|Shares Out. (in M):||15||P/E||0.0x||0.0x|
|Market Cap (in $M):||201||P/FCF||0.0x||0.0x|
|Net Debt (in $M):||429||EBIT||80||87|
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Xerium Technologies, Inc. (“XRM” or the “Company”) is a leading global manufacturer and supplier of two types of consumable products used primarily in the production of paper (including printing and writing paper, corrugated box, and paperboard): (i) machine clothing and (ii) roll covers. The Company’s operations are strategically located in the major paper-producing regions of North America, Europe, South America and Asia-Pacific.
XRM was originally formed in 1999 when it was sold out of Invensys to Apax Partners for $820MM. Apax grew the business for several years and then tried to sell it for $1BN - $1.25BN during 2002, however the sale process was unsuccessful and Apax changed course, doing a large dividend recap instead. In 2005, Apax took XRM public, with primary proceeds used to pay down debt. The business bumped around after the IPO, registering good years in 2006 – 2008, and suffering with the paper and packaging market and overall economy in 2009 – 2012. In 2010, with over $620MM of debt, the Company could not manage its debt burden and was forced into a restructuring where pre-petition lenders received $10MM in cash, $410MM in take-back loans and 82.6% of post-reorg equity. Pre-petition equity holders received 17.4% of post-reorg equity. Two P/E investors own approximately 27% of the shares .
We have looked at XRM in the past and have struggled to get comfortable with the Company’s business prospects, particularly the fact that about 90% of XRM’s sales are to paper manufacturers, which we know to be in steep secular decline. Our concern seemed justified as the Company’s EBITDA dropped from $114MM in 2010 to $108MM in 2011 and $89MM in 2012. However, management has been highlighting that the paper manufacturing industry is comprised of much more than simply writing and printing paper. In fact, the Company points out that presently, writing and printing paper makes up just 23% of the overall paper industry, with the other 77% being comprised of tissue paper, containerboard and corrugated board, among other types of pulp-based products – all of which are actually growing, thanks in large part to strong demand from China.
The deterioration of the Company’s financial performance over 2011 and 2012 is then more attributable to European economic softness (2011, 2012 and 2013 GDP change of +1.6%, -0.3% and +0.1%, respectively) and meaningful paper and packaging industry overcapacity (particularly in Europe), leading to capacity reductions and hence lower demand for machine clothing and rolls. This explanation is borne out in XRM’s reported results where sales in North America, Asia Pacific and Europe changed +0.4%, +3.0% and -15.6%, respectively, from 2011 to 2013. In addition, in 2011, sales in Europe represented 38.3% of consolidated total net sales, whereas in 2013, this figure dropped to 34.7%.
To a lesser extent, the Company’s sales have also been hurt by paper manufacturers extending the life of roll covers by increasing maintenance service and the use of newer paper machines which require fewer rolls; both items negatively impacting the Company’s roll covers segment.
With this in mind, management has provided some data supporting the idea that the majority of the product end-markets to which it is exposed are in growth mode, as follows: fiber cement growing 8.5% through 2017, non-woven products growing approximately 5.4% annually, paper and board market overall growing ~2% per year, tissue paper growing between 5% - 7% annual with especially strong demand in Asia, and printing and writing paper declining 3% per year. Management has not provided a sufficient level of detail on how its current product end-market sales break down, but it is our understanding that about 30% of sales are to printers making printing and writing paper, about 2% to 5% of sales are for the higher-growth fiber cement and non-woven markets, and about 13% to 16% of sales are to other non-paper based applications (industrial rolls, mechanical service, pulping applications, etc.), and about 50% of sales for tissue, boxboard and other related pulp and paper products.
Factoring in all of these items, management believes annual sales growth of 1% to 2% per year is reasonable. The Company registered net sales growth of 1.5% in 2013 and improved adjusted EBITDA from $89MM in 2012 to $107MM in 2013.
In the past, our opinion of XRM was negatively biased based on the Company’s exposure to the secularly declining sheet paper industry, however, we have come around to a more positive view on the Company, namely, that XRM is actually a good business but one that has suffered for a number of years, first because of the secular decline of sheet paper which began accelerating in the 2007 – 2010 timeframe, corresponding to the proliferation of tablet computers and advanced smartphones, second, because of the 2008/2009 global recession and the disproportionate pain experienced by the highly cyclical pulp and paper industry, third, because of a shift in paper manufacturers to new machines that require less rolls and hence less roll covers, in addition to paper manufacturers making an effort to extend the life of roll covers through increased maintenance, and fourth, and most recently, because of prolonged economic weakness in Europe and drawn out structural capacity problems in that market.
These macro / industry headwinds aside, XRM is the solid #2 global player in both the machine clothing and roll covers markets (both markets are fairly consolidated), boasting high barriers to entry, recurring revenue streams (products consumed in paper making process), leading R&D capabilities that generate valuable intellectual property and keep the Company competitive, a detailed restructuring and realignment plan that will reduce costs and position the Company to grow along with the market, and a higher exposure to growth industries than to the secularly declining printing and writing paper market.
The majority of the company's restructuring charges are behind them and there is now a strong incentivized management team that will be using capex that was prior focused on cutting and now move towards growth. The company has underinvested in its business for years and is now able to focus on serving its customers again in order to win more/new business.
We feel that as margins begin to expand and top line stabilizes in the back half of the year, the stock will re-rate meaningfully higher closer to $20+ a share. Two PE type investors are currently the largest holders in American Securities and Carl Marks Management (the latter has been involved since before the filing). the end of a massive restructuring program should lead to a meaningful re-rating in the company's shares.
n Prior to maturity the Company will call its 8.875% notes and capture some cash interest savings – this will improve the cash flow story
n Successful demonstration of restructuring initiatives leading to better operating margins
n Opening of the Company’s plant in China which will alleviate the cost burden of shipping products from Europe to Asia, allowing the Company to achieve machine clothing gross margins more in line with Albany.
n We anticipate earnings in the back half of the year to start to lap easier comps which should show stabilization and point out the potential FCF of the business.