Sylvamo (MCX: SLVM) - paper manufacturer. The company was spun off in October 2021 from International Paper. Let's understand, what is the company, What are the benefits and where are the risks?.
What the company makes money on
Sylvamo produces paper. The company generated $3 billion in 2020, of which 34 million fell on intra-corporate transactions, which are deducted from revenue.
In the report, revenue is distributed as follows:
- Office and roll paper and market pulp — 89%. In Russia, the company's products are known for their green packs of SvetoCopy office paper..
- Market pulp - 8%. The company sells market pulp to fabric manufacturers, specialized printing studios and other companies.
- Packaging cardboard - 3%. Paper sale, which is then used for the production of bags and product packaging.
Most of the company's revenue comes from there, where the company has its factories:
- North America - 48%.
- Europe - 30%.
- Latin America — 21%.
- Intracorporate transactions 1%.
Alas, the company only discloses details of its financial performance by region. I counted two: operating margin and return on assets.
Operating margin. Percent, which remains from revenue minus the cost of doing business. The larger the indicator, the more competitive advantages the company has.
I have adjusted the operating income to reflect the available data: added depreciation and subtracted the cost of investing in the business. US companies love accelerated asset depreciation, due to which the operating profit is underestimated, although the real need for investment is tiny, so I decided to make an adjustment.
Return on assets. How much does the company earn in Adjusted Operating Income cents per dollar invested.
Company financial indicators for 2020
| Adjusted operating margin | Return on assets | |
|---|---|---|
| North America | 5% | 9% |
| Latin America | 17% | 10% |
| Europe | 11% | 10% |
Positive moments
The company recently spun off. In the American Outdoor Brands review, I have already pointed out the market anomaly: shares of spun-off companies bring higher yields, than the reference index, at a distance of 22-27 months after the release. I, certainly, I don't hint at anything, but Sylvamo stood out 1 October 2021, so it's been a little over a month..
Management plans to reduce debt. International Paper spun off Sylvamo for a reason, and how a hereditary nobleman put the company "on the counter" and asked to pay 1.5 billion dollars.
Sylvamo had to take on debt at 3.2% per annum. How long the debt will have to be paid is still unknown, we will know about it, when will the quarterly report come out.
Considering, that EBITDA on 30 June 2021 amounted to $ 463 million for the last 12 Months, net debt to EBITDA ratio is 2.75×.
The company has a large debt load, so management wants to reduce debt first. We will have to temporarily forget about dividends and share buybacks. But as soon as the debt burden is reduced, then immediately think about it. This is what the management says.
Debt reduction matters for several reasons.. The company will reduce the cost of paying interest, which will increase cash flow by the amount of interest expense. Paying the debt will allow you to use free money to pay dividends and buy back shares., there are no large investment projects yet.
Now the value of the company (enterprise value, EV) is approximately $ 2.6 billion: 1,2 billion — market value of all shares, 1,5 billion — amount of debt, 0,1 billion - money, which reduce the amount of debt. It can be assumed, what if investors continue to value the business at or near $2.6 billion and the company reduces debt, then investors will revalue the market capitalization to around the current EV.
Paper - base. Sylvamo earns most of its revenue from uncoated paper. According to the forecasts of the industry publication RISI, this market will be stable after the crisis - unlike other paper segments. The reason: uncoated paper has more end users, from school students to book manufacturers.
If you look at the demand for the main product - A4 paper - using Google Trends by main consumption regions, then you can see, that no digitalization is happening yet and demand is stable.
Cheap, even with debt. The closest analogue of Sylvamo is the shares of the Domtar company, which is in the process of being acquired by another company.
At the moment, it is estimated at 11% by the multiplier "cash flow / enterprise value" (OCF / EV) and has a return on invested capital 13%. At the same time, Sylvamo has a multiplier equal to 16%, and the profitability 23%.
Such a difference in valuation can only be explained by the large debt of Sylvamo. But if the debt starts to be reduced, then such a difference in valuation should go away and Sylvamo should be priced more expensive by multipliers.
Controversial points
Tax connection. Brazilian tax authorities dispute goodwill amortization by Brazilian subsidiary Sylvamo, which helped reduce taxes at a profit. Tax claims total $ 492 million.
But in the scenarios of the development of events there is such an item: some or all of the costs will be covered by International Paper, because all this mess happened at the time of her ownership of the unit.
Legacy is so so. Sylvamo inherited $ 338 million in pension obligations from International Paper for 31 December 2020. The pension plan is now funded for 97%. Lack of funding in 3% - a trifle, but if pension obligations rise, then part of the company's income will go to finance liabilities, and not for additional investment in the business or the payment of dividends with share repurchases. Therefore, in subsequent reports it will be necessary to check, how much are employees' pensions financed.
Big seller in the market. After spinning off the company, International Paper has 19,9%, or 8.8 million, Shares, and management wants to sell this package within a year. If the company starts selling shares in large blocks, then at specific moments they can sag a lot.
What's the bottom line?
If you trust the Sylvamo leadership and are not afraid, that demand and paper prices will fall, you can buy shares to reduce debt. In doing so, consider, that there will be a large seller of shares in the market in the form of the former owner of International Paper and on the horizon of several years there is a risk in the form of a fine from the Brazilian tax. In the end, it's up to you.
