May 25, 2020 - 4:39pm EST by
2020 2021
Price: 28.78 EPS .95 0
Shares Out. (in M): 17 P/E 30 0
Market Cap (in $M): 477 P/FCF 3.65 0
Net Debt (in $M): 880 EBIT 93 0
TEV (in $M): 1,357 TEV/EBIT 14.6 0

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Clearwater Paper Corporation (NYSE:CLW)


I don’t know how fast we will recover from the COVID crisis so I have been focusing on names that are either beneficiaries of the current environment and that typically fare well through a recession. I wrote about Clearwater Paper (NYSE: CLW) on VIC on October 27, 2018 (here) and noted that it has significant countercyclical characteristics which I actually believe will be significantly enhanced because of the Covid crisis. As I described in the October 2018 writeup, CLW operates in two segments, Consumer Products (CPD) and Pulp & Paperboard (PPB). The CPD segment produces and sells private label tissue. The PPB segment produces SBS-grade paperboard and pulp that is consumed internally by both segments. Please review our original write up if you would like incremental descriptions of those businesses and our discussion of the sum of the parts analysis that highlights the value that a larger scale paper producer could extract in an acquistion. Our original thesis was that the business would benefit from the ramp up of a new $390 million NTT tissue machine and warehouse expansion at its Shelby, NC plant and that they would see incremental benefits from a new digester that was built in CLW’s Lewiston ID plant. Fast forward to today and CLW’s completion of the Shelby plant expansion was late by two quarters and overbudget by $40 million.  The new continuous digester never achieved the $25-35 million cost saving benefit that was expected because of issues surrounding its process and ultimately only yielded a $10 million benefit. Ultimately, these missteps were followed by a replacement of the prior management.


CLW’s CPD will benefit from work from home trends and higher unemployment as more private label tissue is used in consumer’s homes. Also, in the face of improving demand, input costs have declined and are likely to stay subdued which will expand profit margins. Finally, CLW’s new expansion at its Shelby plant should lead to higher volumes produced and improved margins as the plant ramps over the next year. CLW’s PPB business will also benefit from work at home trends as consumers purchase more center isle food goods using SBS packaging. This benefit should help to offset declines in more discretionary folding carton demand and lower food service demand for SBS cup stock. Ultimately, CLW will likely generate significant free cash flow that should lead to a reduction of leverage that should shift value to the equity.  The background of the Chairman and the newly hired CFO seem favorable for a possible future sale of the business to a larger paper company that can leverage its scale.   


CLW’s CPD business stands to benefit significantly from the increase in demand for private label tissue in the wake of the COVID recession. Initially, when consumers were sheltering in place there was a rush to buy tissue as consumers stocked up in fear of shortages.  According to RISI’s US Tissue Monthly, capacity utilization for tissue manufacturers hit 99% for March and retail scanner data showed toilet tissue sales rising 99.2% for the four weeks ended 3/21/20 before falling back to 44.8% for the last four weeks ended 4/18/20. If hording were the only driver for tissue demand, then there would be a short-term increase in demand followed by consumer destocking which would lead a weak market. However, not all tissue is the same. The tissue that you use at home (AH) is very different than the tissue you will find away from home (AFH) in hotels, restaurants, airports, office buildings and public schools. About 1/3 of all tissue is AFH and 2/3’s is AH. The AFH tissue tends to be made with a high recycled content and is made with a different form factor. Typically, AFH tissue is made on different machines all together and there is a very limited ability to recalibrate AFH machines to make AH tissue.  In Q1 2020, 90% of CLW’s tissue by volume was private label AH which commands a higher margin than AFH tissue.

Initially, when consumers were sheltering in-place, they not only purchased but consumed significantly more AH tissue because their use occasions rose significantly as they did their business at home instead of at work. If we conservatively assume that 40% of AFH tissue was replaced with AH tissue use that implies than AH tissue consumption rose by 20% during the lockdown. For a market that typically grows with population at 0.75% to 1.0% that is a dramatic increase that is tough to keep up with.  It helps to explain why tissue shortages have persisted throughout the lockdown after the initial hording that took place in March.  


Many companies like Facebook, Shopify, Square and Twitter have announced that they will shift some of their employees to work from home or allow employees to work from home upon request.  Economists estimate that roughly 36-37% of jobs in the US could realistically be performed from home. If we assume that the percentage of time spent working at home from those that could increases by 10% following the end of the crisis that would suggest an incremental 1.2% of AH tissue consumption after shelter in place comes to an end. This coupled with what is likely to be a high unemployment rate for some time to come should lead to significantly increased AH tissue use well past the lockdown.  The CBOE projects that by the fourth quarter of 2021 the employment-to-population ratio will be 4.8% lower than it was prior to the COVID crisis which would suggest that consumption of at home tissue would be increased by about 1.7% by that effect.  Collectively, the workforce shift to work from home that would suggest that growth of AH tissue use would likely grow from its typical 0.75-1% rate to around 3.25% to 4% which should lead to greater pricing power as it takes about two years to build a new tissue machine.


Private label AH, which is what CLW makes, is particularly well positioned to thrive in this environment. In the US about 25-30% of AH tissue is private label compared to Europe where 2/3’s of AH tissue is private label.   Each year private label takes about 1% of share from branded tissue makers. Unlike Boomers and X-ers, millennials are more willing to try private label and when people are unemployed they tend to trade down from more expensive brands like Charmin and Cottonelle.  During the shortages of the lockdown, many consumers had no choice but to try private label tissue in instances where branded tissue was unavailable. That will likely make it easier for budget conscious consumers to switch away from branded tissue which tends to be 20-30% more expensive. CLW is poised to take advantage of the current demand environment with its new Shelby plant expansion finally online and contributing. CLW has confirmed the new machine is running and producing tissue with specs on par with ultra-quality branded players and will eventually produce ~70,000 tons/yr.  Ultra-quality private label tissue demand growth has been around 8% a year for the last several years and it commands higher prices and generates higher margins than lower quality grades. Shelby 1 produces roughly 70k tons/year of ultra-quality tissue and CLW’s Las Vegas pant produces about 38k tons/year of ultra-quality tissue.  That means that Shelby 2 will add an incremental 65% to CLW’s ultra-capacity which should lead to an improvement to the overall margin profile of CLW’s CPD business.


As you can see in the chart below, private label toilet paper penetration has accelerated meaningfully from its previous trajectory. This share gain is not likely temporary and most of those that switch tend to stay private label buyers afterwards


CLW’s CPD margins will expand from lower input costs (ex: purchased pulp, diesel, electricity, natural gas, polyethylene, caustic, and chlorate). We estimate this will be a benefit of at least $25m and possibly closer to $35m which should flow to the bottom line. The set up could be somewhat similar to ‘08/’09 where input prices fell dramatically but demand did not. The prices below will fluctuate throughout the year but it is evident that the impact of COVID will be more positive that negative as inputs fall while demand persists.


Past management’s poor execution and lack of visibility on Shelby II offset the fundamental tailwinds that CLW should have been enjoying. The Parent Roll Spread below is the industry spread published in RISI’s US Tissue Monthly that shows the spread between pulp prices and unconverted tissue parent rolls. As you can see in the chart below, EBITDA has inflected significantly and is starting to better reflect the current benefits of far lower input prices.


CLW’s PPB business

There has been some concern about weakness in the SBS market because of reduced food service volumes and diminished demand for cup-stock.  We think the fear of SBS price reductions is overdone. Price reductions were announced pre-Q1 call for CLW and even so, these price reductions equated to about -3% vs Q1 volumes up 4% due to CLW’s large exposure to more favorable end markets like food and pharmaceuticals. The CEO stated in the Q1 call that the 2/3rds of CLW’s SBS business supplies recession-resilient market segments like paper plates, packaged food and pharma. The segments hit hardest by the crisis will likely be things like foodservice and tobacco, which CLW is much less exposed to.  As food service opens up, some of the lost demand will be restored.  Also, some changes that have taken place like the elimination of reusable cups at Starbucks to avoid contagion will lead to incrementally increased use of disposable SBS cups going forward.

There is also a possibility that SBS may see somewhat of a trade-down benefit given the current disparity between CUK and SBS prices.

The spread continues to expand and RISI articles from earlier in Q1 have cited several sources beginning to talk about making the switch from CUK to SBS if the price disparity persists. From Q4-2019 to now the spread has fallen from -$80 to -$110 and if it continues to widen, we feel that there is a significant probability that converters begin to switch from CUK to SBS.   Additionally, the market is pretty concentrated and larger players like Westrock and Graphic Packaging are incented to take economic downtime to support prices when the market is week. On its Q1 conference call Westrock announced that it took 13,000 tons of economic downtime in the quarter and another 14,000 tons in April across their system or collectively a little less than 0.5% of total annual industry capacity. Nonetheless, we have incorporated what we believe to be management’s conservative guidance for SBS price reductions in our earnings estimates.

New Management

The new management team in place is likely far more desirable/reliable than those previously at the helm. Arsen Kitch, the new CEO, was responsible for turning around the Shelby 2 facility and getting it operational ASAP. He has been with the company since 2013 in various FP&A roles. Prior to that he was a Director of Finance at Nestle from ’11-’13.  Michael Murphy, the new CFO, previously worked for Kapstone Paper and Packaging as a VP of Strategy and Strategic Initiatives from ’16-’18 and as VP of Finance from ’15-’16. Murphy helped to orchestrate Kapstone’s sale to Westrock. Prior to Kapstone he worked as VP and Treasurer at Boise Inc. from ’12-’15. Boise base bought out by Packaging Corp. Even more noteworthy is that the current chairman of CLW, Alexander Toeldte, was the CEO of Boise when it sold to Packaging Corp.  We think there is a probability that CLW may become a future acquisition target after a period of execution and deleveraging.


After a long period of capital projects, CLW resumed generating FCF in Q4 2019 and will be reducing its large debt load to a more palatable level over the next 1-2 years.  With a projected current free cashflow yield of $7.87 per share that equates to 27.4% on CLW’s last closing price of $28.78.  The company has already reduced its net leverage to < 5.0x from its high of 6.3x in Q3 2019. We believe it is feasible for them to pay down approximately $129m in debt this year which would take leverage to just above 4.0x turns.

The company currently trades at $28.78 or 6.2X EV/EBITDA based on our estimates of $219.3MM for 2020 EBITDA. Based on sell-side estimates of $192.3MM in EBITDA, which we believe are low given current market dynamics, CLW trades at 7X EV/EBITDA. This is also a discount to many peers in the boxboard/tissue space that typically trade closer to 8-9x. Historically, given the lack of execution of prior management, we think this discount to the group was warranted. Fortunately for CLW shareholders, former management has been removed and we believe the new team will run CLW for cashflow, reduce debt and ultimately sell the business to a larger paper company.







The table above illustrates just how accretive the reduction will be for holders of CLW’s equity going forward if you only assume a modest increase of its current multiple to 7.5x. If you assume that ~200m is their steady-state EBITDA, you get a high-DD IRR depending on your horizon and that is conservative as it assumes no growth. If you wanted to assume that CLW also gets the leverage/management penalty removed  from its multiple you could argue that it should be trading closer to 8x EV/EBITDA, more in-line with its paper and packaging peers


1.)    Pulp prices could rise higher than expected if many mills close permanently or go out of business. This would only impact CLW on the portion of their pulp that they purchase on the open market. As we saw in 2018, pulp prices can be volatile and inversely impact earnings on upswings. However, we view this risk as limited given the oversupply in port inventories reported going into COVID.

2.)    Management cannot execute the plan for improving operations and reducing debt. We have only seen one quarter with the new management team at the helm and it will take consistent outperformance to convince the sell-side and other investors that there is light at the end of the tunnel. We think new management will perform well and have a better understanding of what a “beat-and-raise” reputation could do for the stock. Thus, We think they will continue to set reasonable expectations that they beat and raise on.

3.)    SBS prices fall more than we expect. CLW produces 825,000 tons of SBS paperboard a year.  For every $10 price decrease CLW sees revenue decline and margin compression of $8.25MM. At the beginning of the year RISI declared a $30 price decrease for SBS folding box board. If demand for packaged food moderates and there is not an equivalent increase in food service demand, SBS prices could fall further than management is estimating if there is not further industry response with additional economic downtime.

4.)    Bad luck. This is an industry that has its fair share of fires/explosions/disruptions and CLW is no exception to that. Going through the past annual presentations you will see there is “always something” that comes up whether it be a natural gas pipeline disruption, a power outage, a union strike, or good ole fashioned bad weather. To accommodate this we have built in an annual -$10m drag to our model to account for the unexpected maintenance/disruptions/miscellaneous expenses.

5.)    CLW fails to capitalize on the current tissue market dynamics and gain share/sell through Shelby 2 inventory. I view this as the smallest probability risk but also one that would have the largest impact if it were to occur. If CLW cannot properly take advantage of the current market dynamics, you could see the “bad management” discount placed back on the stock as analysts and investors view this as history repeating itself.


CLW should be insulated and benefit from the weaker economic environment and will have numerous shots on goal now that it is now being run by more engaged management that is far more capable of capitalizing on the business’ current opportunities. The business has numerous tailwinds in an industry that has an exceptionally low degree of cyclicality and private label penetration just got turbo charged. CLW’s debt paydown will be extremely accretive to equity holders given their high degree of leverage and rapidly improving fundamentals. We believe the intrinsic value of the equity is much closer to the mid-$50’s in a base case and the low-$70’s in a bull case presenting upside of ~70-150% respectively. CLW is turning over a new leaf and now and once management proves themselves we think the multiple will expand.

·         Private label tissue penetration is accelerating and looks to stay that way. Millennials and Gen X have a higher propensity to purchase/try private label products.

·         Inputs costs have fallen dramatically, so much so that they will likely offset most of the volume/price reductions in PPB segment.

·         New management with successful track records will continue to prove operational abilities. Possible buyout optionality based on CFO and Chairman’s prior experience with public companies.

·         SBS price reduction fears are overblown and SBS stands to benefit from converters switching inputs to take advantage of SBS-CUK price disparity. 


I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


CLW will likely continue to beat earnings generate cashflow and delever which should shift value to the equity. 

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