Description

While candidly this isn’t my typical investment, and it should be sized appropriately, I recommend buying shares of RE:NEWCELL AB (RENEW SS), an innovative ~$300mn market cap listed in Sweden.

Renewcell’s founding researchers, Mikael Lindstrom and Gunnar Henriksson at the Royal Institute of Technology in Stockholm (their MIT), first developed a process to convert cotton waste into 100% recyclable fabric in 2012. The company build a demonstration plant in 2017 and it attracted the interest from many of the leading fashion brands. In 2017, H&M became a large minority shareholder. Soon thereafter the company which makes a very advanced and patent protected Circulose® branded product became the world’s first commercial scale 100% textile-to-textile recycling plant. In late 2020 the company listed on the Nasdaq First North Premier Growth Market at ~76 before peaking at >300 in early 2021.

Shares are now trading at ~90, which I believe represents an attractive ~10x ’24 YE exit run-rate EBITDA. Ultimately, I think the stock will be worth ~265 in 18 months, which provides >200% base case upside. The downside is considerable, given unproved technology and large capital required for continued growth beyond 2025, but recent actions have de-risked the story a bit. Commercial production is scaling at its first facility and it has raised all the equity it needs for the next +2 years.

It’s also worth highlighting that this fits many of the criteria required for it to be potential 10x over the next 5+ years. The TAM is immense (only ~1% of apparel is recycled into new clothing), the unit economics are VERY strong and demand has already proven to be insatiable. More importantly there are many regulatory mandates coming over the next few years that will support massive commercialization.

At this point >70% of apparel ends up in landfills and/or is incinerated. This has left fast fashion companies with growing PR headaches and “green washing” claims are now being exposed as being insufficient given the severity of the environmental issues that these companies are creating. Moreover, in 2019, the European Commission identified textiles as a priority product category for the circular economy and two vital political initiatives were initiated, the EU Circular Economy Action Plan (2021) and the EU Waste Directive Framework. The EU Waste Directive Framework requires EU countries to separate all textile waste by 2025, which we see can lay the ground for new sourcing options for Renewcell. This is expected to significantly increase the flow of fashion waste in need of a destination and enable lower input costs for RENEW, making Circulose® product even more price competitive.

This presents RENEW with a unique position in the fashion value chain, as the only commercial supplier to fiber manufacturers that can produce a ~100% recyclable fiber that can be used to replace cotton and polyester (plastic), just at a time where ESG concerns around fast fashion and the apparel industry are coming to the forefront.

To support this assertion, H&M is its largest investor (~10%) and one of the worst ESG/fast fashion culprits. They invested pre-IPO and helped hand pick the company’s CEO (former GE). In addition, H&M has consistently participated in subsequent fundraising rounds to maintain its ~10% position. On top of this Fidelity and Capital Group are both top shareholders, which is rare to see for a company of this size. Lastly, its recently hired (July 2020) CFO left his position as CFO at Svenska Cellulosa (SCAB SS), a $10bn USD market cap to join RENEW which is about 1/30th its size. Therefore, this is a pretty strong sign post for where he thinks the value of this company can go over time.

After breaking ground ~1.5 year ago at its first facility in Sweden, RENEW began testing production in August 2022 and they announced its first delivery of its patented Circulose® to its customers in Dec 2022.  While first production was delayed by a few months the current operations are starting to ramp as expected and they expect to capacity of 60k mt/yr by YE 2023.

During 2021-2022, RENEW has seen overwhelming demand from some of the largest fabric producers which has led to many large multi-year offtakes at an estimated ~25-30% EBITDA margins. In 2022, as a result of this strong demand RENEW decided to accelerate its production and to bring forward its planned expansion from 60k mt/y to 120k mt/yr by two years.

In Q4 2022, Lenzing, one of the largest fabric producers agreed to purchase 80-100k mt over 4 years for ~1.5 bn SEK, and implied price/mt of $1,500 USD (vs. the $1,250 previously disclosed as needed for >25% EBITDA margins). It has also been disclosed that Lenzing is partnering with Renewcell because its customers (apparel companies) are pushing them to do this.

RENEW now has >120mn mt/yr of committed offtake agreements with 3–4-year contracts and they are looking to accelerate expansion at their existing facility to 250k by 2024/2025. Longer term, the company plans to produce 360k mt/yr by 2030.

During Jan 2023, RENEW produced 1,000 mt of product and they now target 60k mt/yr capacity (~5k mt/month by YE ’23). This will increase to 120k mt/yr by YE 2024 and capacity can easily grow from 60k mt/yr to 120k mt/yr within ~1 year (by YE ’24) and there only is ~200mn SEK CapEx that remains to accomplish this.

Moreover, commercial success has been very strong with good results from collections with H&M, Zara, Tommy Hilfiger, PVH, Kering and Levi’s just to name a few. Moreover, its own customers are now helping RENEW build its Circulose® brand. In 2022, Levi's released the classic 501 with the name "Levi's 501® Original Designed for Circularity” using a blend of Circulose® and organic cotton.

1H 2021 and 2022 was a tough period for most growth stocks and RENEW did have some teething issues. Slower ramp-up and higher overhead costs due to component shortages and covid inspired delays drove consensus EBITDA cuts to 2024-2023 estimates. However, the company recently completed a cap raise at ~100 and they now have sufficient cash and access to credit (mostly EU ESG-focused credit institutions looking to subsidize projects just like this) to achieve its targeted 120k mt/yr run-rate expansion by YE ’24.

Not only does the company’s product provide ESG related enthusiasm, but the unit economics are phenomenal.

At the time of RENEW’s Nov 2020 IPO, Circulose® was priced at USD 1,250/t as indicated in the initial offtake agreement with Sanyou (~40k mt/yr for 5 years). However, with rising input costs and higher cotton prices most recent deals are being announced at $1,500 USD/mt. For conservatism I’m assuming revenue/mt of $1,300 USD/mt. In total, the company has announced 120mn mt of orders and therefore has already fully sold out its capacity through ’24.

In terms of raw mat costs, RENEW now has supply agreements for >100k mt/yr at an estimated ~$220 USD/mt over 3-4 years. Based on mgmt’s guidance total COGS/mt will be ~$700 USD/mt (~45% gross margins) and there’s an additional opex/mt of $75 USD/mt which implies unit costs of $775/mt vs. RENEW’s >$1,300 USD/mt selling price (~40% contribution margins). I’d also note that its Plant 1 lies in the lower price electricity region SE2 (Sundsvall) and that a stronger USD provides RENEW margin tailwinds.

In addition, RENEW is in a very strong position in regards to raw mat supply (discarded apparel) as there’s a glut of this stuff available which highlights why the apparel industry pain is once again RENEW’s gain. Essentially, RENEW is buying waste that has little value to other waste collection companies and RENEW is developing an ecosystem of suppliers globally to procure this material at attractive prices.

Ultimately, RENEW has guided towards 15-20% plant level EBITDA margins at ~50k mt/yr with ~30% EBITDA margins at 120k mt/y capacity. I assume 25% EBITDA margins. In regard to overhead costs, I estimate ~250mn SEK in 2024 as needed support 120k mt/yr by YE 2024.

In regard to capital needs, the company reiterated in Q4 that its most recent equity offering was put in place to cover all CapEx and losses associated with achieving ~120k mt/y capacity and that they don’t need any equity through 2024.

RENEW currently has 800mn debt and cash of 290mn for net debt ~500mn SEK. Of this cash, ~175mn is unrestricted and they have credit facilities of ~200mn SEK which remain untapped. Therefore, this is ~375mn SEK capital available until they reach EBITDA +ve in 2H 2023. I also assume they burn 300mn SEK (vs. ~400mn in ’22) and there’s an additional ~100mn capex in ’23. Therefore, the math make sense. They need ~400mn to get through 2023 and ~350mn is already earmarked, plus they should be EBITDA +ve by Q4 2023.

Putting this all together, I have RENEW achieving exit run-rate ’24 EBITDA of ~400mn SEK. At 25x EBITDA this leads to an EV of ~10bn SEK at which time ND will be ~900mn leaving us an equity market value of >9.1bn SEK. Including ~34mn shares leads us to >260 target price or ~200% upside.

If we roll forward to 2026 and ~240k mt/yr of capacity I see ~400 target price (assuming 100% debt financing) as RENEW will have to build another facility which could take 1.5-2 yrs and cost an estimated ~1bn SEK bringing them to ~2.2x PF ND/EBITDA.

But the opportunity is HUGE. The global market for textile fiber amounted to >100mn mt/yr and demand for textile fiber is also expected to grow by 50% by 2030 as a consequence of increasing numbers of people entering the global middle class and the expansion of fast fashion retailers. Of this there is an estimated ~30mn mt/yr of product that Circulose can look to replace. While RENEW’s 2030 targets of 360k mt/yr sound ambitious is only ~1% of the TAM.

Longer term, the CEO has a strategy to license this technology but they would be very careful about what they share and they would only due it if they can control the process themselves. While there is competition, many of them are seen as 3-5 years behind RENEW and the TAM will be plenty big enough for there to be many winners.

Catalyst

Hitting '23 production targets on time and budget. New sales off take agreements