It was no coincidence that the three worst performers in share price terms among the ISEQs's largest companies, Smurfit, Waterford Wedgwood and Independent Newspapers, have the biggest exposure to the economic well-being of the Asia/Pacific region.

Smurfit's direct sales to the region are minimal but the weakness in demand from Asia had a materially negative impact on the overall global supply/demand position in paper/ paperboard products, leading to a significant deterioration in the pricing environment for these products.

Other commodity sectors such as steel and chemicals where pricing has become virtually global were similarly affected, but investors in containerboard companies will be particularly disappointed as product pricing was beginning to to recover after the wave of capacity expansion in the 1994-97 period, and the supply/demand position seemed at last to be moving in favour of producers.

In the event, weak Asian demand led to a 30 per cent fall in overall US containerboard exports from April/ May onwards and a consequent shortfall of one million tons in demand, equating to 3 per cent of US capacity, a very sizeable shortfall in a commodity industry.

The result for Smurfit will be a further delay in the recovery of its profit base. The carry-through effect of weak pricing is likely to mean that 1999 profits (excluding exceptionals) are likely to be around £100 million (#126 million), lower than the average for 1997/98 and well below the previous cyclical peak of £420 million in 1995.

Apart from delaying the profit recovery, the Asia crisis has proven again that the paper sector, as a commodity sector, is a highly cyclical animal, more vulnerable than most other sectors to the general vagaries in global demand and to perturbations in the different regional economies of the world.

From a domestic perspective, Smurfit's poor share price performance contrasts sharply with the very strong share price gains of other large capitalisation Irish stocks like AIB and Bank of Ireland, which are benefiting from their very large exposure to the Irish economy and improving international valuations for banking stocks in a low inflation environment, or Elan which operates in the defensive/growth sector of pharmaceuticals.

Worse still, Smurfit's performance compares unfavourably with CRH, which operates in the cyclical building materials industry. The key difference, however, is that CRH's products don't "travel" across continents (cement excepted) and profits derived from individual country markets such as Ireland and the US better reflect local demand conditions. Hence, CRH can smoothen the cyclicality through geographic diversification.

Does all this mean that Smurfit and the sector will be forever out of favour with investors? No. The major determinants of demand for Smurfit shares will be the appetite among international investors for paper/paperboard stocks and then the relative attractions of Smurfit.

For specialist paper sector investors in Smurfit, the performance will be judged against the rest of the sector (which has been performing poorly) rather than against the likes of AIB. The future then comes back to fundamental analysis of the prospects for product pricing in the sector and Smurfit's profits outlook.

Rest assured that product pricing will recover, but in order to attract longer term support from investors and to command a better stock market rating, the paper sector must be able to demonstrate that recovery will not be just a 12-month phenomenon and that it is capable of sustaining a higher level of product pricing and profitability through future cycles than in the past.

The difficulty for most of the 1990's has been excess capacity brought on by over aggressive capital spending; excess capacity has now been created by "lost" demand due to the Asia crisis. However, there are good grounds for optimism that the industry is facing a structurally different cycle.

The hopeful signs are than the industry is at last taking measures to address the lack of discipline on the supply side, particularly in Smurfit's key grade, containerboard. The first indications came in the form of downtime or temporary capacity closures. Now several leading producers have mothballed significant capacity on a permanent basis.

All told, the capacity base in the US containerboard supply system has been reduced by 6 per cent in this manner. Importantly also, these supply side changes are resulting from a restructuring of the industry which means that more capacity is controlled by fewer players.

The potential to move that industry to a higher and more sustainable level of profitability has now been established but, in the short term at least, product price recovery will be dampened by sluggish global demand. Still, 1999 should see the start of a good recovery in product pricing and share prices should respond accordingly.

Jefferson Smurfit Corporation was the key player in the consolidation and capacity reduction moves in the global containerboard industry in 1998, taking over ling-time rival Stone Container in the US and then closing 1.6 million tonnes of containerboard capacity.

The risk here is that this sort of industry leadership will provide opportunities for competitors but the Smurfit move has already forced a significant response from the sector in the form of a merger announcement from two other leading players, IP and Union Camp, and further consolidation and (possibly) capacity closures are likely in the sector in 1999.

With the merger of JSC and Stone, Smurfit has become the largest containerboard producer in the world and should therefore be a major beneficiary of an improving medium term outlook for the product grade. Why then, have the shares underperformed the US paper/paperboard sector over the past year?

The answer, we believe, lies in the perceived financial risks attaching to this deal, following the unexpected weakening of product prices after the initial announcement of the deal. The combined entity of JSC/ Stone has net debts of $7 billion (#5.93 billion); the medium term product pricing outlook may be bright but the short-term outlook remains uncertain, given the uncertainty attaching to the performance of the global economy.

At 124p, Smurfit is trading well below its book net asset value of 150p. Over the past eight years, the shares have traded on 1.3 times NAV on average. The book NAV's of the group's European and Latin American businesses are well supported by recent industry transactions (and by the value Smurfit itself has realised for asset disposals, principally its Condat paper mill in France).

The current share price appears then to heavily discount the value of the group's investment in JSC/Stone in the US. The investment here will be more fully recognised in the shares when the financial risk is seen to be reduced. In the absence of product price recovery this can still be achieved through the sale of newsprint assets already earmarked for disposal.

In conclusion, then, the climate for global commodity producers is likely to remain very difficult in 1999, but there is enough potential at the stock specific and industry subsector levels to make Smurfit shares a worthwhile investment for 1999.

John Conroy is head of equities with NCB Stockbrokers