SUZ - Suzano: Pressure Starts On Pulp But Pivot Could Be Coming

Summary

• As of the last quarter, pulp prices had continued to rise, and a superb result emerged with EBITDA meaningfully up.
• Pulp prices since then have started to decline slightly for the first time in a long time, and we should see a small reversal in Suzano fortunes.
• Over the next couple of years declines should be slow, since we think sharp short-term drops will be less likely given stronger macro indicators.
• Capacity is coming into the industry which will pressure prices, but the multiple assumes that and more.
• The capital allocation policies look great with buybacks and a new dividend, and the future dividend could be huge. The main risk is political.

Suzano ( SUZ ) is a company that we've followed and owned at points for a long time, and is our way of keeping track of happenings in the pulp markets. The situation now is that pulp had continued to inflate until in September prices started to turn on macro fears. In the longer term they will continue to decline as capacity is entering the market, including more of Suzano's own with Cerrado. The multiple more than accounts for the longer term price declines, and probably prices in shorter term price declines that are becoming increasingly unlikely according to our macro view. Suzano is actually looking quite appetizing right now, and we have quite a lot of expectations for their new dividend which is sustainable at the 5% level even with the Cerrado CAPEX which ends in H2 2024. While the fundamentals look great, the risks are political in nature.

Q3 Breakdown

The Q3 was driven by price action more than volumes. Despite many industries seeing peaking pricing in Q3, especially basic materials, pulp continued to see growth, in fact it grew sharply in price.

EBITDA grew, and margins even expanded despite cost pressures with cash costs rising further.

The chief driver of cash costs remains chemicals and other intermediate inputs that go into pulp, whereas energy is a nonfactor. On top of that, wood prices have been inflating as well at 20%, less than the 24% average.

The Cerrado project is a major initiative for the company that we've covered at length. Is it is a CAPEX sink, accounting for 50% of the company's run-rate CAPEX, and is about a third finished. It will expand the company's capacity by about 20%, and mirrors moves being done by other pulp producers as well since the goods boom in late 2020 and 2021. Capacity increases like these are driving the longer term, downward forecasts in price - however the additional volumes will sustain their current massive cash flows in the longer term. Cash flows from operations exceed this CAPEX by a little less than 2x, with the margin being usable for the dividend it's sustainable at the 5-6% level given recent prices.

Bottom Line

The company's capital allocation policy is really changing a lot at this moment. For a long time it was a deleveraging story. Leverage started coming down fast enough, and despite new CAPEX projects happening at the same time, Suzano is beginning to pay a dividend, which should amount to about 5-6% in yield on a free cash flow coverage basis. The company has already bought back 4% of its float since March, and is going to keep buying back about 3% more over the next 18 months until it's over and they consider another project. When the Cerrado project is done, the dividend could more than double.

Pulp prices are lower however , and investors should be aware of this.

While the last quarter included a sharp and unexpected price increase, it is coming down off those highs but slowly. This could continue as recession fears mount. However, we think the market is in for a positive surprise over the coming months as rate hikes are nearing their end in our opinion. Inflation expectations are sinking as is inflation, and there won't be much more reason for the Fed to keep hiking rates. We don't agree with downgrading the pulp industry and already have long expected capacity additions.

Suzano trades at a miniscule multiple, 3x for the 2022 forecasts, which implies disaster in pulp markets which have repeatedly defied expectations. Goods demand is still rather strong, and since we don't think a harsh recession is coming, we think the market has got it wrong here. Regardless, a 3x multiple is a bankruptcy multiple almost, and the price is languishing with the valuation, having cycled back down close to lows of this year.

While longer term pressure on prices are coming for pulp, the Cerrado project is highly advantageous from a cost perspective due to its proximity to the rainforest, and should be able to keep Suzano earnings pretty solid thanks to volume compensation over the next couple of years.

Investors should be aware that there may be some political risks with the left leaning Lula. This should not be undervalued, since no questions were asked about the Amazon while Bolsonaro ruled and Lula has made some vows to correct things here. This may be the market's reason for the current, very low multiple. This could also change the cost profile and even volume potential despite Cerrado investments, and should be viewed as a risk for Suzano.

Nonetheless, investors should regard Suzano with interests, although geopolitical risks should be respected.

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