CLW - Clearwater Paper: Moving To The Sidelines

2023-12-30 00:34:51 ET

Summary

• Clearwater Paper's target price and rating have been lowered due to a lack of catalyst.
• We see the company between a rock and a hard place with limited growth optionality vs. CAPEX maintenance.
• Lower multiple due to smaller size and historical operational issues. We reset Clearwater's expectations with a neutral rating.

Here at the Lab, one year after our last publication , we are back to comment on Clearwater Paper Corporation ( CLW ). As a reminder, the company manufactures consumer tissue, napkins, away-from-home tissue, and pulp across the United States. Clearwater is a major private-label supplier to wholesalers, retailers, and distributors. Our supportive buy rating was backed by a resilient demand through periods of economic slowdown and an acceleration toward non-label products in an inflationary momentum. Our internal team was also confident in the closure of smaller producers with the possibility of the company gaining market share penetration and additional pricing power. Unfortunately, this evolution has no visibility, so we believe Clearwater Paper's economics may continue to lag in the short-term horizon. Therefore, we are lowering our target price and rating from a Buy to a Neutral status. Here at the lab, we are still confident that the company is well-positioned thanks to a better demand-supply in the USA tissue sector and lower pulp prices. In addition, we see the paperboard demand to normalize in the near term. Despite that, we believe there are better opportunities within the sector while waiting for Clearwater to make strategic changes. We do have a long-standing buy on International Paper and we recently started to cover Smurfit Kappa (again with an overweight), which entered the US market with the WestRock acquisition (previously covered by our team).

Looking back to the Q3 results, the company delivered an adj. EBITDA of $80.6 million versus a consensus average of approximately $74 million, confirming the previous management outlook between $73 and $83 million. At the divisional level, Pulp and Paperboard were below our forecast, while the Consumer Products segment confirmed its positive trajectory. In numbers, Pulp and Paperboard volume slightly disappointed with lower shipments and weaker average prices. Looking ahead, these are our key points:

1. The Q4 2023 EBITDA outlook is set between $60 and 70 million and is aligned with our year-end forecast results. For 2023, we are now projecting an adjusted EBITDA of $285 million. Cypress Bend maintenance and lower carton price activities will negatively impact the performance in the quarter. Looking at Fig 1, we can see how the management is projecting a $5/7 million impact on the EBITDA bridge in Q4. Despite that, Clearwater Paper Corporation forecasts significant maintenance for 2024. In numbers, the company's adjusted EBITDA will be impacted by $30/35 million (Fig 1). This is one of the reasons why we have revised our 2024 EBITDA estimates from $260 million to $235 million;
2. An additional concern is our pessimistic view of the price-cost relationship between tissue and paperboard. The company depends on external sources of fiber. If we are looking at the 2022 figures, Clearwater sourced approximately 30% of its pulp requirements externally. In addition, lower freight costs and a solid paperboard price coupled with a strong US dollar might attract EU competition;
3. On a positive note, the company is advancing on strategic optionality. Clearwater Paper might expand its product portfolio and has also announced an openness toward inorganic acquisitions. Given the limited FCF possibility, we believe there is limited maneuver on the M&A front, given the company's debt and related CAPEX investments. The company recently refinanced its 2025 notes, and following this successful operation, the S&P rating agency raised the company's outlook to Positive;
4. Looking at the comps, in late October, Billerud announced its decision to postpone the Escanaba paper mill to an integrated paperboard production facility. The company might already have a 1.1 million tonnes paperboard capacity in 2025 with the possibility of a facility expansion. We see this postponement as a short-term upside of Clearwater Paper's production optionality; however, as suggested in December 2021, the company may (again) become a takeover target for Billerud.

Source: Clearwater Paper Corporation Q3 results presentation - Fig 1

Fig 2

Conclusion and Valuation

Rolling forward our 2024 estimates and considering maintenance CAPEX, we arrive at an adjusted EBITDA of $235 million. Compared to our last publication, we decided to value the company with a lower EV/EBITDA multiple from 5.5x to 5x. Here at the Lab, we believe the company should trade at a discount versus North American paper companies. This is based on smaller size and historical operational issues. Therefore, applying the new multiple, we arrived at an enterprise value of $1.17 billion, including the net debt development (Fig 2); Clearwater Paper's equity value is $623 million. Therefore, our target price moved from $43 to $39 per share, with an equal weight valuation on the forward 12-month estimates. Aside from the usual sector risks, such as higher pulp price, energy costs, transportation, and wage inflation, we should also report that in 2022, 48% of Clearwater’s turnover was generated by ten customers. This poses a severe risk in case of business loss.

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