GLT - Glatfelter: A Casualty Of The Ukrainian Conflict

2023-05-08 08:52:55 ET

Summary

• Shares of engineered materials manufacturer Glatfelter are down 80% since YE21 as the Russian conflict, as well as high input and energy costs, have taken a toll.
• The result of ill-timed acquisitions and poor operational performance is its net leverage ratio surging from 1.7 at YE20 to 7.4 at YE22, resulting in the renegotiation of debt covenants.
• With new management’s efficiency initiatives in process, a recent refinancing that pushed its earliest maturity out to 2026, the recent beneficial owner and insider buying merited a deeper dive.
• A full investment analysis follows in the paragraphs below.

"I'm a greater believer in luck, and I find the harder I work the more I have of it. "? Thomas Jefferson

Today, we take a deeper look at a small cap concern that has had its share of challenges over the past 12-18 months. The company has a dominant niche in some of its markets but has been greatly impacted by the conflict in Ukraine. Via some recent acquisitions. it is trying to execute a turnaround despite a high debt load. The company has seen some considerable beneficial owner and insider buying recently. A sign better times are ahead? A full analysis follows below.

Company Overview

Glatfelter Corporation ( GLT ) is a Charlotte, North Carolina based manufacturer of engineered materials - primarily from wood pulp and synthetic fibers - such as single-serve coffee filtration, tea bags, wallcover, specialty wipes, and absorbent hygiene products, amongst many others. These goods are produced out of 16 plants in seven countries. Glatfelter was formed in 1864 as a paper mill, went public in 1955, made two key acquisitions in 2021, and was compelled to initiate a turnaround strategy in 2H22. The stock trades around $3.50 a share and sports an approximate market cap of $155 million.

Operating Segments

The company views its operational performance through three segments: Airlaid Materials; Composite Fibers; and Spunlace.

Airlaid Materials consists of highly absorbent and engineered cellulose-based Airlaid nonwoven materials including hygiene products, specialty wipes, as well as tabletop, adult incontinence, and home care products, of which the largest input is fluff pulp, consisting of synthetic fibers, super absorbent polymers, and latex. This segment generated FY22 operating income of $54.8 million on net sales of $601.5 million versus operating income of $42.2 million on net sales of $470.3 million in FY21. Part of the improvement was the full-year contribution of Georgia-Pacific's U.S. nonwovens business, which Glatfelter acquired for $170.9 million in May 2021.

Composite Fibers comprises filtration material for coffee and tea products, composite laminates, gift wrap, and wallcover (a base material for wallpaper), amongst others. The largest inputs are wood pulp, synthetic fiber, as well as abaca pulp and fiber. This unit was responsible for FY22 operating income of $16.9 million on net sales of $523.9 million as compared to FY21 operating income of $37.4 million on revenue of $556.8 million. Year-over-year performance was negatively impacted by lower sales to Ukraine and Russia as well as high input and energy costs.

Spunlace consists of consumer wipes, health care, feminine hygiene, beauty care, and critical care products - with some overlap with the company's Airlaid segment - which are derived from synthetic fibers, pulp-based fibers, fluff pulp, and base paper. This division came into being with Glatfelter's purchase of Jacob Holm for an enterprise value of $304 million in October 2021. It accounted for an FY22 operating loss of $9.3 million on net sales of $365.9 million.

Other and unallocated comprised primarily of corporate overhead was negative $226.4 million in FY22 versus negative $49.7 million in FY21, hurt by goodwill and asset impairment charges of $190.6 million, the largest contributor being the recently acquired Jacob Holm segment.

Recent Share Price Performance and Turnaround Initiatives

The company enjoys dominant market-leading positions in feminine hygiene, table tops, baby wipes, wallcover, pasting paper for batteries, as well as tea and single-serve coffee filtration. In an attempt to improve its overall growth trajectory, Glatfelter exited its declining specialty paper business for $365 million in FY18 and used the proceeds to purchase Georgia Pacific's European nonwovens business for $175 million and start up a new facility in Fort Smith, Arkansas in an attempt to expand its Airlaid business.

Its stock essentially traded between $10 and $20 a share from the time it exited the specialty paper business through YE21, somewhat buttressed by pandemic-related demand for sanitary wipes. Its stock entered 2022 at $17.20 a share, yielding 3.3%. However, a loss of business from the Ukraine-Russia conflict - both countries were key end markets for its high-margin wallcover products - input price inflation that couldn't be completely passed on to its customer base, elevated energy prices, and supply chain issues hurt business across the board, but especially at its recently acquired Jacob Holm. This underperformance triggered a cash bleed at Glatfelter, which experienced an outflow of $79.5 million during 1H22. Already carrying a heavy debt burden from its two acquisitions in FY21, Glatfelter had to draw down more to operate. This action combined with its declining profitability (on an Adj. EBITDA basis) put the company tenuously close to violating the maximum net leverage ratio covenant - 4.8 on March 31, 2022 vs a 5.25 ceiling - on its $400 million credit facility and €220 million term loan, compelling it to amend its credit agreements in May 2022. The maximum net leverage covenant was increased to 6.75 though YE23, after which the ratio was to step down to 4.0. As a harbinger of this news, the [NOW] former CFO resigned in April 2022.

The $0.07 per share (non-GAAP) miss in 1Q22 (announced on May 3, 2022), along with the news of the amendment to its debt covenant framework sent shares of GLT below $10. Surprisingly, the company paid its regular $0.14 per share quarterly dividend on June 30, 2022 (declared May 5, 2022), as if to assure the market that its circumstances were transitory.

However, with net debt of $728.8 million to close out 1Q22 and only able to generate Adj. EBITDA of $23.0 million in the year's first stanza, it was becoming increasingly clearer to the market that Glatfelter's financial situation was more dire than management was outwardly projecting.

When the company reported 2Q22 earnings on August 2, 2022, its net leverage ratio had risen to 5.3 as TTM Adj. EBITDA fell $11.5 million. Unsurprisingly, the CEO was transitioned three weeks later, and as part of the new CEO's (Thomas Fahnemann) capital reprioritization program, Glatfelter's dividend was suspended on September 21st, freeing up $25 million. Short on details for the capital redeployment strategy, shares of GLT hit rock bottom ($2.08) on October 14, 2022.

With the release of the company's 3Q22 financial report on November 3, 2022, Fahnemann provided more granularity regarding Glatfelter's cost cutting initiatives and declared that the company's entire portfolio was under review, with the strong insinuation that certain businesses would be divested to reduce debt. The market responded with a two-day 35% rally to $3.67 a share.

4Q22 Earnings:

And its stock was trading above $4 a share when the company announced 4Q22 financials that included a loss of $0.16 a share and Adj. EBITDA of $22.3 million on net sales of $373.9 million versus a gain of $0.04 a share and Adj. EBITDA of $25.7 million on net sales of $334.5 million in 4Q21.

Management guided FY23 Adj. EBITDA to $115 million based on a range midpoint. It also announced that it had a commitment in place to pay down its €220 million term loan (due February 2024) but was short on details, except to say that FY23 interest expense would be ~$73 million. In total, FY23 free cash flow will likely be an outflow of $20 to $30 million after an outflow of $78.6 million in FY22.

1Q2023 Earnings:

Last week, the company posted its first quarter numbers . The company had a non-GAAP loss of 13 cents per share as sales fell one percent on a year-over-year basis to $378.2 million. Notably, operating cash flow improved $35.6 million compared to the same period a year ago. Leadership also reaffirmed its annual guidance of $110 million - $120 million in Adjusted EBITDA for 2023.

Balance Sheet & Analyst Commentary

With its net leverage ratio at 6.0 and short on refinancing details, the market initiated a selloff that sent shares of GLT below $3 during the second half of March 2023. In fact, with net debt of $734.4 million and TTM Adj. EBITDA of $98.8 million at YE22, Glatfelter's actual net leverage was 7.43, but debt covenants allow for certain (undisclosed) addbacks to bring the ratio into compliance at 6.0.

Then on March 30, 2023, the company announced the details of its refinancing, which replaced the €220 million term loan with a €250 million term loan due 2029; thus, pushing its earliest debt maturity out to FY26. Furthermore, it amended its revolving credit facility with a new covenant structure " that reflects the company's current operating environment and liquidity, " strongly suggesting that its net leverage ratio ceiling was lifted again, although specific details were absent at that time.

At the end of the quarter, Glatfelter had Cash and marketable securities of just under $90 million and net debt was $775.6 million compared with $734.4 million at the end of 2022. Management also stated that ' leverage as calculated in accordance with the financial covenants of our bank credit agreement was in compliance at 3.0 times as of March 31, 2023 .'

No Street analyst has recognized these developments. The only commentary since 2020 occurred when BMO Capital Markets' Mark Wilde reiterated an outperform and lowered his price target from $18 to $12 in May 2022, citing war-related sanctions on Russian for the move.

A more recent opinion was provided by beneficial owner Carlson Capital, who purchased 500,000 shares of GLT at an average price of $3.09 on March 29, 2023 - the day before the financing details were announced - bringing its ownership interest to 13%. This comes on the heels of purchases by the company's Chief Administrative Officer and a Senior VP in late February.

Verdict

On a non-GAAP basis, Glatfelter lost $0.44 a share and Adj. EBITDA of $98.8 million on revenue of $1.49 billion in FY22. Despite new management's initiatives to drive the company towards profitability, an Adj. EBITDA forecast of $115 million - if achieved - doesn't suggest profitability.

New management's efficiency initiatives will trim some fat but the growth prospects beyond that of GDP are challenging - Russia notwithstanding - as Glatfelter holds dominant market positions in many of its product lines, meaning that it isn't as likely to generate above average returns through market share gains. This is not an indictment of CEO Fahnemann, who seems very competent. It's just that he inherited such a mess, that it's going to take several quarters before signs emerge that the barge is turning around, save the sale of an unprofitable business line or manufacturing facility. As such, the recommendation is to take a wait-and-see approach and avoid the shares for now.

"Luck has a way of evaporating when you lean on it ."? Brandon Mull

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