analysis
When examining a firm’s value, two types of financial analysis must be utilized:
ratio analysis and cost flow analysis. Throughout this section, we will use these analysis
methods to conduct trend and cross-sectional ratio analyses, financial statement
forecasting and estimation of the cost of capital. Ratio analysis is an overall assessment
of a firm or firms’ performance and it provides an objective overview of industry and
firm-specific trends. This section will examine PKG’s financial ratios and compare them
to its peers within the industry. Following ratio analysis, the financial forecasts will be
analyzed, which ultimately will provide a foundation for valuing the firm. Lastly, this
section will estimate the cost of equity, the cost of debt and the weighted average cost
of capital. When analyzing the financials of PKG and its peers, it is important to note
that all firms do not all have the same fiscal year end. While PKG, IP, and KS all share a
fiscal year end of December 31st, RKT does not. Rock-Tenn Co.’s fiscal year end is
September 30th, which causes their ratio analysis to cover a different period of time.
Liquidity and Operating Efficiency Ratios
Liquidity ratios reflect how able a firm is to satisfy its debt obligations using its
assets. Simply put, liquidity is how quickly an asset can be converted to cash. Similarly,
operating efficiency ratios reflect how quickly a firm can turn its products or services
into cash. It is imperative for a firm to maintain this level to keep efficient operations
and keep up with liabilities coming due. This section will analyze and examine the
Page | 55
following ratios: the current ratio, quick ratio, inventory turnover, inventory days,
accounts receivable turnover, accounts receivable days, and working capital turnover.
Current Ratio
The current ratio is used to analyze a firm’s ability to use its short-term assets to
satisfy short-term liabilities. The current ratios displayed below were calculated by
dividing the total current assets by the total current liabilities. In general, if the
resultant current ratio is less than one, the firm is considered risky and it’s current
financial position unfavorable. This is because the current ratio tells you the amount of
current assets available (in dollars) to pay for every one dollar of debt or current
liabilities. If the value is less than one then the firm would unable to pay for all of its
current liabilities within the year with all of the liquid assets. Conversely, if a firm has a
current ratio that is substantially larger than one, it may signify that the firm is poorly
managing its receivables and inventory, and thus minimizing their growth potential.
Page | 56
Packaging Corporation’s annual current ratio was higher than its industry peers
until 2011. In 2012 PKG’s current ratio rises to its highest value of 3.60. We see this as
preparation for the acquisition of Boise Inc., due to the 31% decrease in current
liabilities and a 33% increase in cash (PKG 2013 10K). Packaging Corporation
approaches its mean current ratio value following the acquisition, and it is the industry
leader as of 2013.
Quick Asset Ratio
The quick asset ratio is similar to the current ratio in comparing current assets to
total current liabilities, but it varies in that it only includes assets that are quickly
convertible to cash. This includes: cash, accounts receivables, and short-term
investments. Inventories (although considered a current asset) are not included
because it may be difficult for a firm to quickly turn the inventory to cash; the quick
asset ratio removes illiquid assets from consideration. Like the current ratio, a quick
asset ratio equal to or greater than one conservatively shows the firms capability of
satisfying its current liabilities. It also important to note that a quick asset ratio less
than one is not always detrimental to a firm because the inventories are not taken into
account and are generally a large portion of current assets.
Current Ratio 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 1.75 2.39 1.98 2.15 3.60 2.25 2.35
IP 1.55 1.88 1.78 2.21 1.78 1.76 1.83
KS 1.50 1.51 1.91 1.85 1.34 1.78 1.65
RKT 1.09 1.47 1.12 1.69 1.56 1.94 1.48
Industry Average 1.38 1.62 1.82 3.32 3.85 2.40 2.40
Page | 57
Similar to the current ratio, Packaging Corporation’s liquidity remains competitive
with the industry average and its industry peers until 2011, when it increased its current
assets in anticipation of the Boise acquisition. PKG remains the industry leader as of
2013.
Inventory Turnover
The inventory turnover ratio provides insight about a company performance
relative to its industry peers. A low ratio may indicate that a firm has low sales or
greater on hand inventory than is necessary. Furthermore, a low ratio suggests poor
firm health due to excessive investment in inventory, which is subject to depreciation,
possible obsolescence and price volatility. A high ratio is indicative of strong sales and/
or efficient management of inventory. Firms which are capable of managing their
Quick Asset Ratio 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 1.18 1.81 1.38 1.48 2.57 1.46 1.65
IP 1.49 1.79 1.26 1.72 1.24 1.21 1.45
KS 0.80 0.94 1.28 1.04 0.78 0.98 0.97
RKT 0.66 0.85 0.70 1.05 0.94 1.19 0.90
Industry Average 0.98 1.20 1.21 2.14 2.37 1.47 1.56
Page | 58
inventory efficiently are able to gain an advantage because they are able to avoid
investing extra capital into inventory. Below, the inventory turnover ratios were
calculated by dividing cost of goods sold by inventory.
PKG’s inventory turnover ratio has generally been above the industry average
and its peers. The Boise acquisition in 2013 distorted this ratio because PKG acquired
the firm’s entire inventory balance while it was only able to recognize two months of the
firm’s revenues.
Days Supply of Inventory
The days supply of inventory ratio measures the span of time a firm takes to
convert their inventory into revenue and is the first step in the cash to cash cycle.
Similar to the inventory turnover ratio, the days supply of inventory (DSI) ratio provides
Inventory Turnover 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 9.03 8.08 7.90 8.15 8.19 5.37 7.78
IP 7.51 6.98 7.87 8.17 7.54 7.51 7.60
KS 4.02 5.82 8.75 6.44 8.55 6.10 6.61
RKT 8.12 7.45 8.45 5.19 8.90 8.21 7.72
Industry Average 6.55 6.75 8.36 6.60 8.33 7.27 7.31
Page | 59
a measurement in days of how efficiently the firm manages its inventory. A lower DSI is
ideal, as it reduces the amount of time that a firm’s capital is tied up in inventory.
Below, the ratios were calculated by dividing inventory by cost of goods sold and
multiplying their quotient by 365.
As seen in the above information, PKG was able to turn over its inventory in the
shortest amount of time relative to its peers. There is not much segmentation within
the firms with regards to their DSI, which indicates that the firms’ management within
the industry are efficiently managing inventory. In 2013, PKG’s DSI rose to 68.03 days
to turn over their inventory, causing them to have both their highest and the industry’s
highest ratio at the end of the year. This rise is largely attributable to the acquisition of
Boise Inc., which caused a 53% increase in inventory and 21% increase in cost of
Days Supply Inventory 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 40.43 45.17 46.22 44.79 44.57 68.03 48.20
IP 48.59 52.26 46.35 44.66 48.40 48.59 48.14
KS 90.75 62.72 41.70 56.71 42.68 59.87 59.07
RKT 44.97 48.96 43.20 70.38 40.99 44.47 48.83
Industry Average 61.44 54.65 43.75 57.25 44.02 50.97 52.01
Page | 60
goods sold from the 2012 levels (PKG 10K). Following a large acquisition it’s expected
for there to be an effect on the efficiency, which is evident on the 2013 DSI value for
PKG and the 2011 value for RKT. Overall, PKG has been able to manage an average
DSI value of 48.20 days, which is four days better than the industry.
Accounts Receivables Turnover
The accounts receivables turnover provides insight into how efficiently a firm
collects its outstanding short-term debt and accounts receivable. A higher turnover ratio
is favorable because accounts receivable do not gain interest. Therefore, a higher ratio
suggests that a firm is productive with their credit policies. It is also important to note
that the use of accounts receivables is highly dependent on the type of industry the firm
is situated in. Due to the nature of the corrugated paper and packaging industry sales
are typically conducted on credit, yielding an accounts receivable. Below, the ratio is
calculated by dividing the annual sales by accounts receivables.
Page | 61
PKG was not subject to the volatility experienced by the rest of the industry, but
as of 2013 it had the smallest A/R turnover. PKG was dominant in its ability to collect
revenue from credits in 2011, yet it has become increasingly inefficient through 2013.
Accounts receivables have grown 45% from 2012 (PKG 10K), but efficiency has
decreased, which may be attributable to the acquisition of Boise Inc. While PKG has a
healthy average A/R turnover 8.06 days, Kapstone and Rock-Tenn Co. indicate more
efficient management of their receivables.
Days Sales Outstanding
The days supply outstanding (DSO) ratio further expands on the accounts
receivables turnover and is the second step in the cash to cash cycle. This ratio
indicates the duration of time in days that it takes for the firm to collect on its
receivables. Generally, a lower value is preferable. This denotes that the firm is able to
efficiently collect on its credit sales, and thus has greater cash flows. The data shown
below was calculated by dividing accounts receivables turnover by 365 for the amount
days in the period.
Accounts Receivable Turnover 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 9.25 8.83 8.29 8.19 8.08 5.70 8.06
IP 7.55 8.67 7.45 6.88 7.16 7.17 7.48
KS 7.39 10.90 9.91 7.02 9.22 7.16 8.60
RKT 9.34 9.19 8.99 5.35 8.56 8.41 8.30
Industry Average 8.09 9.59 8.78 6.42 8.31 7.58 8.13
Page | 62
Similar to the results of the accounts receivables turnover, PKG has decreasing
efficiency, but has an overall average better than the industry. In 2013 PKG has
acquired a DSO of 64.04 days compared to the industry average of 48.43 days, which
shows a substantial decrease in efficiency that is likely due to the acquisition of Boise
Inc. It is also possible for PKG to have changed their credit terms to increase the
turnover of accounts receivable. Having favorable credit terms would help increase the
amount of accounts receivable turns, thereby decreasing the duration to collect on the
associated receivables. It should be noted how in 2012, while industry peers were
lowering their DSO, PKG’s increased.
Days Sales Outstanding 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 39.44 41.33 44.05 44.58 45.18 64.04 46.44
IP 48.34 42.10 48.97 53.02 50.95 50.93 49.05
KS 49.36 33.50 36.83 51.97 39.59 50.95 43.70
RKT 39.08 39.72 40.62 68.28 42.65 43.40 45.63
Industry Average 45.59 38.44 42.14 57.76 44.40 48.43 46.13
Page | 63
Cash to Cash Cycle
The cash to cash cycle, or cash conversion cycle, indicates the amount of time in
days for the company to sell its inventories and then collect on the receivables
associated with the sales. A lower value is better, which shows that the firm is able to
efficiently sell its inventories. Therefore, it increases the firm’s liquidity. Below, the data
below was calculated by simply adding days sales outstanding and days supply
inventory.
As observed above, PKG has maintained a relatively short cash to cash compared
to their industry peers for the past five years. In 2013, however, PKG had a cash to
cash cycle of 132.04 days, the longest cycle in the industry. PKG has an average of
cycle of 94. 64 days while the industry average is 98.14.
Cash to Cash Cycle 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 79.86 86.50 90.28 89.37 89.74 132.07 94.64
IP 96.93 94.35 95.32 97.69 99.35 99.52 97.19
KS 140.11 96.22 78.52 108.68 82.27 110.82 102.77
RKT 84.05 88.68 83.83 138.66 83.65 87.87 94.46
Industry Average 107.03 93.08 85.89 115.01 88.42 99.40 98.14
Page | 64
Working Capital Turnover
The working capital turnover measures how effectively a firm utilizes its working
capital (current assets less current liabilities) to generate revenues. A higher value is
preferable because it shows that the firm is capable of maintaining or creating more
sales with less investment in working capital. The resultant data is useful to analysts in
determining how effective a firm is at purchasing inventory and satisfying operating
costs. The results below were calculated by dividing the period’s revenue by working
capital.
PKG remains below the industry average of 10.35 with the lowest average of its
industry peers at 5.62. The firm’s performance has been downward trending with their
lowest turnover being at 4.44 in 2013. In 2012, while PKG’s industry peers realized
greater turnovers, PKG’s turnover decreased 30.25%.
Working Capital Turnover 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 8.71 4.18 6.17 6.02 4.20 4.44 5.62
IP 9.53 6.60 7.14 4.55 7.12 7.46 7.07
KS 8.20 11.49 7.39 7.81 17.64 8.28 10.14
RKT 46.54 13.45 9.87 2.92 4.77 5.44 13.83
Industry Average 21.43 10.52 8.13 5.09 9.84 7.06 10.35
Page | 65
Liquidity Analysis Conclusion
Overall, PKG has maintained a healthy level of liquidity. In recent years, their
growth is evident as they may have below average ratios following an acquisition. PKG
has demonstrated PKG would likely realize the most benefit by focusing resources and
efforts on improving working capital turnover. We will discuss and analyze PKG’s
profitability on an absolute and relative basis. Altman’s Z-score will also be used later in
this section to analyze the probability of the firm going into bankruptcy
Profitability Ratios
Profitability ratios measure a firm’s ability to generate earnings. For these ratios,
a higher value compared to competitors and the industry indicates that the firm is doing
well. Our analysis team examined 7 profitability ratios including: sales growth
percentage, gross profit margin, operating profit margin, net profit margin, asset
turnover, return on assets (ROA), return on equity (ROE). All of these ratios are
important in determining the performance of the industry, and comparing firms in the
industry.
Sales Growth Percentage
The sales growth ratio shows the percentage increase or decrease in a firm’s
revenue from period to period. This ratio makes it easy to compare revenue growth
with competitors and determine which firms have growth the most due to an increase
in market share, or by entering new markets. Large changes year to year are mostly
the result of acquisitions or industry cyclicality. To calculate this ratio we divided the
current year’s revenue by the prior year’s revenue, then subtracted one from that
result.
Page | 66
Packaging Corporation’s sales growth has steadily increased over the past three
years. There is less volatility with Packaging Corps sales growth compared with the rest
of the industry. Having a more stable growth rate makes it easier to forecast sales and
reduce costs. Since economies of scale plays such an important role in this industry,
overproduction in a year with poor sales can lead to an increase in inventory and sales
in the next year.
Gross Profit Margin
Gross profit margin is measured by dividing gross profit, which is revenue minus
cost of goods sold, by revenue. The gross profit margin shows the percentage of
revenue that is left after subtracting the cost of the goods sold (CoGS). The higher the
ratio, the more able the firm is to control the costs of manufacturing their products.
Annual Sales Growth 2009 2010 2011 2012 2013 Average (08-13)
PKG -9.1% 13.5% 7.6% 8.5% 28.9% 9.9%
IP -5.9% 7.8% 3.4% 6.9% 4.5% 3.3%
KS 20.4% 23.9% 15.7% 34.3% 43.6% 27.6%
RKT -1.0% 6.7% 79.9% 70.6% 3.7% 32.0%
Industry Average 4.5% 12.8% 33.0% 37.3% 17.3% 21.0%
Page | 67
In an industry like corrugated packaging and paper, which relies heavily on
volume, there is a competitive advantage in having the highest possible gross profit
margin. In 2009, after the financial crisis, the entire industry saw a sharp rise in the
gross profit margin. The high margins could have resulted from the fact that wood pulp
prices dropped $300 per cubic meter, which was a 10-year low. In 2010, those gains
were lost, but growth has been steady ever since. Our analysis group agrees that
Packaging Corp and its competitors are converging to a uniform, industry wide, gross
profit margin of 24%.
Gross Profit Margin 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 20.8% 19.9% 21.8% 20.7% 22.5% 23.4% 21.5%
IP 24.5% 34.9% 26.6% 27.2% 26.0% 27.0% 27.7%
KS 31.0% 43.8% 18.4% 21.9% 19.9% 24.3% 26.6%
RKT 19.1% 27.1% 24.0% 18.4% 16.6% 19.3% 20.8%
Industry Average 24.9% 35.3% 23.0% 22.5% 20.9% 23.6% 25.0%
Page | 68
Operating Profit Margin
Operating profit margin is the total operating income divided by total revenue.
The operating profit margin is similar to the gross profit margin because it includes
expenses such as, sales, general, and administrative expenses (SGA) and variable costs.
The money that is left over can cover other expenses like interest expense and taxes.
Again, a higher percentage means the firm has higher operating efficiency and could
also mean a better pricing strategy.
The operating profit margins for the whole industry followed the same trends
that gross margin experienced. Operating margin rose drastically in 2009, but then lost
momentum going into 2010. Our analysis attributes Packing Corp’s unusually high
margins in 2009 and 2012 to tax credits awarded for the use of alternative fuels. The
Operating Profit Margin 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 10.3% 16.4% 7.6% 10.4% 15.6% 12.9% 12.2%
IP -2.2% 8.2% 5.6% 8.5% 6.4% 5.0% 5.3%
KS 9.7% 23.9% 8.8% 11.8% 9.0% 12.6% 12.6%
RKT 7.6% 14.9% 12.4% 6.6% 5.8% 8.5% 9.3%
Industry Average 5.0% 15.7% 8.9% 9.0% 7.1% 8.7% 9.1%
Page | 69
operating profit margin has been relatively steady over the past three years; this could
represent a decreased interest in acquisitions. Again, Packaging Corp did not meet the
minimum requirements for a restatement of the financial statements. Therefore, all
ratios use unadjusted numbers from their 10-K’s.
Net Profit Margin
Net profit margin is important for analysts and investors because it allows them
to determine how profitable the firm is after all expenses and gains or losses have been
accounted for. To determine net profit margin, net income is divided by total revenue. A
high net profit margin reflects a firm that has the most effective cost controls and can
return a higher percentage of revenues to its shareholders.
Net Profit Margin 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 5.8% 12.4% 8.4% 6.0% 5.8% 11.9% 8.4%
IP -5.2% 2.9% 2.7% 5.1% 2.9% 4.8% 2.2%
KS 3.8% 12.7% 8.3% 13.7% 5.2% 7.3% 8.5%
RKT 2.9% 7.9% 7.5% 2.6% 2.7% 7.6% 5.2%
Industry Average 0.5% 7.8% 6.2% 7.1% 3.6% 6.6% 5.3%
Page | 70
Packaging Corp has led the industry in net profit margin. This can be attributed
to its acquisition of Boise, which resulted in an increase in revenue due to the firm’s
robust containerboard production. The industry as a whole has seen a steady net profit
margin, but there was a sharp increase in industry margins in 2013 due to the hedging
wood pulp prices and more efficient production mills.
Asset Turnover
Asset turnover represents a firm’s ability to earn revenues for every dollar of
assets it has on its books. Firms that generate more revenue per dollar of assets will
have the higher ratio, while a firm that manages its assets poorly will have a lower
ratio. This ratio is lagged in that it is calculated by dividing the current year’s sales by
the previous year’s total assets; this lag reflects the fact that the previous year’s ending
balance in assets is also the amount of assets the firm had available at the start of the
current year.
Page | 71
Packaging Corp and KapStone Paper had industry-leading asset turnover. This
trend goes against the conventional thinking that firms with the highest asset turnover
in the industry have the lowest profit margins. The industry rise in 2011 can be
attributed to the overall increase in demand of corrugated packaging. Packaging Corp
was average when compared with the industry in 2010, 2011, and 2012, but rose in
2013. This again could be contributed to the recent acquisition of Boise. In 2011 Rock-
Tenn is an outlier because they acquired Smurfit-Stone, and nearly doubled their sales.
Since this ratio is lagged it divided their 2011 sales by 2010 total asset: therefore, not
accounting for the increase in assets as a result of the acquisition. Acquisitions in this
industry are important to firms that want to maintain a competitive advantage and high
profit margins. This could be an indicator that this industry might go through a heavy
acquisition year in the near future.
Return on Assets
Return on assets (ROA) represents the net income generated per dollar of
assets. Like asset turnover, this ratio is a lagged meaning the current year’s net income
is divided by the previous year’s ending asset balance. A higher ratio could mean better
decision making by management towards strategically utilizing assets.
Asset Turnover 2009 2010 2011 2012 2013 Average (08-13)
PKG 1.11 1.13 1.18 1.18 1.49 1.22
IP 0.87 0.99 1.03 1.03 0.90 0.96
KS 0.87 1.17 1.26 1.08 1.54 1.18
RKT 0.93 1.04 1.85 0.87 0.89 1.12
Industry Average 0.89 1.07 1.38 0.99 1.11 1.09
Page | 72
Again, Packaging Corp was an industry leader in ROA. The industry as a whole
experienced a slow decline until 2012, but the industry rebounded in 2013. Packaging
Corp has consistently beaten the industry when it comes to return on assets, and it has
widened this differential with the acquisition of Boise.
Return on Assets 2009 2010 2011 2012 2013 Average (08-13)
PKG 13.7% 9.5% 7.1% 6.8% 17.8% 11.0%
IP 2.5% 2.7% 5.2% 2.9% 4.3% 3.5%
KS 11.0% 9.7% 17.2% 5.6% 11.2% 10.9%
RKT 7.4% 7.8% 4.8% 2.4% 6.8% 5.8%
Industry Average 7.0% 6.8% 9.1% 3.6% 7.4% 6.8%
Page | 73
Return on Equity
Return on equity (ROE) is one of the most important financial ratios when
analysts compare firms. This ratio represents a firm’s ability to generate profits with the
money invested in it by the firm’s owners. Because this ratio analyzes the effect of
money reinvested by the stockholders, investors seek high returns on equity. There is
one problem with this ratio, in that it does not explicitly state the amount of financial
leveraged used to achieve the returns. Management who want to earn a bonus, or want
their firm to appear better to outside investors and analysts can manipulate this ratio.
This ratio is also lagged and can be calculated by taking net income for the period and
dividing it by total stockholders’ equity.
Once again Packaging Corp is leading the industry with the highest return on
equity. The industry had similar return but in 2012 Packaging Corp rose significantly
more than its competitors. Our analysis team contributes this sharp increase to its
Return on Equity 2009 2010 2011 2012 2013 Average (08-13)
PKG 38.9% 22.8% 15.7% 17.7% 45.0% 28.0%
IP 15.5% 11.5% 19.3% 11.5% 21.2% 15.8%
KS 44.3% 18.7% 29.6% 11.5% 24.5% 25.7%
RKT 34.6% 29.1% 13.9% 7.4% 21.3% 21.3%
Industry Average 31.5% 19.7% 21.0% 10.1% 22.4% 20.9%
Page | 74
acquisition of Boise and the $2 billion of long-term debt they received as a result.
Although Packing Corps leverage did noticeably increase in 2013, its debt to equity ratio
is still average when compared to its competitors.
Profitability Ratio Analysis Conclusion
Our analysis concludes that Packaging Corp profitability is outperforming its
competitors. We attribute some of their success to their strategic acquisition of Boise. It
is unlikely, however, that these trends will continue as the industry adjusts over time to
Packaging Corp. Packaging Corp and its managers have been both effective and
efficient in that they were able to increase almost every profitability ratio. If Packaging
Corp can maintain its profitability at its current level it will see a definite increase in its
stock price and will turn into an industry leader.
Capital Structure Ratios
Introduction
The capital structure of a firm portrays how its operations are being financed.
Analyzing a firm’s capital structure ratios effectively will allow my analysis team to
understand how the firm is obtaining funds. There are many methods of funding
available to firms and they all come at different costs. First our team will look at the
debt to equity ratio to get an understanding of how Packaging Corp. is leveraged.
Debt to Equity
The most common truth in accounting is that assets must always equal liabilities
plus shareholders’ equity. The debt to equity ratio will take a look at the latter part of
that equation and measure the firm’s debt (total liabilities) in proportion to total
shareholders’ equity. Typically, a higher number indicates that the firm uses more debt
to finance its assets. Relative to its industry competitors PKG is doing a good job at not
Page | 75
financing too much of its assets with debt. PKG has the second best average in its peer
group for debt to equity at 1.75.
Times Interest Earned
When analyzing the proportion of interest comprising operating income the times
interest earned ratio can be a useful tool. Times interest earned ration defines the
number of times a company can pay its interest expense out of the earnings before
interest and taxes account. When a firm’s ratio is below one, this is considered
undesirable and risky to potential investors. To come up with the times interest earned
our team divided EBIT by total interest payable. When analyzing the ratio, once again
PKG has the second best average after KapStone with International Paper in last with a
Debt to Equity Ratio 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 1.84 1.39 1.21 1.60 1.53 2.96 1.75
IP 5.12 3.24 2.71 2.92 3.90 2.83 3.45
KS 3.02 0.92 0.72 1.06 1.19 2.98 1.65
RKT 3.70 2.71 1.88 2.13 2.14 1.49 2.34
Industry Average 3.95 2.29 1.77 2.04 2.41 2.43 2.48
Page | 76
low average of only 2.12. PKG has sufficient operating income to cover its interest
payment.
Altman’s Z-score
The Altman’s Z-score is used to measure the possibility that a given firm will
declare bankruptcy, or the firm’s credit risk. The standard rule typically is that if the
score is below 1.8 the company is heading towards bankruptcy. If the score is above
3.0 the company does not expect to go bankrupt at any time in the near future.
According to our assessment International paper, who has the worst results for the
three ratios we analyzed, is the only firm in risk of bankruptcy at this time. PKG’s
average is 3.15 and we do not expect the firm to go bankrupt any time soon.
Times Interest Earned 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 7.56 10.06 5.78 9.41 7.03 8.17 8.00
IP (1.13) 2.88 2.35 3.70 2.52 2.39 2.12
KS 2.68 7.95 13.60 17.67 9.08 8.80 9.96
RKT 2.48 4.32 4.88 3.42 4.24 7.64 4.50
Industry Average 1.35 5.05 6.94 8.26 5.28 6.28 5.53
Page | 77
Internal Growth Rate
A firm’s internal growth rate is the maximum asset growth a firm could achieve
by reinvesting the funds it derives from operations less any dividends paid during the
year; it is assumed that the firm receives no funds from outside sources. This is a
conservative measure of growth in that it reflects a firm’s ability to grow based on the
return it earns on its available assets. The IGR is calculated by multiplying the firm’s
Return on Assets by the plowback ratio (1- Dividends/Net Income). The graph below
shows the IGR for all firms we are analyzing, as well as an industry average excluding
PKG.
Altman's Z-Score 2008 2009 2010 2011 2012 2013 Average (08-13)
PKG 2.73 3.31 3.32 3.07 4.03 2.42 3.15
IP 1.19 1.80 1.87 2.02 1.76 1.98 1.77
KS 1.55 3.48 3.48 2.41 3.64 2.42 2.83
RKT 1.74 2.40 2.63 1.28 1.80 2.27 2.02
Industry Average 1.49 2.56 2.66 1.90 2.40 2.22 2.21
Page | 78
While its competitors experienced volatility in IGR, Packaging Corp. has seen a
consistent drop in IGR from 2008 to 2012, with a slight increase afterwards. This is due
to a 20% drop in net income (relative to 2010) in years 2011 and 2012. All firms in the
industry, including PKG, experienced their lowest IGR in 2012 due to an increase in
income tax provisions that decreased net income and return on assets. PKG had an
industry-leading 13% IGR in 2013; however, this figure is distorted by the acquisition of
Boise. PKG’s net income grew more than 60% in the year 2013, but the assets used to
calculate ROA still reflected pre-acquisition levels, inflating IGR. Our team has
estimated the 2014 IGR to be just under 5%, which more accurately reflects the growth
rate achievable on the post-acquisition assets of PKG. This figure converges with the
IGR’s of IP and RKT, which, along with the results of the ROA analysis, suggests that
Internal Growth Rate 2009 2010 2011 2012 2013 Average (08-13)
PKG 9.7% 6.6% 3.7% 1.9% 13.3% 7.1%
IP 2.0% 2.0% 3.5% 1.2% 2.6% 2.3%
KS 11.0% 9.7% 17.2% -2.8% 11.2% 9.3%
RKT 6.9% 7.0% 3.5% 1.8% 6.1% 5.1%
Industry Average 6.6% 6.3% 8.1% 0.0% 6.6% 5.5%
Page | 79
larger firms in this industry cannot increase their net income enough relative to their
assets to enable aggressive growth.
Sustainable Growth Rate
A firm’s sustainable growth rate is the upper limit at which a firm can grow
without changing its capital structure. Unlike IGR, sustainable growth enables a firm to
use leverage to grow, so SGR is always higher in magnitude than IGR; forecasters
consider an estimated growth rate to be reasonable when it falls between IGR and SGR.
The allowance for leverage means that SGR is a more realistic measure is assessing a
firm’s growth potential. A firm’s SGR is calculated by multiplying IGR by (1+D/E Ratio).
The graph below shows the SGR for all firms we are analyzing, as well as an industry
average excluding PKG.
Sustainable Growth Rate 2009 2010 2011 2012 2013 Average (08-13)
PKG 27.6% 18.8% 10.4% 5.4% 37.8% 20.0%
IP 12.3% 12.4% 21.6% 7.2% 16.0% 13.9%
KS 44.3% 39.1% 69.3% -11.5% 45.0% 37.2%
RKT 32.3% 33.1% 16.6% 8.5% 28.7% 23.8%
Industry Average 29.6% 28.2% 35.8% 1.4% 29.9% 25.0%
Page | 80
All firms in the industry, including PKG, saw their SGR behave in the same way
IGR did from 2008 to 2013. The lowest growth rates occurred in 2012 due to the
increase in income tax provisions. As with IGR, PKS’s SGR will decrease sharply once
the full effect of the Boise merger has been realized.
Capital Structure Conclusion
As shown by the debt to equity ratio, the percentage of invested capital allocated
to debt is generally higher in the packaging industry. Packaging Corp. has shown strong
numbers for its industry and seems to be effectively structuring their capital financing.
Financial Forecasting
Introduction
Forecasting a firm’s financial statements is an integral part of the business
valuation process, as it is the foundation for valuation models. Fundamental analysis is
used to analyze ratios and historical trends for the firm and industry. Educated
assumptions are then made to estimate the future performance of the firm. Given that
the resultant forecast is an analyst opinion based on current available data, the amount
of time forecasted is critical in determining the accuracy. Thus, a longer period would
yield a less accurate forecast due to having less known data to form opinions from.
Based on the conditions and assumptions we have made, we will utilize Packaging
Corporation’s income statement, balance sheet, and statement of cash flows to forecast
the coming ten years of financial information.
Income Statement
The financial forecasting process begins with the income statement. The
resulting assumptions from the income statement forecast will be utilized to
subsequently forecast the balance sheet and the statement of cash flows. Thus, rational
Page | 81
forecasts are important to the project and valuation as a whole. When making
predictions and assumptions regarding the future performance of the firm the historical
performance, reasonable future business projections, and notably current economic
conditions should all be considered.
The first and most important step in forecasting the income statement requires
projecting the annual sales growth. A 9% loss in sales growth occurred as a result of
the 2008 financial crisis, but PKG has since grown with some volatility as the economy
recovered. In 2013 PKG acquired Boise Inc. causing a substantial increase in sales
growth, which was carried through 2014. Due to decreased efficiency from the
acquisition we projected sales growth to drop to 4.50% in 2015, but then steadily
increase to 8.50% by 2018 and remain constant through 2023. After forecasting the
annual sales growth, the common size income statement is created. The common size
income statement is a measurement of each line item in relation to the total annual
sales of that year. Using this method provides an advantageous approach in analyzing
trends within the firm. The gross profit margin followed a similar trend as it rose to
levels of 21% in 2014 to 22% in 2016, and thereafter. Furthermore, it also important to
not that PKG’s expenses been adjusted to exclude a fuel mixture tax credit. Values
affected by this are total operating expenses, operating income, income before taxes,
and net income. This is because it is not possible to estimate the amount of tax credits
in the future. We anticipate for total operating expenses less the tax credit to fall
decrease from their 2013 values of 10.5%, but an increase in selling expenses would
cause a rise to 12% in 2015. After 2015 the expenses are projected to steadily
decrease to 11% in 2017 and remain at this level until 2023.
Following the forecast of expenses, operating income, income before taxes, and
net income are projected using the same trends and assumptions previously used.
Operating income levels after adjustment for the alternative fuel mixture tax credit
decreased steadily from 2013 levels of 12.9% to 11% in 2017 and thereafter. The
income before taxes decreased from 2013 levels of 11.9% to 2015 level of 8.0% as the
company continues to make adjustments following the acquisition of Boise Inc. By 2017
Page | 82
the value of income before taxes rose to 10% and remained thereafter. And lastly, the
net income was forecasted out. We anticipate net income in 2014 falling to 7.0% from
the previous 2013 level of 11.9%, but steadily rising to 10% in 2017 and remaining
thereafter. Next, we will utilize the forecasted information off the income statement to
help examine dividends and forecast the balance sheet and statement of cash flows.
Dividend Forecasting
In our valuation, we assumed that the number of shares outstanding will not
change; under this assumption, we can use can forecasted dividends to estimate future
changes in total equity. Our team analyzed PKG’s historical dividend policy and found it
to follow a stair step function; quarterly dividends have increased by 5 cents every 4
quarters. We believe PKS’s forecasted income is stable enough to continue following
this stair step policy and increase annual dividends by 20 cents per year for the
foreseeable future.
Page | 83
Pac
kagi
ng
Co
rpo
rati
on
Inco
me
Sta
tem
en
t
(In
Mil
lio
ns)
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
An
nu
al S
ale
s G
row
th
-9.0
%13
.4%
7.6%
8.5%
28.9
%61
.0%
4.5%
6.5%
7.5%
8.5%
8.5%
8.5%
8.5%
8.5%
8.5%
8.5%
Re
ven
ue
2,36
0$
2,
148
2,43
6
2,
620
2,84
4
3,
665
5,90
0
6,
166
6,56
6
7,
059
7,65
9
8,
310
9,01
6
9,
782
10,6
14
11
,516
12,4
95
Co
st o
f G
oo
ds
Sold
1,86
9
1,
721
1,90
3
2,
078
2,20
4
2,
806
4,66
1
4,
871
5,12
2
5,
506
5,97
4
6,
482
7,03
3
7,
630
8,27
9
8,
983
9,74
6
Gro
ss p
rofi
t49
1
42
7
532
54
2
641
85
9
1,23
9
1,
295
1,44
5
1,
553
1,68
5
1,
828
1,98
4
2,
152
2,33
5
2,
534
2,74
9
Op
era
tin
g Ex
pe
nse
s
Sale
s, G
en
era
l an
d A
dm
inis
trat
ive
234
$
22
8
241
25
8
280
32
7
502
67
8
689
70
6
766
83
1
902
97
8
1,06
1
1,
152
1,24
9
Alt
ern
ativ
e F
ue
l Mix
ture
Tax
Cre
dit
-168
86-9
6
Oth
er
Op
era
tin
g Ex
pe
nse
s15
15
20
11
12
59
Tota
l Op
era
tin
g Ex
pe
nse
s24
9
75
347
26
9
196
38
6
561
74
0
755
77
6
842
91
4
992
1,
076
1,16
8
1,
267
1,37
4
Op
era
tin
g in
com
e24
2
35
2
185
27
3
443
47
4
679
55
5
689
77
6
842
91
4
992
1,
076
1,16
8
1,
267
1,37
4
No
n-O
pe
rati
ng
Exp
en
ses
Inte
rest
Exp
en
se32
$
36
32
29
63
58
Inco
me
Be
fore
Tax
es
210
317
15
3
244
38
1
415
59
0
493
62
4
706
76
6
831
90
2
978
1,
061
1,15
2
1,
249
Pro
visi
on
fo
r In
com
e T
axe
s75
51
(5
2)
85
21
7
(21)
Ne
t in
com
e13
6
26
6
205
15
8
164
43
6
649
55
5
689
77
6
842
91
4
992
1,
076
1,16
8
1,
267
1,37
4
Fore
cast
ed
Fig
ure
sH
isto
rica
l Re
sult
s
Page | 84
Pac
kagi
ng
Co
rpo
rati
on
Inco
me
Sta
tem
en
t
Co
mm
on
Siz
e (
In M
illi
on
s)20
0820
0920
1020
1120
1220
1320
1420
1520
1620
1720
1820
1920
2020
2120
2220
2320
24
An
nu
al S
ale
s G
row
th
-9.0
%13
.4%
7.6%
8.5%
28.9
%60
.98%
4.50
%6.
50%
7.50
%8.
50%
8.50
%8.
50%
8.50
%8.
50%
8.50
%8.
50%
Re
ven
ue
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%
Co
st o
f re
ven
ue
79.2
%80
.1%
78.1
%79
.3%
77.5
%76
.6%
79.0
%79
.0%
78.0
%78
.0%
78.0
%78
.0%
78.0
%78
.0%
78.0
%78
.0%
78.0
%
Gro
ss p
rofi
t20
.8%
19.9
%21
.8%
20.7
%22
.5%
23.4
%21
.0%
21.0
%22
.0%
22.0
%22
.0%
22.0
%22
.0%
22.0
%22
.0%
22.0
%22
.0%
Op
era
tin
g Ex
pe
nse
s
Sale
s, G
en
era
l an
d A
dm
inis
trat
ive
9.9%
10.6
%9.
9%9.
8%9.
8%8.
9%8.
5%11
.0%
10.5
%10
.0%
10.0
%10
.0%
10.0
%10
.0%
10.0
%10
.0%
10.0
%
Alt
ern
ativ
e F
ue
l Mix
ture
Tax
Cre
dit
-7.8
%3.
5%-3
.4%
Oth
er
Op
era
tin
g Ex
pe
nse
s0.
6%0.
7%0.
8%0.
4%0.
4%1.
6%
Tota
l Op
era
tin
g Ex
pe
nse
s (A
s St
ate
d)
10.6
%3.
5%14
.2%
10.3
%6.
9%10
.5%
Wit
ho
ut
Tax
Cre
dit
10.6
%11
.3%
10.7
%10
.3%
10.3
%10
.5%
8.5%
11.0
%10
.5%
10.0
%10
.0%
10.0
%10
.0%
10.0
%10
.0%
10.0
%10
.0%
Op
era
tin
g in
com
e10
.3%
16.4
%7.
6%10
.4%
15.6
%12
.9%
Wit
ho
ut
Tax
Cre
dit
10.3
%8.
6%11
.1%
10.4
%12
.2%
12.9
%12
.5%
10.0
%11
.5%
12.0
%12
.0%
12.0
%12
.0%
12.0
%12
.0%
12.0
%12
.0%
No
n-O
pe
rati
ng
Exp
en
ses
Inte
rest
Exp
en
se1.
36%
1.68
%1.
31%
1.11
%2.
22%
1.58
%
Inco
me
Be
fore
Tax
es
(As
Stat
ed
)8.
9%14
.8%
6.3%
9.3%
13.4
%11
.3%
Wit
ho
ut
Tax
Cre
dit
8.90
%6.
94%
9.81
%9.
31%
10.0
2%11
.32%
11.0
0%9.
00%
10.5
0%11
.00%
11.0
0%11
.00%
11.0
0%11
.00%
11.0
0%11
.00%
11.0
0%
Pro
visi
on
fo
r in
com
e t
axe
s3.
2%2.
4%-2
.1%
3.2%
7.6%
-0.6
%
Ne
t In
com
e (
As
Stat
ed
)5.
8%12
.4%
8.4%
6.0%
5.8%
11.9
%
Wit
ho
ut
Tax
Cre
dit
5.8%
4.6%
11.9
%6.
0%2.
4%11
.9%
11.0
%9.
0%10
.5%
11.0
%11
.0%
11.0
%11
.0%
11.0
%11
.0%
11.0
%11
.0%
His
tori
cal R
esu
lts
Fore
cast
ed
Fig
ure
s
Page | 85
Balance Sheet
After forecasting the income statement, we are able to forecast is the balance
sheet. The first and one of the most important steps begins with forecasting total
assets. To do so, we’ll need to link the income statement with the balance sheet. The
asset turnover ratio (ATO) plays a vital role in linking the two statements. PKG’s asset
turnover ratio from 2008 through 2013 has remained around 1.1 with the exception of
2013 where the ATO rose to 1.5, due to an 60% increase in net income after the
acquisition of Boise. Inc. We used same trend of utilized in forecasting revenues with
ATO. After 2013, we anticipate the asset turnover falling to 1.160 in 2014 and rising to
1.165 in 2015 and thereafter. Because the asset turnover ratio is total sales over total
assets, we were able to utilize the forecasted ATO ratio in conjunction with the
forecasted revenues to calculate the total assets. The total assets along with liquidity
ratios will be an integral part in forecasting the remainder of the balance sheet; now a
common size balance sheet must be constructed to aide in identifying trends and
patters within the firm.
With the common size balance sheet we’re able to analyze and project how
much of total assets is non-current assets and current assets. Based on the viewed
trends with the historical data, we based projected current assets and non-current
assets to be 30% and 70%, respectively. We do not foresee PKG participating in any
large acquisitions in the near future based on the Q3 earnings conference call. These
assumptions were kept constant through 2023, and provided a steady progression for
the company to grow. Next, the total equity was estimated. We calculated total equity
by adding the difference between net income and dividends of the year and adding it to
the total equity of the previous year. This method of calculation was utilized, because
the future issuance and/or repurchase of stock are neither predictable nor knowable
given current data.
Page | 86
Pack
agin
g C
orpo
rati
on B
alan
ce S
heet
(In
Mill
ions
)20
0820
0920
1020
1120
1220
1320
1420
1520
1620
1720
1820
1920
2020
2120
2220
23
Cur
rent
Ass
ets
Cas
h an
d C
ash
Equi
vale
nts
149
261
197
156
207
191
Acc
ount
s R
ecei
vabl
e25
5
24
3
29
4
32
0
35
2
64
3
71
1
71
7
84
2
84
0
83
2
90
3
98
0
1,
063
1,
154
1,
252
Inve
ntor
y20
7
21
3
24
1
25
5
26
9
52
3
63
8
65
8
70
2
68
8
66
4
72
0
78
1
84
8
92
0
99
8
Tota
l Cu
rren
t A
sset
s63
3
88
5
80
0
81
2
93
7
1,
487
1,
595
1,
691
1,
818
1,
972
2,
140
2,
322
2,
519
2,
733
2,
966
3,
218
Non
-Cur
rent
Ass
ets
Goo
dwill
37
39
39
58
67
527
Prop
erty
, Pla
nt a
nd E
quip
men
t1,
221
1,
183
1,
338
1,
477
1,
366
2,
806
Tota
l No
n-C
urr
ent
Ass
ets
1,30
7
1,26
8
1,42
6
1,60
0
1,51
7
3,71
3
3,72
1
3,94
5
4,24
1
4,60
2
4,99
3
5,41
7
5,87
8
6,37
7
6,92
0
7,50
8
Tota
l Ass
ets
1,94
0
2,15
3
2,22
6
2,41
2
2,45
4
5,20
0
5,31
5
5,63
6
6,05
9
6,57
4
7,13
3
7,73
9
8,39
7
9,11
1
9,88
5
10,7
25
Cur
rent
Lia
bilit
ies
Shor
t-Te
rm D
ebt
109
109
109
15
15
39
Tota
l Cu
rren
t Li
abili
ties
362
371
405
377
260
661
658
735
790
857
930
1,00
9
1,09
5
1,18
8
1,28
9
1,39
9
Non
-Cur
rent
Lia
bilit
ies
Long
-Ter
m D
ebt
548
549
549
793
779
2,50
9
Tota
l No
n-C
urr
ent
Liab
iliti
es89
4
88
3
81
2
1,
107
1,
224
3,
226
2,
851
2,
715
2,
587
2,
472
2,
349
2,
215
2,
067
1,
903
1,
720
1,
514
Tota
l Lia
bili
ties
1,25
6
1,25
4
1,21
7
1,48
4
1,48
4
3,88
7
3,50
9
3,45
0
3,37
7
3,33
0
3,27
9
3,22
4
3,16
2
3,09
1
3,00
9
2,91
3
Stoc
khol
der'
s Eq
uity
Com
mon
Sto
ck1
1
1
1
1
1
Add
itio
nal P
aid
In C
apit
al34
1
35
2
31
8
25
4
26
4
33
7
Ret
aine
d Ea
rnin
gs34
2
54
6
69
0
67
4
70
4
97
5
1,
469
1,
849
2,
344
2,
906
3,
516
4,
177
4,
897
5,
681
6,
538
7,
474
Tota
l Sto
ckh
old
er's
Eq
uit
y68
4
89
9
1,
009
92
9
96
9
1,
313
1,
807
2,
187
2,
682
3,
244
3,
854
4,
515
5,
235
6,
019
6,
876
7,
812
Tota
l Lia
bili
ties
an
d S
tock
ho
lder
's E
qu
ity
1,94
0
2,15
3
2,22
6
2,41
2
2,45
4
5,20
0
5,31
5
5,63
6
6,05
9
6,57
4
7,13
3
7,73
9
8,39
7
9,11
1
9,88
5
10,7
25
His
tori
cal R
esul
tsFo
reca
sted
Fig
ures
Page | 87
Pack
agin
g C
orpo
rati
on B
alan
ce S
heet
Com
mon
Siz
e (I
n M
illio
ns)
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
Cur
ren
t A
sset
s
Cas
h an
d C
ash
Equi
vale
nts
7.7%
12.1
%8.
8%6.
5%8.
4%3.
7%
Acc
ount
s R
ecei
vabl
e13
.1%
11.3
%13
.2%
13.3
%14
.3%
12.4
%
Inve
nto
ry10
.7%
9.9%
10.8
%10
.6%
11.0
%10
.1%
Tota
l Cu
rren
t A
sset
s32
.6%
41.1
%35
.9%
33.7
%38
.2%
28.6
%30
.0%
30.0
%30
.0%
30.0
%30
.0%
30.0
%30
.0%
30.0
%30
.0%
30.0
%
Non
-Cur
ren
t A
sset
s
Goo
dwill
1.9%
1.8%
1.8%
2.4%
2.7%
10.1
%
Prop
erty
, Pla
nt a
nd E
quip
men
t62
.9%
54.9
%60
.1%
61.2
%55
.7%
54.0
%
Tota
l No
n-C
urr
ent
Ass
ets
67.4
%58
.9%
64.1
%66
.3%
61.8
%71
.4%
70.0
%70
.0%
70.0
%70
.0%
70.0
%70
.0%
70.0
%70
.0%
70.0
%70
.0%
Tota
l Ass
ets
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
Cur
ren
t Li
abili
ties
Shor
t-Te
rm D
ebt
5.6%
5.1%
4.9%
0.6%
0.6%
1.0%
Tota
l Cu
rren
t Li
abili
ties
28.8
%29
.6%
33.3
%25
.4%
17.5
%17
.0%
18.8
%21
.3%
23.4
%25
.8%
28.4
%31
.3%
34.6
%38
.4%
42.8
%48
.0%
Non
-Cur
ren
t Li
abili
ties
Long
-Ter
m D
ebt
Tota
l No
n-C
urr
ent
Liab
iliti
es71
.2%
70.4
%66
.7%
74.6
%82
.5%
83.0
%81
.2%
78.7
%76
.6%
74.2
%71
.6%
68.7
%65
.4%
61.6
%57
.2%
52.0
%
Tota
l Lia
bili
ties
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
Stoc
khol
der'
s Eq
uity
Com
mon
Sto
ck0.
1%0.
1%0.
1%0.
1%0.
1%0.
1%
Add
itio
nal P
aid
In C
apit
al49
.9%
39.2
%31
.5%
27.3
%27
.2%
25.7
%
Ret
aine
d E
arni
ngs
50.0
%60
.7%
68.4
%72
.6%
72.7
%74
.3%
Tota
l Sto
ckh
old
er's
Eq
uit
y10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%
Tota
l Lia
bili
ties
an
d S
tock
ho
lder
's E
qu
ity
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
His
tori
cal R
esul
tsFo
reca
sted
Fig
ures
Page | 88
Statement of Cash Flows
The final step in the financial forecasting process is to project the
statement of cash flows. Although there are three sections of the statement of cash
flows, only the cash flows from operations- CFFO and cash flows from investing
activities-CFFI will be utilized to forecast expected future cash flows. Due to the volatile
nature of the statement of cash flows, it’s typically the most difficult statement to
forecast, and will serve as an important part of the valuation process.
Forecasting of the cash flows from operations usually begins with three
important ratios: CFFO/Sales, CFFO/ Operating Income, and CFFO/ net income. Of
these three, CFFO/Sales was used because it had the least volatility and provided a
steady increase in cash flows provided by operating activities. Following previous
assumptions of PKG’s operating activity, the value used for CFFO/Sales in 2014 was
14.2%, which is down from 16.6% in 2013. We expect cash flows to decrease due to
the acquisition of Boise Inc., but to increase steadily to 14.4% in 2017 and remain
thereafter through 2023. It’s important to note that although there was a decrease in
the ratio used, cash flows from operating activities are anticipated to steadily increase
through 2023. Projected CFFO for 2013 is $608,000,000 and expected to grow steadily
to $1,663,000,000 by the year 2023.
Forecasting the cash flows from investing activities first begins with calculating
the change in non-current assets off of the balance sheet. The change in non-current
assets is then adjusted for depreciation and amortization, which yields the projected
changes in adjusted non-current assets. It is important that the non-current assets are
adjusted for depreciation and amortization as CFFI tracks the cash flows associated with
capital assets and notably, property, plant, and equipment. We anticipate depreciation
and amortization to rise steadily from $421,000,000 in 2014 to $637,000,000 in 2023.
Net CFFI of $-428,000,000 decreased in 2014 by 70% from its 2013 values. Thereafter,
we anticipate CFFI to increase steadily to $-1,225,000,000 through 2023.
Page | 89
Pac
kagi
ng
Co
rpo
rati
on
of
Am
eri
ca S
tate
me
nt
of
Cas
h F
low
s
(In
Mil
lio
ns)
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
Cas
h F
low
s Fr
om
Op
era
tin
g A
ctiv
itie
s
Ne
t in
com
e13
6
266
20
5
158
16
4
436
41
3
493
62
4
706
76
6
831
90
2
978
1,
061
1,15
2
De
pre
ciat
ion
& a
mo
rtiz
atio
n14
8
151
15
6
164
17
1
218
42
1
427
42
7
438
42
4
460
49
9
541
58
7
637
Am
ort
izat
ion
of
de
bt
dis
cou
nt/
pre
miu
m a
nd
issu
ance
co
sts
(1)
(1)
(1)
(1)
4
De
ferr
ed
inco
me
tax
es
(11)
(1
4)
(121
)
27
183
(1
64)
Sto
ck b
ase
d c
om
pe
nsa
tio
n9
7
7
10
12
15
Acc
ou
nts
re
ceiv
able
21
14
(50)
(1
7)
(25)
(3
1)
Inve
nto
ry(3
)
(5
)
(2
8)
(8)
(12)
33
Pre
pai
d e
xpe
nse
s-
(9
)
(4
)
(1
)
(1
)
(2
)
Acc
ou
nts
pay
able
(31)
22
25
(1
)
(4
0)
54
Acc
rue
d li
abil
itie
s(1
0)
5
11
6
(2
)
(5
5)
Oth
er
wo
rkin
g ca
pit
al7
(8)
12
1
Oth
er
no
n-c
ash
ite
ms
(121
)
13
7
7
(49)
10
3
Ne
t ca
sh p
rovi
de
d b
y o
pe
rati
ng
acti
viti
es
269
30
6
350
34
6
404
60
8
838
86
3
939
1,
019
1,
106
1,
200
1,30
2
1,
413
1,53
3
1,
663
Cas
h F
low
s Fr
om
Inve
stin
g A
ctiv
itie
s
Inve
stm
en
ts in
pro
pe
rty,
pla
nt,
an
d e
qu
ipm
en
t(1
33)
(114
)
(3
23)
(293
)
(130
)
(234
)
Pro
pe
rty,
pla
nt,
an
d e
qu
ipm
en
t re
du
ctio
ns
2
-
2
-
-
Acq
uis
itio
ns,
ne
t-
(3
)
(5
7)
(35)
(1
,175
)
Oth
er
inve
stin
g ac
tivi
tie
s3
(2)
57
(2
)
Ne
t ca
sh u
sed
fo
r in
vest
ing
acti
viti
es
(135
)
(1
19)
(321
)
(3
50)
(1
08)
(1
,411
)
(428
)
(6
51)
(722
)
(7
98)
(815
)
(8
84)
(959
)
(1
,041
)
(1,1
29)
(1
,225
)
Cas
h F
low
s Fr
om
Fin
anci
ng
Act
ivit
ies
De
bt
issu
ed
150
39
7
1,99
8
De
bt
rep
aym
en
t(1
)
(1
)
(1
)
(4
37)
(1
,075
)
Co
mm
on
sto
ck r
ep
urc
has
ed
(39)
(1
15)
(1
11)
(8
)
Div
ide
nd
pai
d(7
7)
(62)
(7
6)
(118
)
(109
)
(155
)
(1
75)
(194
)
(2
14)
(233
)
(2
53)
(272
)
(2
92)
(3
11)
(3
30)
Oth
er
fin
anci
ng
acti
viti
es
2
9
6
23
(2
0)
Ne
t ca
sh p
rovi
de
d b
y (u
sed
fo
r) f
inan
cin
g ac
tivi
tie
s(7
5)
(93)
(3
6)
(246
)
787
(1
55)
(175
)
(1
94)
(214
)
(2
33)
(253
)
(2
72)
(292
)
(311
)
(330
)
Ne
t ch
ange
in c
ash
111
(6
4)
(40)
51
(16)
25
4
37
22
7
58
64
71
81
93
10
8
CFF
O/S
ale
s11
.4%
14.2
%14
.4%
13.2
%14
.2%
16.6
%14
.2%
14.0
%14
.3%
14.4
%14
.4%
14.4
%14
.4%
14.4
%14
.4%
14.4
%
CFF
O/O
pe
rati
ng
Inco
me
111.
2%86
.9%
189.
2%12
6.7%
91.2
%12
8.3%
CFF
O/N
et
Inco
me
197.
8%11
5.0%
170.
7%21
9.0%
246.
3%13
9.4%
Ch
ange
In N
C A
sse
ts39
(1
58)
(174
)
83
(2
,196
)
Ch
ange
In A
dju
ste
d N
C A
sse
ts(1
12)
(314
)
(3
38)
(8
8)
(2,4
14)
(4
28)
(651
)
(7
22)
(798
)
(8
15)
(884
)
(9
59)
(1,0
41)
(1
,129
)
(1,2
25)
DEP
/PP
E La
gge
d12
%13
%12
%12
%16
%15
%15
%15
%15
%15
%15
%15
%15
%15
%15
%
PP
E Tu
rno
ver
1.76
2.06
1.96
1.
93
2.68
2.
10
2.
17
2.
25
2.
50
2.
50
2.
50
2.
50
2.
50
2.50
2.
50
His
tori
cal R
esu
lts
Fore
cast
ed
Fig
ure
s
Page | 90
Pac
kagi
ng
Co
rpo
rati
on
of
Am
eri
ca S
tate
me
nt
of
Cas
h F
low
s
Co
mm
on
Siz
e (
In M
illi
on
s)20
0820
0920
1020
1120
1220
1320
1420
1520
1620
1720
1820
1920
2020
2120
2220
23
Cas
h F
low
s Fr
om
Op
era
tin
g A
ctiv
itie
s
Ne
t in
com
e50
.6%
86.9
%58
.6%
45.7
%40
.6%
71.7
%49
.3%
57.1
%66
.4%
69.2
%69
.2%
69.2
%69
.2%
69.2
%69
.2%
69.2
%
De
pre
ciat
ion
& a
mo
rtiz
atio
n55
.0%
49.3
%44
.6%
47.4
%42
.3%
35.9
%
Am
ort
izat
ion
of
de
bt
dis
cou
nt/
pre
miu
m a
nd
issu
ance
co
sts
-0.4
%-0
.3%
-0.3
%-0
.3%
1.0%
0.0%
De
ferr
ed
inco
me
tax
es
-4.1
%-4
.6%
-34.
6%7.
8%45
.3%
-27.
0%
Sto
ck b
ase
d c
om
pe
nsa
tio
n3.
3%2.
3%2.
0%2.
9%3.
0%2.
5%
Acc
ou
nts
re
ceiv
able
7.8%
4.6%
-14.
3%-4
.9%
-6.2
%-5
.1%
Inve
nto
ry-1
.1%
-1.6
%-8
.0%
-2.3
%-3
.0%
5.4%
Pre
pai
d e
xpe
nse
s0.
0%-2
.9%
-1.1
%-0
.3%
-0.2
%-0
.3%
Acc
ou
nts
pay
able
-11.
5%7.
2%7.
1%-0
.3%
-9.9
%8.
9%
Acc
rue
d li
abil
itie
s-3
.7%
1.6%
3.1%
1.7%
-0.5
%-9
.0%
Oth
er
wo
rkin
g ca
pit
al2.
6%-2
.6%
3.4%
0.3%
0.0%
0.0%
Oth
er
no
n-c
ash
ite
ms
0.0%
-39.
5%39
.1%
2.0%
-12.
1%16
.9%
Ne
t ca
sh p
rovi
de
d b
y o
pe
rati
ng
acti
viti
es
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
Cas
h F
low
s Fr
om
Inve
stin
g A
ctiv
itie
s
Inve
stm
en
ts in
pro
pe
rty,
pla
nt,
an
d e
qu
ipm
en
t98
.5%
95.8
%10
0.6%
83.7
%12
0.4%
16.6
%
Pro
pe
rty,
pla
nt,
an
d e
qu
ipm
en
t re
du
ctio
ns
-1.5
%0.
0%-0
.6%
0.0%
0.0%
0.0%
Acq
uis
itio
ns,
ne
t0.
0%2.
5%0.
0%16
.3%
32.4
%83
.3%
Oth
er
inve
stin
g ac
tivi
tie
s-2
.2%
1.7%
0.0%
0.0%
-52.
8%0.
1%
Ne
t ca
sh u
sed
fo
r in
vest
ing
acti
viti
es
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
Cas
h F
low
s Fr
om
Fin
anci
ng
Act
ivit
ies
De
bt
issu
ed
-416
.7%
-161
.4%
253.
9%
De
bt
rep
aym
en
t1.
3%1.
1%2.
8%17
7.6%
-136
.6%
Co
mm
on
sto
ck r
ep
urc
has
ed
41.9
%31
9.4%
45.1
%-1
.0%
Div
ide
nd
pai
d10
2.7%
66.7
%21
1.1%
48.0
%-1
3.9%
Oth
er
fin
anci
ng
acti
viti
es
-2.7
%-9
.7%
-16.
7%-9
.3%
-2.5
%
Ne
t ca
sh p
rovi
de
d b
y (u
sed
fo
r) f
inan
cin
g ac
tivi
tie
s10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
100.
0%10
0.0%
Ne
t ch
ange
in c
ash
111
(6
4)
(40)
51
(16)
25
4
37
22
7
58
64
71
81
93
10
8
His
tori
cal R
esu
lts
Fore
cast
ed
Fig
ure
s
Page | 91
Cost of Capital Estimation
To discount the forecasts of asset performance and value its assets, our analysis
team must assess the cost of all capital provided. This assessed cost is known as the
Weighted Average Cost of Capital and equals the average cost to a firm of obtaining
capital from both debt and equity sources. The Weighted Average Cost of Capital
(WACC) is the discount rate our analysis team will use to discount the firm’s financials.
The cost of debt and the cost of equity must be estimated in order to calculate the
WACC. If the cost of capital is relatively high or low, the firm financials are understated
and overstated respectfully.
Cost of Debt
The cost of debt is the effective rate that a company pays on its current debt.
The cost of debt and the risk associated with it are positively correlated, meaning as the
cost of debt increases so does the risk associated with the firm.
To calculate the weighted average cost of debt for Packaging Corp. all current
and non-current interest bearing liabilities are taken into account. The non-interest
bearing debts are not considered to be financial liabilities. As a result, our analysis team
adjusted the balance sheet to reflect this removal of non-interest bearing accounts. The
next step for our team was finding the associated interest rates for current and non-
current liabilities.
Page | 92
According to PKG 10-K, total long-term liabilities are equal to $3,226,420. From
here, we calculated the weights related to each interest bearing liabilities. The cost of
debt will equal the weighted average of the interest bearing liabilities. This resulted in
weighted average rate of 2.52%.
Cost of Equity
The cost of equity is the rate of return shareholders require on equity, or in other
words, the cost of equity is the return that the market warrants for the risk taken for
taking an ownership stake in a company. The Capital Asset Pricing Model (CAPM) is
used to compute the cost of equity. The CAPM uses the following formula:
Cost of Equity = Risk-Free Return + Firm Beta * (Market Return – Risk-Free Return)
The risk free rate, systematic risk, the market risk premium, and a size-adjusted
beta are all taken into account in the CAPM. Our analysis team acquired the risk free
rate from bond yields on the St. Louis Fed website. For this analysis, the most the 10-yr
treasury rate at the end of September (2.52%) was used. The market return was taken
Page | 93
from the historical returns of the S&P 500 returns. The market risk, the return investors
require over the risk-free rate, was assumed to be 7% due to uncertainty in the market
following the financial crisis. The beta comes from the multiple regressions for company
returns and market risk premiums for relative treasury yields.
Our team ran multiple regressions using five points of the yield curve: the 10-
year, 7-year, 2-year, 1-year and 3-month treasury rates. Running multiple regressions
using multiple treasury rates ensures that the best beta can be identified. Beta is the
relationship a firm’s return has with market returns; firms with a Beta of 1 move with
the market, firms with a Beta of less than 1 are less sensitive to changes in the market,
and firms with a Beta larger than 1 are more sensitive to changes in the market.
Time
(Months)Beta
Beta Lower
Bound
Beta Upper
Bound
Adjusted R
Squared
Market Risk
Premium
Risk-Free
RateKe
Size
Premium2-Fact Ke
Ke Lower
Bound
Ke Upper
Bound
72 1.41 1.14 1.68 60.8% 7% 2.52% 12.39% 0.9% 13.287% 11.42% 15.16%
60 1.14 0.83 1.45 47.9% 7% 2.52% 10.51% 0.9% 11.409% 9.26% 13.56%
48 1.16 0.79 1.53 45.6% 7% 2.52% 10.65% 0.9% 11.551% 8.98% 14.13%
36 1.29 0.80 1.78 44.6% 7% 2.52% 11.55% 0.9% 12.452% 9.05% 15.85%
24 1.29 0.54 2.05 33.8% 7% 2.52% 11.58% 0.9% 12.479% 7.21% 17.74%
Time
(Months)Beta
Beta Lower
Bound
Beta Upper
Bound
Adjusted R
Squared
Market Risk
Premium
Risk-Free
RateKe
Size
Premium2-Fact Ke
Ke Lower
Bound
Ke Upper
Bound
72 1.41 1.14 1.68 60.8% 7% 2.52% 12.39% 0.9% 13.290% 11.42% 15.16%
60 1.14 0.83 1.45 47.9% 7% 2.52% 10.51% 0.9% 11.414% 9.26% 13.57%
48 1.16 0.79 1.53 45.6% 7% 2.52% 10.66% 0.9% 11.559% 8.98% 14.14%
36 1.29 0.81 1.78 44.7% 7% 2.52% 11.56% 0.9% 12.461% 9.07% 15.86%
24 1.30 0.55 2.05 33.9% 7% 2.52% 11.59% 0.9% 12.493% 7.24% 17.75%
Time
(Months)Beta
Beta Lower
Bound
Beta Upper
Bound
Adjusted R
Squared
Market Risk
Premium
Risk-Free
RateKe
Size
Premium2-Fact Ke
Ke Lower
Bound
Ke Upper
Bound
72 1.41 1.14 1.68 60.7% 7% 2.52% 12.39% 0.9% 13.286% 11.42% 15.16%
60 1.14 0.83 1.45 47.8% 7% 2.52% 10.52% 0.9% 11.416% 9.26% 13.58%
48 1.16 0.79 1.53 45.4% 7% 2.52% 10.65% 0.9% 11.552% 8.97% 14.14%
36 1.29 0.80 1.78 44.5% 7% 2.52% 11.55% 0.9% 12.451% 9.04% 15.86%
24 1.29 0.54 2.05 33.8% 7% 2.52% 11.58% 0.9% 12.484% 7.22% 17.75%
Time
(Months)Beta
Beta Lower
Bound
Beta Upper
Bound
Adjusted R
Squared
Market Risk
Premium
Risk-Free
RateKe
Size
Premium2-Fact Ke
Ke Lower
Bound
Ke Upper
Bound
72 1.41 1.14 1.68 60.7% 7% 2.52% 12.39% 0.9% 13.286% 11.41% 15.16%
60 1.14 0.83 1.45 47.7% 7% 2.52% 10.51% 0.9% 11.414% 9.25% 13.58%
48 1.16 0.79 1.53 45.3% 7% 2.52% 10.65% 0.9% 11.546% 8.96% 14.13%
36 1.29 0.80 1.78 44.4% 7% 2.52% 11.55% 0.9% 12.445% 9.04% 15.85%
24 1.29 0.54 2.05 33.7% 7% 2.52% 11.57% 0.9% 12.473% 7.20% 17.74%
Time
(Months)Beta
Beta Lower
Bound
Beta Upper
Bound
Adjusted R
Squared
Market Risk
Premium
Risk-Free
RateKe
Size
Premium2-Fact Ke
Ke Lower
Bound
Ke Upper
Bound
72 1.41 1.14 1.68 60.7% 7% 2.52% 12.39% 0.9% 13.288% 11.42% 15.16%
60 1.14 0.83 1.45 47.8% 7% 2.52% 10.52% 0.9% 11.418% 9.26% 13.58%
48 1.16 0.79 1.53 45.5% 7% 2.52% 10.66% 0.9% 11.558% 8.98% 14.14%
36 1.29 0.80 1.78 44.6% 7% 2.52% 11.56% 0.9% 12.457% 9.05% 15.86%
24 1.30 0.55 2.05 33.9% 7% 2.52% 11.59% 0.9% 12.494% 7.24% 17.75%
1 Year
2 Year
3
Month
10 Year
7 Year
Page | 94
Our team found that the 10-year treasury rate over 72 months provided the
highest explanatory power (Adjusted R^2) when comparing PKG’s return to the market.
From the regression tables, we are able to conclude that PKG’s Beta is 1.41. Yahoo
Finance determined Beta to be 1.29, and this agrees with our conclusion that PKG has a
moderately high (60%) systematic risk. Therefore, 60% of the volatility in PKG’s returns
can be explained by changes in the market. The CAPM provided a centered cost of
equity of 13.29%, with a lower bound of 11.42% and an upper bound of 15.16%. Our
team used a 95% confidence interval, so investors can be 95% sure PKG will earn
between 11.42 and 15.16% on its equity.
Backdoor Cost of Equity
A less rigorous method for obtaining the cost of equity is the backdoor cost of
equity. Instead of using historical information through CAPM to approximate returns on
equity, the backdoor method manipulates the following formula to estimate a cost of
equity.
Price/Book = 1 + (ROE – Ke)/(Ke – g)
To backdoor cost of equity is driven by the current Price/Book ratio, the average
ROE of our 10 year forecast, and the firm’s geometric average equity growth rate over
the next 10 years. We calculated the backdoor cost of equity to be 13.20%. When
compared to our estimated cost of equity of 13.29%, the results reflect investor
confidence that PKG will continue to grow following the Boise acquisition.
Weighted Average Cost of Capital
A firm’s WACC represents its cost of asset financing, in terms of debt or equity. It
can also be described as the weighted average return that a company is expected to
make in order to satisfy all capital investors, both equity and debt holders. The WACC
Page | 95
multiplies the weights of the market value of equity and debt to the total market value
of the firm by the respective costs of debt and cost of equity. The values are then
added to estimate the weighted average cost of capital. The process can be described
by this formula:
WACCBT = ((MVD/MVF) * Kd) + (MVE/MVF * Ke)
To calculate the weight of equity, we first had to calculate the market value of
equity. The market value of equity is equal to the number of shares outstanding
multiplied by the closing price of the stock on the specific date. According to 2013 PKG
10-K, the firm had 97.17 million shares outstanding and their stock closed at $71.77 as
of November 3, 2014. Therefore the implied market value of equity is $6,973,891. The
market value of interest bearing debt as stated on PKG’s 2013 balance sheet was
$2,887,286. By adding the market value of liabilities and the market value of equity we
can determine the market value of the firm. PKG had a market value of $9,637,286.
The weight of total liabilities is 29.28% and the weight of total equity is 70.72%. This
indicates that PKG’s value is primarily held in the value of its equity.
To find the WACC, the weight of total liabilities is multiplied by the cost of debt
and the weight for total equity is multiplied by the cost of equity. As stated in the cost
of debt section above, PKG had a cost of debt of 2.52%. The cost of equity used for
WACC was taken from the 10-year 2-factor cost of equity, estimated to be 13.29%.
PKG’s before-tax WACC is estimated to be 10.14%, and the firm’s after-tax WACC
9.88%.
Page | 96
Conclusion
The weighted average cost of capital represents the minimum rate of return at
which Packaging Corp. of America produces value for its investors. Our Analysis team
calculated a before tax WACC of 10.14% and after tax WACC of 9.88%.
Method of Comparables
Comparables are frequently utilized by analysts in determining the value of a
firm. This method prices firm value by using a comparison of the firm's results of
various ratios to that of the competition. A great benefit of using this approach is that
the inputs are widely accessible and are calculated using a standardized computation.
There are a couple of associated weaknesses with this method. Firstly, the method only
takes into consideration one year of data, which is typically not indicative of the firm’s
future performance or performance as a whole. Secondly, it’s possible to calculate
negative share prices and prices which would be improbable for the firm to achieve.
The aforementioned issues lead to the method being inconsistent in calculating a firm’s
value.
To value the status of PKG's share price, we will use a 10% analyst opinion of
the October 31, 2014 observed closing share price of $72.08. Therefore, prices
calculated below $64.87 will be deemed overvalued, and any price calculated above
$79.28 will be considered undervalued. The data used as inputs for PKG and its industry
peers have been collected using PKG’s 10-K and YCharts. It’s important to note that
the calculated peer averages do not include PKG, but only the competitors.
Furthermore, peer outliers were not considered in the calculation of the peer average to
provide a meaningful comparison.
Page | 97
Price to Book Multiple
The price to book (P/B) ratio looks at the relationship between the current stock
price of a firm and the book value on a per share basis. The book value is solely
dependent on the reported financials; therefore the calculated ratio is not susceptible to
forecast error. In general, a lower P/B ratio suggests that the firm is undervalued. The
P/B ratio, shown below, is calculated by dividing the share price by the book value per
share.
The average P/B multiple of PKG’s industry peers is 2.82. At 4.57, PKG has a
higher multiple than average, suggesting that the firm is overvalued. The model price of
44.41 falls well below the “fairly valued” range. This result is subject to the limitations
of the P/B ratio, which relies solely on the book value of assets. PKG carries large
amounts of property, plant, and equipment which may not be valued at their true
market value due to GAAP policies regarding asset write-downs. This discrepancy is
overshadowed by the fact that the P/B ratio does not take into account the differences
in capital structures among firms. In this case, the results of this comparison should not
be relied upon.
Price to Earnings (Trailing Twelve Months)
The trailing price to earnings ratio is calculated using the past four quarters, or
year, of the earnings per share (EPS) and the current share price (PPS). Therefore, this
method tends yield more reliable results than the forward P/E, because the earnings
used have already been reported. The firm’s value was calculated by multiplying the
industry average P/E and multiplying it by PKG's EPS.
COMPANY PPS BVS Comparable Ratio Peer Average PKG Share Price
PKG 72.08 15.78 4.57 2.82 Book Value/Share 15.78
KS 30.76 8.46 3.64
IP 50.62 16.09 3.15
RKT 51.15 30.76 1.66
44.41
Values at 10/31/14 - In Millions Except Per-Share DataPRICE/BOOK
Driver
Page | 98
The average P/E (TTM) multiple of PKG’s industry peers is 20.56. At 13.67, PKG
has a lower multiple than average, suggesting that the firm is undervalued. The model
price of 108.43 falls well above the “fairly valued” range. This share price, however, is
reached using the highly volatile historical earnings of PKG and its peers. Analyst
opinions regarding future growth and profitability are not taken into account, so a
future-focused comparison would provide a more relevant stock valuation. In this case,
the results of this comparison should not be relied upon when making investment
decisions.
Price to Earnings (Forward)
The forward price to earnings ratio is calculated similar to the trailing P/E ratio,
but instead utilizes forecasted information for the earnings. Using this method, the
earnings component of the EPS formula was collected from YCharts. Because the
resulting ratio is dependent on the accuracy of forecasted data, it's possible for the
calculated price to have some distortions. In order to mitigate distortions, data was
collected from YCharts for PKG and its industry peers.
The average P/E (Forward) multiple of PKG’s industry peers is 14.42. At 15.47,
PKG has a higher multiple than average, suggesting that the firm is overvalued. The
model price of 66.33 falls within the “fairly valued” range. This share price takes into
COMPANY PPS EPS Comparable Ratio Peer Average PKG Share Price
PKG 72.08 5.27 13.67 20.56 EPS (Diluted TTM) 5.27
KS 30.76 1.51 20.37
IP 50.62 1.97 25.74
RKT 51.15 3.28 15.58
108.43
PRICE/EARNINGS (TRAILING) Values at 10/31/14 - In Millions Except Per-Share Data
Driver
COMPANY PPS EPS Comparable Ratio Peer Average PKG Share Price
PKG 72.08 4.66 15.47 14.24 EPS 4.66
KS 30.76 2.09 14.72
IP 50.62 3.36 15.07
RKT 51.15 3.96 12.92
PRICE/EARNINGS (FORWARD)
Driver
Values at 10/31/14 - In Millions Except Per-Share Data
66.33
Page | 99
account analyst opinions regarding future growth and profitability; this future-focused
comparison provides a more dependable stock valuation.
Dividend Payout Multiple
The dividend payout ratio analyzes the relationship between the firm’s dividends
on per share basis divided by the price per share. An inherent flaw in this valuation
method is that all peer competitors must consistently pay dividends to yield a
meaningful valuation. Out of PKG’s competitors, KapStone does not actively pay
dividends and IP is an outlier in the dataset. Therefore the comparison was only
between RKT and PKG, which is not significant enough for the valuation method to
carry weight. For this reason the dividend payout ratio will not influence our overall
view of PKG value.
Once we omitted KapStone, which does not pay dividends, and International
Paper, which pays out unusually high dividends, the average dividend payout ratio of
PKG’s industry peers is 22%. At 30%, PKG has a higher payout ratio than average,
suggesting that the firm is overvalued. The model price of 7.49 falls well below the
“fairly valued” range. This comparison, however, is only between two firms, so the
computed stock price does not reflect PKG’s performance relative to its industry. The
results of this comparison should not be relied upon when making investment decisions.
P.E.G. Multiple
The P.E.G. multiple is calculated by dividing the P/E ratio by the 5-year
forecasted growth rate of earnings per share: (P/E)/EPS Growth) = P.E.G. This
valuation ratio is similar to the standard P/E ratio except that earnings growth is
COMPANY DPS Net Income Comparable Ratio Peer Average PKG Share Price
PKG 157.26 517 30% 22% ANNUAL DPS 1.62
KS 0 181 0% SHARES 97.17
IP 605.04 857 71%
RKT 103.62 480 22%
Driver
Values at 10/31/14 - In Millions Except Per-Share Data
7.49
DIVIDEND PAYOUT
Page | 100
considered when calculating P.E.G. High growth rates will result in a lower P.E.G. ratio,
all else equal; firms with low P.E.G. ratios may be considered undervalued. Our team
calculated this model’s per-share price by multiplying the average P.E.G. ratio of PKG’s
industry peers by the firm’s 5-year EPS growth rate and EPS.
The average P.E.G. ratio of PKG’s industry peers is .36. At .50, PKG has a higher
ratio than average, suggesting that the firm is overvalued given its earnings
performance. The growth rate implied by the P.E.G., however, is over 26%. When we
adjusted the growth rate to a more realistic 13%, the stock price fell within the “fairly
valued” range. The results of this comparison should be viewed with skepticism due to
the volatile nature of PKG’s earnings and theunusually high growth rate implied by the
P.E.G. ratio provided by YCharts.
Enterprise Value/EBITDA
The enterprise value to EBITDA (earnings before interest, tax, depreciation, and
amortization) is calculated by dividing the firm's enterprise value by EBITDA. Enterprise
value is an important value as it represents the value of the actual operations of the
firm. It is calculated by taking the sum of the market value of liabilities and equity and
subtracting the cash assets and investments of the firm. Due to the variables of the
ratio, the firm's capital structure does not affect the valuation results. It's important to
note that EBITDA is a non-GAAP measure; therefore this ratio should not be the sole
measure in determining the value of a firm.
COMPANY Comparable Ratio Peer Average PKG Share Price
PKG 0.59 0.36 5-YR EPS Growth (%) 26.26
KS 0.27 P/E (F) 15.47
IP 0.57
RKT 0.25
Driver
Values at 10/31/14 - In Millions Except Per-Share DataP.E.G.
147.76
Page | 101
The average EV/EBITDA multiple of PKG’s industry peers is 8.48. At 9.13, PKG
has a higher multiple than average, suggesting that the firm is undervalued. The model
price of 90.65 falls well above the “fairly valued” range. As the largest decrease in
margins occurs in the shift from gross profit to operating profit, and not between
operating profit and net profit, EBITDA reflects most of the firms operating decisions
and characteristics. In this case, the results of this comparison can be relied upon when
making investment decisions.
Enterprise Value/FCF
The enterprise value to free cash flows ratio compares the enterprise value of
the firm by the free cash flows. Free cash flows are the sum of a firm’s cash flows from
both operating and investing activities. The use of enterprise value in this ratio is
important as it helps determine the ability of the firm to generate cash flows in relation
to its enterprise value, which represents the value of the actual operations of the firm.
It’s important to note that the lower the EV/FCF multiple is, the greater the firm’s ability
is to generate cash flows to increase firm value and repay acquisition costs.
The average EV/FCF multiple of PKG’s industry peers is 19.12. At 24.15, PKG has
a higher multiple than average, suggesting that the firm is overvalued. The model price
of 77.50 falls within the “fairly valued” range. Factors in capital investment decisions;
however, due to the disparity in dividend policies, the differences among FCF amounts
COMPANY EV EBITDA Comparable Ratio Peer Average PKG Share Price
PKG 9318 1021 9.13 8.48 EBITDA 1021
KS 4049 445 9.09 CASH 154
IP 29600 3161 9.36 SHARES 97.17
RKT 10112 1450 6.97
90.65
ENTERPRISE VALUE/EBITDA
Driver
Values at 10/31/14 - In Millions Except Per-Share Data
COMPANY EV FCF Comparable Ratio Peer Average PKG Share Price
PKG 9318 386 24.15 19.12 FCF 386
KS 4049 183 22.12 CASH 154
IP 29600 1570 18.85 SHARES 97
RKT 10112 617 16.38
77.50
ENTERPRISE VALUE/FREE CASH FLOW
Driver
Values at 10/31/14 - In Millions Except Per-Share Data
Page | 102
cannot be fully explained by operating decisions alone. In this case, the results of this
comparison must be viewed with skepticism making investment decisions.
Enterprise Value/Sales
The EV/ Sales multiple, which is calculated by dividing the enterprise value of the
firm by the annual sales. The ratio uses the enterprise value to look at the cost of sales
in relation to the firm’s value. In general, the lower the multiple, the more undervalued
the firm appears. Although a lower multiple usually suggests that a firm is undervalued,
a higher multiple may also denote a favorable firm value. Therefore comparison to
industry peers is especially important when utilizing this multiple.
The average EV/Sales multiple of PKG’s industry peers is 1.24. At 1.64, PKG has
a higher multiple than average, suggesting that the firm is overvalued. The model price
of 48.29 falls well below the “fairly valued” range. Firms in this industry have had
similar margins; a comparison of sales –before any operating and production cost are
accounted for- can still yield useful results. In this case, the results of this comparison
can be relied upon when making investment decisions.
Conclusion
Due to the inherent flaws within the comparables, our results are inconclusive
regarding the value of PKG. This is largely attributable to the use of only one year’s
worth of data, which leads to volatile results as seen below. Therefore, the results
below will not be utilized or depended upon in the ultimate valuation of PKG. The P/B,
Dividend payout, and EV/ Sales multiples indicate that PKG is overvalued. Conversely
COMPANY EV SALES Comparable Ratio Peer Average PKG Share Price
PKG 9318 5682 1.64 1.24 SALES 3665
KS 4049 2301 1.76 CASH AND EQUIV. 154
IP 29600 31725 0.93 SHARES 97
RKT 10112 9895 1.02
48.29
ENTERPRISE VALUE/SALES
Driver
Values at 10/31/14 - In Millions Except Per-Share Data
Page | 103
the trailing P/E, PEG, and EV/EBITDA indicate that PKG is undervalued. Both of the
forward P/E and EV/FCF indicate that PKG is fairly valued.
Due to the inconsistencies and inconclusive results within the method of
comparables it will not be the only method for valuing PKG. In the following section we
will analyze PKG’s value using intrinsic valuation models, which are more depending on
fundamental financial theory.
Intrinsic Valuation Models
Intrinsic valuation models use forecasted performance, as well as an applicable
discount rate, to place a value on a firm’s equity. These models rely on forecasted
information, so they are subject to forecast error; however, these models are grounded
in finance theory, and investors can refer to these models when making investment
decisions. One key assumption in these models is that, in the long run, a firm will
deliver its required rate of return, and the value of the firm will approach zero. In this
section, our team will utilize the discounted dividends, discounted cash flows, residual
income, abnormal earnings growth and long run residual income models to assign a
value to the equity of Packaging Corporation of America.
These models use the cost of capital and growth rates our team estimated in the
precious section. To account for both estimation error and best/worst case scenarios, a
sensitivity analysis will be performed for each of these models to observe how changes
in inputs affect the models’ output. Our team will use a 10% boundary approach when
valuing PKG; if the share price derived by these models is 10% higher or lower than the
RESULT
Overvalued
Undervalued
Fairly Valued
Overvalued
Undervalued
Undervalued
Fairly Valued
Overvalued
SUMMARY OF COMPARABLES
RATIO
P/E Trailing
P/B
EV/Sales
EV/FCF
EV/EBITDA
P.E.G.
Dividend Payout
P/E Froward
Page | 104
11/03/14 share price of $71.77, then we can conclude that the stock is not fairly
valued. Our team will base our final recommendation on how the prices given by the
following models fall within above, or below the fairly valued range. It is important to
note that the evaluation date of this report is 11/01/14; our team, however, was unable
to retrieve the November 1st share price, so we used the close price of $71.77 on
Monday, November 3rd for our valuation models. PKG’s financials did not require any
restatements, so we will only perform these valuations based on as-stated values.
Discounted Dividends Model
The Discounted Dividends Model derives the intrinsic value of a firm by
discounting future dividend payments to shareholders by the firm-specific two-factor
cost of equity. The discounted dividends model is based on finance theory, but it makes
the unrealistic assumption that investors buy into stock solely for the dividend stream
and not appreciation in stock price. The discounted dividends model discounts dividends
forever; therefore most of the firm’s value is placed in a stream of dividends that
cannot be predicted with any certainty. Also, the model does not place any value in the
growth a firm achieves when it does not pay out dividends, but rather invests retained
earnings back into the company. Overall, this model does not have high explanatory
power.
Our team calculated the share price under this model by first discounting the
dividends per share from our previous forecast by the cost of equity; we then estimated
a perpetuity growth rate by projecting out dividends for 50 years using the stair step
function where annual dividends per share increase by 20 cents every year. We then
averaged the growth rate over these 50 years to arrive at a perpetuity growth rate of
2.79%. We then calculated the present value of both the 10-year dividend stream and
the perpetuity; we divided this number by the total shares outstanding to arrive at the
model price per share. To make this model price comparable to the price observed at
11/03/14, we grew the model share price by the cost of equity for the fraction of a year
that separates the model price and observed price (307 days).
Page | 105
This model shows that, within a reasonable range of perpetuity growth rates and
cost of equity, the stock is overvalued. Even in a best-case scenario of low cost of
equity and high growth rate the stock is overvalued. The results of this model should be
viewed with skepticism due to the unrealistic assumptions it makes and the
unpredictability of dividend payouts.
Discounted Free Cash Flow Model
In contrast to DDM, which focuses on distribution of dividends, the Discounted
Free Cash Flow Model (DCF) focuses on the generation of free cash flows (FCF). The
DCF model offers greater explanatory power than the DDM, but still maintains its own
inherent issues. One main issue is that the model is dependent on the FCF forecasts,
which are difficult to predict due to the inconsistency with capital expenditures (CAPEX).
Therefore there is a certain degree of forecasting error incorporated into the DCF
model, which is compounded over time. The DCF model utilizes the assumption that the
market value of equity (MVE) equals the market value of assets (MVA) less the market
value of liabilities (MVL). In the DCF model, the MVA is calculated by taking the present
value of the annual FCF into perpetuity. To calculate PKG’s year-by-year FCF, cash flows
from investing activities (CFFI) are subtracted from the cash flows from operating
activities (CFFO) for the forecasted ten-year period. The before-tax WACC is then used
to discount the year-by-year free cash flows to the present value. It’s important to note
the difference between of WACCBT and WACCAT to avoid accounting for taxes twice,
24.64$ 0.8% 1.8% 2.8% 3.8% 4.8%
9.3% 34.86 37.37 40.64 45.11 51.56
11.3% 27.69 29.05 30.72 32.84 35.61
13.3% 22.89 23.69 24.64 25.79 27.21
15.3% 19.46 19.96 20.54 21.22 22.04
17.3% 16.91 17.24 17.61 18.04 18.54
64.59 < Fair < 78.95Overvalued < < Undervalued
PKG Discounted Dividends Sensitivity Analysis
Cost of
Equity
Perpetuity Growth Rate
10% Analyst Position
Page | 106
because the after-tax net income is already included in the cash flows from operating
activities. Similar to the DDM valuation, the discounted free cash flows model will be
separated into two sections, years 1-10 and 11-infinity. For years 1-10, the FCF is
calculated on an annual basis and then discounted back to present value using before-
tax WACC. Next, the present value of FCF from year 11 into perpetuity is calculated.
After the present values of all FCF have been added, we are then able to
estimate PKG’s market value of assets. It’s important to note that to calculate the
market value of equity; we assume that the MVL is equal to the book value of liabilities.
Therefore, PKG’s MVE is equal to the calculated MVA less the book value of liabilities.
The market value of equity is then divided by the number of shares to yield the implied
model price. Lastly, the time-consistent price is calculated by multiplying the implied
model price by a 10-month future value factor. Below, a sensitivity analysis is shown
with incremental variables for WACCBT and the perpetuity growth rate (g).
The results of this model are almost equally distributed between over and
undervalued, with two fairly valued combinations and two abnormal results. These
results indicate that the stock is close to fair value in equilibrium; however the results of
this sensitivity analysis are highly sensitive to changes in before-tax WACC and
perpetuity growth rate. The results of this model should viewed with skepticism due to
the volatility of its results
34.11$ 4.50% 5.5% 6.5% 7.5% 8.5%
8.1% 47.68 73.54 130.94 367.71 -710.91
9.1% 27.15 40.57 64.15 116.50 332.45
10.1% 13.95 21.86 34.11 55.64 103.43
11.1% 4.78 9.83 17.05 28.24 47.91
12.1% -1.96 1.45 6.06 12.67 22.90
64.59 < Fair < 78.95
Perpetuity Growth Rate
WACC (BT)
10% Analyst Position
Overvalued < < Undervalued
PKG's Discounted Free Cash Flow Sensitivity Analysis
Page | 107
Residual Income Model
The Residual Income Valuation Model, like the DDM and FCF, uses the future
performance of a firm in both a forecasted period and in perpetuity to compute its
intrinsic value. Unlike the two previous models, however, the RIV model also takes into
account that a portion of a firm’s intrinsic value lies in its current equity. The RIV has
high explanatory power because the model places a high value on near-term year by
year values rather than in perpetuity; near-term forecasts are more reliable then long-
term forecasts, and the inputs for the RIV model are less speculative than the inputs
used in the FCF model.
This model is driven by the difference between net income and benchmark
income (the income a firm generates when it delivers the return on equity required by
shareholders). Residual income is calculated as Net Income less the previous year’s
book value of equity multiplied by the firm’s cost of equity. If residual income is
positive, a firm’s forecasted ROE is beating its cost of equity and the firm is creating
value for shareholders. If residual income is negative, the firm’s forecasted ROE is less
than its cost of equity and the firm is destroying value for shareholders. In the long run,
a firm must deliver its cost of equity, so residual income must converge to zero. Our
team assumes PKG’s change in residual income to be -30%, or the firm’s net income
will decrease 30% each year; the firm will continue to shrink until it is delivering the
return investors require. This -30% growth rate reflects the fact that competitive
advantages decay at a moderate rate. Firms do not have the guaranteed protection of
patents, but the industry is still slow to change due to the large investments in PPE.
We then discounted the year-by-year and perpetuity residual income values at
the cost of equity to; this value represents the portion of the firm’s market value of
equity that is made up of residual income. The market value of equity as of 12/31/13 is
then calculated by adding this value to the book value of equity and dividing that
number by shares outstanding. To make this model price comparable to the price
observed at 11/03/14, we grew the model share price by the cost of equity for the
fraction of a year that separates the model price and observed price (307 days). We
Page | 108
then ran a sensitivity analysis to determine the effects a change in cost of equity or
growth rate, within a plausible range, would have on the model price.
This model shows that, within a reasonable range of perpetuity growth rates and
cost of equity, the stock is overvalued. We determined that 36% of the share price is
attributed to the current BV of equity, 58.4% is attributed to the present value of year-
by-year residual income and 5.5% is attributed to the residual income perpetuity. In
this case, the RIV model places the majority of PKG’s value in the future. Considering
that even in a best-case scenario, where PKG has a low cost of equity and can maintain
its competitive advantages for a long time, the stock is overvalued.
Abnormal Earnings Growth Model
The Abnormal Earnings Growth model is based on the same principle as the RIV
model in that it compares its forecasted ROE to a benchmark value. The AEG, however,
does not place any value in the current book value of equity. This makes the AEG model
susceptible to forecasting error, but this model still has a high degree of explanatory
power. The benchmark income is calculated by multiplying the previous year’s net
income by (1+Cost of Equity). This value is then compared to cumulative dividends
earnings, the sum of the year’s net income and dividend reinvested earnings (the
previous year’s net income*Cost of Equity). The AEG is identical to the change in
residual income for a given year. In the long run, a firm must deliver its cost of equity,
41.65$ -10% -20% -30% -40% -50%
9.3% 64.51 60.15 58.00 56.73 55.89
11.3% 52.67 50.22 48.95 48.18 47.67
13.3% 43.63 42.34 41.65 41.22 40.92
15.3% 36.62 36.04 35.71 35.50 35.36
17.3% 31.10 30.94 30.85 30.79 30.75
64.59 < Fair < 78.95
Perpetuity Growth Rate
Cost of
Equity
10% Analyst Position
Overvalued < < Undervalued
PKG's Residual Income Sensitivity Analysis
Page | 109
so residual income must converge to zero. Our team assumes PKG’s change in residual
income to be -30% to reflect that the firm will continue to shrink until it is delivering the
return investors require. This -30% growth rate reflects the fact that competitive
advantages decay at a moderate rate. Firms do not have the guaranteed protection of
patents, but the industry is still slow to change due to the large investments in PPE.
We then discounted the year-by-year and perpetuity AEG values at the cost of
equity to; this value represents the portion of the firm’s market value of equity that is
made up of AEG. The market value of equity as of 12/31/13 is then calculated by
adding this value to the book value of core net income and dividing that number by
shares outstanding. To make this model price comparable to the price observed at
11/03/14, we grew the model share price by the cost of equity for the fraction of a year
that separates the model price and observed price (307 days). We then ran a sensitivity
analysis to determine the effects a change in cost of equity or growth rate, within a
plausible range, would have on the model price.
This model shows that, within a reasonable range of perpetuity growth rates
using the equilibrium cost of equity, the stock is overvalued. Under all growth rates, an
increase in the cost of equity over the equilibrium rate decreases the stock price even
more; a decrease in cost of equity results in the stock being undervalued. Our team
determined that 90.6% of the share price is attributed to core net income, 11.1% is
attributed to the year-by-year AEG and -1.7% is attributed to the perpetuity. While this
61.61$ -10% -20% -30% -40% -50%
9.3% 110.29 108.28 107.29 106.71 106.32
11.3% 79.83 79.69 79.61 79.56 79.53
13.3% 60.72 61.30 61.61 61.81 61.94
15.3% 47.98 48.80 49.26 49.55 49.76
17.3% 39.07 39.92 40.41 40.73 40.96
64.59 < Fair < 78.95
Cost of
Equity
10% Analyst Position
PKG's Abnormal Earnings Growth Sensitivity Analysis
Overvalued < < Undervalued
Perpetuity Growth Rate
Page | 110
model places most of the firm’s value in near-term, the results of this model should be
viewed with skepticism due to its sensitivity to changes in the cost of equity.
Long-Run Residual Income Model
The Long-Run Residual Income Model operates under the same principles as the
Residual Income Model: a firm with a positive residual income will add value, a firm
with negative residual income will destroy value and residual income will converge to
zero in the long run. The driver of this model is residual income, which is calculated
using a ROE (in our case the 10-year average of the 2014-2023 ROE) and a long-run
residual income perpetuity growth rate rather than separate 10-year forecast and
perpetuity. Therefore, the market value of equity is calculated by adding the residual
income segment to the firm’s book value of equity. Our team determined that the
average ROE based on our 10-year forecast is 17%; we also assumed the -30% growth
rate used in the previous two models would be appropriate. The Long-Run Residual
Income model is based on this function:
MVE = BVE0 + BVE0*(1+(ROE – Ke)/(Ke-g))
In this formula, the market value of equity depends on ROE, Ke, and g. A
sensitivity analysis must be used to assess the valuation’s response to changes in these
variables, buy the difficultly of conduction a three-dimensional sensitivity analysis on
paper limited our team to conduct three separate sensitivity analyses, each holding one
variable constant.
Page | 111
This model shows that, within a reasonable range of perpetuity growth rates,
cost of equity and return on equity, the stock is overvalued. We can say definitively that
the stock is overvalued under the Long-Run Residual Income Model.
16.29$ -10% -20% -30% -40% -50%
9.29% 20.38 18.39 17.42 16.84 16.45
11.29% 18.75 17.48 16.83 16.43 16.16
13.29% 17.40 16.68 16.29 16.05 15.89
14.29% 16.81 16.31 16.04 15.87 15.76
15.29% 16.26 15.97 15.81 15.70 15.63
64.59 < Fair < 78.95
PKG's Long-Run Residual Income Sensitivity Analysis
Constant 17% Return on Equity
Growth Rate
Ke
10% Analyst Position
Overvalued < < Undervalued
16.29$ 9.0% 13.0% 17.0% 21.0% 25.0%
9.29% 14.45 15.94 17.42 18.90 20.38
11.29% 13.97 15.40 16.83 18.26 19.69
13.29% 13.52 14.91 16.29 17.68 19.07
14.29% 13.31 14.68 16.04 17.41 18.78
15.29% 13.12 14.46 15.81 17.15 18.50
64.59 < Fair < 78.95
PKG's Long-Run Residual Income Sensitivity Analysis
Overvalued < < Undervalued
Constant -30% Growth
Return on Equity
Ke
10% Analyst Position
16.29$ 9.0% 13.0% 17.0% 21.0% 25.0%
-10% 12.24 14.82 17.40 19.98 22.56
-20% 13.07 14.88 16.68 18.48 20.29
-30% 13.52 14.91 16.29 17.68 19.07
-40% 13.80 14.93 16.05 17.18 18.31
-50% 13.99 14.94 15.89 16.84 17.78
64.59 < Fair < 78.95
10% Analyst Position
Overvalued < < Undervalued
PKG's Long-Run Residual Income Sensitivity Analysis
Constant 13.29% Cost of Equity
Return on Equity
Growth
Rate
Page | 112
Final Recommendation
To arrive at our final recommendation, our team will consider the comparable
and intrinsic valuation models, with more weight being placed in the intrinsic models
due to their high explanatory power. The Residual Income and Abnormal Earnings
Growth models were the most relevant when valuing PKG’s stock. The Residual Income
model showed without question that the stock is overvalued; the Abnormal Earnings
Growth model indicated that the stock is overvalued at the cost of capital our team
estimated, and the price plummets with any increase in the cost of equity. Our
recommendation is for PKG stock holders to sell; holding this stock would be risky due
to its sensitivity to changes in cost of equity.
Page | 113
Appendix
Regression Using 10-Year T-Bill Rate
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.605518003
R Square 0.366652052
Adjusted R Square 0.337863509
Standard Error 0.043804103
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.024437907 0.024437907 12.73604057 0.001715838
Residual 22 0.042213587 0.001918799
Total 23 0.066651495
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012461472 0.009870855 1.26245103 0.220005342 -0.00800943 0.032932373 -0.00800943 0.032932373
X Variable 1 1.294119048 0.362624391 3.568758967 0.001715838 0.542082089 2.046156007 0.542082089 2.046156007
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.679624333
R Square 0.461889234
Adjusted R Square 0.446062447
Standard Error 0.043215254
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.054502852 0.054502852 29.18401741 5.15752E-06
Residual 34 0.063496979 0.001867558
Total 35 0.117999831
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.01408415 0.007959966 1.769373116 0.085801334 -0.002092447 0.030260748 -0.002092447 0.030260748
X Variable 1 1.290296793 0.238845509 5.402223377 5.15752E-06 0.804904318 1.775689267 0.804904318 1.775689267
Page | 114
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.683745494
R Square 0.467507901
Adjusted R Square 0.455931986
Standard Error 0.041870188
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.070801658 0.070801658 40.38625826 8.48656E-08
Residual 46 0.08064318 0.001753113
Total 47 0.151444838
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013637933 0.006314665 2.159724133 0.036041359 0.000927173 0.026348694 0.000927173 0.026348694
X Variable 1 1.161615466 0.182787114 6.355018352 8.48656E-08 0.793684088 1.529546844 0.793684088 1.529546844
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.698125651
R Square 0.487379424
Adjusted R Square 0.478541138
Standard Error 0.045138969
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.112357592 0.112357592 55.14411228 5.63884E-10
Residual 58 0.118176539 0.002037527
Total 59 0.23053413
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013147516 0.005989742 2.195005337 0.032179563 0.001157744 0.025137287 0.001157744 0.025137287
X Variable 1 1.141237997 0.15368329 7.425908179 5.63884E-10 0.833607469 1.448868525 0.833607469 1.448868525
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.783045051
R Square 0.613159552
Adjusted R Square 0.607633259
Standard Error 0.055083006
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.336647131 0.336647131 110.9531559 4.40495E-16
Residual 70 0.212389625 0.003034138
Total 71 0.549036757
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011873462 0.006545833 1.813896165 0.073979548 -0.001181791 0.024928715 -0.001181791 0.024928715
X Variable 1 1.409564449 0.133818177 10.5334304 4.40495E-16 1.142672512 1.676456387 1.142672512 1.676456387
Page | 115
Regression Using 7-Year T-Bill Rate
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.606672957
R Square 0.368052077
Adjusted R Square 0.339327171
Standard Error 0.043755661
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.024531221 0.024531221 12.81299517 0.001671944
Residual 22 0.042120274 0.001914558
Total 23 0.066651495
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011851632 0.009929831 1.193538122 0.245370911 -0.008741577 0.03244484 -0.008741577 0.03244484
X Variable 1 1.296150297 0.362101257 3.579524433 0.001671944 0.545198252 2.047102342 0.545198252 2.047102342
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.680187227
R Square 0.462654663
Adjusted R Square 0.446850389
Standard Error 0.043184508
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.054593172 0.054593172 29.27402076 5.03048E-06
Residual 34 0.063406659 0.001864902
Total 35 0.117999831
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013473525 0.008001778 1.683816509 0.101378095 -0.002788043 0.029735094 -0.002788043 0.029735094
X Variable 1 1.291549068 0.23870951 5.410547177 5.03048E-06 0.806432976 1.77666516 0.806432976 1.77666516
Page | 116
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.68407467
R Square 0.467958154
Adjusted R Square 0.456392026
Standard Error 0.041852482
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.070869847 0.070869847 40.45936463 8.31935E-08
Residual 46 0.080574991 0.00175163
Total 47 0.151444838
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.013066651 0.00633835 2.061522556 0.044930366 0.000308215 0.025825087 0.000308215 0.025825087
X Variable 1 1.162763669 0.182802413 6.360767613 8.31935E-08 0.794801496 1.530725842 0.794801496 1.530725842
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.698380908
R Square 0.487735893
Adjusted R Square 0.478903754
Standard Error 0.045123272
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.11243977 0.11243977 55.22284588 5.52434E-10
Residual 58 0.11809436 0.00203611
Total 59 0.23053413
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.01260016 0.006004995 2.098279739 0.040246276 0.000579856 0.024620464 0.000579856 0.024620464
X Variable 1 1.142027315 0.153679911 7.431207566 5.52434E-10 0.834403551 1.449651079 0.834403551 1.449651079
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.782980852
R Square 0.613059015
Adjusted R Square 0.607531287
Standard Error 0.055090163
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.336591933 0.336591933 110.90614 4.44555E-16
Residual 70 0.212444823 0.003034926
Total 71 0.549036757
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011225913 0.006554876 1.712604844 0.091211913 -0.001847376 0.024299202 -0.001847376 0.024299202
X Variable 1 1.409956185 0.133883736 10.53119841 4.44555E-16 1.142933494 1.676978876 1.142933494 1.676978876
Page | 117
Regression Using 2-Year T-Bill Rate
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.605758975
R Square 0.366943935
Adjusted R Square 0.33816866
Standard Error 0.043794008
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.024457362 0.024457362 12.7520563 0.0017066
Residual 22 0.042194133 0.001917915
Total 23 0.066651495
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.010298998 0.010139166 1.015763822 0.320783395 -0.010728345 0.031326341 -0.010728345 0.031326341
X Variable 1 1.294816549 0.362591927 3.571002142 0.0017066 0.542846916 2.046786181 0.542846916 2.046786181
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.678681407
R Square 0.460608452
Adjusted R Square 0.444743995
Standard Error 0.043266653
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.05435172 0.05435172 29.03398736 5.3769E-06
Residual 34 0.063648111 0.001872003
Total 35 0.117999831
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012081506 0.008136803 1.484797774 0.146810585 -0.004454466 0.028617479 -0.004454466 0.028617479
X Variable 1 1.290125766 0.239430078 5.38831953 5.3769E-06 0.803545304 1.776706227 0.803545304 1.776706227
Page | 118
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.682421708
R Square 0.465699388
Adjusted R Square 0.454084157
Standard Error 0.04194123
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.070527768 0.070527768 40.09385602 9.19122E-08
Residual 46 0.08091707 0.001759067
Total 47 0.151444838
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011674151 0.006423347 1.817455977 0.075664249 -0.001255377 0.024603679 -0.001255377 0.024603679
X Variable 1 1.161643604 0.183456875 6.331970943 9.19122E-08 0.792364067 1.530923141 0.792364067 1.530923141
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.697428422
R Square 0.486406404
Adjusted R Square 0.477551342
Standard Error 0.045181789
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.112133277 0.112133277 54.92975695 5.96321E-10
Residual 58 0.118400853 0.002041394
Total 59 0.23053413
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011108974 0.00606531 1.831559061 0.072154168 -0.001032064 0.023250012 -0.001032064 0.023250012
X Variable 1 1.142237503 0.15411772 7.411461188 5.96321E-10 0.833737368 1.450737639 0.833737368 1.450737639
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.782631491
R Square 0.61251205
Adjusted R Square 0.606976508
Standard Error 0.055129086
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.336291629 0.336291629 110.6507791 4.67285E-16
Residual 70 0.212745127 0.003039216
Total 71 0.549036757
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.009370121 0.006586185 1.422693255 0.159266362 -0.003765611 0.022505852 -0.003765611 0.022505852
X Variable 1 1.40936945 0.133982357 10.51906741 4.67285E-16 1.142150064 1.676588836 1.142150064 1.676588836
Page | 119
Regression Using 1-Year T-Bill Rate
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.60487637
R Square 0.365875423
Adjusted R Square 0.337051578
Standard Error 0.043830952
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.024386144 0.024386144 12.69349838 0.001740647
Residual 22 0.042265351 0.001921152
Total 23 0.066651495
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.010098393 0.010177737 0.992204162 0.33188623 -0.011008942 0.031205729 -0.011008942 0.031205729
X Variable 1 1.293242178 0.362985431 3.56279362 0.001740647 0.540456469 2.046027888 0.540456469 2.046027888
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.678116547
R Square 0.459842052
Adjusted R Square 0.443955053
Standard Error 0.04329738
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.054261284 0.054261284 28.94455189 5.51237E-06
Residual 34 0.063738547 0.001874663
Total 35 0.117999831
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011909175 0.008158935 1.459648252 0.153565352 -0.004671775 0.028490125 -0.004671775 0.028490125
X Variable 1 1.289318452 0.239649641 5.380014116 5.51237E-06 0.802291785 1.77634512 0.802291785 1.77634512
Page | 120
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.681859576
R Square 0.464932482
Adjusted R Square 0.453300579
Standard Error 0.041971319
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.070411625 0.070411625 39.97045877 9.50668E-08
Residual 46 0.081033214 0.001761592
Total 47 0.151444838
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011494453 0.006438114 1.785375783 0.080794454 -0.001464799 0.024453704 -0.001464799 0.024453704
X Variable 1 1.16079462 0.183605557 6.322219449 9.50668E-08 0.791215804 1.530373437 0.791215804 1.530373437
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.696993509
R Square 0.485799951
Adjusted R Square 0.476934433
Standard Error 0.045208456
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.111993469 0.111993469 54.79656646 6.17442E-10
Residual 58 0.118540661 0.002043805
Total 59 0.23053413
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.010874165 0.006077952 1.789116564 0.078817973 -0.001292178 0.023040509 -0.001292178 0.023040509
X Variable 1 1.142051368 0.154279764 7.402470294 6.17442E-10 0.833226868 1.450875869 0.833226868 1.450875869
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.782521963
R Square 0.612340623
Adjusted R Square 0.606802632
Standard Error 0.055141279
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.33619751 0.33619751 110.5708934 4.74639E-16
Residual 70 0.212839247 0.003040561
Total 71 0.549036757
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.009053269 0.006592675 1.373231518 0.174063145 -0.004095407 0.022201946 -0.004095407 0.022201946
X Variable 1 1.40937781 0.134031544 10.51526953 4.74639E-16 1.142060324 1.676695295 1.142060324 1.676695295
Page | 121
Regression Using 3-Month T-Bill Rate
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.606662779
R Square 0.368039728
Adjusted R Square 0.339314261
Standard Error 0.043756089
Observations 24
ANOVA
df SS MS F Significance F
Regression 1 0.024530398 0.024530398 12.8123149 0.001672326
Residual 22 0.042121097 0.001914595
Total 23 0.066651495
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.01058041 0.010090212 1.048581562 0.305754331 -0.010345409 0.03150623 -0.010345409 0.03150623
X Variable 1 1.2963103 0.36215557 3.57942941 0.001672326 0.545245616 2.047374983 0.545245616 2.047374983
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.679376522
R Square 0.461552459
Adjusted R Square 0.445715766
Standard Error 0.043228775
Observations 36
ANOVA
df SS MS F Significance F
Regression 1 0.054463112 0.054463112 29.14449857 5.21437E-06
Residual 34 0.063536719 0.001868727
Total 35 0.117999831
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.012310707 0.008108331 1.518278769 0.138188865 -0.004167404 0.028788818 -0.004167404 0.028788818
X Variable 1 1.290942095 0.239126919 5.398564492 5.21437E-06 0.804977727 1.776906464 0.804977727 1.776906464
Page | 122
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.683091624
R Square 0.466614166
Adjusted R Square 0.455018822
Standard Error 0.04190531
Observations 48
ANOVA
df SS MS F Significance F
Regression 1 0.070666307 0.070666307 40.24151055 8.82805E-08
Residual 46 0.080778531 0.001756055
Total 47 0.151444838
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011904237 0.006405118 1.858550796 0.069496107 -0.000988597 0.024797071 -0.000988597 0.024797071
X Variable 1 1.162627896 0.183275158 6.343619673 8.82805E-08 0.793714138 1.531541655 0.793714138 1.531541655
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.697831717
R Square 0.486969105
Adjusted R Square 0.478123745
Standard Error 0.045157031
Observations 60
ANOVA
df SS MS F Significance F
Regression 1 0.112262999 0.112262999 55.0536203 5.77349E-10
Residual 58 0.118271131 0.002039157
Total 59 0.23053413
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.011386395 0.006051586 1.88155561 0.064917984 -0.00072717 0.023499961 -0.00072717 0.023499961
X Variable 1 1.142512819 0.153981356 7.419812687 5.77349E-10 0.834285646 1.450739992 0.834285646 1.450739992
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.78279357
R Square 0.612765774
Adjusted R Square 0.607233856
Standard Error 0.055111034
Observations 72
ANOVA
df SS MS F Significance F
Regression 1 0.336430933 0.336430933 110.7691451 4.56604E-16
Residual 70 0.212605823 0.003037226
Total 71 0.549036757
Coefficients Standard Error t Stat P-value Lower 95% Upper 95% Lower 95.0% Upper 95.0%
Intercept 0.009731472 0.00657845 1.479295743 0.143547676 -0.003388831 0.022851776 -0.003388831 0.022851776
X Variable 1 1.409740924 0.133946048 10.52469216 4.56604E-16 1.142593954 1.676887893 1.142593954 1.676887893
Page | 123
Dividend Payout Ratio 91.9% 28.9% 30.2% 48.1% 72.0% 25.0%
Historical Stock Price 14.11 23.01 25.84 25.24 38.88 63.28
Shares Outstanding 102,397,952 103,018,358 102,308,231 98,325,974 98,143,000 98,172,000
Market Value of Equity 1,445 2,370 2,644 2,482 3,816 6,212
PKG
Working Capital/Total Assets 0.14 0.24 0.18 0.18 0.28 0.16
Retained Earnings/Total Assets 0.18 0.25 0.31 0.28 0.29 0.19
EBIT/Total Assets 0.12 0.16 0.08 0.11 0.18 0.09
Market Value of Equity/Total Liabilities 1.15 1.89 2.17 1.67 2.57 1.60
Sales/Total Assets 1.22 1.00 1.09 1.09 1.16 0.70
Dividend Payout Ratio 33.5% 20.6% 25.3% 32.3% 59.9% 39.7%
Historical Stock Price 12.43 26.78 27.24 29.6 40.85 49.03
Shares Outstanding 433,600,000 437,000,000 438,900,000 438,900,000 439,900,000 447,200,000
Market Value of Equity 5,390 11,703 11,956 12,991 17,970 21,926
IP
Working Capital/Total Assets 0.10 0.14 0.14 0.21 0.12 0.12
Retained Earnings/Total Assets 0.05 0.08 0.10 0.12 0.11 0.14
EBIT/Total Assets -0.02 0.08 0.06 0.07 0.05 0.05
Market Value of Equity/Total Liabilities 0.24 0.60 0.65 0.64 0.70 0.94
Sales/Total Assets 0.92 0.91 0.99 0.96 0.87 0.92
Dividend Payout Ratio 0.0% 0.0% 0.0% 0.0% 150.8% 0.0%
Historical Stock Price 12.85 16.78 16.63 16.13 19.86 40.44
Shares Outstanding 28,370,248 45,418,074 46,081,712 46,449,695 94,950,120 95,706,212
Market Value of Equity 365 762 766 749 1,886 3,870
KS
Working Capital/Total Assets 0.09 0.08 0.15 0.10 0.06 0.08
Retained Earnings/Total Assets 0.07 0.19 0.27 0.28 0.25 0.16
EBIT/Total Assets 0.07 0.23 0.09 0.09 0.10 0.08
Market Value of Equity/Total Liabilities 0.67 2.37 2.55 1.30 3.05 1.95
Sales/Total Assets 0.72 0.94 1.09 0.81 1.07 0.66
Dividend Payout Ratio 18.3% 6.8% 10.2% 27.0% 22.9% 10.3%
Historical Stock Price 34.82 50.41 53.95 57.7 72.93 105.01
Shares Outstanding 38,228,523 38,707,695 38,903,036 70,467,904 70,884,002 72,023,820
Market Value of Equity (Millions) 1,331 1,951 2,099 4,066 5,170 7,563
RKT
Working Capital/Total Assets 0.02 0.07 0.03 0.09 0.07 0.11
Retained Earnings/Total Assets 0.14 0.21 0.28 0.09 0.10 0.16
EBIT/Total Assets 0.07 0.15 0.13 0.03 0.05 0.08
Market Value of Equity/Total Liabilities 0.56 0.93 1.10 0.57 0.71 1.18
Sales/Total Assets 0.94 0.98 1.03 0.51 0.86 0.89
Altman's Z-Score Schedule
Page | 124
Analyses Regarding the Need for Restating Financials
2008 2009 2010 2011 2012 2013
Net PP&E 1,221 1,183 1,338 1,477 1,366 2,806
30% Threshold 366 355 401 443 410 842
Goodwill 37 39 39 58 67 527
2008 2009 2010 2011 2012 2013
Operating Income 242.0 352.0 185.0 273.0 443.0 474.0
30% Ceiling 72.6 105.6 55.5 81.9 132.9 142.2
Impairment Expense 0.0 12.3 13.0 13.0 7.0 9.3
New Goodwill 2008 2009 2010 2011 2012 2013 2014 2015 2016
2008 37 12.3 12.3 12.3
2009 2 0.7 0.7 0.7
2010 0 - - -
2011 19 6.3 6.3 6.3
2012 9 3.0 3.0 3.0
2013 460 153.3 153.3 153.3
Should Expense - 12.3 13.0 13.0 7.0 9.3 162.7 156.3 153.3
Did Expense - - - - - - - - -
Adjustment - 12.3 13.0 13.0 7.0 9.3 162.7 156.3 153.3
Beginning GW Bal. 37.0 26.7 13.7 19.7 21.7 472.3 309.7 153.3
New Goodwill 2.0 - 19.0 9.0 460.0
Did Expense - - - - - - - -
Should Expense 12.3 13.0 13.0 7.0 9.3 162.7 156.3 153.3
Adj. Ending Balance 37.0 26.7 13.7 19.7 21.7 472.3 309.7 153.3 -
PKG Goodwill Impairment Analysis
Hypothetical Goodwill Impairment Costs do not Exceed 30% of Operating Income
Goodwill Balances do not
Exceed 30% of Net PP&E
PKG R&D Expense Analysis
2008 2009 2010 2011 2012 2013
Operating Income 242 352 185 273 443 474
20% Threshold - R&D Exp. Must Exceed This To Warrant Restatement 48.4 70.4 37 54.6 88.6 94.8
R&D Expenditures 8.3 9.4 10.9 12.5 11.3 11.5
R&D as a Percentage of Operating Income 3.43% 2.67% 5.89% 4.58% 2.55% 2.43%
R&D Expenditures Do Not Exceed 20% of Operaing Income; Restatement is not Required
Page | 125
PKG Operating Lease Liabiliy Analysis
2009 2010 2011 2012 2013 Beyond 2013
12/31/2008 10-K Op. Lease Liabilities 27.4 19.9 19.9 7.6 7.6 24.8
2010 2011 2012 2013 2014 Beyond 2014
12/31/2009 10-K Op. Lease Liabilities 28.2 21.3 21.3 9.7 9.7 18.1
2011 2012 2013 2014 2015 Beyond 2015
12/31/2010 10-K Op. Lease Liabilities 28.6 21.2 21.2 8.3 8.3 30.2
2012 2013 2014 2015 2016 Beyond 2016
12/31/2011 10-K Op. Lease Liabilities 31.2 24.4 24.4 10.9 10.9 45.5
2013 2014 2015 2016 2017 Beyond 2017
12/31/2012 10-K Op. Lease Liabilities 33.9 26.4 26.4 12.8 12.8 66.1
2014 2015 2016 2017 2018 Beyond 2018
12/31/2013 10-K Op. Lease Liabilities 56.5 40.1 40.1 20.5 20.5 71.6
Total Undiscounted Lease Liabilities 20% of NC Liabilities Total NC Liabilities Year
107 179 894 2008
108 177 883 2009
118 162 810 2010
147 221 1107 2011
178 245 1224 2012
249 645 3226 2013
(In Millions)
Even without discounting to the present, operating lease liabilities do not exceed 20% of total
Non-Current liabilities; restatement is not required.
Page | 126
Intrinsic Valuation Models
PKG Discounted Dividends Model
Period 1 2 3 4 5 6 7 8 9 10 11
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Dividends Per Share 1.60 1.80 2.00 2.20 2.40 2.60 2.80 3.00 3.20 3.40 3.60
Present Value Factor 0.88 0.78 0.69 0.61 0.54 0.47 0.42 0.37 0.33 0.29
PV Yearly Dividends 1.41 1.40 1.38 1.34 1.29 1.23 1.17 1.11 1.04 0.98
Value of Perpetuity in 2023 34.29$
Total PV Yearly Dividends 12.34 56%
PV of Perpetuity 9.85 44%
Model Price 12/31/13 22.18$ 100%
Time-Consistent Future Value Factor 1.11
Time-Consistent Price 11/03/14 24.64$
Observed Share Price 11/3/14 71.77$
Initial Cost of Equity 13.29%
Perpetuity Growth Rate 2.79%
Total Share Value
Share Value Attributed to Dividend Perpetuity
Share Value Attributed to Next 10 Year's Dividends
PKG Free Cash Flow Model Monetay Values in Millions Besides Per-Share Values
Period 1 2 3 4 5 6 7 8 9 10 11
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Cash Flow from Operations 838 863 939 1019 1106 1200 1302 1413 1533 1663
Cash Flow from Investing (428) (651) (722) (798) (815) (884) (959) (1,041) (1,129) (1,225)
FCF Firms' Assets 409 212 217 221 291 316 343 372 404 438 476
PV Factor 0.908 0.824 0.748 0.680 0.617 0.560 0.509 0.462 0.419 0.381
PV YBY Free Cash Flows 372 175 162 150 180 177 175 172 169 167
Possible Growth Rates -48% 2% 2% 32% 9% 8.5% 8.5% 8.5% 8.5% 8.5%
Value of Perpetuity in 2023 13,064$
Total PV YBY FCF 1,898 28%
PV of FCF Perpetuity 4,973 72%
Market Value of Assets (12/31/13) 6,871 100%
Book Value of Debt 3,887
Market Value of Equity 2,984
Shares Outsanding (Millions) 97.17
Model Price (12/31/13) 30.71$ Time-Consistent FV Factor 1.11
Time-Consistent Price (11/03/14) 34.11$
Observed Share Price (11/03/14) 71.77$ WACC (BT) 10.14%
Initial Cost of Equity 13.3%
Perpetuity Growth Rate 6.50%
Share Value Attributed to Next 10 Year's FCF
Total Share Value
Share Value Attributed to FCF Perpetuity
Page | 127
PKG Residual Income Model Monetay Values in Millions Besides Per-Share Values
Period 0 1 2 3 4 5 6 7 8 9 10 11
Year 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Net Income 649 555 689 776 842 914 992 1,076 1,168 1,267
Total Dividends 155 175 194 214 233 253 272 292 311 330 350
Book Value of Equity 1,313 1,807 2,187 2,682 3,244 3,854 4,515 5,235 6,019 6,876 7,812
Annual Normal Income (Benchmark) 174 240 291 356 431 512 600 696 800 914
Annual Residual Income 475 315 399 420 411 402 392 381 368 353 304
PV Factor 0.88 0.78 0.69 0.61 0.54 0.47 0.42 0.37 0.33 0.29
YBY PV RI 419 245 274 255 220 190 164 140 120 101
% Change in RI -33.6% 11.8% -7.0% -13.6% -13.7% -14.0% -14.3% -14.7% -15.2% -14.0%
Value of Perpetuity in 2023 702$
Book Value of Equity 1,313 36.0%
Total PV of Yearly Residual Income 2,129 58.4%
PV of Perpetuity 202 5.5%
MVE (12/31/13) 3,644 100.0%
Shares Outstanding (Millions) 97.17
Model Price (12/31/13) 37.50$ Time-Consistent FV Factor 1.11
Time Consistent Price (11/03/14) 41.65$
Observed Share Price (11/03/14) 71.77$
Initial Cost of Equity 13.29%
Perpetuity Growth Rate -30.00%
Total Share Value
Share Value Attributed to Residual Income Perpetuity
Share Value Attributed to Next 10 year's Residual Income
Share Value Attributed to Current BV of Equity
PKG Abnormal Earnings Growth Model Monetay Values in Millions Besides Per-Share Values
Period 0 1 2 3 4 5 6 7 8 9 10
Year 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Net Income 436 649 555 689 776 842 914 992 1076 1168 1267
Total Dividends 109 155 175 194 214 233 253 272 292 311 330
Dividends Reinvested at 13.29% 14 21 23 26 28 31 34 36 39 41
Cumulative Dividends 663 576 713 802 871 945 1025 1112 1206 1308
Normal Earnings 494 735 629 781 880 954 1036 1124 1219 1323
Abnormal Earnings Growth 170 -160 84 21 -9 -9 -10 -11 -13 -15 -16
% Change in AEG -194.2% -152.7% -74.8% -141.3% 6.6% 9.1% 11.2% 12.8% 14.1% 10.7%
PV Factor 1.00 0.88 0.78 0.69 0.61 0.54 0.47 0.42 0.37 0.33
Present Value of AEG 170 -141 66 15 -5 -5 -5 -5 -5 -5
Residual Income Check Figure (Change In Residual Income) -160 84 21 -9 -9 -10 -11 -13 -15
Value of Perpetuity in 2023 (37.28)$
Core Net Income 649 90.6%
Total PV of AEG 79 11.1%
PV of Perpetuity -12 -1.7%
Total Average Net Income Perp 716 100.0%
Shares Outstanding (Millions) 97.17
Forward Adjusted EPS 7.37
Capitalization Rate - Perpetuity 13.29%
Intrinsic Value Per Share (12/31/13) 55.48$ Time Consistent FV Factor 1.11
Time Consistent Pice (11/03/2014) 61.61$
Observed Share Price (11/03/2014) 71.77$ Initial Cost of Equity 13.29%
Perpetuity Growth Rate -30%
Share Value Attributed to Next 10 Year's Abnormal Earnings Growth
Share Value Attributed to Core Net Income
Total Share value
Share Value Attributed to Perpetuity
Page | 128
PKG Long-Run Residual Income Model
Book Value Equity 1,313$
ROE 17%
Ke 13.29%
Growth Rate -30%
Market Value Equity (12/31/13) 1,426$
FV Time Factor 1.11
Market Value Equity (11/03/14) 1,583$
Shares Outstanding (Millions) 97.17
Estimated Share Price (11/03/14) 16.29
Observed Share Price (11/03/14) 71.77$
Page | 129
Works Cited
"Study: Ebook Growth Stagnating in 2013." Digital Book World. n.d. Web. 14 Sept.
2014.
AAP, Association of American Publishers. “Bookstats.” Web. Sept. 2014. Bemis Company, Inc. Annual 10-K reports, 2009-2013. Web. Sept. 14, 2014. Digitalbookworld.com. “EBook Growth slows to Single Digits in 2013.” April 1, 2014.
Web. Sept. 2014 International Paper. Annual 10-K reports, 2009-2013. Web. Sept. 14, 2014 . Jan. 22, 2013. Wharton College of Business. Web. Sept. 15, 2014 LI, Hui. “The Impact of EBooks on Print Book Sales: Cannibalization and Market
Expansion.” Packaging Corporation of America. Annual 10-K reports, 2009-2013. Web. Sept. 14,
2014. Rock-Tenn Company. Annual 10-K reports, 2009-2013. Web. Sept. 14, 2014. "Study: Ebook Growth Stagnating in 2013." Digital Book World. n.d. Web. 14 Sept.
2014.
Usatoday. "E-book Sales Are up 43%, but That's Still a 'slowdown'" USA Today.
Gannett, 16 May 2013. Web. 14 Sept. 2014. Yahoo Finance. "Slowing Ebook Sales May Embolden Publishers in Amazon Spat."
Yahoo Finance. n.d. Web. 14 Sept. 2014.
"YCharts: The Financial Terminal of the Web - Stock Screener, Financial Research, Stock Charts and Economic Indicators." YCharts: The Financial Terminal of the Web. N.p., n.d. Web. 2 Dec. 2014.
