Description

Summary

Buy Clearwater Paper - CLW - stock

CLW is at $33.5 right now.   $769mm market cap

Quick pitch:

-         If Recession: The company will do well in a recessionary scenario as input costs fall much quicker than the prices of what they sell (tissue and SBS).  Plus private label tissue gains share in recessions

-         No Recession: The company will continue on its current path: take share, finish their integration, and complete their new plant.  There's a lot of organic growth that the company can do to grow EBITDA 44%+ in 2 years (just from finishing up the merger and finishing up their expansion) - not factoring any changes in input costs (which are trending down).

Business - CLW has 2 business lines that each make up ~50% of revenues

1)      Private label tissue (national footprint, and competes in the residential and commercial markets).  Makes napkins, towels, facial tissue, toilet paper, etc.   They're the largest behind the major 3 - Kimberly Clark, Georgia Pacific, P&G. 

2)      SBS - solid bleached sulfate paper board - which is used in food packaging and higher quality packaging.  4^th largest

Both products have held margin quite well through cycles and private label tissue suffers little volume volatility and is taking share from branded.  Just look at their numbers over the last 5 years and especially through 2008-2009

In Europe,  60%+ of the tissue market is private label while in the US it is 20-30%.  So there's room to grow. 

So from a secular perspective, they benefit from volume growth that's tied to population and from increased private label penetration.  

I think you can be patient as it's not going to run away from you in the near term or anything.  As you've seen, in this market you can just be patient on everything.  But CLW clearly holds up better than the rest of the market

- Multiples

5.3x 2011 EBITDA 

4.7x 2012 EBITDA

4.1x 2013 EBITDA

14% 2011 FCF yield

16%  2012 FCF yield

20% 2013 FCF yield

I think this stock could go to $48 in a year, +45%

At those levels it'd trade at 5.4x 2012 EBITDA and 11x 2012 EPS

And 4.8x 2013 EBITDA and 9x 2013 EPS

I think mutual funds and hedge funds alike would be drawn to the story. 

Financials

CLW has an organic path of growth from:

1) a ultra premium tissue expansion that they're building

2) and synergies (recently bumped it up from $15-20mm of synergies to $30-40mm)

For 2011, I think they can put up about $225mm of EBITDA  (I add back some of the integration expenses).

Here are the major driving factors of EBITDA over the next 2 years:

-          Synergies of $30-40mm (CLW initially announced $15-20mm of synergies) by end of 2012.  I factor in $25mm of synergies.  They have a detailed breakdown of the synergies that seem readily achievable.  Especially given that the merger is a good geographic fit and Cellu Tissue was selling a lot of parent rolls (when simply converting them to tissue is highly accretive)

-          New premium bathroom tissue plant and converting lines (i.e. Shelby) that should generate around $50mm of EBITDA, supposed to be completed in 2013.  In the meantime, the company will start up some converting lines (start 2 of the 7 total, which management has said will generate $10mm of EBITDA annually).  They'll also start other converting lines up 1H 2012

o        The plant will make 70k tons (using $3,120 / ton, which is about 20% higher than what they managed to achieve normally which is reasonable given this will end up in higher premium products), and a 20% incremental margin (similar to what competitors are able to achieve), should be able to do $44mm of EBITDA from the TAD machine.  Add in $10mm from the initial 2 converting lines, and you get about $54mm of EBITDA

o        Management expects IRRs twice their WACC (which they think is about 9-10%), which implies about $50 mm of EBITDA

o        So on the plus side, you'll get some incremental EBITDA from the converting lines starting up so you don't have to wait till the end of 2012 to see any benefits

-          They expect to raise pricing on the tissue side by about 2.5% blended in Q4 2011 & Q1 2012.  That's about $25mm in incremental EBITDA. The large branded guys are already raising prices.

-          Also, they are net short 400,000 tons of pulp.  So if pulp falls $50 / ton, they get an incremental $20mm of EBITDA.  Pulp is currently falling

Those 1st 3 items should add $100mm of EBITDA to the $225mm of EBITDA that they'll put up in 2011 over the next 2 years.

Also, note that D&A is much higher than actual capex.  D&A here is about $80mm while maintenance capex is more like $40mm. 

Key catalysts

-          Progress in integration and bringing up the new expansion that will make ultra premium toilet paper (they bought Cellu Tissue in Dec 2010)

-          Synergies done by end of 2012

-          Pulp prices coming down (they are about 70% back integrated into pulp) - they are net short 400k tons of pulp (of course helps when pulp goes down,  hurts when pulp goes up).  CLW before the acquisition was not exposed to much pulp.   KMB and P&G have no integration.   GP does

o        The business actually benefitted a lot in the last recession as pulp prices tanked and people switched over to private label.  If pulp prices move down $50,  EBITDA goes up $20mm (about 8% of EBITDA).  In the last downturn, pulp fell $200.  Other commodity costs falling would help as well

o        i.e. a recession may have a high likelihood of actually being positive for the company

-          Large branded competitors just passed through a pricing increase - 1^st price increase in tissue since 2008.  Will be implemented in Q4 2011  / Q1 2012.  So that should get into numbers soon

-          It makes logical sense for someone who is long pulp (e.g. Domtar) to get into more consumer products.  Domtar recently bought a diaper company

-          They could get another ~$25mm or more in cash from tax credits from tax credits for the cellulosic biofuel tax credits

Valuation

-          this trades inline or slightly cheap to some of the packaging and paper guys.  However, tissue and SBS is a much better business with the highest margins and more steady top and bottom lines.

-          This should probably trade somewhere between packaging names and KMB.  So perhaps 6-7x EBITDA

-          Packaging guys are around 4-5x EBITDA,  Branded consumer products are more like 8-9x EBITDA.

-          Tissue makers have been acquired for 7-7.5x LTM EBITDA in the past

$125mm of cash

$538mm of debt

23mm shares

Market cap $770mm

2011 EBITDA $225mm

2012 EBITDA $285mm

2013 EBITDA $325mm

Business

Tissue (consumer products)

CLW (After the acquisition of Cellu Tissue) now covers the entire US and sells products in every category (away from home, at home, napkins, tissue, toilet paper) and at every price point (value to premium).  The entire industry is running at full capacity

Private label tissue as a whole has been growing in line with population and it's been slowly taking share from branded.   The last recession helped shift people over to their products.  Pricing is also been very stable.  The branded guys understand that it's better for them to lose share slowly and try to maintain margins. 

On the West Coast, private label is 39% the Grocery market.  On the East Coast, private label has only 24% share in groceries.   So there's room to grow that on the east coast and mid west.  CLW was mostly a West Coast participant. 

In Europe, private label has about 2/3rds, in the US it's around 25%

So there's plenty of room for private label tissue share to expand, which accelerates in recessions.  Grocers are moving towards it to make more money and hopefully build loyalty. 

Private label has taken large amounts of share in the grocery channel from branded (numbers from 02-10 in CLW's presentation)

-          private facial tissue from 14% share to 32%

-          bath tissue from 13% share to 21%

-          paper towels 18% share to 32%

The only area where branded hasn't lost share is in ultra bathroom where branded has 90%+ of that market.  But now private label (and CLW) are building plants that are capable to making that ultra premium bathroom segment (using a "through air dried" process) to finally get into that market.

Personally, I like Charmin ultra strong, if there finally was a good private label brand of Charmin ultra strong,  I'd probably buy it.

Hence CLW's new expansion (along with the rest of the industry's) is smart.  There's not enough private label premium quality toilet paper to compete.   Customers are asking CLW and First Quality for the product.  This is more a demand driven expansion that should be easily filled when it comes online. 

In addition, the capacity coming online 425k tons over the next 3-4 years is about 5% of the market.  The tissue market has grown at around 2% a year consistently since 1996.  Makes sense given population growth is about 1-1.5% a year and you get some share gains.  So that new capacity is just about enough to cover population growth.  Operating rates should stay in themed / high 90%s.

In addition, only 210k of that new capacity is private label TAD premium tissue, which should have higher demand

Pulp and paperboard (Bleached Paperboard)

The pulp & paper board segment is a bit differentiated as it makes higher quality paperboard that is used in milk cartons and juice boxes, pharmaceuticals, etc.   e.g. DVD, CD cases, postcards, etc.    Customers like it for the better print surfaces, etc.  They have 11% of that market (GP, Meadwestvaco and IP are ahead of them)

Supposedly, they try to make SBS on the quality premium end of the spectrum, so ekes out slightly higher margins.  SBS is itself the highest value grade of boxboard.

SBS also tends to hold margins quite well.  Pricing has been very strong ever since 2002 where a lot of capacity and consolidation happened (and was very strong in the last downturn).  IP and MWV have about 45% of the capacity.  The industry is quite rational and has exhibited that through the downturn and the last decade. 

Operating rates are in the 92-93% area at the moment and inventories are low.  Generally they can gain pricing at the 92%+ area.  Even in 2008-2009 prices were quite steady despite operating rates in the high 80s.  Inventories are pretty low right now

SBS could lose a little share to recycled though, but generally it is a steady grower inline with population. 

Lumber

Embedded in one of their business lines in a wood products division as well - which mostly provides the pulp they need.  Currently that line got subsumed into their pulp business for reporting purposes.  [They're trying to convince investors that they're a consumer products company]

Not meaningful for now, but could help generate some meaningful EBITDA if that ever comes back (my guesstimate is around ~$10-15mm of incremental EBITDA if they can just get back to flat EBITDA in lumber)   

Risks

-          people are concerned about management trying to juggle too many things at once (large merger integration and a large new plant expansion on the east coast).

o        Thus far synergy guidance has been increased from $15-20mm of synergies to $30-40mm

o        The initial phase of the new plant is already up and running on time and on budget.  They already have some converting lines up as well (which are generally very high ROI investments as cutting up tissue rolls into finished product is surprisingly lucrative.

§         So that will benefit them slightly as that project starts to generate about $10mm of EBITDA a year already

o        Q1 and Q2 2011 were a little messy from a reporting standpoint, so that's been ironed out

-          Pulp prices are of course a risk

o        But for now they're coming back down.  Pulp prices of course shift depending on paper and packaging demand

-          Branded guys set prices,  private label follows

o        Branded guys have recently been hesitant on raising prices, but recently have finally instituted a pricing increase.

-          Somewhat recession resistant

o        Actually earnings in the consumer and bleached board side were up a lot through the last recession

o        SBS could be up or flat in a recession,  but tissue will most likely be up a lot

-          Little FCF after the expansion

o        A pain given they're working on that expansion,  but at least they're putting it into good use to grow EBITDA in a smart expansion

Last Downturn

 From 2008 to 2009

CLW consumer products volumes grew ~5% and pricing was up about 4.5%. 

In SBS, volumes were down 7%,  but pricing was actually up 2.6%. 

Meanwhile,  pulp was down about 25%

Wood Fiber is 28% of COGS, chemicals are 11%,  freight 10%, energy 8%, labor 38%, maintenance and repair 6%.

So in a downturn, COGS would most likely fall much faster than their revenues, and in an upturn, they've done a good job or holding attractive normalized margins. 

Management

I'm not a huge fan of management - they're OK.  When they had all that cash, it made a lot of sense to buyback a ton of stock and/or institute a small dividend.

Although this plant expansion is smart, they could have handled it better as well rather than disappointing all their investors and leading them to think a dividend might be in the offing.

Also, this company generates a lot of cash, but management basically tries to do everything with it (buyback, expansion, acquisition, small pension contributions, etc. ).  So they're all over the place on capital allocation.

But I think they could easily do a dividend eventually, which would help this company become more like a consumer products company with a better multiple also.

They're good operators, but this business is one that's pretty difficult to mess up. 

Brief Company History

The company was spun out of Potlach in December 2008.

It was a bit of an orphaned stock given when it was spun off.   It started trading at about $7 a share (yes it's $33.5 now).   It was trading at around 3x EBITDA back then and the market basically didn't give it any value for the cash on its balance sheet

Cellu Tissue (another private label tissue company which CLW eventually acquired), IPOed at Jan 2010 (PE firm Weston Presidio bought it in 2006 and wanted to sell).    CLU was also trading very cheap (around 3x EBITDA as well). 

I thought both were surprisingly cheap especially given that they have stable private label tissue businesses and should trade higher than regular packaging / paper names.  Just didn't get any coverage and traded like paper names

CLW got a ton of cash from black liquor ($170mm) and a lot of activists and hedge funds wanted CLW to do a large buyback or special dividend.  The company then decided to do a huge expansion (the TAD plant in NC to make premium private label toilet paper) in mid 2010.  Investors were not happy and the stock tanked 20%.   

It subsequently recovered quickly and then the company then announced the CLU acquisition in Sept 2010 (which the market liked).  Cellu Tissue complemented CLW well geographically as CLW was mostly West Coast and Cellu Tissue is East Coast.   Also, CLW was more focused on the at home premium market, while Cellu Tissue brought other lower end product categories and the away from home market as well.

Then the stock flatlined for a while as investors understandably didn't feel like waiting for the integration and expansion.  But I think you're getting to the point where enough time has passed and you'll start seeing some EBITDA from the expansion and get some synergies as well.   Maybe you should wait a bit more

In May 2011, the stock tanked again as they had messy Q1 earnings caused by the acquisition.  Also they had a higher than expected maintenance expense.  It was also the 1^st quarter after the company merged.   Pulp and input prices were also high and going up.  Numbers optically looked bad because Cellu Tissue has lower margins than old CLW because they don't convert a lot of their parent rolls.  

Cellu Tissue (almost 100% exposed to pulp), got hit hard in 2010 and the stock tanked to $8 from $13 where it first IPOed.  CLW announced that they were going to acquire Cellu for $12

HY Bond

CLW also has HY bonds, which are trading kind of rich, for good reason

Only 2.4x total leverage,  1.8x net leverage.  BB- So quite well covered

CLW    10?  16     110 price  7.1% YTW  
CLW    7?   18     101 price   8.0% YTW   callable in 2016 at 105.3

They've been trading down a bit with the market, but these bonds are rock solid.

Catalyst