MATV - Mativ: Favorable Risk/Reward Opportunity Post Merger

Summary

• Mativ is a high-quality business that is currently under-earning and expected to experience an inflection in EPS.
• Mativ's earnings potential is higher than the historical performance, despite the noise surrounding inflation and other short-term headwinds.
• Confusion around the company's recent merger provides a solid opportunity for investors.

Executive Summary

Shares of Mativ ( MATV ) are cheap and present a compelling investment opportunity. Mativ is a high-quality business that is currently under-earning and expected to experience an inflection in EPS growth with the synergies resulting from its recent merger. At 7x EPS, MATV stock offers strong upside with little downside risk.

Business Overview

MATV is a specialty materials business formed as a result of the merger of Schweitzer-Mauduit (SWM) and Neenah (NP). The companies completed their all-stock merger on July 7th, 2022.

The legacy Schweitzer-Mauduit business is a specialty materials company that produces paper, reconstituted tobacco, and other specialty products. The company was founded in 1995 as a spinoff from Kimberly-Clark and is based in Alpharetta, Georgia. SWM historically operated through three business segments: Advanced Materials & Structures, Engineered Papers, and Filtration. The company's products are used in a variety of industries, including tobacco, food and beverage, medical, and transportation.

The legacy Neenah business is also a specialty materials company that produces a wide range of products, including filtration media, specialty papers, and packaging products. The company was founded in 2004 as a spinoff from Kimberly-Clark and is also based in Alpharetta, Georgia. NP historically operated through two business segments: Technical Products and Fine Paper & Packaging. Its products are used in a variety of end markets, including filtration, industrial, and consumer applications. Neenah has been focused on expanding its product portfolio through strategic acquisitions and investments in technology and innovation.

The merger between Schweitzer-Mauduit and Neenah was motivated by the potential for significant cost synergies and the creation of a leading global specialty materials company. The two companies had complementary product lines and customer bases, which would allow for cross-selling opportunities and improved customer service. Additionally, the combination would create a more diversified business with increased scale and resources to pursue growth opportunities.

The pro forma financials of the combined company, now known as Mativ, show significant potential for value creation. The merger is expected to result in approximately $65 million in cost synergies in the first twelve months, primarily through supply chain and procurement efficiencies. Pro forma revenues are estimated to be roughly $2.7 billion, with pro forma EBITDA of $450 million.

The upcoming financial reports will combine four pro forma business lines into two segments.

1. Advanced Technical Materials ((ATM)) – 65% of Revenue, 55% of EBITDA (Source: Company Q3 presentation )
   • Advanced Materials & Structures, which accounts for approximately 38% of the segment’s revenue, offers highly-engineered resin-based products such as nets, films, adhesive tapes, foams, and non-wovens, and serves various end markets including healthcare, construction, industrial, transportation, and filtration. These products are primarily petrochemical and resin-based, with a focus on polypropylene derivatives.
   • Technical Products, which make up approximately 27% of the segment’s revenue, include a range of filtration and coated substrates utilized in end-markets such as water, transportation, personal care, medical, and consumer goods. These products are primarily derived from softwood pulp.

2. Fiber-Based Solutions ((FBS)) – 35% of Revenue, 45% of EBITDA (Source: Company Q3 presentation)

• Engineered Papers, approximately 20% of the segment’s revenue, specializes in tobacco-related papers that have a unique self-extinguishing feature for safety when not actively being smoked.
• Fine Papers & Packaging, which accounts for approximately 15% of the segment’s revenue, is a niche supplier of specialty or high-end printing paper serving the printing, packaging, and label end-markets. The segment offers a range of products, including premium printing papers, packaging and label papers, and laminates. These products are used in a variety of industries, including cosmetics, luxury goods, and pharmaceuticals. The legacy NP fine papers and packaging segment primarily produces softwood pulp-based derivatives.

The ATM business is the crown-jewel specialty materials business of MATV, where customers are offered a high-touch product based on quality and performance. Although the 14% margins of the ATM business may seem unremarkable, they are currently depressed due to cyclical pricing pressures, which are expected to improve. On the other hand, the FBS segment is lower quality, but generates strong free cash flow, a high profit margin with very little capital required for growth.

Achievable Pro Forma Targets

The investment opportunity presented by the combined business lies in understanding its true earnings potential, which is masked by the noise surrounding its historical performance.

Firstly, adjusted for the acquisitions done independently by both businesses before the merger, the combined business should already be doing around $400m of EBITDA. Therefore, with an additional $65 million of expected synergies, the business doesn't require any growth to reach the management's target of $450 million EBITDA.

Secondly, Over the past eighteen months, the two business segments have faced significant input cost inflation, particularly for resins, pulp, and energy. Management highlighted that these cost pressures led to a cost headwind of around $60 million in 2021, which has yet to recover. However, the good news is that all three input costs - resins, pulp, and energy - have recently seen prices start to roll over, indicating that these cost headwinds may transform into cost tailwinds as the lower prices flow through.

Overall, with the $65 million of cost synergies and the $60 million of cost headwinds that are likely to subside, management's EBITDA guidance appears highly attainable under the current circumstances.

Valuation

MATV is currently trading at 6.8x management’s $450mm EBITDA target, which, per the above analysis, appears achievable. As a base case, a sum of the parts analysis on this $450mm EBITDA, using 10x EBITDA on the ATS segment, and 6x on the FBS segment, yields a share price of $36.09 – roughly 45% higher than the current trading price.

ATS segment peers are typically valued in the range of 10-12x EBITDA, with higher-margin businesses like ATS at the higher end of that range. On the other hand, FBS segment peers are usually valued at 6-8 times EBITDA, reflecting the lower quality and cyclicality of this cash flow stream.

In a downside scenario, it is reasonable to assume that management falls short of its $450 million EBITDA target and is only able to achieve $400 million of EBITDA pro forma.

Applying a punitive 7.5x EBITDA to $400m yields us a price target of $23.36, ~9% lower than the current trading price.

In summary, the current market price of approximately $25 presents a favorable risk-reward opportunity with relatively low downside risk and considerable upside potential, even without overly optimistic assumptions about the company's future performance.

Risks

Investing in MATV is not without risk. The company's historical performance is muddied by the impact of input cost inflation and other operational challenges, making it difficult to evaluate. Additionally, the company operates in a highly competitive industry, and any downturn in demand for its products could impact its financial performance.

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