Packaging Corp of America

Packaging Corp. of America announced second-quarter net sales of $2.5 billion, up 14.7% year over year, mostly due to record-breaking shipment volume. Diluted earnings per share came in at $2.35, exceeding the company's $2.33 guidance by $0.02.

Why it matters: Cost inflation remains a significant headwind for the packaging industry, as higher freight costs were a $0.26 drag on PCA's EPS in the second quarter. Management has already implemented two price increases this year in response to the inflationary environment. Heading into the third quarter, we expect the company to benefit from higher realized prices following the second price increase for containerboard and corrugated products. Although management did not comment on any additional price increases in the second half, we suspect that further hikes might be necessary to offset cost inflation driven by higher oil, fiber, and electricity prices.

The bottom line: We maintain our $167 fair value estimate for no-moat PCA and see the shares as overvalued, currently trading in 1-star territory. We prefer to wait for a more attractive entry point, especially in light of ongoing inflationary headwinds. Gross margins have been under pressure as management tries to combat higher freight costs with price hikes. Realized price increases were more than offset by higher freight and labor costs, leading second-quarter gross margin to decline to 20.6% from 22.2% year over year.

Following second-quarter results, we've maintained our $167 fair value estimate.

We anticipate solid growth and profitability for PCA over our 10-year forecast horizon, with consolidated sales projected to grow at a roughly 6% compound annual rate, driven by the Greif acquisition, and operating margins averaging approximately 16% (compared with a 10-year average of around 15%). We see operating margins normalizing from pandemic-era highs over our forecast due to slowing price growth for containerboard and UFS paper.

The packaging segment has performed well in recent years as the company expanded its modest containerboard business into one of the largest producers in North America. PCA increased its containerboard production capacity organically and through strategic acquisitions, while opting to focus on specialty products and regional customers. While PCA does not produce nearly the volume that International Paper and Smurfit Westrock do, it usually generates stronger returns from its less commoditized products. That said, containerboard price growth has been constrained due to the conversion of paper assets to containerboard. Over our 10-year forecast, we expect revenue in the packaging segment to grow at a 4.7% compound annual rate, boosted by the Greif acquisition, with margins averaging roughly 16.1% as modest price increases are realized and supply chain disruptions abate.

Revenue in the paper business has declined every year since PCA acquired Boise in 2013. Demand for paper continues to fall as consumers and businesses embrace digital alternatives. This was exacerbated during the pandemic, when students and employees relied heavily on technology to learn and work as schools and office buildings were closed. Demand has somewhat rebounded from pandemic-era lows, but we see little room for long-term volume growth. Declining paper sales created an opportunity for PCA and its competitors to convert paper assets to containerboard production, which provided additional containerboard capacity but limits paper volume growth. While we expect fewer paper asset conversions going forward, PCA will continue to evaluate paper assets to determine if they could provide more value in containerboard production. Over our 10-year forecast, we expect revenue in the paper segment to grow at a 0.8% compound annual rate with margins averaging 14.8% as marginal price increases are met with softening demand.

We do not think PCA benefits from an economic moat, despite being one of the largest containerboard manufacturers in North America. A majority of its business (92% of 2025 revenue) involves manufacturing containerboard, which is mainly used in corrugated packaging products. Over the last two decades, consolidation has shifted a once-fragmented industry into four major players and a handful of smaller companies due to the high capital costs required to efficiently produce containerboard. Almost all of PCA's packaging segment sales are in North America, where the company accounts for approximately 10% of industry supply. While there are some traces of efficient scale and cost advantage, we do not think they are substantial enough for an economic moat.

PCA is one of the largest producers of containerboard and corrugated packaging in North America. The containerboard industry has gone through a period of consolidation, with four players now controlling approximately 70% of supply. Many incumbents have deep roots in traditional paper but have since pivoted to containerboard as demand for paper declined and corrugated packaging rose. PCA still operates a paper business, but its production volume and sales have declined for years as paper assets have been converted to containerboard production. Machines used to make paper can be converted to produce containerboard, making it an attractive opportunity for legacy paper producers looking to capitalize on growing demand. Additionally, e-commerce growth has increased regional and global shipping, with many opting to ship with corrugated packaging for its low cost and durability. This dynamic provided a strong incentive for paper companies to convert their aging paper mills to containerboard mills. During the period of consolidation, corrugated packaging companies enjoyed widening margins as prices were increased aggressively. Following this, incumbents and new entrants were quick to increase supply, mainly by converting aging paper mills to containerboard, putting pressure on containerboard prices. While e-commerce provided a tailwind, declining paper consumption and a flat volume outlook for food and beverage (two significant containerboard end markets) diminished upside. Today, the corrugated packaging industry shows elements of a rational oligopoly but continues to face pressure from converted paper mills and threats of substitutes from plastic packaging.

We see little contribution from efficient scale to PCA's economic moat. The consolidated nature of the North American containerboard market combined with the commoditized nature of containerboard makes for an industry that could enjoy an efficient scale moat source. However, the conversion of paper assets has increased capacity and limited containerboard price growth. Lower price growth has constrained margins and hindered PCA's ability to earn strong returns on its invested capital. While high capital costs usually inhibit new entrants from entering a market with efficient scale, smaller paper producers can join the market with relative ease by converting their paper assets to containerboard production.

As one of the largest containerboard producers in North America, PCA could benefit from a cost advantage moat source, but we see little evidence to suggest it enjoys this competitive advantage. PCA operates eight packaging and paper mills across the United States. Once the raw materials are processed at its mills, they are transported to one of its 90 converting and packaging plants. PCA's plants are dispersed throughout North America to minimize the distance between the plants and customers due to the low value/weight ratio of corrugated board. Competitors have comparable mill and plant footprints as they source raw materials in similar areas and require a dense plant network to service customers efficiently. While PCA is one of the largest producers of containerboard and could benefit from scale, its production is spread across a handful of mills and numerous plants that each have their own fixed cost structures, preventing it from capitalizing on any operating leverage advantage.

For commodity producers, position on the cost curve is significant. Operating as a low-cost producer can lead to years of strong economic profits and provide a durable competitive advantage. That said, the low value/weight ratio of containerboard forces producers to operate with a regional and even local presence, with each location having its own cost curve and rendering the industrywide cost curve largely irrelevant. PCA's substantial size in the containerboard industry does little to lower operating and input costs, forcing the company to compete on price. Without a cost advantage or efficient scale, PCA, as a commodity producer, does not possess an economic moat, in our view.

PCA's paper business produces uncoated freesheet paper that is sold to a variety of customers in North America under its Boise Paper brand. UFS paper is primarily used in businesses and schools for printing, writing, and publishing. A majority of the UFS paper produced by PCA is commoditized and produced in line with industry standards for size, weight, and color. Its commoditized paper competes mainly on price, limiting returns that the company can earn on its paper business. Demand for UFS paper has declined for years as consumers and businesses shifted from printed materials to electronic alternatives. This encouraged PCA and its competitors to move away from paper; many opted to convert their paper assets to containerboard production. While the segment has struggled to consistently earn a profit in recent years, we expect slow growth and limited operating profits for PCA's paper business over our forecast. However, the paper business is not large enough to have a material impact on our opinion of PCA.

PCA's focus on specialized products and regional customers will enable the firm to continue earning stronger returns than its competitors.

PCA, International Paper, and Smurfit Westrock will remain disciplined in taking economic downtime when needed in order to safeguard prices.

After many producers converted their paper assets, PCA will benefit from its remaining paper business as tight supply enables price growth.

Despite a period of attractive margin expansion in containerboard production, the best days are behind PCA as new capacity weighs on linerboard prices.

Since much of its paper assets have been converted to containerboard production, PCA is mainly a containerboard business and will see a decrease in revenue and profitability when e-commerce demand normalizes.

Demand for paper will continue to fall, which will prevent price growth in PCA's paper business and constrain consolidated margins.