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Shares of Clearwater Paper Corporation (NYSE:CLW) surfaced on my radar as the paper business announced a substantial acquisition recently. The company is doubling its focus on paperboard and is looking to get out of the more competitive tissue business, in which it holds a smaller market share.
That looks good on paper, but still has to play out in reality. While current earnings multiples are non-demanding by all means, I am somewhat cautious to jump onboard amidst the big strategic moves being made, the fact that margins currently come in above-average already, as well as a mediocre long term performance.
The Business
Clearwater Paper is a $2 billion business which is comprised out of two pretty equally large paperboard and consumer product business.
The company is a top 5 manufacturer of paperboard, in which it serves a diversified range of end markets, making it well positioned for more sustainable products. Applications to think of mostly include folding cartons, as well as cup & plates, as the business unit generated $1.06 billion in sales in 2023 on which EBITDA margins of 19% and segment margin of 16% were reported.
In the consumer products business, Clearwater provides tissue products with national scale supply chain capabilities, benefiting from a trend towards private brands and resilient consumer demand. The unit mostly produces towels and bath products, complemented by smaller sales of facial products and napkins.
With $1.02 billion in sales, the unit is similar in size to the paperboard business, yet EBITDA margins of 15% and segment margins of 9% come in a bit lower, as the market shares in this larger segment is much more modest. With a 6% market share, the company is a smaller business in relation to Georgia-Pacific, Procter & Gamble (PG) and Kimberly-Clark (KMB), as key competitors. Operating with sustainable fibers, Clearwater claims to benefit from resilient and defense product positioning as well as a sustainable future.
Current Results
In February, Clearwater reported its 2023 results, a year in which revenues were essentially flat at $2.08 billion. Aided by lower energy costs, among others, operating profits improved to $177 million, for margins equal to 8.5% of sales, up more than three points from the year before.
With net earnings reported at $107 million, Clearwater posted GAAP earnings equal to $6.30 per share, based on a share count of just over 17 million shares. Net debt is reported at $463 million, a manageable amount with EBITDA for the year reported at $281 million, for a 1.7 times leverage ratio. The lack of improvement in full year sales was in part the result of a 3% fall in fourth quarter sales, attributed to a natural gas disruption at one of its mill operations, as well deflationary pressures.
With 17 million shares trading at $40, the $680 million equity valuation values the business at $1.14 billion based on the enterprise valuation. This means that the company trades at a non-demanding multiple of just around 7 times earnings.
Moreover, the company guided for a solid 2024 coming up, a year in which the company sees continued strength in the tissue market, with paperboard demand expected to recover in the second half of the year.
Perhaps of greater significance, the company announced a huge deal alongside the release of the 2023 results, one with greater strategic ramifications.
A Big Deal
On the same day of the release of the full year results, Clearwater reached a $700 million deal to acquire the Augusta, a Georgia-based bleached paperboard manufacturing facility from Graphic Packaging (GPK).
The site has 600 thousand tons of bleached paperboard annual capacity, set to contribute some $140-$150 million in EBITDA by 2026, with current EBITDA reported at $100 million, suggesting that a 7 times EBITDA multiple has been paid. In comparison, Clearwater trades just over 4 times EBITDA, as it is this higher multiple which frankly makes me a bit cautious here.
That said, synergies should reduce the EBITDA multiple to 4.5 times by 2026 mostly on the back of increased utilization numbers, while the greater market share in this business makes it a more attractive market segment versus the more competitive tissue market.
Moreover, the company announced that it will explore strategic options for its tissue business as it focuses on paperboard, in which it has a larger market share.
That might be needed, as pro forma net debt will jump to $1.16 billion upon closing of the deal, with EBITDA seen just below $400 million here, for a leverage ratio near 3 times, although the company said on the call that leverage ratios are seen in the mid-3s as near-term EBITDA is expected to be pressured by maintenance actions.
And Now?
Investors like what they see, as shares of the firm have risen from levels in the mid-thirties to towards the $40 mark in the second half of the month. While this is up from a $20 level pre-pandemic, note that this was already a $60 stock in the 2014-2016s.
The reason for that and the low earnings multiple is easily understood if we look back in time, this being a $2 billion business a decade ago already. While 2023 operating margins were strong and showed a big improvement, on average these margins have ranged around 5% of sales over this period of time, as some 15% of the shares have been bought back over this period in time as well.
Given the lackluster performance by Clearwater Paper Corporation, and a more expensive deal, through which some leverage is incurred, I am leaning cautious despite a low current multiple. Every one point change in operating margins impacts earnings per share by nearly a dollar, as the current margin performance historically has been very high.
Even if margins normalize, Clearwater Paper Corporation trades at just around 10 times earnings, which looks compelling, but given the mediocre long term performance and bolt decision being made, I am taking a wait-and-see approach here.
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