Clearwater Paper Stock: Set To Benefit From Industry Tailwinds (NYSE:CLW)

Clearwater Paper Company (NYSE:CLW) has been a mean to beneath common enterprise over the previous decade and its inventory has mirrored this. This isn’t shocking given the truth that paper product corporations are usually capital intensive, and function in a really cyclical, fragmented and aggressive business. Solely the very well-run corporations within the business can sustainably generate above common returns on invested capital and compound earnings over time.

This has been the case with Packaging Company of American (PKG). Packaging Corp has generated 14% returns on invested capital over the previous decade and its inventory is up properly over that point resulting from its larger money flows and since the market acknowledges its larger high quality and assigns it a better a number of.

Packaging Corp does function an uncoated freesheet paper phase which Clearwater doesn’t, however each corporations function a paperboard phase. Regardless of this similarity, the distinction in ROIC has to do with the truth that Packaging Corp operates extra effectively and invests capital extra intelligently. These merchandise are additionally commoditized so there’s minimal product differentiation when in comparison with Clearwater, so it’s a decrease price operator merely due to higher enterprise execution.

Clearwater’s low returns on invested capital don’t imply it’s at all times a nasty funding, it simply signifies that funding timing is way more necessary. Traders should contemplate provide/demand dynamics of the business to a a lot higher diploma, as it will largely decide earnings. Moreover, a long-term holding interval received’t bail out traders that incorrectly time their buy of the inventory.

At the moment the business’s provide/demand dynamics are creating a good scenario for Clearwater. In its client merchandise phase which incorporates manufacturing of personal label tissue merchandise, demand is excessive as customers commerce down from identify manufacturers which have pushed worth will increase nearly so far as they might have. On the similar time, within the paper and paperboard phase, demand is rising once more as client product good corporations have decreased packaging stock and are ordering them once more. Each of those dynamics will result in larger gross sales and better margins in 2024. As a result of improved outcomes, I can see the inventory buying and selling a lot larger in 2024 as earnings rise and the a number of at which it trades rises.

I’m initiating protection with a purchase score and a $50 worth goal primarily based on each my estimate of Clearwater’s intrinsic worth and primarily based on an 6x a number of of my estimate of 2024 EBITDA. The primary dangers of this thesis stem from the cyclicality of the business, the low high quality nature of the enterprise, and the packaging business’s excessive sensitivity to adjustments in GDP.

Enterprise Overview

Clearwater operates two segments: pulp and paperboard, and client merchandise.

The pulp and paperboard phase primarily includes the manufacture of bleached paperboard for high-end packaging and Clearwater is among the 5 largest producers of bleached paperboard in North America. Bleached paperboard is used for folding carton packaging that packages pharmaceutical, beauty, meals and beverage merchandise, for cold and hot cups, plates and meals containers, for liquid packaging (e.g. juice, soup, milk and wine), and for heavy weight paper grade (e.g. blister board, signage, promotional literature).

This phase has skilled deteriorating fundamentals over the previous 12 months as demand for client product items has declined relative to demand for providers which has led to decrease demand for packaging for these merchandise. Corporations that produce items stocked up on packaging stock assuming that demand for his or her merchandise can be the identical in 2023 because it was in 2022 and have been left overstocked when this didn’t happen. Nevertheless all indicators are indicating that packaging inventories for these corporations are virtually normalized and that demand is beginning to come again. This could result in a rebound in earnings for this phase over the subsequent 12-18 months.

The patron merchandise phase produces and sells each premium and worth at-home tissue merchandise equivalent to tub tissue, facial merchandise and serviette merchandise. Clearwater accounted for five% of the at-home tissue product market in U.S.

In the newest quarter, Clearwater talked about on its earnings name that personal label tissue market share reached an all-time excessive of 36.3%. This rise is sensible with the context of identify model corporations elevating worth to excessive ranges to offset declines in quantity and a extra price acutely aware client as recession fears are excessive. That is nice for Clearwater as EBITDA development on this phase has offset declines within the pulp and paperboard phase.

Previous Monetary Outcomes

As I discussed above, Clearwater has traditionally been a mean to beneath common enterprise with low and risky returns on invested capital.

ROIC is low because of the excessive capital depth of the enterprise and the extraordinary business competitors. Clearwater’s inventory instructions such a low a number of due to these persistently low returns on invested capital and due to the corporate’s low development. In truth many business friends commerce at related multiples for a similar causes. With so little product differentiation, returns on invested capital come right down to effectivity of operations.

Notably, manufacturing of tissue merchandise and paperboard includes loads of manufacturing facility area, heavy equipment, shifting components and upkeep capital expenditures.

Clearwater’s income was flat within the decade previous to the pandemic and margins rose and fell with the business’s provide dynamics. Not like most corporations on this business, Clearwater has not made many acquisitions over the previous decade. The one one was its acquisition of Manchester Industries of Richmond in 2016 for $68 million. Even with this acquisition, gross sales didn’t develop in 2016 or 2017.

Previous to the pandemic, capital expenditures as a proportion of income have been lumpy, excessive, and far bigger than depreciation. Increased income, extra cautious capex planning and extra manufacturing facility downtime brought on capex to return in decrease than depreciation in the course of the pandemic years. These elements, together with the low and lumpy margins have brought on Clearwater to generate low returns on invested capital and low returns on acquisitions.

Value Goal and Dangers

My purchase score is principally because of the acceleration of the optimistic traits within the tissue merchandise and packaging merchandise industries which can be occurring on the similar time. With assist from these traits, I estimate that 2024 EBITDA can be $246 million. With a 6x a number of, $523 million of internet debt, and 16.99 million totally diluted shares excellent, I estimate that Clearwater’s may commerce for $56.

To get $246 million of EBITDA in 2024, I’m assuming 1% income development in 2023 adopted by 2% development in 2024, a 7% EBIT margin in 2024, and D&A equal to 4.5% of income in 2024.

The first dangers I see are from the cyclicality and low high quality nature of the enterprise. Nevertheless after I mannequin out Clearwater’s future money flows, I bake in adjustments in margins to account for the packaging business’s enterprise cycles. With these fluctuations, I estimate that the intrinsic worth of the enterprise is the same as about $44. Taking the midpoint of those estimates, I’m assigning Clearwater with a $50 worth goal.

Financial weak spot is after all a big danger given how delicate packaging merchandise are to GDP. With rising charges, the recession narrative is entrance in middle in most traders’ minds however current knowledge has indicated that the economic system continues to be fairly sturdy. In September, non-farm payrolls rose by 336 thousand, handily surpassing the 160 thousand additions that have been anticipated.

The Atlanta Fed’s most up-to-date GDPNow Q3 actual GDP development estimate additionally remained excessive at 4.9%. That is solely an estimate, however it takes under consideration a lot of the current financial knowledge that has been launched. With this financial energy, demand for client merchandise needs to be sturdy which, together with the favorable business provide dynamics will result in larger margins and better earnings for Clearwater.

Moreover, the paper and packaging business could be very fragmented so the bigger corporations roll-up smaller paper corporations to assist with development. This might present a little bit of a ground on Clearwater’s inventory as most acquisition EBITDA multiples vary within the 6-9x vary. If the inventory falls resulting from deteriorating financial circumstances, a bigger and higher capitalized firm could use it as a possibility to aim to accumulate Clearwater. If EBITDA drops to $160 million, because it has on the low level of previous business cycles, a 6x a number of would put the inventory at $32.

I wouldn’t wager on an acquisition like this taking place however it’s one other approach to think about the worth of the enterprise.

Ultimate Ideas

Clearwater will not be a terrific enterprise, however it’s coming into a interval the place the availability/demand atmosphere for each tissue merchandise and packaging merchandise are optimum. Within the tissue merchandise phase, customers are buying and selling down to non-public label merchandise which Clearwater manufactures and that is creating larger demand for its merchandise. Within the packaging phase, client items corporations have decreased stock of packaging that they constructed as much as meet what they thought can be one other excessive demand atmosphere in 2023. Each of those elements are positives for Clearwater.

As earnings inflect upwards over the subsequent 12-18 months, I feel that traders will bid the inventory as much as a better a number of. I estimate that Clearwater will generate $246 million in EBITDA in 2024 and with a 6x a number of, I estimate the inventory will commerce for $56.

Moreover, I estimate Clearwater is price $44 per share primarily based on its future money flows. Taking the center level of those worth targets I’m assigning the inventory a purchase score with a worth goal of $50. Given the truth that the packaging and tissue enterprise has traditionally been a poor enterprise, I’d not plan on holding Clearwater’s inventory for a very long time. If it approaches my $50 goal I’d study the availability aspect thesis to see whether it is holding up and contemplate trimming or promoting the place.