BLRDY - Billerud: Adding More Writing New Options

2023-07-12 06:59:39 ET

Summary

• I remain bullish on Billerud stock despite a 10-20% decline since my last article, purchasing more shares and writing new options in the low 70s.
• I attribute the decline to rising input costs, softening demand, and cost inflation, but believe these issues are temporary and do not impact the company's long-term potential.
• Despite current challenges, Billerud's strengths include a 16% ROCE, low net debt to EBITDA ratio, and strong sales growth in its business segments.

Dear readers/followers,

If you recall my article on Billerud ( OTCPK:BLRDY ), you'll know that I am LONG this company with a firm "BUY" rating. I've both seen assigned options for my personal portfolio, as well as purchased shares in my commercial portfolio. As the company has declined about 10-20% since my last article and recent buys, I have written new options in the low 70's, as well as purchased more shares, expanding my stake to a target of 0.8% to 2% in total for each portfolio.

In this article, I mean to show you my continued positive stance on Billerud, why I don't see the decline as anything worrying, and why I believe in the outperformance in Billerud.

Let's get going - and let me show you my expectations for the company.

Billerud - A lot to like at this valuation

So, you know that I'm primarily a valuation-focused investor. This comes with the assumption not only of buying a company at a certain valuation but also of selling/rotating that company at another valuation. It means that every company I invest in comes with a "BUY" target at a certain price, but also a price when I'd be selling the stake - or parts of it.

I've invested in Billerud for years - selling at times, then buying again when it drops. My quick-and-dirty rule in the past was "BUY" <105 SEK and Sell >130-140 SEK, and it was honestly a workable model post-2015-2016. I love seeing the company dropping as low as we're seeing here, sometimes touching below 80 SEK/share.

Scandinavia in general is a geography you want to look at if you like timber/wood/fiber/paper/carton investments - we have a lot of them. Not just Billerud, but companies like UPM (UPMKY), Enso (SEOJF), Huhtamäki (HOYFF), and others. Many of these companies are already in my portfolio, and the addition of Billerud is to me, a very positive one.

Billerud's latest results is what we have to go by here as to why we're suddenly down around 20% since my last article.

There is some justification for this. The company's rising input costs, softening demands for certain sectors, and overall cost inflation and macro as well as the problematic Swedish FX, it's a mix of factors that does justify some discounting of the company's value here. In addition, there was an outbreak of blastomycosis at the Escanaba mill - a rare infection that aside from its human implications, also comes with an EBITDA impact of about 100-150M due to idling.

This is part of course for companies like Billerud - especially with an international asset and sales profile, so it again doesn't really cause me to impact the longer-term potential for the business.

The performance saw 55% net sales increase versus 1Q22, but 11% decline in EBITDA and a 32% decline in Pre-tax income with operating pre-CapEx CF going negative and a -40% EPS decline. This goes some way to explain that decline - except I tell you that at least part of this downcycle was able to be forecasted due to what we've seen in the past 8 months.

The sales increase was organic - and Billerud has managed some pricing positives, but most of the revenue results coming from volume/mix, meaning actual sold quantity going up quite significantly.

What this means, if this is recurring, is that once margins normalize, the company can turn this into a significant profit increase.

Cost inflation is currently the company's main problem. Raw materials and logistical costs are the primary culprits as to why the company's EBITDA on an adjusted basis is down - a 1.32B+ SEK impact which was well above the sub-100M profit enhancement program. The company also does not see this going away into 2Q23 - neither do I. And this goes to explain at least some of the negatives here, with forecast specifics such as these being very illustrative of the current situation.

The issue, which is far from unique to Billerud, is that in Europe, due to a number of factors, we're seeing record-high input costs - a mix of Fibre costs, chemical costs, energy costs (though these are falling), and logistical costs. The net profitability results for this mix can currently only give us one result - a YoY negative one. Once these start normalizing, or pricing reflects the new margins, then we'll see better results.

The underlying reasons for these unfavorable developments are numerous. Inflation, the Russian import stops, the energy price developments, the chemicals that are rising at the same time as caustic soda going down, and other things. Pricing outside of Europe, such as in the company's US market, is on the other hand stable.

Remember, the company has a variety of attractive overall areas, from papers/packaging to board - all in all two business segments, which both are showing impressive sales growth from almost all categories.

Volumes are soft because of customer destocking , not because demand is low, as well as expectations for a weaker market that may materialize. But the net reason for the lower valuation and decline in share price overall is to mind related to the profitability issues that the company is currently seeing. Frankly, Billerud cannot do much to address this. They're already doing what they can - things like hedging their energy prices, curtailing production where possible, and the like.

But do not mistake these troubles for Billerud being weak. Billerud is very strong. With a ROCE of 16% at current levels and a net debt to EBITDA of 0.7x, the company is at the lowest leverage in a very long time. The company is guiding at a reduced CapEx pace - just south of 3B SEK for the year, almost a billion which will go to the Frövi Boiler.

The company's current negative CF conversions are due to lower operating liabilities and a one-off tax payment - not anything fundamentally wrong with the business. The inventories being worked down is a matter of course for any basic materials company like this.

But do not forget the positives that are being slightly disguised here at this time. I'm talking about things like the company's 3-year profit and efficiency program being fully on track, including the 400M SEK EBITDA in 2023 alone, along with an initiative pipeline for the next few years. The company is transparent in its modest expectations for the 2023E period, including 2Q23.

But this does not take away from what I view as immense positives here, including a market-leading percentile 50%+ gross margin, and net margins at almost 10% for a company like this. I'll show you why I view this company as being as one of the more undervalued businesses in this segment, and why the recent decline only caused me to go deeper into the company as an investment.

Billerud Valuation - Plenty to like about this investment

Billerud is very much a well-working business in this area, split between Board and Paper products. Despite recent impacts, I foresee only minimal EPS disruption or downturns - and I am not alone here. In my last article, I gave the company a conservative long-term PT of 127.5 SEK. I'm not shifting this target as of the time of this article.

The company will see an EPS decline from its significant 2022A levels. Of this I have no doubt, and I have guided for this before. However, I believe inventory normalization and costs and inflation flattening out in 2024 and beyond will cause an EPS resurgence, with triple-digit EPS growth in 2024E YoY, followed by double digits in 2025E as the company's cost savings and capacity improvements come online. What is happening now is mere, to me, noise obfuscating the path to what I view as likely here - and that is a triple-digit RoR to a range of 15-18x P/E.

The company is already a high yielder, and Billerud has a fairly attractive overall dividend policy. I don't think they will massively cut next year - so that 5-7% here, that's fairly safe. But to me, the eventual upside is what's interesting here. Many analysts give the company a target not in the low 100s, but in the low 200s, based on a fundamental upside and growth - and as you can see, an 18x P/E premium which is historically accurate, implies a share price of nearly 190 SE/share for the company in the longer term.

Current analysts have lowered their estimates considerably, at least when we look at S&P Global. 7 analysts follow the company and give ranges from 120 down to 75 SEK/share. That's a far cry from about a year back, when the lowest PT was around 140 SEK, and the highest around 210 SEK. This shows the short-term oriented nature of most standard analysts, and why I don't put a lot of credence in their long-term reliability. My own targets have far more to do with longer-term trends. That is why I consider the average PT of 95 SEK/share too low by far.

GF Valuation trends mixing indicators like a tangible book projected FCF, sales, multiples, lynch valuations, and DCF implies a normalized share price of as high as 200 SEK. I consider this too high as well, not taking into account the near-term implications of inflation and the ongoing downturn.

Instead, I would most definitely "BUY" shares of the company here - but I would do so carefully and not over-allocating because we might see sub-80 SEK again. That is why my options are being written at strikes around 70-72.5 SEK/share, and why I'm very happy with my 89 SEK cost basis for my commercial account, and with dividends, I'm actually in the green.

This is a cyclical investment - and I believe that I know how this one is going to play out over time. I will make a very nice profit from it eventually - though it's impossible to say exactly when this profit will materialize. If pressed to guesstimate, based on current macro and global trends, I would say that in mid-2024 we'll see a fundamental turnaround here.

Holding the company until then, and well past this, does not give me the slightest amount of pause or concern.

Billerud is a rock-solid business despite the lack of a credit rating, its yield is one I consider safe, and I would "BUY" it at anything below 127.5 SEK for the long term. I could theoretically impair this to reflect the current downturn, but I believe doing so would not be fair to the company's longer-term potential.

Just know that patience is required. Aside from that, here is my thesis.

Thesis

• Billerud is a very solid packaging/forestry company with assets and sales in both NA and Europe. It's top-tier in terms of margins and profitability, and after its recent M&A, I believe it's in a position than ever before. At the right price, the combination of packaging resilience and dividend payouts makes Billerud an absolute "must-have" to me.
• My current PT comes to a conservative 10-12x P/E, which implies a 125-130 SEK share price - I go to 127.5/share.
• That makes the company a "BUY". I already own a large stake, but I'm buying more, and I'm not shifting my price target at this time. It's 127.5.

Remember, I'm all about : 1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.

2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.

3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.

4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.

Here are my criteria and how the company fulfills them ( italicized ).

• This company is overall qualitative.
• This company is fundamentally safe/conservative & well-run.
• This company pays a well-covered dividend.
• This company is currently cheap.
• This company has a realistic upside based on earnings growth or multiple expansion/reversion.

The company therefore fulfills every investment criteria I currently hold and I give it a "BUY" here.

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