Description

RYAM equity offers an asymmetric risk / reward, with a path to >$20 / share (versus ~$5 current). Previously written up in Sep 2020 focusing on the 5.5% junior debt in the 60s – the credit story has fully played out and the balance sheet has been fixed (i.e. looming TL debt maturity extended, >$300MM of cash build with asset sales and FCF generation). Since the prior RYAM debt write-up roughly 18-months ago, RYAM has transformed their biz on couple fronts yet is being ignored by the equity market. Comparing the “past” (18-mths ago) vs “today” is informative as a lot has changed tilting the odds heavily in favor of the equity:

The “Past” / 18-mths ago:

1)      Creation value: in late 2020, TEV was ~$1.3Bln and almost ~$1BlnMM through the debt

2)      Biz composition: Post the Tembec black-eye acquisition, lumber + newsprint units were undeniably perceived as the DOG assets of RYAM … both lumber and newsprint sat on the “higher-end” of the cost curve (regardless of RYAM CEO comments denying such) and were $-losers in most years (and significant $-losers in the really bad years) … RYAM ultimately sold the lumber + newsprint assets to GreenFirst (GFP CN) and while the market might debate the sale price, I believe RYAM got an excellent deal as the market likes to focus on the lumber side (5-STDEV moves in recent quarters to upside), but loses focus on the newsprint assets which are / will be a liability for the buyer. In addition to the >$200MM sale, RYAM retains small amount of GFP CN equity ($30-$40MM of value that RYAM likely monetizes in the n-term) and more importantly, RYAM retains the ~$112MM of lumber duties that will likely come through the door as cash (assume 80% to be conservative) once resolved.

3)      Cycle uncertainty: Biz was sucking wind on all fronts in the depths of COVID, market was concerned they’d trip debt covenants which effectively meant a $50-$75MM EBITDA year given lumber + newsprint at risk of burning -$75MM of EBITDA combined (can debate how much of a $-loser, but my sense in the early days of COVID was that the market was freaked out on both lumber + newsprint)

4)      Low quality CEO: CEO lost credibility largely driven by a 1-2 punch of sloppy cap allocation (buying Tembec for too much and putting the BS under strain) followed by operational hic-cups (most notably a botched boiler refurb)

5)      Equity impairment risk / looming maturity wall: Given a TL that was maturing in 2022 and a biz operating during COVID at cycle-low levels, the junior 5.5% note was trading in the 60s less than 18-mths ago. Equity impairment risk was front & center

Fast forward to “Today”:

1)      Creation value: Today, TEV is ~$860MM, significantly inside of the debt “create” of ~$1Bln 18-months ago and ~$1.3Bln TEV 18-mths ago

2)      Biz composition … much improved: Post the lumber + newsprint disposition, all the super-high-beta stuff has been removed. IMHO, getting rid of lumber can now be viewed as a coin-flip, but getting rid of newsprint is an absolute homerun and more importantly, is a game-changer in cleaning up the go-forward story. More notably, the remaining biz offer high(er) barriers to entry and are much more visible + RYAM sits on the lower end of the cost curve.

a.       3 drivers of their biz on “remainco” include 1) Specialty pulp (annualized contracts, effectively a quasi-duopoly structure, coveted assets) + 2) more commoditized high-yield pulp (while volatile at times, RYAM is lower cost on curve and more importantly, cotton is the key px signal to focus on right now – as high-yield pulp is an alternative at times and I expect entire pulp market to get pulled up over the next few quarters … additionally, some of the pulp is very rational as fluff is a consolidated market largely dedicated by 1-player on pricing) + 3) paperboard (coveted by multiple parties even at the COVID-lows is my impression and likely worth >$400MM, steady / solid earnings power)

3)      Cycle uncertainty: Fast forward to today, RYAM has a modest balance sheet (inside of $500MM of net debt factoring in the lumber duties). Additionally, 2 of the 3 remainco segments are at an interesting inflection point. Specialty pulp segment has annual contracts and the market will likely be surprised by the trajectory of pricing this year (more clarity to come) as well as next year. Regaining pricing power on Specialty is core to the thesis and biz reverting back up to ~$245-$335MM of EBITDA on remainco (see below). Additionally, the high-yield pulp is also at an inflection point as many of these grades touch / interact w/ clothing alternatives and cotton (see highs) is the leading indicator to the health of these “wood alternatives”. I recall this dynamic played out in a very similar fashion in 2011 when cotton also got to these nose-bleed levels … ultimately pulled all the alternatives (be it wood pulp and chemical) to high levels. RYAM is well placed to benefit from this dynamic yet the market is ignoring. IMO, the set-up into 22E – 23E is very interesting as the market is skeptical that the 3 remainco biz units can do ~$150MM (let alone my view that this likely overshoots well north of >$300MM and normalizes in the $250-$300MM range).

4)      Low quality old CEO … replaced w/ new CEO in Dec 2021: Market ignores the shift in management less than 2-months ago, when RYAM appointed an outsider (Vito Consiglio). The old CEO (as mentioned above) had a terrible reputation and even activists were pushing for his removal during 2019 – 2020. The new CEO seems highly credible as he worked w/ PE firms for the past 2-years, previously ran large division of Ashland and worked at other reputable industrial / chems cos earlier in his career (Danaher, R&H, etc). Also notable is his age (57), TBD on what his intent might be, but I’ve always viewed paperboard as non-core and likely allows RYAM to focus on what they do best (PULP)

5)      Equity impairment risk / looming maturity wall … has been solved: Entire debt stack is trading at a 6.5%-7% yield. Biz also sits on >$300MM of cash and another ~$100MM coming through once lumber duties + tax refunds come through the door

Normalized earnings power / why now: The biz previously generated ~$350 - 400MM of EBITDA slamming Tembec and old RYAM together (even scrubbing for the lumber / newsprint assets that have been sold). My guess is that we will get more clarity on the annualized pricing terms on Specialty on the Q4 earnings and (over time), the market will grow more comfortable that ~$300MM is a readily achievable target for EBITDA on a normalized basis.

Re: why now, 2 primary reasons on why the biz is in the early stages of inflection: 1) Specialty pulp will see significant pricing power (get visibility on Q4 call for this year contract, and pricing power will likely continue given a more balanced S/D environment), and 2) high-yield pulp is in the sweet spot over the next 12-months (given alternatives spiking), decent shot the market gets more constructive a period of over-earning as well.  At $300MM of EBITDA, as example, the biz will likely spit out >$150MM of FCF (even assuming step-up in capex) or a ~45%+ FCF yield to the equity. This is too rich for a biz that’s on healthy footing, has runway (debt mats been pushed out), and multiple bidders would be interested in all 3 of the operating segments

Simplified cap structure: $500- $550MM of net debt (not factoring in FCF generation in Q4 21 – 22E) and $$330-$340MM market cap.

What playing for: In total, RYAM’s enterprise is likely worth in excess of $2Bln depending on how they play their hard. Will be interesting to see if the new CEO sells pieces (paperboard the likely focus) and then shifts focus to adding pieces on core Specialty / high-yield pulp.  Regardless of any action, RYAM’s Specialty + high-yield are likely worth well in excess of $1.6Bln (one could argue the Specialty alone is worth that amount) and paperboard is likely worth >$400MM (my sense is they had bids during COVID-low levels of >$300MM as an example). At $2Bln (~7x normalized EBITDA NOT factoring in future FCF which will drop the multiple lower), equates to $20 - $25 / share of FV. More importantly, think the biz inflection which is ongoing will help reinforce the fact that biz will produce >$100MM of normalized FCF (>30 – 50% FCF yield to equity) on ~$245MM-$335MM of normalized EBITDA.  At current ~$5 / share levels, even w/ cycle uncertainty risk in the markets, think the downside if “market risk” volatility (call it $1-$2 bucks in a nasty nasty tape), but the upside is >$15 - $20 bucks (15 – 20x payouts). RYAM’s remainco biz units offer high-barrier to entry, are coveted by many different strategic + PE buyers (on all 3 legs) and are in the early stages of a biz inflection. The FCF yield to equity is too rich at 30-50% (path to normalization now and >FCF as biz likely overshoots). As a result, I like the set-up and am long RYAM equity.

Catalyst

2022 results

New CEO providing his framework (low hurdle given the old CEO was hated)

Capital allocation priorities with growing cash balance

Potential for asset divestiture (or outright sale) particularly the paperboard segment