Spring $50/ton Containerboard Hike Formally Announced

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1 January 28, 2018 Spring $50/ton Containerboard Hike Formally Announced Containers & Packaging $ Rating Price FY EPS FY P/E Company Name 01/26/ E 2018E Containers & Packaging, Market Weight Greif, Inc. (GEF) A x 17.4x International Paper Company (IP) x 14.6x KapStone Paper & Packaging Corp. (KS) 2 V x 15.6x Packaging Corporation of America x 18.3x (PKG) Sonoco Products Company (SON) x 18.1x WestRock Company (WRK) A x 17.1x Source: Company data and Wells Fargo Securities, LLC estimates 1= Outperform, 2 = Market Perform, 3 = Underperform, V = Volatile, = Company is on the Priority Stock List NA = Not Available, NC = No Change, NE = No Estimate, NM = Not Meaningful Two North American containerboard producers announce $50/ton price increase for March 1 implementation. Late Friday (1/26), industry trade journal (RISI) mentioned customer contacts indicating notification of a $50/ton containerboard price increase effective with shipments on March 1. As of Sunday (1/28) afternoon two companies (International Paper and KapStone) were confirmed to be out in the market with an increase. We maintain our view that $25/ton realization is the most likely outcome, unless Southeast OCC costs surpass $150/ton over the next days. Given a backdrop of solid industry fundamentals (growing demand, tight supply, and rising global containerboard prices) and attractive capital redeployment options, we highlight Outperform-rated International Paper and WestRock as being our two favorite names in the paper packaging subsector. Why do we only expect $25/ton realization? While we were not surprised by the price increase, our $25/ton net price realization differs from the $50/ton announcement due to current trends in OCC. Despite Chinese import licenses being issued for 4.2 million tonnes of recovered paper thus far in Q1, export OCC prices (from the United States to China) have actually trended lower by $23/ton since January 5. As a result, we expect another benign month of inflation in OCC during February. In our view, rising OCC costs (above $150/ton) is the necessary ingredient to support full realization; and, given timing of the Lunar New Year (resulting in Chinese mill downtime), we don t anticipate much in the way of rising OCC until at least the later part of February. Continued on the next page. Please see page 4 for rating definitions, important disclosures and required analyst certifications. All estimates/forecasts are as of 01/28/18 unless otherwise stated. 01/28/18 20:37:04 ET Christopher D. Manuel Senior Analyst chris.manuel@ we llsfargo.com Gabe S. Hajde Associate Analyst gabe.hajde@ we llsfargo.com Wells Fargo Securities, LLC does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of the report and investors should consider this report as only a single factor in making their investment decision.

2 Containers & Packaging What to expect next? WRK kicks off Q4 earnings seasons for the containerboard producers tomorrow (1/29), followed by PKG on Tuesday (1/30), and we would expect to hear an announcement from both companies regarding an increase coming days. We note, just this evening, WRK moved up its FQ1 earnings release from Wednesday morning (1/31) to Monday (1/29) morning. The release is also now expected to include a strategic announcement. As for visibility to the hike, corresponding increases to box contracts, and timing of when higher prices will hit company income statements, the answer is three discrete periods. If successful, we would anticipate RISI to reflect the price increase with its March Price Watch survey, scheduled to be published on Friday March 16, Next, box contracts typically contain language stipulating a lag period, resulting in partial realization during calendar Q2 and full realization in calendar Q3. Thus, optics and clear line of site won t be attained until October 2018, when Q3 earnings are reported. Price momentum continues to build across several other paper grades. In addition to rising containerboard prices, several announcements were made this last week regarding multiple boxboard grades. First, WRK informed customers on January 24 of a $50/ton price CUK increase (effective with March 1 shipments). The notice follows GPK s notification on January 10 of a $50/ton hike, effective with shipments beginning February 10. In URB, Caraustar followed SON s January 17 announcement, with its own $50/ton increase (effective with February 26 shipments). Lastly, a $50/ton CRB increase has gained full industry support, with implementation dates ranging from February 5 February 12. Key Issue Update Two North American containerboard producers announce $50/ton price increase for March 1 implementation. Late Friday (1/26), industry trade journal (RISI) mentioned customer contacts indicating notification of a $50/ton containerboard price increase effective with shipments on March 1. As of Sunday (1/28) afternoon two companies (International Paper and KapStone) were confirmed to be out in the market with an increase. Increased demand, tight supply conditions, and rising input costs were cited as the primary factors contributing to higher prices. The announcement did not come as a surprise and reinforces our above consensus projections for three of the four primary containerboard producers (IP, KS, and WRK). Recall, On January 8, we raised estimates to incorporate a $25/ton net price increase in our projections. Please see our January 2018 Containerboard Barometer Supply Constraints To Prompt Spring Hike for additional detail. The four containerboard stocks reacted positively to the news around 2:00pm on Friday afternoon, a trend we would expect to preside during Monday session trading. Figure 1. Domestic Containerboard Price Sensitivity (Impact of Hypothetical +/- $25/ton) Com pany A nnu al Capacit y (K t ons) Est im at ed V ert ical Int egrat ion Dom est ic Sales t o Independent Conv ert ors Export s A nnu al EBIT DA Im pact of $ 25/t on Dom est ic Price EPS Im pact FCF Im pact International Paper (1) 12,025 80% 9% 11% $25 5 $0.39 $0.35 Greif, Inc % 1 3 % 5% 18 $0.1 8 $0.1 7 KapStone Paper & Packaging 1,680 60% 30% 1 0% 38 $0.42 $0.38 Packaging Corp. of America (2) 3, % 2% 3% 91 $0.60 $0.5 4 West Rock (3) 7, % 1 2 % 1 3 % $0.7 6 $0.4 1 (1) IP export breakdown: 50% EMEA, 35% Latin America, 15% Asia. Excludes ~1 million tons of gypsum liner and other specialty grades. (2) Forecasted to be 95% following Wallula, Washington mill conversion and as Sacramento Container tons are internalized. (3) WRK export breakdown: 50-55% to Latin America, 25-30% Middle East, 20-25% Europe. Source: Company data; RISI; Wells Fargo Securities, LLC estimates Why do we only expect $25/ton realization? While we were not surprised by the price increase, our $25/ton net price realization differs from the $50/ton announcement due to current trends in OCC. Despite Chinese import licenses being issued for 4.2 million tonnes of recovered paper thus far in Q1, export OCC prices as of January 26 (from the United States to China) have actually trended lower by $23/ton since January 5. As a result, we expect another benign month of inflation in OCC during February. Furthermore, rising OCC costs (above $150/ton) is the necessary ingredient to support full realization; and, given timing of the Lunar New Year (resulting in Chinese mill downtime), we don t anticipate much in the way of rising OCC until at least the later part of February. 2 Wells Fargo Securities, LLC

3 OCC Price $/ton Spring $50/ton Containerboard Hike Formally Announced Figure 2. Export OCC to China Moves Lower Despite Import Licenses Being Issued $300 $250 Correlation: 0.94 R-Square: 0.88 China Imported OCC, United States (1) Domestic OCC, United States $200 $150 $100 $50 (1) Cost of material, insurance, and freight. Numbered grade designations in parenthesis refer to the specifications of the US recycling association, ISRI. However, quality of China imports often varies from the official ISRI standard. Source: Company data; RISI; Wells Fargo Securities, LLC What to expect next? WRK kicks off Q4 earnings seasons for the containerboard producers tomorrow (1/29), followed by PKG on Tuesday (1/30), and we would expect to hear an announcement from both companies regarding an increase coming days. As for visibility to the hike, corresponding increases to box contracts, and timing of when higher prices will hit company income statements, the answer is three discrete periods. If successful, we would anticipate RISI to reflect the price increase with its March Price Watch survey, scheduled to be published on Friday March 16, Next, box contracts typically contain language stipulating a lag period, resulting in partial realization during calendar Q2 and full realization in calendar Q3. Thus, optics and clear line of site won t be attained until October 2018, when Q3 earnings are reported. Additionally, the Fiber Box Association is scheduled to publish December 2017 box shipments (including an annual review) on Thursday (2/1) where we expect same-structure growth of at least 3%. We believe investors will also be eager to hear company commentary regarding January shipments, where we expect positive trends. Price momentum continues to build across several other paper grades. In addition to rising containerboard prices, several announcements were made this last week regarding multiple boxboard grades. First, WRK informed customers on January 24 of a $50/ton price Coated Unbleached Kraft ( CUK ) increase (effective with March 1 shipments). The notice follows GPK s notification on January 10 of a $50/ton hike, effective with shipments beginning February 10. In Uncoated Recycled Board ( URB ), Caraustar followed SON s January 17 announcement, with its own $50/ton increase (effective with February 26 shipments). Together Caraustar and SON make up over 75% market share in URB. Lastly, a $50/ton CRB increase has gained full industry support, with implementation dates ranging from February 5 February 12. Figure 3. Various Boxboard Grades Expected to Move up in Coming Months CRB Grade/Company Amount Effective Date Estimated Market Share Graphic Packaging $50/ton February 10, % WestRock $50/ton February 5, % PaperWorks Industries $50/ton February 12, % Caraustar $50/ton February 12, % White Pigeon $50/ton February 12, % CUK/CNK WestRock $50/ton March 1, % Graphic Packaging $50/ton February 10, % URB Sonoco Products $50/ton February 19, % Caraustar $50/ton February 26, % Cascades $50/ton February 26, 2018 <3% Source: Company data; RISI; Wells Fargo Securities, LLC Wells Fargo Securities, LLC 3

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