Sep 07, 2005. /Lesprom Network/. Nordic pulp and paper stocks are seen as increasingly attractive by many investment banks due to their low valuations after recent weak performance, good short-term demand prospects and a solid global economy. Shares in the Nordic firms, including global leaders Stora Enso and UPM-Kymmene, have risen steadily from their May troughs. But they are still well below peaks reached in March when investors bet the sector would be able to increase prices after profits had dived for the past few years. Investors are still worried about the long-term outlook for the cyclical industry, where prices have slid for several decades and global market growth is seen slowing further, but many argue short-term prospects for the Nordic firms are good. "We like the sector for three main reasons. First, it is a very out-of-favour, cyclical laggard," Morgan Stanley said in a recent research note. "Second, valuations are very attractive on a host of our models. Third, fundamentals are improving; macro fundamentals in particular, but we are also seeing the first nascent signs of an industry restructuring, especially in packaging," it added. U.S. peers have raised prices in the past 12 months, with faster economic growth translating into better advertising demand. But the Nordic groups have largely missed out on the usual cyclical upturn as the weak dollar undermined their overseas exports and rising energy and chemicals prices offset their hefty cost cuts. Return on capital employed (ROCE) - a key measure of profitability for the industry - was less than 3% at both Stora and UPM in the first half of 2005, while many investors are not bothering to look at anything yielding less than 10% in the current environment of robust growth. Finnish firms were also hit hard by a seven-week labour conflict from mid-May that slashed their second-quarter earnings by Euro 400 million, but also depleted client stocks of paper used in magazines and catalogues ahead of the key season. Nordic paper firms trade at a price to book value (P/BV) multiple of 1 versus an average of 2 for all European industries, making them the worst-performing sector in 2005, Morgan Stanley said. CSFB analyst Lars Kjellberg, who also rates the sector as "overweight", says a seasonal pick-up in demand from September, combined with low paper inventories, should help to increase prices. "We would buy into the sector through names that have a significant exposure to graphic paper, operational leverage and preferably an exposure to North America through exports and/or a domestic presence," he said in research note dated September 5. "We expect companies with this profile to show superior earnings momentum in H2 both sequentially and year-on-year," Mr. Kjellberg added, citing Stora and UPM as his top picks. According to Reuters data, Stora and UPM are trading at forward price to earnings (P/E) ratios of 26.4 and 24.5, respectively. The average multiple for global paper firms with a market capitalisation of over $2.5 billion is about 21, according to Reuters data. But some analysts said not all macroeconomic data was conclusively good, despite a positive showing in some recent leading indicators. They also pointed to surging oil prices. Deutsche Bank analyst Mathias Carlson, who has a negative view on paper sector stocks, thinks underlying demand is not as strong as perceived by the market and that this will show in the September-December period. "I think the valuations for Nordic paper stocks are too high still and I don't think we will see any type of price increases in the second half of this year," Mr. Carlson said. "The oil price rise can only be negative, through higher energy prices, higher chemical cost, and also a weaker dollar. And that comes on top of industry fundamentals. So we stick to our stance, we think it is too early to buy these stocks."