KLBAY - Klabin: Q3 Earnings Resilience In The Face Of Industry Challenges

2023-10-28 08:27:48 ET

Summary

• Klabin's Q3 results show resilience in the face of challenging sector conditions, particularly low pulp prices.
• The paper unit showed promising results with a recovery in packaging sales, while the pulp division had a weak performance.
• Despite weak net profit, Klabin's performance in its paper unit and substantial volume of pulp sales are positive highlights.
• The company is expected to continue distributing substantial dividends, with a potential yield of 5% to 6%.

The Brazilian pulp and paper giant Klabin ( KLBAY ) recently published its third-quarter results. Although these results were not outstanding, they indicate a positive sequential improvement.

As I highlighted in my initial article about the company, Klabin has recently faced challenges from declining pulp and paper prices, primarily attributed to reduced operating capacity. However, the company has made notable strides in its deleveraging efforts, improving operational efficiency and contributing to enhanced profitability and more substantial dividend payouts in the coming years.

Despite reporting a weak net profit, Klabin's third quarter showed promising results in its paper unit, with a recovery in packaging sales. Moreover, there are expectations of improved pulp prices in the future, although this business division had a weak performance in the current quarter.

The lack of more significant revenue growth for Klabin should not necessarily be viewed negatively. Given the challenging conditions in the sector, this stability is commendable. It's worth noting that other domestic peers, such as Suzano ( SUZ ), may face even more significant challenges due to their higher cyclical exposure to the pulp sector.

Therefore, I believe that, despite not reporting an outstanding quarter, Klabin has maintained stable numbers without a significant decline, which is a positive outcome. Furthermore, the company remains well-positioned to continue distributing substantial dividends over the coming years.

Klabin’s Q3 Results

Klabin released its third-quarter figures, reporting an EBITDA of R$1.352 billion. This represents a modest quarterly increase of 0.6% but a year-over-year decline of 41%. Adverse exchange rate variations impacted the financial results as the reduction in biological assets resulted in a net profit of R$258 million, marking a quarterly drop of 73.4% and an annual drop of 87.4%.

On the other hand, the company's revenues showed marginal growth, reported at R$4.4 billion, a 2.5% increase quarter-over-quarter, although still 19.8% below the same period last year.

The positive surprise came from the pulp business, where increased volumes (up 27.4% compared to the previous quarter) and lower costs (down 3.6% compared to the last quarter) were observed.

An additional significant point to note is the increase in net debt, which rose to R$20.9 billion, compared to R$19.5 billion in the second quarter of 2023. This led to a higher leverage ratio of 3.2 times the net debt/EBITDA, compared to 2.6 times in the second quarter of 2023. This represents a reversal of the company's recent deleveraging efforts following the completion of the Puma II project. However, it's worth noting that the Puma II project is expected to enhance the company's profitability over the next few years.

Klabin's consolidated return, measured by the return on invested capital ((ROIC)) metric, was 13.8% in June 2023, marking a 5.5 percentage point decline compared to last year. Klabin attributes this retraction to the reduced operating cash flow and the capital increase employed.

Breaking down the company's results by segment, here are the following key highlights:

Pulp:

Pulp volumes saw a strong performance, with a reported volume of 425k. Sales of Short Fiber reached 315kt, marking a 29.0% increase quarter-on-quarter and a 6.6% rise year-on-year. Long Fiber + Fluff also reached 111kt, recording a further 23% increase quarter-on-quarter but a slight 4.2% decline year-on-year.

According to the company, the increase in volume was mainly attributed to improved demand in Asia and greater efficiency at the Puma I unit following scheduled maintenance stoppages.

Paper and Packaging:

Despite the weak dynamics in Kraftliner, the third-quarter volume reached 102kt, reflecting a 4.4% increase in the quarter but a substantial 27.7% year-on-year decline. This suggests a short-term sequential improvement, primarily driven by the ramp-up of MP28. MP28 is commencing containerboard production, with plans for a small conversion of cardboard boxes soon.

However, in the face of a more challenging international environment, the price situation for Kraftliner is expected to remain relatively weak. The increase in US exports disrupts the international supply and demand balance, resulting in realized product prices of R$3,400/t. This represents a quarter-over-quarter decrease of 14.8% and a year-on-year decline of 35.2%.

Paperboard experienced a lower volume primarily due to the 11-day scheduled maintenance stoppage at Monte Alegre. However, this decline was partially offset by the commencement of the MP28 ramp-up, resulting in a sales volume of 165kt. This reflects a modest drop of 2.5% in the quarter and a decrease of 9.2% over the year.

Corrugated boards, on the other hand, entered a more favorable seasonal period but still faced challenges in passing on price increases. There was an uptick in volume in the year's second half in preparation for the holiday season. Corrugated sales reached 226kt, marking a 4.6% quarterly increase. Given the frequent corrections in prices due to inflation and Brazilian GDP growth, corrugated paper prices retracted to R$5,850/t. This represents a 1.1% decrease quarter-on-quarter and a 1.8% increase year-over-year.

Outlook for the Upcoming Quarters

I remain skeptical that the third quarter marked a turning point for Klabin, indicating a return to significant operational growth.

While the overall results in 3Q23 were not as dire as they could have been, I anticipate that Q4 could still present challenges, particularly for the paper and packaging division. However, there are prospects for improvement in the pulp segment. Additionally, higher pulp prices in China offset ongoing cost inflation and the marginal recovery of pulp and kraftliner prices in Europe. Hence, the potential for a full-scale recovery seems limited due to the persistent oversupply resulting from recent capacity expansions in pulp, kraftliner, and paperboard.

Although pulp prices have shown some recent recovery, with two price increases implemented for the Chinese market, the current price level is likely unsustainable. I do not foresee a sustained upward trend in the commodity's price. It's worth noting that if selling prices increase, the company can maintain or even enhance its profit margins, benefiting shareholders.

Klabin Remains an Attractive Dividend Stock

Klabin has announced the approval of the distribution of interest on shareholders' equity (JCP) in the total amount of R$319 million to shareholders, equivalent to $0.11 per share.

This practice, specific to the Brazilian tax system and corporate finance, involves companies paying interest to their shareholders on the equity invested in the company. It has distinct tax implications in Brazil. Unlike dividends, JCP is accounted for as an "expense" for companies, reducing taxable net income.

Considering that one analyst estimates Klabin's EPS for 2023 at $1.66, this represents a 56% increase. To achieve this, the company must report a net profit of $1,316.4 million in 2023, which I believe is still feasible. Therefore, considering Klabin's expected payout for 2023 of 54.1%, this would result in a dividend per share of $0.13. Since the company pays quarterly dividends, Klabin's dividend yield would be approximately 5.8%, with an annual payout of $0.52.

Assuming a more conservative return on investment ((ROI)) of 5%, with Klabin's current share price at $8.90, this would indicate a fair value of $13.60, representing an upside of 52.8% in my assessment. This is close to the levels seen in 2021 and early 2022, during a solid upside in the kraft pulp cycle.

Conclusion

While some investors may find Klabin's quarter uneventful and lacking revenue and profit growth surprises, I view it differently. Given the persistently challenging sector conditions characterized by low pulp prices, the results were not disappointing and can be considered positive.

The key highlights include the paper and packaging volume growth despite scheduled paperboard maintenance. Additionally, the substantial volume of pulp sales is noteworthy, driven by operational improvements following the stoppage at Puma I in the previous quarter.

However, there are less favorable aspects to consider. Kraftliner continues to face pricing challenges due to international factors. EBITDA did not exhibit significant quarterly growth, with paper sales declining while pulp sales increased. Furthermore, the bottom line was weak, partly due to unfavorable exchange rate fluctuations impacting the financial result.

Nevertheless, the company is expected to continue distributing substantial dividends in the upcoming quarters, and we will likely see a yield of between 5% and 6%. Considering the current valuation is heavily discounted, I reaffirm my bullish outlook on Klabin following the Q3 earnings release.

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