Description
If you want to buy a company that has near-term revenue growth of approximately 10%, long-term revenue growth of 4% to 6%, increasing capacity utilization, and a strong technology position with a 2005 P/E of 11.1x going to 7.4x in 2006, then read on.
Polymer Group (POLGA), which emerged from Chapter 11 in March 2003, is a manufacturer of nonwovens. Nonwovens are essentially low cost substitutes for textiles. Prominent applications include diapers and feminine hygiene products for consumers and packaging and wiping products in the industrial sector. POLGA’s customers include consumer product companies such as Procter & Gamble and Johnson & Johnson and industrial companies such as Johnson Controls.
The operating environment for POLGA at this time is very favorable. With 21 facilities in 12 countries, the company’s Asian and Latin American operations are operating at capacity while its U.S. and European operations are operating at approximately 80% of capacity on average. However, certain of these facilities are running at capacity and utilization is increasing at others, especially in the U.S.
Short-term, POLGA’s results will be enhanced by the recent start-up of an operation in Mexico that should boost sales by just over $25 million in 2005 and a similar facility in Columbia that is expected to be fully operation in 2006. With a 25% EBITDA contribution margin, these facilities alone should boost 2006 EBITDA by approximately $12 million to $134 million in total, up from an estimated $101 million in 2004.
Macro Thesis
We think the macro environment in which POLGA competes is attractive for the following reasons:
1. Growth. Over the last 10 years, volume in the nonwovens industry has grown at an average of 7% per year. Overall, this growth has been relatively consistent from year-to-year. Growth is expected to continue at a rate of 7% with growth in developed markets expected at 6% and in developing markets at 8.5%. Even with possible price erosion of 1% to 2%, these are attractive growth rates. Short-term, growth rates should be much higher given strong demand for non-wovens and pass-through of raw materials costs (more on this later). Growth in developed markets is expected to be driven by new applications for non-wovens for which, with a history of over-spending on R&D, POLGA should be well-positioned. For example, the Company is a major supplier for the Swiffer line of products (made by Procter & Gamble) that has shown strong growth recently. Growth in emerging markets is expected to be volume-driven as developing economies modernize. Again, with its widely distributed facilities base, POLGA should be well-positioned to take advantage of this potential.
2. Little cyclicality in consumer sales (55% of sales). Consumer market end products that use nonwovens include diapers, tampons and sanitary napkins, baby wipes, surgical gowns and dressings. Most of these applications are “defensive” in nature and sales of products for these end uses should prosper whether or not economic growth is strong.
3. Sales of industrial products (45% of sales) poised for strong results. This more cyclical component of POLGA’s revenue base represents sales of products such as cable wrap, house wrap, protective apparel and flexible packaging, which is developed from polyolefin fibers. This segment has been posting strong year-over-year results and should continue to do so as economic growth persists in the industrial sector.
The Raw Materials Issue
POLGA’s principal raw materials are polypropylene, polyethylene, and polyester. Owing to rising oil prices this year, polypropylene prices have been on a tear while polyethylene and polyester prices have also risen. The net effect has been for POLGA’s margins to be compressed on a percentage basis although this impact has been offset by volume and price increases and cost-cutting.
Approximately 25% of POLGA’s sales are pursuant to long-term contracts that allow for the pass-through of raw material price increases on a quarterly basis. POLGA’s contracts with P&G and J&J are like this. The remaining 75% of sales allow for pass-through of costs with a 30-day notice period. Since most of POLGA’s facilities are running at capacity, obtaining the price increases has not been a problem. POLGA anticipates increasing the number of long-term contracts given the certainty these contracts offer regarding passing on increasing raw material prices.
Be all that as it may, with rapidly increasing raw materials costs, there is a lag effect between obtaining price increases and the impact of rising raw materials costs on COGS. However, the positive factors of (i) new operations in Mexico, (ii) increasing capacity utilization, and (iii) the continuing impact of cost reduction programs should mean that, on a dollar basis, POLGA will maintain EBITDA levels. Once raw materials costs stabilize, margins for POLGA should increase. In the financial model below, we have not given the Company a lot of credit for this possibility.
Micro Thesis
POLGA offers significant growth potential that is driven by:
1. Attractive industry fundamentals.
2. New facilities in Mexico and Columbia.
3. Free cash flow that is used to repay debt, further increasing earnings and cash flow.
Details of our financial model are provided below.
Polymer Group Model
($ in millions)
Historical(1) Projected
2003 1Q2004 2Q2004 3Q2004(2)4Q2004 2004 2005 2006 2007 2008
Cont.Rev.778.5 206.7 206.6 200.0 213.7 827.0 884.9 946.9 994.2 1043.9
Growth % 3.0% 5.0% 3.9% 8.1% 8.1% 6.2% 7.0% 7.0% 5.0% 5.0%
Mexico Rev - - 4.0 6.1 6.2 16.3 25.5 27.2 28.6 30.0
Cali Rev - - - - - - - 25.0 26.3 27.6
Rev(3) 778.5 206.7 210.6 206.1 219.9 843.3 910.4 999.11049.1 1101.5
Growth 3.0% 5.0% 3.9% 11.4% 11.2% 8.3% 7.9% 9.7% 5.0% 5.0%
EBITDA(4) 92.1 24.5 25.8 24.4 26.1 100.6 115.4 134.2 146.1 159.0
Margin 11.8% 11.8% 12.5% 11.8% 11.8% 11.9% 12.7% 13.4% 13.9% 14.4%
D&A(5) 51.4 13.1 13.3 13.3 13.3 53.1 53.3 53.6 53.8 54.1
EBIT 40.7 11.3 12.5 11.1 12.8 47.6 62.1 80.6 92.3 104.9
Int.(6) 7.0 6.9 27.8 26.2 23.8 20.3
Min.Int.(7) 0.6 0.6 3.1 4.0 4.6 5.2
EBT 3.5 5.2 31.2 50.4 64.0 79.4
[email protected]% 1.4 2.0 12.2 19.6 24.9 31.0
NI 2.2 3.2 19.1 30.7 39.0 48.4
Shares(8) 18.0 18.3 19.1 20.5 22.1 23.9
EPS $0.12 $0.17 $1.00 $1.50 $1.77 $2.02
WC Bal. 140.2 150.0 153.5 153.5 155.3 168.4 184.8 194.1 203.8
Net Income 2.2 3.2 19.1 30.7 39.0 48.4
NI Growth N/M N/M N/M 61.3% 27.0% 24.1%
+D&A 13.3 13.3 53.3 53.6 53.8 54.1
-Cap Ex(9) 10.0 16.1 35.0 30.0 30.0 30.0
-Ch. in WC(10) 0.0 1.7 13.1 16.4 9.2 9.7
=FCF B4 Debt Service 5.4 (1.4) 24.2 37.9 53.6 62.8
FCF Growth % N/M N/M N/M 56.4% 41.5% 17.2%
FCF Per Share $0.30 ($0.08) $1.27 $1.85 $2.43 $2.62
Term Loan Prepayment 5.4 0.0 24.2 37.9 53.6 62.8
P/E 11.1x 7.4x 6.3x 5.5x
P/FCF 8.8x 6.0x 4.6x 4.2x
Notes
1. Historical results exclude one-time and unusual items.
2. The third quarter is traditionally a weaker quarter for POLGA.
3. We have (conservatively) assumed revenue growth of continuing operations at the projected industry rate of 7% per annum for 2005 and 2006 (no price erosion) and 5% thereafter. We have also assumed that the new facility in Mexico produces $4.0 million of incremental revenues in the first half of 2004 when it was only operational for 2 months, $12.3 million in the second half of 2004, and $25.5 million in 2005. For 2006, we projected new revenues of $25 million derived from the Columbian facility that has just begun to be built. For the second half of 2004, we have assumed strong year-over-year growth because of price increases implemented to pass through raw material costs.
4. We have assumed that POLGA’s EBITDA margin will return to the 11.8% level of the first quarter in the second half of 2004 as rising polypropylene prices apply pressure. We then assume that prices will stabilize in 2005 allowing the EBITDA margin to grow at a rate of 0.75% annually in 2005 and 2006. Finally, we assume that the EBITDA margin grows at 0.5% in 2007 and 2008 to 14.4% as a result of operating leverage. We believe that the business could push margins towards 15% over time as was projected in the Company’s plan of reorganization. The upside, however, may be much higher. In 1999, for example, POLGA reported EBITDA margins of 21% for total EBITDA of $190 million. POLGA management is actually targeting 15% EBITDA margins by the end of 2005.
5. We have assumed depreciation and amortization increases of $0.25 million per year from its level in the first half of 2004.
6. Minority interests assumed to be 5% of EBIT.
7. Interest expense is based on an average interest rate of 6.5% per Company guidance. Note that POLGA refinanced its credit facility in April of this year such that interest costs have been radically reduced from 2003 levels. As a result, POLGA should report net income in the third quarter and fourth quarter this year, an event not necessarily appreciated by the market.
8. Shares outstanding include shares from the conversion of the convertible preferred shares that accrue at 16% per year and exercisable options in the money (treasury method). This convertible preferred security causes unwarranted dilution to the Company’s common stock holders. However, it is now callable at any time with cash or stock. We understand the Company is reviewing how to call this preferred without causing a “downward spiral” in the price of the common stock. Forcing conversion (through a call) of this convertible preferred would dramatically increase POLGA’s EPS and CFPS results going forward. We view this conversion as a meaningful event for the common shareholders of the Company, and we do not think the risk of a downward spiral is significant. We are in the process of drafting a letter to the Company’s Board expressing our views on the issue and will post a copy of our correspondence as a message to this posting.
9. Capital expenditures are assumed to be $30 million per year per the reorganization plan plus an incremental $5 million in 2004 and 2005 for the construction of the new facility in Cali, Columbia.
10. Working Capital is assumed to be 18.5% of LTM revenues going forward, an average rate from the last few years.
Valuation
Enterprise Value
$198.6 Equity Value (17.9 million fully diluted shares at $11.10)
(20.9)Cash
30.0 Minority Interest (approximately 6x percentage share of EBITDA)
433.0 Long-Term Debt
________
$640.8 Total Enterprise Value
Comparable Company Analysis
While there are no pure play comparables for POLGA, a selection is shown below. Note that while Intertape Polymer Group is often mentioned as a comparable to POLGA, it is so only for certain elements of the oriented polyolefin part of POLGA’s business, which is less than 25% of POLGA’s total sales. It is not a good comparable.
Comparable Company Multiples
EV/ EV/
P/E P/E EBITDA EBITDA
Company Ticker 2005 2006 2004 2005
DuPont DD 15.9x 13.4x 9.9x 8.6x
Intertape Polymer Group ITP 9.1x N/A 7.8x 6.5x
Japan Vilene 3514 JP 16.6x N/A 7.9x 7.4x
Buckeye Technologies BKI 11.0x N/A 10.4x 7.8x
Kimberly-Clark KMB 16.5x 15.1x 10.3x 9.8x
Median 15.9x 14.3x 9.9x 7.8x
Polymer Group POLGA 11.1x 7.4x 6.4x 5.6x
Sources: First Call, IBES and Toyo Keizai estimates.
Using these multiples results in the following valuation targets.
Comparable Company Valuation
EV/ EV/
P/E P/E EBITDA EBITDA
2005 2006 2004 2005
Valuation Multiple 15.9x 14.3x 9.9x 7.8x
POLGA EPS/EBITDA $1.00 $1.50 $100.6 $115.4
POLGA Target Value $15.88 $21.41 $30.98 $25.89
Average $23.54
Discounted Cash Flow Analysis
Given the lack of good comparable companies, we have also used a DCF analysis to value POLGA. For our analysis, we used the same assumption as in our above model.
Implied Share Price
Discount Rate Implied Terminal
10.0% 11.0% 12.0% 13.0% 14.0% FCF Growth Rate
Terminal Multiple
6.0x $22.45 $20.90 $19.42 $18.00 $16.65 3.5%
6.5x $25.48 $23.83 $22.25 $20.73 $19.28 4.1%
7.0x $28.52 $26.75 $25.07 $23.45 $21.91 4.6%
7.5x $31.55 $29.68 $27.89 $26.18 $24.54 5.1%
8.0x $34.58 $32.61 $30.71 $28.90 $27.17 5.5%
Blending valuations from the discounted cash flow analysis and comparable company analysis supports our price target of $20 to $25 per share, a gain of 80% to 125% from current levels.
Potential Upside
1. A take-out. Given that MatlinPatterson owns over 80% of the Company, pursuing a sale may be their best exit option. We think strategic acquirers would find POLGA’s market-leading position and the potential for an accretive transaction as attractive. We also think financial acquirers would show interest in the high single digit EBITDA multiple range.
2. With the convertible PIK preferred callable at any time, we anticipate POLGA will call this security soon. This will dramatically improve the per share results we have anticipated. We are actively promoting this transaction with the Company.
3. Increased margins. The Company has set its sights on reaching a 15% run-rate EBITDA margin over the next 12-18 months and a 20% EBITDA margin in the next 5 years. If POLGA hits these numbers, a value of $30 per share would be justifiable.
Potential Issues
1. Increasing polypropylene prices and other raw materials costs may continue to pressure margins for POLGA. Fortunately, with many operations running near capacity and long-term contracts, POLGA has been able to pass on much of the increased pricing albeit with a lag effect.
2. With over half of POLGA’s sales in international markets, the company does have some foreign exchange risk. However, if you are long-term negative on the dollar, this factor is a positive.
3. This is an illiquid stock with a small float. In our opinion, this should be strong motivation for MatlinPatterson to sell the Company.
Catalysts
1. Conversion of the convertible PIK preferred.
2. Stabilization of oil prices.
3. Sale of the Company.
Bottom Line
Polymer Group is an inexpensive producer of nonwovens that has gotten little attention. The Company offers upside from attractive industry characteristics, new facilities, and deleveraging. If POLGA redeems its preferred shares with common stock, per share results will get a significant boost. Finally, with over 80% ownership, we think a sale of the Company is a likely exit strategy for MatlinPatterson.
Catalyst
1. Conversion of the convertible PIK preferred.
2. Stabilization of oil prices.
3. Sale of the Company.