Description

Sylvamo was written up in 2021 by compounders post the spin-off from IP at $28.16. I recommend reviewing that write-up as it provides excellent background information on the business and industry. Since the spin, the stock has appreciated to a recent $57 per share representing a total return including dividends of 135%. Rather than review the basics of the business – the company is a global producer of uncoated free sheet and pulp I am going to highlight three reasons why I think the stock is an attractive value today. The current share count is 41 million shares which equates to a market cap of $2.4 billion. Gross financial debt is $950m and the company has cash of $220m. The total enterprise value is $3 billion.

My investment thesis is as follows:

1. Brazil is a terrific asset that has shown tremendous resiliency over time and should continue to accrete value.

2. The North American inventory destocking period is over, and the company has significant earnings upside from industry conditions normalizing.

3. Europe earnings should improve meaningfully from the breakeven results in 2023.     

The company reported adjusted EBITDA of $607m in 2023, free cash flow of $294m, and Adjusted EPS of $6.51. I believe the company can earn $8 per share this year. Capital will continue to be allocated to a mix of continued deleveraging, dividends, and opportunistic share repurchases. I think the stock can trade at 10x my target earnings for a target price of $80.  

1. Brazil is a terrific asset.

Brazil consists of three uncoated free sheet plants – Luis Antonio, Mogi Guacu, and Tres Lagoas with the capacity to produce 1,105k short tons (“st”) of paper and 165k st of pulp annually. The company is advantaged in that it owns eucalyptus plantations in close proximity to the Sao Paolo mills and has a long-term supply agreement with Suzano for the third plant. The vertical integration and location of the plants result in the manufacturing facilities being in the first quartile of costs globally. This is evident in the financial results of the plants.  Going back to 2007, Brazil has generated adjusted EBITDA of $250m-$330m annually with only the COVID year of 2020 being below that. In 2022, the assets earned $281m of EBITDA and $205m of EBITDA – CapX. In 2023, EBITDA was $271m and EBITDA – CapX was $159m due to one-time elevated capital expenditures related to increased planting.  

During the fourth quarter, the company commissioned a study to value the forestlands near the plants:

“…In addition to providing global competitive advantages, our Brazilian forest lands have significantly increased their value. In the fourth quarter, we commissioned a third party to appraise our forest land. In December, they valued it at about $1 billion at the current exchange rate.

The updated valuation reflects an increase of about $600 million from our 2021 appraisal done by the same firm. Increasing demand for land wood in Brazil has driven this increase in valuation. Our forest lands are not only towards the global competitive advantage but also an enduring repository of shareowner value.”

Simply put, the Brazilian assets represent arguably the best integrated uncoated free sheet network in the world.

In 2024 I estimate the assets will generate $280 million of EBITDA.

       2.North America Normalization

In North America, Sylvamo produces paper and market pulp in Eastover and Ticonderoga and has commercial agreements with International Paper for supply from their Georgetown and Riverdale mills. Including the IP agreements, Sylvamo has capacity of 1,630k st of uncoated free sheet and 115k st of market pulp. Consumers stocked up on uncoated free sheets in 2022 and the resulting hangover in 2023 resulting in significant end markets destocking. According to the Pulp and Paper Council, through 3Q23 retailer demand for UCFS was -21% compared to end market consumption of -6%. To adjust for the inventory correction, Sylvamo took significant downtime of 246 kt or 15% of capacity. The unabsorbed fix cost per ton of downtime is estimated at $350-$400 per ton or $85 -$100 million.

Furthermore, while industry demand over time declines by 3%-4% due to digitization, the inventory destock was so severe that demand in 2024 is estimated to increase 6%-7%. Additionally, the industry is consolidated with Domtar and Sylvamo the largest producers and acting rationally. Evidence of this is that Domtar earlier this year announced a plant closure representing 3%-4% of industry capacity.

In 2022, North America generated $370 million in EBITDA and in 2023 $329 milion. Assuming a normal year of production and being conservative on the fixed cost absorption, I believe this segment can earn $380 million this year.

         3. Europe Improving

Since the writeup by compounders in 2021, Sylvamo’s European footprint has changed. The company sold the Russian assets for ~$400 million and acquired a modern mill in Sweden for $160 million. Total uncoated free sheet capacity is 765k st with market pulp of 130k st. The European industry is much more fragmented, and a few competitor mills have recently closed taking out industry capacity.

The segment earned $70 million in EBITDA in 2022. Including the Swedish assets Sylvamo only earned $7 million of EBITDA in 2023. Due to weak industry conditions, the company took significant downtime last year of 132k st, or 17% representing unabsorbed fixed costs of $45-$55 million.

At a recent industry conference John Sims, Sylvamo’s CFO, said that the inventory correction in Europe is over and they are currently running full out.

Assuming a normal year of production and being conservative on the fixed cost absorption, I believe Europe can earn $50 million of EBITDA this year.

Conclusion

Putting this all together, I estimate Sylvamo can generate $710 million of EBITDA  in 2024 and $8 of EPS. Depreciation spending is roughly equal to Capx spending inclusive of growth projects. The company pays a dividend of $1.20 annually leaving $275 million of free cash flow to be allocated between debt paydowns, special dividends, and share repurchases.

Furthermore, Atlas Holding, a well-respected private equity investor with expertise in the capital goods industry including the paper industry owns ~15% of the company and is well represented on the board. They acquired their stake in 2022 and have not sold a share. While speculating on their eventual game plan is beyond the scope of this write up, I am confident that they are aligned with shareholders and will be responsible stewards of capital.

Catalyst

Normalization of North America operating earnings.

Europe stabilization and fixed cost absorption.

Significant free cash flow to allocate opportunistically.