SUZ - Suzano Q3: Tough But Weathering The Storm

2023-11-01 16:39:01 ET

Summary

• Suzano faced challenges in Q3, including declining revenues and margins due to plummeting pulp prices in a challenging commodity market.
• Despite the challenges, Suzano managed to adjust prices and make investments for product diversification, positioning itself for future growth.
• Expectations of a recovery in realized pulp prices, driven by increased Chinese demand, and a discounted valuation compared to peers make Suzano an attractive investment opportunity.

Suzano S.A. ( SUZ ) is one of the world's largest pulp companies and, like other players in the sector, it has been facing a challenging commodity cycle, resulting in plummeting prices. Kraft pulp prices have been slowly recovering from a significant decline since the end of last year, leading to a decrease in Suzano's revenues and margins, which has put pressure on its profitability.

The company's third-quarter report at the end of October reiterated this challenging scenario. Pulp prices declined sharply, prompting a temporary halt in part of the production capacity to improve future price dynamics. In this context, Suzano's ability to adjust prices to continue its investment plan and expand its operations becomes crucial. This was demonstrated in the quarter's results, which, while still poor, remained within a normal range in a challenging commodity market.

As I mentioned in my previous article on Suzano, my bullish thesis on the company was centered around its attractive valuation compared to its peers during a bearish commodity cycle. The potential for improvement in the company's bottom line in the coming quarters is driven by potential enhancements in China's long-term price curve, which has become more evident in recent months.

Therefore, even though Suzano is trading at a more discounted valuation multiple compared to its peers and has reported a challenging quarter, the company remains well-positioned to carry out its investments to diversify its products with lower production costs.

Suzano's Q3 earnings

Suzano's third quarter was characterized by a significant shift from a net profit of R$5.448 billion in the same period last year to a net loss of R$729 million. Net revenue amounted to R$8.948 billion, marking a year-over-year decline of 37%. Despite a slightly retraced sequential quarterly decrease of 2.3%, the annual reduction of 36.7% remained more significant.

According to the company, the variation in the topline results can largely be attributed to the decline in the operating result, leading to a drop in net revenue and a negative deviation in the financial result. The exchange rate depreciation on debt and derivative operations impacted this financial result. Suzano notes that these effects were partially mitigated, primarily by deferred income tax credits and the social contribution, a tax imposed on the net profit of Brazilian companies. These mitigations were significantly related to the negative results of exchange rate fluctuations and derivative operations.

Adjusted EBITDA reached R$3.695 billion, marking a 57% decrease compared to the same period in 2022, resulting in a 20-percentage point reduction in the margin, bringing it down to 41%. Suzano explains the annualized drop in EBITDA with four key factors:

1. A lower average net pulp price in dollars (-33%).
2. Reduced volume sold (-10%) due to the devaluation of the U.S. dollar against the Brazilian real (-7%).
3. Higher SG&A expenses (+12%), primarily resulting from increased administrative costs due to higher personnel expenses (variable remuneration).
4. Including expenses related to acquiring Kimberly-Clark Corporation's ( KMB ) tissue business in Brazil.

With this decline in EBITDA, Suzano's leverage increased to 2.7x compared to 2.1x in the same period the previous year.

In the pulp business unit, despite successive price adjustments since June, prices continued to suffer. Suzano realized pulp sales at $547/t, reflecting a decrease of 4.7% quarter-over-quarter. This was contrary to the hardwood commodity curve, which stood at $530/t in 3Q23 compared to $520/t in 2Q23, showing a quarterly increase of 1.9%. It is anticipated that price pass-throughs will become more prominent in Suzano's realization process in 4Q23 and 2024, given that the company operates with approximately one-month delayed contracts compared to the spot market.

In the paper business unit, results remained resilient in the domestic market. However, a price decline in the foreign market was the primary factor in reducing EBITDA per ton in the period. Despite the drop in the average net realized pulp price, the third quarter of 2023 saw improved market sentiment, driven mainly by a significant increase in demand in China.

Excluding the production component with a higher cash cost, there was a significant cost reduction in 3Q23, with COGS (Cost of Goods Sold) excluding stoppages reaching R$861/t, in line with our estimates. Additionally, Suzano benefited from reduced downtime costs (R$74/t in 3Q23 vs. R$87/t in 2Q23) from the maintenance of the newer Três Lagoas plant. As a result, COGS, including stoppages, amounted to R$935/t, reflecting a quarterly decrease of 7% and a yearly increase of 4.6%.

In addition to the quarterly numbers, the company announced investments of R$1.66 billion for the construction of a new paper mill and a biomass boiler in Aracruz, Espírito Santo, as well as the conversion of a machine in Limeira, São Paulo, which will increase the production capacity of fluff pulp. According to Suzano's CEO Walter Schalka, the investment in fluff pulp in São Paulo announced the previous day is "just the first phase."

The outlook is for a recovery in the realized price

The Chinese demand for hardwood pulp has gradually improved recently, leading to further price increases in October and November. However, these improvements are expected only to be reflected in the company's results in the upcoming quarters. During the earnings call , Suzano's management pointed out that pulp orders from China were at "very healthy" levels in October and are expected to remain strong in November.

Suzano realized pulp sales prices at $544/t, representing a 4.7% decrease quarter-over-quarter. This contrasts with the hardwood pulp commodity curve, which stood at $530/t in 3Q23 compared to $520/t in 2Q23, showing a 19% increase quarter-on-quarter. We expect that price pass-throughs will become more pronounced in Suzano's realization process starting in 4Q23 and continuing into 2024. This expectation is based on the fact that the company operates with contracts with a one-month lag compared to the spot market.

Additionally, I've observed a potential confirmation of a turning point in pulp prices. The lowest point of the hardwood pulp curve was $480/t in mid-May, followed by successive price increases that pushed the curve to $580/t. There is a high likelihood that this trend will continue, possibly reaching $630/t in 2024. Consequently, I anticipate a brighter outlook for the company's performance in the coming quarters.

However, it's crucial to note that blindly assuming a faster recovery than expected, especially with increasing Chinese demand, carries certain risks. A more pessimistic scenario could suggest limited room for further price increases, particularly considering the entry of significant additional capacity into the market and ongoing global macroeconomic uncertainties.

Valuation and conclusion

At first glance, the third quarter posed challenges for Suzano, with several vital metrics showing declines. These challenges included marginal decreases in pulp sales, a continued descent in realized hardwood prices, and total revenues and EBITDA declines.

Realized pulp prices continued declining, significantly impacting revenue, which decreased by 2.3% compared to the previous quarter and a substantial 36.7% drop annually. EBITDA also saw a decline of 5.7% compared to the last quarter, primarily due to pulp-related factors.

Despite the highly challenging pulp price scenario, the results were better than expected in my assessment. Pulp prices showed a significant recovery, driven by increasing demand from China. Pulp orders from China remained strong in October and are projected to remain robust in November. Furthermore, the company substantially reduced cash costs despite the ongoing challenging circumstances.

When evaluating the company's current valuation multiples, it is noteworthy that Suzano is currently trading at the most discounted forward EV/EBITDA relative to its main domestic peers (such as Klabin S.A. ( KLBAY )) and international peers, such as U.S.-based International Paper Company ( IP ), and Finland's Stora Enso Oyj ( SEOAY ) and UPM-Kymmene Oyj ( UPMMY ).

However, this discount, which could be justified by Suzano's greater dependence on kraft pulp price fluctuations due to the less diversified nature of its products, tends to make less sense in light of Suzano's new alternative investment plans in fluff and tissue. These plans should enhance its product diversification.

Considering that since my initial bullish article on Suzano in September 2023, shares have fallen by approximately 7%, I still believe that this decline presents an opportunity to invest in Suzano during a low-cycle period with substantial growth potential, especially as demand in China is expected to strengthen for Q4 and beyond.

For further details see: