CLW - Clearwater Paper: Improved Balance Sheet But Headwinds In Paperboard

2023-11-10 23:45:32 ET

Summary

• Clearwater Paper reported higher year over year adjusted EBITDA and adjusted net income per diluted share for Q3 2023.
• The company's Pulp and Paperboard business will face headwinds, given RISI reported an $80 per ton decrease in folding carton prices in the third quarter.
• Given its debt repayment efforts in the past few years, Clearwater Paper has reached a leverage ratio where debt repayment is less urgent.
• Management has not indicated they plan on increasing capital returns substantially with the more flexible free cash flow, however.
• Although the company's free cash flow yield in terms of EV is relatively attractive in a low interest rate world, the yield isn't super attractive given the current higher interest rate environment.

Clearwater Paper Corporation ( CLW ) is a premier private brand tissue manufacturer and a producer of paperboard products.

In terms of tissue products, Clearwater Paper makes bath tissue, facial tissue, paper towels, napkins and more. The company supplies private branded tissue to major retailers such as grocery, club, and discount stores.

In terms of paperboard products, the company makes foodservice cups, folding cartons, and more.

In 2022, Clearwater Paper's Consumer Products business, which mainly is comprised of tissue products, accounted for $950.2 million in sales, and the company's Pulp and Paperboard business accounted for $1.1363 billion in sales.

On October 30, Clearwater Paper reported third quarter earnings for 2023 that indicated less debt but future headwinds in the company's Pulp and Paperboard business.

Q3 2023

For Q3 2023 , Clearwater Paper had net sales of $520 million , down 3% year over year.

Adjusted EBITDA was $81 million, up $3 million from Q3 2022. Adjusted net income was $37 million, up $3 million from Q3 2022.

Adjusted net income per diluted share was $2.19 , up from $1.83 in Q3 of 2022. Adjusted EBTIDA margin was 15.5% versus 14.3% in the same quarter of last year.

While adjusted EBITDA and adjusted net income per diluted share rose, the company's Pulp and Paperboard business will face headwinds in the future.

As a result of softer demand, RISI has reported an $80 per ton decrease in folding carton prices in the third quarter, reflecting the first decrease in more than three years.

Management added ,

As a reminder approximately 35% to 40% of our volume is now indexed to RISI and it typically takes us up to two quarters for price changes under these agreements to be reflected in our financials. If we apply an $80 per ton decrease across all our tons, the annualized impact could be greater than $60 million. These decreases are being partially offset with lower input costs and improved operational performance. We remain optimistic about the long-term prospects for paperboard, but given economic uncertainties we foresee a gradual recovery starting next year. RISI is forecasting a 10.5% decrease in total SBS production this year versus 2022, followed by a 4.2% increase in 2024 and a 5.3% increase in 2025.

In terms of the headwind, management believes it will be a $4 million to $6 million headwind per quarter moving forward.

In terms of outlook, management expects $60 to $70 million in adjusted EBITDA for Q4 and $278 to $288 million in adjusted EBITDA for 2023.

For 2023, management also expects interest expense of $28 to $30 million excluding debt extinguishment costs. The company expects capex of $70 to $80 million for the year.

In terms of the balance sheet, management continues to want to reduce leverage to increase flexibility. The company has reduced net debt by $69 million from Q2 2023, and by $416 million since 2020.

In terms of capital returns, Clearwater Paper repurchased $5 million of stock in the quarter. Since 2022, the company has bought back $20 million in stock and it has $10 million remaining authorized under its stock repurchase program.

Valuation and Free Cash Flow

Clearwater Paper's forward PE ratio is relatively low given its forward PE ratio of 5.1x for 2023, and 7.57x for 2024 as of November 9. In terms of annual EPS, analysts estimate the company will earn $6.99 per share in 2023 and $4.71 in 2024.

While the forward PE ratio is low, the metric doesn't reflect the debt on the balance sheet.

I think free cash flow to enterprise value is a better valuation for the stock (in terms of its value) as free cash flow arguably better describes how much capital management could return to shareholders if they wanted to and enterprise value factors in net debt.

In terms of free cash flow, Clearwater Paper's free cash flow changes from quarter to quarter, sometimes substantially given capex and other spending. Year to date, the company generated $76 million in free cash flow and in 2022, the company had $116.8 million in free cash flow according to my calculations.

Taking the average of the last seven quarters, I calculate an average free cash flow of $110 million per year.

Assuming $110 million in free cash flow, and an enterprise value of $1.07 billion as of November 9, Clearwater Paper has a free cash flow yield (in terms of free cash flow/EV) of 10.3%.

As a result of the headwinds for the paperboard business given the weakness in folding carton prices, I don't really know if Clearwater Paper will increase its free cash flow much in the next few years, especially if there is an economic slowdown or recession next year. In my view, there is a higher likelihood of less free cash flow as a result of the headwind of $4-$6 million per quarter.

So while the company's free cash flow yield (in terms of free cash flow/EV) is pretty decent in a low interest rate environment, there might be better buys out there in a world where the 5 year U.S. Treasury bond yields 4.64% as of November 9.

Capital Allocation

In recent years, Clearwater Paper has focused on paying down debt with its free cash flow. As of September 30, 2023, the company has net debt of $458.3 million , down from $515.5 million at the end of 2022, and $617.2 million at the end of 2021.

Because management has focused on paying down debt in recent years, Clearwater Paper hasn't used much of its free cash flow to pay a dividend or buy back a lot of stock. The company doesn't pay a dividend and only bought back $20 million of stock since 2022.

Given the company's leverage ratio of September 2023 of 1.8x, I would say Clearwater Paper has reached a level where management could return more capital back to shareholders if they wanted to rather than paying down debt. While management has said they continue to want to pay down debt, they can pay down less debt going forward as it isn't as urgent. In terms of goals, the company has said it is targeting a net leverage ratio of around 2.5x through a cycle.

The company's debt maturities are also not in the next few years. In terms of scheduled debt, Clearwater Paper previously had $270 million maturing in 2025 and $275 million maturing in 2028. In October, however, management started the redemption of its 2025 notes and as a result, the company has pushed material debt maturities out to 2028.

If and when management begins using free cash flow to pay more capital returns, Clearwater Paper's valuation could improve if free cash flow is the same or improves.

Clearwater Paper's free cash flow to its market capitalization of $594.96 million is actually pretty attractive as assuming annual $110 million in free cash flow would give a free cash flow yield (in terms of market capitalization) of 18.5%. Assuming an annual free cash flow of $80 million, that's still 13.5%.

If management used all the free cash flow to buy back stock or pay a dividend and the company's free cash flow stayed the same, Clearwater Paper's stock would have upside.

I don't think management will meaningfully increase capital returns however, at least not in the next year.

According to Matthew McKellar and Paul Quinn of RBC, the analysts think management is in the early stages of broadening its product portfolio organically , which will likely use free cash flow. Management has also indicated they are open to increasing scale through M&A which again might use free cash flow to finance.

The company's free cash flow could also decrease more than expected if economic conditions worsen.

Given the economic uncertainty, the high interest rate environment, and the headwinds, I rate Clearwater Paper a 'Hold' currently.

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