2023-06-25 23:44:37 ET
Summary
- Holmen's stock performance has remained stable, validating the previous "Hold" recommendation from December 2022.
- The company is known for its solid business trends, good management, and stability, justifying its high premium in trading.
- Despite a double-digit drop, Holmen still offers potential upside and long-term value for investors at the right price.
Dear readers/followers,
When I last reviewed Holmen (HLMMF) (HLMNY), I did so in December of 2022, my recommendation/rating was a "HOLD". This has turned out to be somewhat prophetic in terms of the profitability for the last 6 months or so because this is what we've seen from the company - and the market - in the meantime.
Holmen is usually a company that's being traded with a high premium. The reasoning for this premium is, as I see it, sound. That's also why my cash-secured puts tend not to be as conservative as with other companies. First of all, the risk premium is usually far lower in this business - the market "knows" it usually doesn't move much. Secondly, even if I do get it, I wouldn't mind holding Holmen for years.
Holmen isn't the largest or even the oldest Swedish forestry business - but it's still almost as old as the American Civil War, and it has solid business trends and good management. Yield is so-so - don't expect much - but do expect solid development and stability here.
Revisiting Holmen and its upside - plenty to like after a double-digit Drop
The company was previously known as Mo och Domsjö AB, which can trace its roots all the way back to 1873, meaning the company has a close-to 150-year history. It's a company where 90% of the business is done in Europe through its own paper and product sales companies and subsidiaries. It also has a majority shareholder - Fredrik Lundberg, and his investment company L E Lundbergföretagen AB (LBGUF), which owns the majority voting share of the business.
3,200 employees generate 17B+ SEK of revenues per year. All of the company's size metrics in the context of the larger sector imply that the company is average - it's the products and asset specifics that show us it being a lot more than average - including the fact that despite revenues, the company is one of the nation's largest forest owners, making it completely self-sufficient for feedstock.
Specific appealing assets include Iggesund Paperboard AB, which is world-leading in the very high-end premium carton for luxury products, which was acquired by Holmen 2 years back. Holmen rarely moves the M&A route, but when they do, they buy market leaders and outperformers.
This is a very attractive mix of capabilities. While there is undoubtedly cyclicality to many of these business segments, the high-level returns over time for this company have been amazing. Holmen has been a great investment that for the past 18 years has delivered TSR of nearly 300%. The latest results Holmen has delivered showed yet another strong margin quarter, with very solid operating profit.
The company went essentially debt-free at the end of the last quarter, thanks to 1.8B worth of FCF, seeing a strong spike in pre-WC cash flow which has really gone a long way to driving down its debt/equity ratio. The forest holding continues to grow - and Holmen is playing the long game here, with competition for Pulpwood intensifying more and more. The closure of Russia as a market, and the fact that forests are a finite resource is likely to continue to drive timber and pulp prices ever-upward.
The forest segment earnings are up 15% on a YoY basis alone. So while in many sectors, trends in commodities are going down, in timber and forest, they're staying elevated or even growing more. At least here.
The company is a strong player on attractive paperboard packaging (550kt per year), and while demand has slowed somewhat as worldwide inventories rationalize, prices have remained stable and attractive.
The company's cost increases have been accepted. While the products might be viewed as elastic product/pricing, the fact is that in this environment, pricing trends are showing more inelastic tendencies, at least in this segment. The same is obviously not true for paper. Holmen still does paper, and while pricing for paper saw a spike in 2021-2022, here pricing is going down - and the demand situation is the same everywhere. It's declining. There will likely continue to be a demand for paper to some extent, but the amount or the extent of it remains to be seen in the longer term. With fiber prices going down again, it's harder and harder to make a profit here. A sub-segment where Holmen is still making profitable results is book paper, not newsprint/recycled fibers. That's why the company is investing more in the Braviken Mill, improving both the book paper and the fluting capacity here.
Wood products are perhaps one of the more interesting company trends however - the company can produce 1.5M cubic meters per year, and while export prices and future prices are normalizing, they are doing so at levels that are still attractive for the company. Infrastructure and building remain major end-user of the products - and Holmen continues to push wood as a realistic alternative of lower Co2 to concrete and steel. It certainly cannot replace the other two in all areas, but there are use cases where wood might be an attractive alternative.
Holmen has one of the best profitability in the entire industry. With a nearly 60% gross margin, 27% operating margin, and almost 11% net income margin, it's absolutely superb and in the 90th+ percentile across its sector. The same is true in debt. The company's debt/EBITDA is now down to 0.03x, with interest coverage of 99.76x (Source: GuruFocus). Despite volatile macro, the company has remained consistently profitable in the face of higher WACC, and it has not only lowered its debt but increased over time, its cash position.
Shareholders now own a significantly higher percentage of the total assets of the company - meaning stockholder equity is going up. This company is undercovered both from the insider trading perspective - not much going on there, and as you can see by the article trends, not many investors seem to care or even know that this company actually exists.
The chronic high valuation that Holmen does have is definitely a problem. Any drop in valuation putting it below 380-390 SEK/share should be highlighted. I last called the company a "HOLD" in my previous article and gave it a price target of 380 per share, which is where I've done my current 25-day dated CSPs. I'm also ready to, and eager to write lower ones if the company continues to drop - because as things look now, we're at a native share price of 382 SEK which is starting to look appealing to me.
Why is this looking appealing to me?
Let me update the valuation of this company and show you.
Holmen - Plenty to like below 400 SEK/share
So, the main reason that I'm positive about Holmen is quality. I also want to point out that most analysts that are forecasting this company seem to have very little idea of how to effectively account for both volatilities in timber/paper, and properly provision for the upside from its forestry segment coupled with the stability of packaging. That is why FactSet analysts have a 50% positive failure ratio - meaning the company actually beats estimates by more than 10-20% at more than 50% or around half the time. And it doesn't just beat estimates by 10% either. Back in 2019 and 2022 the failure of analysts to properly forecast meant that the company beat estimates by 352% and 117% respectively. This is not a good picture for those analysts, despite the positive of a beat. Because that is something that should be able to account for if you know the sector or know what you're doing.
So, when I see a set of forecasts like this...
...I take it with a spoonful of salt. The yield at the current price is around 4.18%. That's well above where the company typically is, and it makes the company attractive. The current share price of 382 SEK is an almost attractive prospect for this company when you take into consideration that 50% outperformance potential - which I consider to be realistic. If we enter the company's numbers and sales, projected FCF, tangible book values, and Graham numbers, we get valuations implying between 350-550 SEK. No matter how you realistically average these out, or look at things like a conservative DCF, even in the case of no more than a 2% terminal stage growth rate, and a 3-4% growth stage rate this company is worth more than 430 SEK/share based on a conservative double-digit discount rate of 10%.
So yes - I and other analysts following Holmen here call the company interesting. It's not at a level yet where I am willing to change my thesis for the common share, but the fact that we're now below 385 SEK means that I will be looking to write new PUTs next week, preferably priced at 330-340 SEK, depending on the risk premiums available.
6 analysts follow Holmen - they all have price targets from 385 SEK to 520 SEK, implying that the company is a "BUY" here. 3 of those are officially at "BUY", and they're likely to change their stance in the near term based on this recent decline.
As I said before, I wouldn't "BUY" the common above 380 SEK per share. But that target is where I, based on my forecasted profit and growth, being able to see an upside of 9-10% per year, which is what I want to see for a business like this if I am to invest.
At under 380 SEK, this company is to my mind a "Must-buy" for its stellar assets and upside as well as fundamentals. Once it hits 450-500 and above, it becomes "too hot", and once it hits 550 SEK, you better run for the doors, because chances are high it'll drop from here, barring something non-recurring.
There are few companies where I can be as clear for the long-term, based on how the company looks today. My conviction here is high, and here is my current thesis for the company.
Thesis
- Holmen is perhaps one of the best paper/forest/wood companies out there. Stellar credit, superb fundamentals, a good basis for value creation with everything pretty much covered. However, it commands the excepted premium.
- The company has recently dropped down to 382 SEK - while this is not yet a "BUY", it's getting there.
- The company is a "HOLD" here with a PT of around 380 SEK per share, where I would start "BUY" on the common share.
- The way I invest in Holmen is by writing puts. I go for the 380s or below where possible and secure yields of 7-11% annualized, waiting for the company to drop and collect premiums in the meantime. I have several contracts currently OTM (out of the money), but I wouldn't be at all sad to see those "filled".
Remember, I'm all about:
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
Here are my criteria and how the company fulfills them (italicized):
- This company is overall qualitative.
- This company is fundamentally safe/conservative & well-run.
- This company pays a well-covered dividend.
- This company is currently cheap.
- This company has a realistic upside based on earnings growth or multiple expansion/reversion.
The company does not have an attractive upside due to valuation issues - I give it a "HOLD" Here, but I'm busy writing attractive put options when the company sees a decline in share price.
For further details see:
Holmen AB: Put Options Are Still My Favored Investment Option