Description

I advocate a long position in the common stock of Rayonier Advanced Materials Inc. (“RYAM” or the “Company”), as it is undervalued by the market with an intrinsic value of $6.00 upside of approximately 40%.

Description

Rayonier Advanced Materials Inc. (NYSE: RYAM) manufactures and sells cellulose fibers primarily in the United States, China, Japan, and Canada, as well as in Europe, Latin America, and other Asian countries.  Its products include cellulose specialties, such as cellulose acetate and cellulose ethers primarily used in dissolving chemical applications; commodity viscose used in the manufacture of textiles for clothing and other fabrics, and in non-woven applications; absorbent materials comprising fibers for absorbent hygiene products; and other products.  RYAM is headquartered in Jacksonville, Florida and operates independently of Rayonier Inc. as of June 27, 2014.

Background

RYAM is an 85 year old business that converts trees into specialty cellulose.  The various grades of specialty cellulose are highly specialized, key raw materials in cigarette filters (acetate), along with a wide array of additional items such as LCD screens, food (thickeners, sausage casings), and certain industrial (tire cord, hoses, paints, lacquer) and pharmaceutical applications.  RYAM is the market leader, with double the specialized cellulose revenues of its nearest competitor.

Investment Thesis

• Underfollowed stock/spinout dynamics
  • Post-split stock is only covered by 2 analysts
  • Expectations have been taken down largely by management re-guidance and competitor sentiment around pricing environment contributing to current stock price weakness
  • Cost overruns for the first independent year appear to be largely one time in nature (wood costs, energy)
• SS/DD imbalance should be temporary and resolve in the second half of this year
  • Industry was capacity constrained, which resulted in capacity adds by RYAM and competitors from 2011; current pricing down approximately 7-8%
  • RYAM is lower quartile on the global cost curve. Key assumptions are continued growth with Chinese cigarette consumption to drive acetate volumes at 0-1% per annum and rational competition (new projects are expensive and take 2-3 years to ramp, no projects of size announced)
  • Competitors acknowledge the challenge of taking share aggressively given the highly specialized nature/high barriers to entry of the product
  • RYAM management is 'feathering' (per CEO) in supply in a more disciplined fashion as the market will absorb it; excess capacity goes to commodity at lower (assume - high teens) margins
• Attractive cash flow dynamics
  • RYAM is through the heaviest part of its CapEx cycle post plant expansion in Jessup, GA and only maintenance CapEx of around 8-9% of revenues expected for the next 3 years
  • Leverage at 4x Net Debt/EBITDA and levered FCF yield is north of 11.8% in a base case and company adds $1.50-$2.00 per share of equity value per year for the next 4 years through deleveraging; basically, investors are paid to wait while the cycle turns
• Current price levels are already pricing in a highly punitive scenario
  • At approximately $4/share, the market is anticipating another 5-7% price drop for 2022 and very limited to no recovery in volumes or prices for the next 3-4 years
  • Valuation is attractive on normalized numbers, which can be reached even assuming further price deterioration
  • If you assume the company had been over-earning in 2021-2022, and that a more sustainable EBITDA margin for the business is in the mid 20’s, it still implies ~$215M EBITDA at 2022 CS prices.  At a 5.5x multiple (30% take-out premium), this assumes the business is fairly priced today with no growth and no deleveraging

Risks

• Capital intensive nature of this business
  • However, one of the most appealing aspects of the investment is that the growth CapEx is in the past when the company put $385 million into additional capacity while under pre-spin parent RYN’s umbrella
• Irrational competition and excess capacity negatively affecting pricing
  • Sateri continues to compete aggressively in specialty cellulose with volumes up 13% YoY post sale of its VSF business.  Additionally, its advantaged position on the cost curve and expansion plans, all of which could keep SS/DD imbalance out for longer than expected
  • However, despite the cost advantage, it is hard to replace volumes from existing players given the customer lock-ins
• Customer concentration
  • Top 10 customers comprise approximately 75% of revenues
    • However, they have long term contracts with Eastman Chemical (21% cellulose sales), Nantong Cellulose (19%), and Daicel Chemical (14%) 
    • Deals with the major Chinese players such as Nantong (subsidiary of China National Tobacco) have been customers since 1994 which speaks to the strength of RYAM’s position as a supplier to Nantong instead of them switching to a domestic supplier
    • To be fair, China is a net importer of timber, the chief raw material of specialty cellulose, and timber is expensive to move
• Management credibility questions
  • Despite tenure, management has not been upfront on what happened to the 30,000 tons volume between June/July, and the inability to acknowledge an over-earning environment of the last 2-3 years is frustrating
• Prolonged spike in key raw material inputs (wood, chemicals such Sodium Sulfate, sulfuric acid, sodium chlorate)
  • Only ~6% of cost of sales, as wood by-products are used to supply the vast majority of the company’s energy needs
• Unforeseen changes in environmental regulation
  • Potential underestimation of environmental liabilities though management claims to have a handle on it
• Union Issues
  • In negotiations with their unions regarding new contracts that were initially rejected by the unions
  • Currently working under the existing contracts while negotiations continue; work stoppage could adversely impact the operations of the business
  • Management is working through the negotiations and expect to have it resolved

What does RYAM do?

• RYAM is the leading global pure play supplier of specialty cellulose (CS) products, a natural polymer for the chemical industry. End markets for CS include acetate (60% of 2022 volumes, cigarette filters and LCD screens, 0-1% market growth, #1 player); high value ethers (food, industrial, pharma construction; 4-6% market growth, top 4 player, opportunity for growth); other cellulose specialties (explosives, inks, tires, 2-3%market growth, #2 player)
• RYAM’s customers have very specific needs, and they demand a very fine-tuned, customized production process (RYAM has significant R&D capabilities and produces 25 grades of specialty cellulose in varying degrees of purity) 
• RYAM brings in raw wood (the primary cost input in specialty cellulose, at 26% of cost of revenues, followed by chemicals at 17%; energy is 6%), debarks and chips it, sends it through the digester house and bleach plant, dries it, packages and ships it according to the customer’s specifications 
• There is a significant degree of customization, refinement, and safety that each customer requires.  One false step, and that cigarette filter imparts a very different flavor; a different false step, and that sausage casing or pharmaceutical material may cause harm to the end consumer 
• Consistency, precision, and production of a safe product are critical at the high end of the cellulose market.  Accordingly, customers require a lengthy qualification process, a consideration that comes into play when one considers barriers to entry and switching costs  
• Commodity viscose (lower margin, variable to spot price) takes up capacity where CS can’t be contracted.  CS pricing largely independent of viscose volatility
• Has long-term customer agreements (3-5 year volume-based contracts with pricing mechanisms)
• Average tenure among top 10 customers is 38 years and the top 10 account for ~70% of revenues. Approximately 60% of revenues are to export customers in Asia/Europe, a highly concentrated industry

Industry/Competitive Landscape

• Global demand for specialty cellulose (acetate, high value ethers, and other cellulose specialties) or “Performance Fibers” derived from wood pulp, is about 1.6 million tons per year 
• Not rayon or textile materials, commodity viscose, etc. 
• Global market for acetate, a key material in cigarette filters, is about 710,000 tons, (44% of the 1.6 million), growing at 1 -2 % annually
• Ethers about 500,000 tons (31%), growing at 4-5% annually
• Other cellulose is about 350,000 tons (22%), growing at 2-3% 
• Technically demanding business that is dominated by a small handful of players such as Georgia Pacific, through its acquisition (2013) of Buckeye Technologies, Borregaard, part of the Orkla group, (largest private company in Norway), Sappi, with $5.9 billion in overall company revenues, Tembec, a $1.5 billion Canadian paper company, and Sateri (Chinese), with $646 million in revenue
• RYAM is the market leader, with 30% market share by volume, roughly double the revenues of its nearest competitor
• In addition to having the dominant market position, RYAM is also the closest thing to a pure play on specialty cellulose which is important when evaluating comps, since the high end is more defensible and offers more attractive margins and returns on capital than commodity viscose, fluff and other close relatives (unlike coated paper, which generates the majority of Sappi’s revenue, for example)
• About 89% of RYAM’s 2022 Revenues (in dollars, as opposed to tonnage) were in specialty cellulose, versus 7% from absorbent materials and 4% from commodity viscose 
• Specialty cellulose accounted for 76% of the production capacity
• RYAM is the global leader in acetate with about 81% of RYAM's specialty cellulose production (61% of the company’s overall tonnage) is tied to cigarette filters
• Balance production was devoted to ethers (top 4 global position) and other cellulose specialties (top 2 global position)

Valuation

• 2023 EBITDA projection at $235 million (assuming 0% pricing increase and 1% margin erosion)
• Model estimates around $89 million of CapEx for 2023, in contrast to the triple digit expenditures of the recent past putting 2023 (EBITDA – CapEx) at ~ $129 million 
• Total debt stands at around $860 million
• Average of specialty fiber companies (including commodity viscose) have traded between 5.8x and 7.7x EV/LTM EBITDA
• In terms of precedent transactions, Georgia Pacific’s acquisition of Buckeye Technologies in April of 2013 at 8.6x LTM EBITDA serves as a potential comp here.  However, it is important to note that only about 30% of Buckeye’s revenues came from specialty cellulose.  In terms of operating stats, Buckeye had 22% EBITDA margins and (EBITDA - CapEx) was about $70 million due to its investment in a 44,000 ton capacity expansion (which has also contributed to pricing declines).  On a normalized basis, this translates to an EBITDA – CapEx multiple of around 11.5x
• Sateri sold their VSF (commodity) business for 8.0x EV/LTM EBITDA; ~11.5x EV/EBITDA-CapEx

SWOT Analysis 

• Strengths:
  • Barriers to entry into this market are high due to the advanced technological know-how required to produce the high purity products, the stringent customer specifications and long product qualification cycle resulting in higher market prices of the specialty-grade pulp which have grown at above 8% CAGR in the past decade
  • The capital-intensive nature of the business is one of the most attractive attributes of RYAM especially after the $385 million CSE investment to convert commodity production capacity in its Jessup, GA plant to specialty cellulose capacity 
  • The CSE plan was due to its customer relationships and was not “built on spec” as RYAM has multi-year purchase commitments in place from its major customers 
  • The CSE project positions RYAM as the only pure-play specialty cellulose producer in the business, further increasing its production scale
  • Average tenure of RYAM’s top 10 customers is 38 years with decades of process development and technical know-how behind them
  • Unlike many of its competitors RYAM it is the only producer with the flexibility to use both hard and softwoods and claims to be the only producer to replicate its customers’ production processes onsite
  • The high-end specialty cellulose players are able to downshift excess capacity to supply commodity viscose and the commodity viscose guys are unable to “up-shift” to specialty cellulose 
  • Specialty cellulose pricing is also largely independent of commodity viscose pricing
• Weaknesses:
  • To be fair, the CSE also adds 190,000 tons of supply to a market with 1.6 million tons of existing global demand 
  • A Georgia Pacific/Buckeye Technologies project further added 44,000 tons to supply, and a Sateri project added further to capacity thereby pushing down pricing 
  • RYAM chose to channel some of its capacity into commodity viscose, opting to “feather in” (per CEO) the specialty cellulose supply over time
  • The pricing pressure from excess capacity was compounded by an industry-wide decline in demand from Europe  
  • Non-acetate end uses for specialty cellulose include tire yarn, paints, hoses, lacquers, and other industrial materials that suffered decreases in demand over the past few years
• Opportunities:
  • RYAM is currently continuing production of some commodity products
  • Given its flexibility, RYAM has focused its production on segments of the cellulose market with more inelastic demand
  • Potential margin improvement could come by shifting capacity to 100% specialty as the market supports it, and as they obtain 100% customer qualification/approval of the new Jessup capacity 
  • Irrespective of a shift in product mix, specialty cellulose prices could rise as demand catches up with supply 
  • RYAM’s increasing presence in ethers (to improve its top 4 position) by targeting areas of high growth and less elastic demand such as food additives and pharma end uses.  Potentially, a portion of the 25% commodity capacity could go in that direction (targeted ether segments are growing in the high single digits versus acetate at 1-2%) as it migrates to specialty cellulose, and a portion of the acetate production could also migrate 
• Threats:
  • Some worry around further anti-smoking legislation in China, which may not be the growth market people expect.  Modeled acetate growth at 1% versus market expectations of 1-2% to be conservative
  • Also there is some ability for pricing to compensate for volume (acetate is ~10% of cigarette costs)
  • Significant unforeseen changes in environmental regulation beyond the currently estimated  liabilities

Catalyst

Value acts as its own catalyst

Private equity buyout