Description

 I recommend a long position in YoungPoong Paper Manufacturing Co., Ltd. (hereinafter "YPP").  YPP is a misunderstood and underfollowed gem.  The stock has not recovered since last year's sell-off by one of Korea's major mutual funds, an event largely irrelevant to YPP's business model and valuation.  As such, the current market neglect and the Company's solid market position present a very compelling opportunity.

THESIS SUMMARY

• - Strong market leader (~40% market share) with solid business model intact and excelling in trough year
• - Near-monopoly company producing steadily high margins in a traditionally low-margin and volatile industry
• - Major institutional sell-off creates extremely low valuation (EBITDA-capex 0.9x ~ 2.2x)
• - All bad assets write-downs (cause of sell-off) completed
• - Market bias still recovering from 47% decline sell-off a year ago
• - Founder ousts son and returns as CEO to instill discipline
• - Earnings already back to "normal" level

VALUATION (Units: shares, KRW mil)

BRIEF PAPER INDUSTRY OVERVIEW

Paper industry is a prototypical capital-intensive industry that requires much upfront fixed asset investments with high electricity and fuel costs to operate the manufacturing facilities.  On a macro scale, the industry cyclical highly correlates with that of the GDP.  Due to the high shipping costs, the paper industry in Korea is primarily domestically oriented.  Until 1997, over-investment of Korean pulp and paper manufacturing facilities caused a glut within the domestic market - coupled with the Asian financial crisis - forcing many small manufacturers to close or become consolidated.  All but one (Donghae Pulp) pre-existing pulp makers liquidated.  Donghae Pulp went into Chapter 11 from 1998 until it was bought out by Moorim Paper in 2008.  It renamed itself as Moorim P&P (Listed: 009580), operating as the only pulp supplier in the Korean domestic market (20% market share).  As a result, Korean paper makers' cost structures widely fluctuate in accordance with the volatile international pulp market price, making the industry seemingly unattractive.

COMPANY OVERVIEW

Founded in July 18, 1970, YPP is a Korea-based company manufacturing paper cardboard products. The Company makes two types of products: 1) paper cores, which are used for films, cotton yarns, fiber drums and papers, and 2) liner boards, which are used for ribbed cardboards and laminating papers.

YPP BUSINESS MODEL

As mentioned above, YPP produces two main products, 1) paper cores and 2) liner boards.  YPP commands a dominant market leadership in niche paper core market while remaining as a minor player in the liner board market.

• 1) Paper Core

A paper core is the solid paper/wooden middle part around which steel, paper, or fabric supplies are wrapped and shipped to their respective uses.  The paper core market is a stable and small niche industry within the turbulent paper industry.  While other paper product types (e.g. printing paper) requires large proportions of pulp for its raw input material, core paper uses less than 10% of the total raw input from pulp.  This advantage safeguards YPP from the unpredictable and volatile production cost fluctuation that hurts other Korean paper manufacturers.  Within the paper core market YPP commands ~40% of total industry revenue of KRW 137 billion (FY2008).  From 2000 to 2008, YPP was the market leader in the Korean paper core industry with 30~41% of total market share.  Unlike those of printing paper and other cardboard paper sectors, the industry landscape of the paper core sector allows YPP to enjoy its stable leadership largely because of:

a) the paper core's small industry size relative to the entire paper industry (average one-seventh of liner board market revenue from 2000 to 2009)

b) scattered revenue sources, where an average buyer of core paper accounts for only KRW 500 million per year

c) most of the buyers retain long-term (10+ years) relationships with their respective paper core suppliers

d) paper core industry in general proves to be a capital-intensive industry, deterring any newcomer from entering the market

From 2003 to 2008, the Company's domestic paper core business grew at an average of 5.6% vs. the market's 0.3% growth.  Moreover, during the 2008 economic crisis the Company grew its market share of the paper core business by 29% vs. the market's 13% growth, increasing its market share from 34.05% to 38.85%.

• 2) Liner Board

YPP is one of the remaining minor players in the oligopolistic liner board market.  The Company has held an average of 4% market share throughout the last ten years.

YPP vs. Domestic Market for 1) Paper Core and 2) Liner Board

<Reasons for precipitous stock decline in February ~ March 2009>

 From February 6, 2009 to March 13, 2009 the stock price tumbled precipitously due to a massive sell-off by one of Korea's major mutual funds, Korea Investment Value Asset Management (K-VALUE).  K-VALUE, proclaimed to be Korea's utmost value-bent mutual fund, have not been able to escape the institutional imperative of short-term NAV fluctuations. 

The reason for the sell-off was due to the unforeseen major earnings revision announcement by YPP.  During the leadership of Lee Taek-Sub ("the son") as CEO from Sep. 2002 ~ Mar. 2009, YPP invested its excess free cash into various overseas assets including Washington Mutual 7.25% perpetuities, Bank Tulanalem 8.5%/15s, Glencore 8%/perp, Kazkommerts Bank, etc.  The invested assets more than halved in value between December 2007 and December 2008.  The founder and former CEO Lee Moo-Jin ("the founder") kicked his son out of the CEO post and returned as CEO as of March 2009.  In the process, YPP conservatively wrote down all of the bad debt/asset losses at the end of FY2008.  No outside investor or K-VALUE had foreseen this event even in 2008 3Q.  As such, K-VALUE and other investors sold off the share in a one-month time horizon driving the price down from KRW 24,150 to KRW 12,750 (47.2% decline).  Currently, the Company has fully written down the losses and now currently only holds Glencore KRW 4 bil (market price).  After much infighting with his father, the son exited his 2.7% position in the open market in August 2009.

With the dominant business model intact and free of all bad asset write-downs, the stock price has not recovered since March, 2009.

RISKS

• 1. Unstable cost structure of Korean paper manufacturers
  • A. As a near-monopoly paper core supplier in Korea, YPP operates in a totally different business than its peer paper makers. As mentioned above, other paper manufacturers' cost fluctuation comes from the volatile international pulp market. However, YPP's paper core uses less than 10% of its raw material from pulp and therefore retains a steady cost structure (See Gross Profit Margin shown in the "Valuations" section).
• 2. Commodity business lowering the barrier to entry
  • A. Due to the capital intensive nature of the paper business, much upfront fixed asset investments with low margin in a steady and dull industry deters any newcomer.
  • B. As a result, only established family-controlled paper makers remain in business forming an oligopoly
• 3. Low return on invested capital business
  • A. The recent consolidation in the old paper families controlling large chunks of the market has put an upward pressure to consumer prices.
  • B. In the case of YPP, its average ROIC between 2003~2009 was 16%, the worst year being 7% in 2008 (See below "Valuations" section).
• 4. Further indiscriminate cash investments
  • A. The main culprit of the indiscriminate cash investments, the son, has been completely ousted from the Company by his father, who returned as Chairman and CEO.

MAJOR HOLDINGS (as of September 30, 2009)

Lee Moo-Jin (founder, Chairman, and CEO)                                      51.28%

YPP Treasury                                                                                 16.83%

Jin Heung Mutual Savings Bank (Value player in Korean market)          13.99%

VALUATION RECAP (Units: shares, KRW mil)

Catalyst

 1. Management Change (founder ousts son and returns as CEO)

• A. Completion of bad asset write-down and extremely clean balance sheet
• B. Focus on core business (paper cores)
• C. Shun from shoddy cash investment practices

2. Sell-off resulting in extremely low valuation

3. Increase in revenue and market share throughout worst year

4. FY2009 bounced back to "normal" levels.