Investors who have remained loyal to Irish shares will be questioning that loyalty as they analyse the performance statistics for the second quarter of 2000.
Over this quarter the ISEQ index fell by 13.5 per cent, making it by far the worst performing market in Europe. For the first half of the year, the market showed a more modest fall of 2.6 per cent compared with a decline of just under 2 per cent for global equity indices.
However, even these figures flatter the performance of the Irish market in that the strong rise in the Elan share price has had a very significant impact on the overall index. If Elan is excluded, it implies that the rest of the market has fallen by 11 per cent so far this year.
Elan now accounts for more than 20 per cent of the ISEQ index and is capitalised at €14 billion (£11 billion). In contrast Smurfit, one of the market's longest established companies and once its largest constituent, is now capitalised at just under €2 billion representing a mere 3 per cent of the total market.
As recently as December 1997 there was only a modest gap between the size rankings of these two companies. At that time Elan accounted for 10 per cent of the market while Smurfit represented 6 per cent of total market capitalisation.
In contrast to the sustained out-performance by Elan, as it advanced within a vibrant and growing pharmaceutical sector, Smurfit has had to survive in a fiercely competitive and mature paper sector. During the 1990s the paper and forest sector in the US has under-performed the Standard & Poor's 500 by more than 50 per cent.
Over long and short periods of time, Smurfit shares have produced disappointing returns and this year have witnessed a 40 per cent decline in the share price.
One of the main reasons for the low rating of paper stocks has been the failure of the industry to control capacity. The prices of the industry's products are extremely sensitive to small shifts in supply and demand. Modest increases in demand will usually lead to a disproportionate rise in the prices of paper products. In the past the industry has typically responded to strength in demand and pricing by building new factories. This additional capacity has ultimately created excess supply, falling product prices and declining profitability.
However, recent years have witnessed a change to this pattern and discipline within the industry has improved. Instead of building new plants, the stronger companies such as Smurfit have been acquiring weaker companies. This process of rationalisation seems set to continue and should result in the closure of many inefficient plants.
Another positive feature is that many companies are using some of their excess free cash-flow to buy back their own shares.
It is therefore difficult to explain why share prices in the sector have been so weak in an environment where the industry's profitability has been improving. Part of the reason is probably accounted for by the shift in investor interest towards new-economy stocks.
Another reason is the likelihood that after years of poor returns investors are sceptical as to whether the industry can improve its long-term profitability.
The issues surrounding the Smurfit share price are essentially the same as those facing the industry as a whole and Smurfit's fortunes are intrinsically dependent on overall conditions facing the global paper sector. However, at the current price of 180 cents, Smurfit shares are on a lowly price-earnings ratio of seven and a dividend yield of 3.7 per cent.
With the book value of the company's assets greater than the company's stock market capitalisation, there seems to be little downside in the current share price. Indeed, a shift in investor sentiment towards a more positive view of the paper sector could result in significant upside from the current depressed Smurfit share price.
