Spreads on bonds of investment-grade paper and forest product companies should beat other industrials over the next three months, according to Akiba Cohen, an analyst at Morgan Stanley, andInstitutional Investor's top-ranked basic industries analyst in the most recent All-America Fixed-Income Research Team survey. Cohen expects the sector, which traded 40-45 basis points wide of the Morgan Stanley Industrial index early last week, to beat the index by 10 to 15 basis points over the next three months. He cites the positive slope in pulp futures prices and relatively low July increase in inventories for North America and Scandinavia as reasons to be bullish about the sector. He also believes that much of the recent merger and acquisition activity has run its course or is in its final stages, allowing companies to focus on debt reduction. Specific credits he recommends because they have finished, or soon will finish, acquisitions and begin to pay down debt include Georgia Pacific (Baa3/BBB-), Domtar (Baa3/BBB-) andBowater (Baa3/BBB).
James Dunn, analyst at Banc of America Securities, says investors should attach only a market weight to the sector. He believes pulp prices have not yet found a bottom, and notes that overall, worldwide inventories remain quite high. Barring a significant pickup in demand or more downtime at paper mills, Dunn says companies will have a hard time raising prices in the near term. These factors will contribute to slowing one of the hotter areas in the investment-grade fixed-income world. He cites a BAS pulp and paper company index, which puts year-to-date returns on paper and forestry credits at 9.8% through August 16, versus 7.82% for the investment-grade market as a whole. He says investors intent on playing the sector should focus on larger, more diversified companies, such as Georgia Pacific and International Paper (Baa2/BBB).