SUMXF - Supremex: Solid 2022 Results And The Dividend Yield Could Reach Double Digits

Summary

• High paper product prices led to record financial results in 2022 and the company is trading at just 3.3x EV/EBITDA.
• Supremex has a history of returning value to shareholders, and dividends and share repurchases for the past 5 years were $20.5 million.
• In my view, the dividend yield could surpass 10% in the near future if paper product prices remain high and there are no further acquisitions this year.
• I think the company should be valued at above 6x EV/EBITDA.

Introduction

I've been looking for value stock investment opportunities in Canada and one of the names that have popped on my radar is Supremex (SUMXF) (SXP:CA). The company has been growing rapidly over the past few years and I think that its 2022 results looked strong. Revenues grew by just over 20% and are expected to continue to grow rapidly this year as the current run rate is about C$350 million ($257.4 million). The dividend yield is somewhat low at 1.75% but I expect it to increase significantly in the near future as Supremex is trading at below 6x P/E. Let's review.

Overview of the business and financials

Supremex was established in 1972 and is currently the largest envelope producer in Canada. It manufactures stock, custom, high efficiency, peal and seal, window, integrated, and photo packaging envelopes. This division accounts for about two-thirds of revenues. The company also has a packaging business focused on products for e-commerce fulfillment, labels as well as folding carton products for the consumer packaged goods, pharmaceutical, and food sectors. The management estimates that Supremex is the leading independent folding carton provider in the province of Quebec. The company has about 6,000 customers and a network of 17 manufacturing plants and 2 distribution centers. Most of them are located near the border with the USA.

If you're thinking "we're in the digital age, barely anyone sends letters in envelopes these days", you'd be on the right track. The transaction mail volume in Canada and the first-class mail volume in the USA have been declining rapidly over the past few years. It's a dying business but the revenues and EBITDA of the envelope business of Supremex have been growing rapidly over the past years. Back in 2018, the adjusted EBITDA of this segment was C$20 million ($15.5 million) and it soared to C$49.9 million ($38.4 million) in 2022.

This significant improvement in the financial results of the envelope segment was achieved mainly through acquisitions - Royal Envelope (Canada) in February 2020, Niagara Envelope ((USA)) in February 2022, and Royal Envelope ((USA)) in November 2022. In 2022, the two new US subsidiaries had combined revenues of C$57.1 million ($43.9 million) and contributed sales of C$12.5 million ($9.6 million) to Supremex since the acquisition dates. The company has been growing inorganically over the past few years and its leading market position is enabling it to achieve economies of scale. However, it's worth noting that a large part of the revenue growth for 2022 can be attributed to high paper product prices as rising energy costs led to the closure of a significant number of paper mills, especially in Europe. In Q4 2022, the average selling price for the envelope business of Supremex was 48.8% higher than a year earlier. If paper product prices go back to 2021 levels, I think that the annual EBITDA of the envelope segment could drop to C$32 million ($23.5 million) to C$35 million ($25.7 million).

Turning our attention to the packaging segment, we can see that revenues have been growing steadily over the past years. Surprisingly, the financial results of this segment don't seem to have benefited from higher paper product prices in 2022 as its revenues inched up by 4.2% to C$72.1 million ($55.4 million) while EBITDA rose by 11.5% to C$15.2 million ($11.2 million). I expect this business to continue growing steadily over the coming years considering that the rapidly growing e-commerce and specialty products segment accounted for 50% of revenues in 2022.

In addition, Supremex announced in January that it acquired Canadian paper-based packaging, print, and point-of-sale products provider Impression Paragraph for C$26.6 million ($19.6 million) on a cash-free and debt-free basis. The latter had revenues of $38.6 million ($28.4 million) for the year ended October 2022.

Turning our attention to the balance sheet, I think that the situation looks good as shareholders' equity was C$124.3 million ($91.4 million) while net debt stood at C$52.5 million ($38.6 million) as of December. The net gearing ratio was 0.44x. Still, keep in mind that Supremex paid $19.6 million for Impression Paragraph in January.

What I really like about this compounder besides the revenue and EBITDA growth is the free cash flow, which has remained above C$20 million ($14.7 million) per year since 2020.

Following the spending of acquisitions, the company has a history of returning value to shareholders, and dividends and share repurchases for the past 5 years stand at C$27.9 million ($20.5 million). Supremex reinstated its quarterly dividend in Q1 2022, and it currently stands at C$0.035 ($0.026) per share. In my view, the dividend yield could surpass 10% in the near future if paper product prices remain high and there are no further acquisitions this year. This situation would not be unprecedented as the dividend yield was above this level in 2018 and 2019. Note that the 2023 dividend payment figures are on an annualized basis.

Turning our attention to the valuation, Supremex has an enterprise value of C$215.4 million ($158.4 million) as of the time of writing and is trading at an EV/EBITDA ratio of just 3.3x. However, 2022 could be viewed as an exceptional year due to high paper product prices. If we assume that annual EBITDA declines to C$47 million ($34.6 million) to C$50 million ($36.8 million) as paper product prices normalize, the EV/EBITDA multiple is 4.4x at the midpoint of the range. In my view, Supremex has a stable business with solid cash flow and should be trading at above 6x EV/EBITDA. This translates into C$9.18 ($6.75) per share, which represents a nice upside potential of 46.4%.

Looking at the risks for the bull case, I think the major one is the macroeconomic situation in the USA and Canada as a prolonged recession is likely to affect demand for the products of Supremex. On February 27, CBS reported that a total of 58% of economists that responded to a survey by the National Association for Business Economics expect a recession in 2023.

Investor takeaway

Supremex is operating in a shrinking market, but its leading position has allowed it to remain profitable over the years. High paper price products led to record financial results in 2022 and the company used the high profits to make several acquisitions which should boost EBITDA in the near future.

The balance sheet looks strong and Supremex has a strong free cash flow which leads me to think that dividend payments and share buybacks could be increased in the coming months. However, keep in mind that the EBITDA of the envelope segment is likely to shrink soon as paper product prices come down.

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