CLW - Clearwater Paper: Buy The Shares For Capital Gains Bonds For 7% Yield

2023-07-14 10:30:00 ET

Summary

• Clearwater Paper will do very well this year as there is virtually no maintenance downtime planned.
• I expect a free cash flow of $6.50 per share based on a $250M EBITDA. Even if the EBITDA drops to $200M in 2024, the FCF/share should exceed $4.
• Clearwater doesn't pay a dividend. But its 2028 bonds are yielding 7% so an investor could consider a combination of both securities.

Introduction

Clearwater Paper ( CLW ) is a large producer of bleached paperboard ( 16% of the US production ) for printers and converters and white label tissue which is mainly sold to large retailers and discount stores under their own brands. The company is a leading producer of Solid Bleached Sulfate paperboard which is mainly used to produce folding cartons and liquid packaging. And according to the company, it accounts for 5% of the at-home tissue market in 2022 thanks to its mass production for no-name brands.

The company operates all over the country as it has plants on the East coast, West coast and in between, as you can see above.

Q1 was good, but the rest of the year should be fine as well thanks to the lack of maintenance activities

Clearwater Paper performed well in the first quarter of this year as it was able to push price hikes through while it was able to keep its operating expenses under control. As you can see below, the total revenue increased by $37M while the operating costs increased by just over $30M which meant the operating income increased by almost $7M which represents a YoY increase of in excess of 20%.

Meanwhile, the interest expenses decreased by $1M as the company continued to repay debt during 2021 and 2022. In FY 202 for instance, Clearwater repaid about $81M of its debt and as you can see below, the vast majority of the remaining debt consists of fixed rate bonds so the interest rate risk is pretty limited in the next few years.

Clearwater was able to reduce its net debt thanks to its strong cash flows. And although the reported operating cash flow in the first quarter of the year was negative, this was entirely caused by investments in the working capital as we saw the inventory levels building up while the company paid down a bunch of accounts payable.

This means that the negative $9.1M in operating cash flow was actually a positive $51.3M and even after deducting the $21.5M in capital expenditures, the underlying free cash flow was a healthy $30M or approximately $1.75 per share.

That’s an excellent result and even when we look at the full-year guidance, it’s still looking like Clearwater Paper will perform very well in 2023. The Q1 net income of just under $24M was generated on an adjusted EBITDA result of $65.7M . That EBITDA is expected to decrease in Q2 to $58-68M and I think it is now fair to expect a full-year EBITDA result of around $250M (I will revise this once the Q2 results are out and a Q3 guidance is provided by the company). We know the total depreciation expenses will be around $100M and the company will likely pay about $28M in interest expenses.

This should result in a pre-tax income of $122M and after applying an average tax rate of 26% (guidance: 25-26%), the net income for FY2023 would be $90M or $5.30 per share. The total capex will likely be $20-25M lower than the depreciation expenses which means the free cash flow per share could easily come in around $6.50 per share. Of course this entirely depends on actually generating $250M in EBITDA but even at a $230M EBITDA (which means the EBITDA will average $55M per quarter during Q2-4), the free cash flow result would still exceed $4/share.

The strong result this year will be generated by the lack of maintenance downtime. As you can see below, the EBITDA will likely be hit negatively by $30-35M in 2024 when Clearwater is scheduling in some maintenance downtime.

But even if the EBITDA drops to $200M in 2024, the free cash flow will still exceed $3/share. Meanwhile, the net debt should be reduced to just around $400M by the end of next year. This will reduce the debt ratio to around 1.6-2 times EBITDA and it will allow Clearwater to hoard some cash and perhaps repay the 2025 bond outright. Even if it only repays $100M and issues a new $175M bond with a 6.5% coupon, it would still save $3M per year in interest expenses.

Investment thesis

I have written put options on Clearwater Paper earlier this year but unfortunately they all expired or will expire out of the money (as the last one to expire is a P22.5 which expires next week). Given the relatively strong performance of the company in the first quarter of this year and the robust guidance for the rest of 2023, I think I will continue to write put options but I will likely have to increase the strike prices if I want to have any chance to actually end up with the stock.

A P25 for October for $0.40 would be a low risk possibility but I am also considering writing a put option with a strike price closer to the current share price. A P30 January 2024 would result in an option premium of $2.15 which would still result in an average purchase price of just under $28 per share. Meanwhile, I also like the 2028 bonds which currently offer a 7% yield to maturity and I think that’s a good return for a debt security.

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