2023-08-30 06:09:37 ET
Summary
- Suzano's recent financial performance was impacted by falling pulp prices, leading to a lower stock valuation.
- Despite efforts to raise prices, short-term recovery expected to be gradual due to significant pulp price decline.
- The prospect of profitability is boosted by the anticipated long-term price curve improvement in China.
As pulp prices continue to fall, approaching what appears to be a near bottom, the Brazilian paper and pulp company Suzano ( SUZ ) maintains an attractive valuation, with its stock reflecting a curve of around $500/t—below the marginal costs of pulp production—to its fundamentals. This comes after the company reported second-quarter financial results that were less negative than initially expected.
While I do not expect the company to reverse the decline in its realized prices over the last three months due to the significant drops in pulp spot prices, even with Suzano's ability to pass on price increases, it is unlikely that we will witness a sequential rise in the short term.
However, anticipating a potential improvement in China's long-term price curve gives me hope for a boost in Suzano's bottom line in the coming quarters.
Pulp and paper volumes
Despite Suzano adhering to the announced maintenance schedule for its production plants, which in Q2 2023 involved the closure of four significant mills, collectively accounting for 4.5 million metric tons of production capacity, the pulp volume presented a positive surprise. It was reported at 2.5 million metric tons (kt), marking a 2.4% increase quarter-over-quarter. This growth was primarily attributed to higher-than-anticipated demand in China.
Suzano's IR
The decline in the international pricing curve contributed to a continued decline in cellulose prices. Suzano's second quarter was characterized by significant drops in the hardwood curve, with an average of $530/t compared to $760/t in the first quarter. Eventually, Suzano's realized price settled at $571/t, indicating a quarterly decrease of 20.8% and a year-on-year drop of 21.3%.
Suzano's IR
Conversely, there was an improvement in paper volumes. While emerging from a negative seasonality and still influenced by the economic slowdown, particularly in the printing and writing segment as well as specific packaging intended for the food industry, which continued to grapple with high inflation, paper volumes saw a positive shift due to increased exposure in the hygienic paper segment. During Q2 2023, Suzano's paper volumes reached 294kt, marking a 5% improvement compared to the previous quarter but still registering a 9.3% decline year-over-year.
Following consecutive increases, paper prices gradually return to a more standard level. Suzano's paper division recorded a realized price of R$7,002/t, reflecting a 5.5% decrease quarter-over-quarter and a 12.9% increase year-over-year. These short-term contractions in paper prices offset part of the gains observed in recent quarters.
Latest financial results
During the second quarter of this year, Suzano experienced a significant decline in revenues, primarily attributed to the performance of its pulp segment.
The company reported consolidated net revenues of R$9.1 billion, reflecting a quarterly decrease of 18.8% and an annual drop of 20.5%. This outcome is primarily driven by a reduction in revenue within the market pulp unit, which amounted to R$7.1 billion. This marked a decline of 22.8% compared to the previous quarter and a 25.3% drop from the last year, primarily attributed to lower realized prices.
Meanwhile, the paper unit displayed a more resilient dynamic, maintaining stability in the quarterly comparison at R$2.0 billion. This balance was achieved as slightly stronger sales and less favorable prices created a balancing effect.
Regarding costs, despite a decreased dilution capacity, the cost of goods sold (COGS) per ton remained relatively steady at R$919/t, showing a modest decline of 1.9% QoQ. This was propelled by healthier price dynamics in inputs, especially chemicals, accounting for a R$21/t reduction and the impact of the decreased USD/BRL exchange rate, contributing to a R$9/t decrease.
Nonetheless, COGS/t demonstrated an annual increase of 7.5% YoY, influenced by elevated expenses in procuring wood and a reduced capacity to dilute fixed costs due to a 5.6% YoY decrease in direct pulp sales.
However, the less favorable side became evident in the EBITDA figures. In simple terms, market participants have embraced high expectations that the increased capacity from global players will disrupt the balance. This disruption is anticipated to create an oversupply of the commodity, leading to a substantial reduction in pulp prices in the first half of 2023.
Given this context, it became nearly inevitable for Suzano to encounter a double-digit EBITDA loss, reaching a total of R$3.9 billion (a 35.3% decrease compared to the previous quarter and a 39.3% decline compared to last year). This impact was particularly pronounced in its most significant unit, which contributes 81% of operational production.
Despite its relatively minor contribution to the consolidated outcome, the paper division experienced a more contained loss due to the resilience of paper in comparison to direct pulp sales in the market. Nevertheless, this division's performance slowed compared to the preceding quarter, reaching R$729 million (a reduction of 12.8% from the previous quarter and 10.9% from the prior year).
Suzano's currency hedging strategy positively influenced net income, success in options, and dollar debt positions. This strategy partially helped offset the EBITDA decline due to operational deliveries. The USD/BRL exchange rate decreased from R$5.20 to R$4.95, resulting in a gain of R$1 billion. Moreover, the dollar-denominated debt significantly benefited the company by substantially reducing the amount in reals.
Conversely, the company encountered a challenge with a negative adjustment of R$1.2 billion in the valuation of biological assets. In summary, while currency hedging and financial factors contributed to mitigating operating losses, challenges like the adjustment of biological assets also had a significant impact.
Despite the double-digit EBITDA decline, Suzano generated an adjusted free cash flow of R$5.1 billion (excluding expansion projects). This underscores substantial operational cash generation. This achievement was made possible by releasing R$2.7 billion in working capital and R$1.3 billion through derivatives during the quarter.
Suzano reached a Net Debt/EBITDA of 2.0x, increasing minimally against the 1.9x seen in the previous quarter due to a lower EBITDA sequencing.
General view and valuation
Suzano's financial performance, marked by a double-digit decline in its EBITDA, has been significantly influenced by the short fiber market, commonly called "hardwood." This pronounced decline in results is primarily attributed to the resolution of challenges in the supply of this fiber, coupled with the anticipation of various significant projects poised to commence or scale up production in the near and medium term.
Nevertheless, owing to the impact of the currency hedge on the financial outcome, the company managed to mitigate the effect on its net profit. This leaves a sense that, given the absence of a bullish trend in the pulp cycle, the Q2 2023 results could have been much more unfavorable.
By June 2024, Suzano intends to finalize the construction of a pulp factory—the Cerrado Project —that will yield an annual production of 2.55 million tons, consequently elevating Suzano's installed market pulp capacity to 13.5 million tons annually. The company has expedited its delivery timeline, now set for the first half 2024. This acceleration is anticipated to integrate the company's operations earlier than initially foreseen and offer enhanced visibility for investors.
Suzano's IR
Despite Suzano's efforts to regain its realized prices over the past three months, the short-term recovery is expected to be gradual, with intermittent readjustments. The company is actively working to raise prices, having successfully implemented increases in June, partially in July, and again in August. This strategic approach is projected to elevate realized prices to approximately US$520/t by the conclusion of 2023.
However, due to the significant declines in pulp spot prices during the second quarter, a sequential increase in the short term is unlikely, even with Suzano's capability to pass on price hikes. Nonetheless, while there's an anticipation of a potential worsening before the improvement in average prices, the long-term price curve in China lends greater confidence to Suzano's profitability.
With a projected EV/EBITDA multiple of 6.7x for 2023, representing a 15% discount relative to the cellulose industry average and roughly 7% below Suzano's historical five-year average, Suzano's current share price seems discounted.
Therefore, considering Suzano's solid profitability in the recent quarter, even amid challenging phases of the commodity cycle, I view Suzano's current valuation as an attractive entry point for investors with a long-term focus.
For further details see:
Suzano: Undervalued Amidst Pulp Price Retreat