SUZ - Suzano's Normalization Still Achieving Pre-Hike Volumes

2023-05-18 07:57:13 ET

Summary

• Pulp prices are still very high, but now volumes are coming down lower, especially in the export markets.
• Suzano gives the reason that they've been having exceptionally low inventories for a while, and there's quite a lot of supply especially in international markets.
• Suzano is seeing some of the destocking effects, and while it's not alarming since volumes are still at Q1 2022 levels, it is somewhat recessionary.
• Moreover, volumes are sinking into China from other regions, where there's a lot more supply on reopening. Europe has seen some weakness.
• We are pretty confident about Suzano's markets, but it is a cyclical play and it is beginning to climb again in price, so we're looking at other things where growth is more secular at similar multiples.

Suzano ( SUZ ) didn't really falter last quarter, producing YoY growth in EBITDA and in volumes thanks to continued price increases - although there are some recessionary signals. Suzano still trades at a very compressed cyclical multiple. We think that the multiple continues to look low, and that in addition to cyclicality and uncertainty weighting on the stock price, there is the issue of Brazilian President Lula and his rhetoric around deforestation which could come to affect Suzano. On balance, while the multiple implies a strong earnings yield, uncertainty around recessionary factors will continue to prevail on the stock price for the time being, as well as a political discount. In reality, inflation up the pipe looks to be slowing enough where further pressures on financial systems should abate. This speculation is what is likely being reflected in current increases in the share price. While Suzano continues to look attractive on the basis of the dividend, the debt isn't self-liquidating anymore either, so don't expect any additional capital appreciation.

Q1 Notes

Volumes are up only a couple of points YoY, sequentially we are seeing more than 10% declines . In terms of prices, sequential price improvements are coming through in addition to YoY growth, where sequential price improvements are helping preserve margins, but they've been slowed down by negative mix effects from more export volumes going to China over Europe, where an ample domestic supply in China due to production recovering to above historical levels and shifted foreign supply meant worse than optimal price realization.

Sequential price improvements were quite limited, but there was the additional help on margin profile of the stalling cash cost developments per ton despite loss of scale. All commodity inputs deflated except for energy, including fiber and chemicals.

Suzano explains the volume declines as being somewhat discretionary, avoiding flooding the market since their inventories were anyway below normalized levels. The idea is that these volume declines could be a single stage decline, and it reflects a reversal to normalized levels happening across industries related to a destocking movement. But Suzano does acknowledge that markets like Europe are seeing less demand, and while it is helpful that markets like China are seeing some recovery, the situation with rate hiking and inflation could be dragging on several end-markets at this point with the exception of tissue demand, which was more constant and not subject to as intensive destocking cycles.

Bottom Line

While there are some recessionary signals from Western markets, that can perhaps be partially explained by destocking offset by tissue resilience, there is a case to be made for the Chinese recovery, where higher than normal domestic production indicates, as is consistent with Suzano's apparent conversations with Chinese customers, a high level of confidence in the China post-lockdown rebound. In general, our view is that pulp prices are probably somewhat sustainable. A slow ease of inflation won't spur sudden price competition, and it is still a year before new major capacity, including Suzano's half-complete Cerrado project, come fully online.

However, we think several things weigh on Suzano, which now has a longer record for its lower multiple. The first is the Lula political discount, since his progressive strategy does look like it might have deforestation squarely in its sights. Suzano could become subject to some regulatory pressures, and regardless of whether this comes to pass or the debate on the extent of their impact if any, markets are likely to continue to judge Suzano with suspicion as far as legitimate ESG concerns go. This will be in place for several years, to the extent that markets are incorporating it into current valuations. The second is the fact that because of peak CAPEX around Cerrado and a quite hefty >7% dividend, Suzano is not actually a deleveraging play anymore. Leverage is staying constant on a sequential basis.

That does mean that that company is yielding almost 10% in terms of dividends and buybacks, which is a great shareholder payout. As an income play, markets may be enticed since the payout ratios are sustainable, but with the climb of Suzano's price along with the rest of the market as they evaluate the possibility of incoming rate cuts as quite likely, especially as wholesale inflation eases close to policy levels in the US, capital payouts are likely to be the sole source of any shareholder return, but at least they make the earning yield into something tangible.

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