These 2 Stocks Survived the Trade War, but Wall Street Hasn't Noticed

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Technically, the trade war between the United States and China hasn't ended yet. Then again, it never really started for the pulp and paper industry. While Wall Street predicted that the conflict would have a devastating impact on International Paper (NYSE: IP) and WestRock (NYSE: WRK), but impressive operating results show the two renewable products leaders hardly flinched in 2018.

That hasn't been enough to reassure cautious analysts. Shares of International Paper and WestRock are down 18% and 37%, respectively, since the beginning of 2018. Both stocks are now trading below the industry average earnings multiple and PEG ratio. Their respective dividend yields have soared to 4.2% and 4.7%. And both should be high on the watch lists of investors who have a long-term mindset.

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Did the trade war skip over this industry?

The boring world of cardboard has been brimming with excitement in recent years. Well, relatively speaking. The rise of e-commerce and a growing global middle class have caused demand and selling prices for corrugated products -- shipping boxes, bulk packaging, food containers, and the like -- to soar to all-time highs.

China in particular has been a driving force in the pulp and paper supply chain in the last decade, both directly and indirectly. The country imports vast quantities of recycled paper, virgin pulp, and finished paper products to supply its growing economy, and to compensate for its lack of domestic forests. The corrugated products business also gets a boost when China imports more American produce, beef, and other goods shipped in paper-based packaging -- or, increasingly, imports the finished paper products themselves. Therefore, pulp and paper manufacturers based in the United States were bracing themselves for the imposition of Chinese tariffs on a wide range of products ranging from recycled paper to pork.

But the threat never quite materialized. International Paper and WestRock reported growth up and down the income statement in calendar 2018 (the latter follows a different fiscal calendar). China's tariffs on American pulp and paper products didn't have a significant impact on the international businesses, and executives at both companies said they haven't seen tariffs indirectly affect demand for packaging, either. Demand for corrugated products in China did begin to wane in the fourth quarter of 2018, but that was chalked up to its slowing economy, not an escalating spat between Beijing and Washington.

Therefore, an honest assessment of the situation would lead one to conclude that although International Paper and WestRock do face the type of headwinds that Wall Street perceives, both stocks are trading at valuations too cheap to ignore.

By the numbers

After years of investing in operating efficiency and writing off bad debt, the pulp and paper industry is finally humming along, and is much better positioned to withstand the next economic downturn. International Paper reported year-over-year revenue growth of 7%, business segment operating income growth of 39%, and operating cash flow growth of 84% in 2018.

A significant amount of the improvement was derived from a lack of the write-offs that had dragged on its results in previous years, but the company's industrial packaging segment, which reports the performance of its corrugated products, grew its operating income by 35% to $2.1 billion last year. It represented 72% of total business segment operating income.

WestRock had similar success. The company grew revenue by just under 10% in its fiscal 2018 (the 12-month period ending Sept. 30), while operating income soared 53% in that span. A sharp reduction in per-unit cost of goods sold, thanks to previous capital investments in upgrading its fleet, contributed to the impressive improvement.

Investors can expect another year of significant growth in fiscal 2019. WestRock closed its $4.9 billion acquisition of KapStone, a leading North American manufacturer of corrugated products, in early November. The deal will significantly increase its cardboard production, which isn't a minor detail considering the strength of corrugated markets.

That strength makes the two companies' current stock valuations all the more bewildering.

For context, the S&P 500 is valued at over 31 times cyclically adjusted earnings. That means both International Paper and WestRock could see earnings drop 70% and still be valued in line with the broader market.

Great businesses at great prices

The direct impacts of the trade war predicted by Wall Street analysts never materialized for International Paper and WestRock. The indirect impacts, such as the predicted decline in shipments of pork or produce reducing demand for paper-based packaging, haven't quite materialized either. It's more likely that slowing economic growth in China and Europe will pose a bigger threat to the pulp and paper industry's bull run, but that would be a risk to the broader global market, too.

Based on their above-average dividends, strong financial flexibility, and the expectations that their growth will continue for the foreseeable future, long-term minded investors might want to give these two companies' stocks a closer look.

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Maxx Chatsko has no position in any of the stocks mentioned. The Motley Fool recommends WestRock. The Motley Fool has a disclosure policy.