Description

RYAM has been a game of whack-a-mole past 12-months (thesis = cycle recovery story on a biz suffering from <0% ROIC on a highly specialized product, industry suffered from ~8-yrs of over-supplied conditions (Bracell supply in 2013-2014 timeframe), and improved S/D would drive path >10% ROIC). Refinancing successfully completed, and market re-focused on earnings power trajectory (and mgmt. over-promised on 2023 and stumbled). Inventory de-stocking and commodity pulp declines fueled the fire more recently on the bear case … Given a highly leveraged cap structure, the stub equity was floppy during this 12-month stretch as sentiment swung positive (earlier in 2023) and then negative more recently (and now priced for death).

Fast forward to today, merits for a re-fresh came this past week w/ the GP Foley supply closure (12-15% of global supply), yet the market is dismissing + bears are highlighting the rearview case that demand is bad – but that’s the rearview perspective. There are historical analogs for supply reductions in the specialty cellulose industry (mid-2003 / below), and this is the "hook" that drives improved S/D, and ROIC for RYAM.

Having earned many battle-wounds in commodities over the years, demand is difficult to call (in fact it’s arguably a loser’s game), but supply doesn’t lie … more importantly, when supply removal occurs, rule-of-thumb is that ~5% global supply cuts (ala refining during COVID) is a ring-the-bell wake-up … in the case of specialty pulp (~1.5MM ton market), a 12-15% supply closure is a BIG deal (yet market ignoring). More discussion on this below but summary of S/D at top = why important

Supply: On the supply side, GP Foley announcement is a big deal confirmed through multiple checkings this past week. More discussion below on what 12-15% global supply reductions means (n-term) for RYAM … as well as historical analogs (mid-2003 supply closures) on what this means m- to l-term for RYAM … but removing ~230-250k tons of nameplate (on a ~1.5MM market) or ~170k of actual production is significant.

Demand: As it relates to demand, this is one of the more interesting aspects to cellulose specialty pulp as it kind of trudges along at global GDP – largely due to ~70% of end-market applications being v stable … the other ~30% might deviate from mean (i.e. construction applications), but there’s reversion to mean. More importantly, CS alternatives are few (small part of the COGS, mission critical and literally can’t shift out to alternatives in many applications). Said a different way, CS demand is niche (~1.3MM tons on a ~1.5MM nameplate capacity) and is v v sticky (growth in demand likely calls for additional 30-40k tons of capacity per annum).

Industry op rates: in the mid-80s nameplate and high 80s effective ... this likely shifts both closer to ~95-100% (unique times as plants typically can't function above 90%). Foley line 1 (CS) is already down from what I hear ... and line 2 (fluff pulp) is in run-down and likely runs out of inventory next 3-5 weeks before full closure.

N-term benefits to RYAM: Supply closure: GP announced closure of 12-15% of the global supply curve at Foley plant (230 - 250k nameplate CS capacity on ~1.5MM ton market, was producing around 160-180k by my estimate).

1) RYAM likely picks up ~65-70% of this biz (call it ~130k tons / allows them to shift capacity away from commodity ops to CS which is a >800-900/ton pick-up in revenue (specialty versus commodity).  For the sake of conservatism, let's assume $500/ton of improved px to be conservative on the ~130k tons of picked up volume, implies close to $50MM of earnings power lift on this RYAM new biz …

2) RYAM will be the only provider of ~150k tons of other CS grades (namely casings, tire cords and specialty filtration) following the closure as well (literally no other producer away from RYAM). Assume $500/ton uplift on this portion = ~$75MM uplift in earnings lift on the RYAM as single-source producer …

3) On the rest of RYAM CS biz (~400k tons of CS), conservatively assumed ~$250 / ton improvement in pricing (TBD, but using the historical 2003 analog of supply cuts, industry witnessed a ~9% CAGR in pricing for >7-yrs) = $100MM uplift in year 1 (this could be a multi-year uplift of ~$50-$100MM of EBITDA in the out years !

M-term / L-term benefits = Historical analog (2003 – 2010+ upcycle)

Interesting historical analog to focus on (Natchez IP facility closed mid-2003 and the industry went through a 10-yr uplift following) - see analog math below, but RYAM captured ~40k tons of biz, and pricing went up ~9% CAGR over the next 6-yrs = EBITDA / ton went from $106 to $380 / ton from 2003 - 2010 and EBITDA for RYAM (on less than 480k tons of capacity) went from $75MM to $272MM

“So-what” on valuation:

The so-what for RYAM is that the biz likely goes from ~$200MM of EBITDA (will be less than that in 2023E for various reasons but let’s assume that’s the baseline) to well north of $400MM in the n-term. More importantly, this doesn't give credit to the multi-year uplift in pricing power(~9% CAGR 7-yrs above would imply $50 - $100MM of additional earnings power uplift per annum for next 5-yrs). Contracts are set annually (typically around London pulp week in Nov) so the Foley closure (line 1 CS offline, line 2 fluff is coming down end of Oct post inventory burned off) is timely into YE negotiations for 2024 pricing. Using n-term math, RYAM equity is ~2x EBITDA and ~2.7x EBITDA-capex (and get multi-year pricing power on top – multiple drops by ~0.5x per annum in the out years using $50-$100MM improved earnings power per annum).

RYAM has their Investor Day on Oct 10th (more clarity to come on this). Q3 - Q4 earnings power will be lousy (market already pricing that in), market ignoring this significant capacity cut announcement (where puck is moving) ... TBD on strategic alternatives they disclosed on the Q2 call related to non-core biz segments, but my sense is that RYAM might be in the early innings of running a sale process on its Temiscaming paperboard plant (industry checkings suggest >400M px tag is not unreasonable). If assume paperboard is a $50MM contributor to bottom line, the "create" on RYAM will be ~1.3x EBITDA and ~1.6x EBITDA-capex by my math (w/ multi-year runway on pricing)

Valuation / what playing for if right on supply reduction improving earnings power:

More to be learned at the Investor Day, and regardless of what updates they provide on strategic alternatives (my sense is Temiscaming paperboard asset might be up for sale – possibility of a >400MM debt deleveraging event), the upside case on RYAM is getting v interesting as the earnings power inflection could be significant

Math below assumes a 7 – 10x unleveraged FCF multiple (EBITDA – capex) and still assumes 100MM of capital expenditures. If right on the earnings strategic alternatives, this one can get interesting …

What keeps this all grounded is that the earnings power figure below is assuming a mid-20% EBITDA margin for the HPC segment (i.e. ~10-15% EBIT margin). During the prior 10-yr bull market, EBITDA margins pushed north of ~40%+ and this ultimately induced additional supply from Bracell focusing on acetate. 20-30% EBITDA margins (10-20% EBIT) still implies a 5-10 year payback on new investments which isn’t enough to incentive supply.

Catalyst

GP closing 12-15% of global supply = big deal for S/D, pricing power and ROIC

Market starts to appreciate ~150-175k tons of RYAM will be sole-source provider (previously split w/ GP)

Market starts to appreciate customers scrambling for certainty of supply

Oct 10th investor day for RYAM

Nov London pulp week (sets 2024 pricing)