Description

Concept: Special Situation

Clearwater post its recently announced Cellu Tissue acquisition positively changes business mix to more attractive private label tissue market (60% of revenues vs 40% before).  Using all cash, CLW acquired CLU at 6.5x EBITDA and on a pro forma basis for the deal, is trading in-line with pure play paper names at 5x EBITDA despite being a much better business.  Mgmt believes they should trade at 5-7x EBITDA.  Opportunities include higher than communicated synergies ($15-20MM, no revenue synergy opportunities communicated) and margin expansion as pulp prices decline from 3 year high of $784.

Price Target:

$100-120 using 6.0x EBITDA multiples on 2011 and 2012 EBITDA estimates of $254MM and $290MM; Street at $244MM for 2011 and $261MM for 2012

•  
  • Pure play paper comps trade at 5x EBITDA
  • Branded tissue players trade at 8-9x EBITDA

Thesis:

• US private label tissue end market demand has been relatively stable as demand has consistently grown 2-3% per year for the last 15 years (no down years)
  • I'd highly recommend going thru some of the company presentations on their website with good industry data
• US private label has taken significant share from branded tissue players over the last 7 yrs (pricing typically 15% below branded players)
  • Private label share has grown from 14% in 2002 to 31% in facial tissue from 2002 to 2009
  • Bath tissue share has grown from 13% to 20%
  • Paper towel share from 18% to 31%
• CLW market share in private label is 56% but 70%+ where they are geographically located
• Pulp prices (30% of COGS) are at cyclical highs
  • $694 price (based on Q3 reported number) vs 400-600 range over last 3 years
  • Lower pulp prices will be a tailwind for margins
• Undercovered name (only 4 real firms cover it) that will enjoy multiple expansion as the Market becomes more familiar w/ the story and appreciates the better business mix relative to other paper names
• While the company is focused on cost synergies and feels "very confident" on realizing these, there likely remain revenue synergy opportunities as CLW predominantly is located on the west coast and sells to the grocery channel where CLU's capacity is predominantly on the east coast with most sales focused in the mass merchandise/dollar store channel - this is unmodeled upside
• We will be able to see warning signs of other paper companies entering the market as costs of a tissue plant is $260-280MM and takes 2 years to build
  • No other paper companies have looked to add capacity in this market
  • Conversions require significant capital and large changes in manufacturing which make them less likely to be a source of new capacity
  • Street modeling sequential declines in EBITDA in Q3 despite tailwind of lower pulp/wood fiber costs and lack of real seasonality in the business; Q3 traditionally is the highest revenue quarter for the company

 Investment Risks

• CLW is a price taker as private label tends to follow branded pricing trends
  • Risk of branded pricing declining as pulp prices decline
• Higher pulp prices will hurt margins
  • Mitigant: $694 is near all-time highs and is declining; CLW believes math works on CLU deal at cyclically higher pulp prices
• New capacity could enter the market
  • Mitigant: takes 2 yrs to build capacity and costs $260-280mm to build new facility

Downside

• Assuming pulp prices do NOT change and pulp/paperboard margins decline from 12-13% Q2/Q3 margin levels DESPITE a $40/ton October price hike and $10MM lower maintenance costs in 2011, CLW will do $233MM of EBITDA (Street at $245MM).  Putting a 5.5x multiple on the stock gives you an $78 stock price ($94 on 2012 EBITDA)

 Upside

• A more realistic scenario is that pulp prices come down 5-10% and pulp/paperboard margins improve as the October $40/ton price goes through.  One should keep in mind that pulp/paperboard will have a $10MM tailwind in 2011 due to lower maintenance costs.  In this scenario, CLW does $254MM of EBITDA.  Using a 6x multiple, I get $99 price (23% upside).  Every 0.5x of EBITDA multiple adds $10/share value.  On 2012 EBITDA, I get $120.

Catalyst