Description

Supremex is a Canadian manufacturer of stock and custom paper envelopes, and in recent years also of paper-based packaging products. They have 13 facilities in Canada and 3 in the United States. Revenue is a bit over $200M. In the envelope business they have 85% of the Canadian market and a small share of the fragmented U.S. market. Envelopes are in secular decline, hence the 2014 pivot into packaging, a product class currently benefiting from a trend toward e-commerce and alternatives to plastic. The way in which the company has managed through the pivot is pretty good so far, especially considering they’ve done lots of acquisitions. Right now revenues are roughly 45% Canada envelope, 25% U.S. envelope and 30% packaging. Their intent is to get to at least 50% packaging relatively soon. The company’s EV is near its historical multiple of ~4x EBITDA but I think that if management continues to carefully manage the process, they’ll end up in a stable situation and be awarded a somewhat higher multiple. Because they’re a little levered, such success could translate into some pretty nice gains for the equity. Another turn of EBITDA would make the stock rise 50%.

Background

Over a period of many years Supremex delivered a decent dividend while the stock traded within a range. The envelope sector was declining (single digits year after year) and it wasn’t clear how well SXP will deal with that. The market has therefore kept the stock trading at a stable but low multiple, which has also persisted in the post-2014 period because the pivot isn’t yet a proven success. They key question is therefore: how will the pivot go? At SXP we find a management team that carries out its duties diligently in terms of operations. CEO Stewart Emerson has been with the company since 1990 and he’s not the only veteran. He is very hands-on and seems very involved in everyday problems (though now the company has appointed a head of envelope + a head of packaging so that he can focus on the bigger things). They also recently hired a CFO with an impressive resume. She’s worked at much bigger companies before, as CFO of Energir and of BMR, both respected in Quebec. Plus, before that, she worked at Saputo and Aldo. It’s kind of impressive that SXP convinced her to join.

Let’s go over some of the developments in recent years to see how the company has sought to protect itself from declining envelope demand.

First, over the past few years, SXP has gone from 60% of the Canadian envelope market with 9 significant competitors, to now 85% with only two small competitors. As envelope use continues its decline, it is reasonable to assume SXP will essentially control the market, perhaps even buy out the other two and then have real pricing power. The only remaining issue will be the speed of decline and how important paper envelopes are to those who still use them. Financially speaking, an envelope is a minuscule portion of the cost of communicating whatever it is that the sender wants to communicate, so there should be pricing power.

Secondly, the company has acquired envelope businesses in the U.S., where the idea is to gradually expand in what is still a fragmented industry and be able to use extra capacity of Canadian envelope facilities to serve U.S. customers. So they see themselves as consolidators; it’s important to note they’re already among the five largest envelope manufacturers in North America, which means there is some scale in place. Because geographical proximity is important in the paper business, SXP has only gradually expanded, first maximizing its opportunities at home in Montreal, then the rest of Canada, and now in selected parts of the U.S. Midwest and U.S. Northeast.

Last but not least, there’s the process, started in 2014, of using the company’s know-how and cash flow from the envelope business to pivot into packaging. The global paper packaging market is expected to grow at a CAGR of 4-5% in the coming years due to demand for eco-friendly solutions as well as consumer awareness of the existence certain new paper-based products. Also, this type of packaging is less seasonal than envelopes; the latter tends to increase in volume around year-end. Packaging is also a pretty effective hedge to envelopes because the same environmental issues that are pushing people to opt for electronic communication instead of envelopes are pushing people to use paper packaging instead of plastic packaging (or of having stuff delivered instead of using cars to go to brick and mortar shops). The covid situation has accelerated all of these trends. In 2020, the USPS reported an increase of 19% in packaging volume. The competencies needed by SXP’s labor force for the packaging business are similar to those of the envelope business, so operationally that’s a plus.

SXP entered the packaging sector via acquisitions. They now have 4 packaging production facilities in Canada and one in the U.S.: the recently-acquired Vista, which they bought to be closer to U.S. customers. SXP is planning to turn Vista’s facility into a fully-integrated e-commerce packaging hub to maximize its opportunities in the country.

SXP’s packaging products include: corrugated boxes, premium quality folding carton packaging (which can be highly customized), micro flute packaging and e-commerce packaging. This includes specialty products like environmentally-friendly mailer envelopes. They are seeking to expand product breadth through acquisitions as well as organic growth. The end markets are diverse; they include: food & beverage (alternatives to single-use plastics), publishing, medical, dental and cosmetics.

As for macro, SXP has great relationships with its suppliers because they give them forecasts and pay well, so they should have an edge when it comes to procurement of materials. As for cost increases, they should be able to pass these on for envelopes in Canada. In the U.S. it might be a bit more tough because it’s a fragmented market. In packaging it depends on the product but where there are relationships with corporate customers, or special customization as opposed to stock items, they will probably do fine with pricing issues. Right now the biggest problem for their customers is getting supplied in the first place.


Valuation

With an EV of 137M, EV/adj.EBITDA is a bit below 4x and EV/sales stands at 0.64x. It’s not mega-cheap but considering they’re at half-equity half-debt, a continued successful execution of the pivot should award them a higher multiple. At 5x EBITDA the stock can rise about 50%. Obviously it won’t be that simple because EBITDA itself will rise in the meantime and the balance sheet may have a bit more debt on it from more acquisitions, plus there will be organic growth. But I think in 2 years most revenue will be from packaging and then it’s just a question of how they execute and how fast the envelope market declines. I think it will be slightly faster than pre-covid but not that fast. It’s probably still a function of older people (or others) who prefer receiving paper correspondence.

Also, there’s an active plan to buy back 5% of shares. The dividend was suspended when covid started; I personally don’t think they should bring it back because the increased focus on packaging – and on acquisitions - implies they’re in growth mode; doesn't sound like a good time for a dividend.


Risks

- Paper input costs: so far they’re doing well through all this but it’s a risk
- Acquisitive company: here again, so far they’re doing good but needs to be monitored. They did have a write-down with respect to one of their acquisitions in the past few years

Catalyst

- Continued success with organic growth of packaging and of U.S. sales
- Good acquisitions at good prices with successful integration processes and synergies
- Continued growth of the relative size of the packaging segment so as to no longer be priced as “an envelope company that may or may not pivot successfully