Sylvamo Review: excellent paper in green packaging, but big debts

Обзор Sylvamo: отличная бумага в зеленой упаковке, но большие долги

Sylvamo (MCX: SLVM) - paper manufacturer. The company was spun off from International Paper in October 2021. Let's understand, what is the company, what can be the benefit and where the risks are buried.

What the company makes money on

Sylvamo produces paper. The company earned $ 3 billion in 2020, of which 34 million were intracorporate transactions, which are deducted from revenue.

In the report, the revenue is distributed as follows:

  1. Office and roll paper and market pulp - 89%. In Russia, the company's products are known for the green packs of SvetoCopy office paper.
  2. Market cellulose - 8%. The company sells market pulp to fabric manufacturers, specialized printing studios and other companies.
  3. Packing cardboard - 3%. Paper sale, which is then used to make bags and pack products.

Most of the company's revenue comes from there, where does the company have its factories:

  1. North America - 48%.
  2. Europe - 30%.
  3. Latin America - 21%.
  4. Intra-corporate transactions - 1%.

Обзор Sylvamo: отличная бумага в зеленой упаковке, но большие долги

Alas, the company only discloses details of its financial performance by region. I counted two indicators: operating margin and return on assets.

Operating margin. Percent, which remains from the proceeds less the costs of doing business. The larger the indicator, the more competitive advantages the company has.

I have adjusted operating income based on available data: added depreciation and deducted business investment costs. 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.

Financial performance of the company 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 exposure. I, sure, I'm not hinting at anything, but Sylvamo stood out 1 October 2021, that is, a little more than a month has passed.

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Обзор Sylvamo: отличная бумага в зеленой упаковке, но большие долги

Management plans to reduce debt. International Paper singled out Sylvamo for a reason, and how a hereditary nobleman put the company "on the counter" and asked to pay $ 1.5 billion.

Sylvamo had to take debt at 3.2% per annum. How much the debt will have to be paid is still unknown, we will find out about this, 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 rather big 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 they will 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 expenses. Debt payment 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 - the amount of debt, 0,1 billion - money, which reduce the amount of debt. It can be assumed, what if investors continued to value the business at or near $ 2.6 billion and the company reduced its debt, then investors will revalue the market cap to around the current EV.

Paper - base. Sylvamo earns most of its revenue from uncoated paper. According to 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 bookmakers.

If you look at the demand for the main product - A4 paper - using Google Trends by main consumption regions, it can be seen, that no digitalization is taking place yet and the demand is stable.

Обзор Sylvamo: отличная бумага в зеленой упаковке, но большие долги

Обзор Sylvamo: отличная бумага в зеленой упаковке, но большие долги

Cheap, even taking into account the 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 it has a return on invested capital 13%. Moreover, Sylvamo has a multiplier equal to 16%, and profitability - 23%.

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This difference in valuation can only be explained by Sylvamo's large debt.. But if the debt starts to be cut, then such a difference in valuation should go away and Sylvamo should be valued more expensive by multipliers.

Controversial points

Tax in touch. 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 a point: some or all of the costs will be covered by International Paper, because all this disgrace 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 liabilities rise, then part of the company's income will go to finance liabilities, and not for additional investment in a business or payment of dividends with the repurchase of shares. Therefore, in subsequent reports it will be necessary to check, how much are employees' pensions financed.

Large seller in the market. After the spin-off, International Paper still 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 strongly.

What is the bottom line

If you believe in the leadership of Sylvamo and are not afraid, that demand and paper prices will fall, then you can buy shares against debt reduction. In doing so, consider, that there will be a large seller of shares in the market in the form of the previous 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.

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