In our shop we have recently been looking for names that to well regardless of the developments in the economy. Clearwater paper (CLW) seemed to fit that bill . Clearwater is organized into two segments, Consumer Products, which produces and sells private label tissue paper, and Pulp and Paperboard, which both produces paperboard used in high-end packaging, and the pulp input to produce both tissue and paperboard. CLW currently trades at $23.67 and we wrote the analaysis below before last week the stock was at $27.27, for a market cap of $449 MM and an enterprise value of $1,155 MM versus TTM EBITDA of $175 MM. All of the numbers below in this write up are based on that higher price. CLW is pretty narrowly followed with 3 amalysts and has about 1/3 of its shares owned by indexes. With this thin stock which only trades an average of 163,000 shares a day, a 1% draw down in the market leads to about 59,000 shares or about 1/3 of the average daily shares traded to hit. We see that the intense current market volitility has likely had a disporporatinate inpact on CLW because of its lack of active manager interest and large exposure to indexes.
We believe there are several idiosyncratic catalysts not priced into the stock. We also find the position attractive for its countercyclical nature, as the business should perform particularly well in the case of a recession. Clearwater has struggled since the stock hit an all-time high of $75 in January of 2015. Since then CLW has fallen into the $20’s due to a number of issues:
Tissue price declines resulting in a $40 MM headwind;
Paperboard price declines due to Chinese competition and a weak dollar costing $80 MM in lost profits;
Higher expenses from transportation, as well as wood fiber and pulp inputs, resulting in a headwind of $48 MM;
Loss of sole source status with Kroger, CLW’s largest tissue customer, resulting in a $25-30 MM headwind.
These issues have more than offset the company’s efficiency initiatives announced in 2014 that were originally projected to increase EBITDA by $115-145 MM.
Many of these headwinds have recently started to abate and Clearwater is likely to see accelerating benefits from several capital projects as they ramp up over the next 4-6 quarters. We believe there is more than 100% upside even if only half of the catalyst we expect occur. We also believe Clearwater shares possess a margin of safety, as a fire-sale liquidation would yield values significantly higher than the current share price.
In the table above (which we preparesd when CLW was at 27.27 now is at 23.67), we outline the bull, bear and base case we see for Clearwater over the next twelve months. Each of the puts and takes to our analysis are numbered and we provide greater detail in order below following a description provided for each of Clearwater’s segments.
Consumer Products: The Tissue Business
Clearwater’s consumer products business produces private label tissue for at home use. Clearwater is one of the largest private label tissue producers in the US. Historically, this business was perceived as being the growth driver for Clearwater. The private label tissue business is characterized by its stable demand and counter cyclical characteristics.
CLW Tissue Assets:
Pulp Input Costs Leading to Industry Capacity Reductions
Pulp is the largest input cost to tissue manufacturing, and because of the persistent increases in pulp prices, US tissue manufacturers have suffered significant margin pressure over the last few years. Many tissue manufacturers are now at a point where they are not meeting cash costs, especially those focused on the lower end of the market that is in oversupply. As a result, it is likely that those market participants with higher costs of production will have to exit the market until prices can rise sufficiently to offset higher costs. Orchids Paper (NYSE: TIS) is on the verge of bankruptcy while both Kimberly Clark and Georgia Pacific have formally announced the closure of plants. Though we have not quantified this in our price target, plant closures should provide longer term support for Clearwater’s tissue business.
Loss of Kroger included in 2018 EBITDA Base
Clearwater’s strongest channel has been grocery which represented 82% of Clearwater’s tissue sales in 2011. Clearwater’s previous initiative to become a national supplier stretched its logistics, leading to excess shipping costs. Prior to 2011, Clearwater was principally focused on the West Coast where it provided nearly 80% of all private label tissue in the region, because of the advantaged locations of its Lewiston Idaho and Las Vegas plants.
In Q3 2017, Clearwater announced that its largest tissue customer, Kroger, would move from a single source model to a multi-source model for private label tissue. We believe the resulting loss of business was approximately 15% of Clearwater’s consumer products sales. Clearwater indicated that they would likely replace 60% of the lost sales by year end. Though this caused a significant headwind for Clearwater and will result in a $25-$30MM decrease in our base level EBITDA for 2018 relative to 2017, we believe it will allow Clearwater to shift to a more regional geographic focus which will mitigate what we believe are significantly elevated shipping costs.
Tissue Segment Catalysts
In February of 2017, Clearwater announced its intention to spend $340 MM to expand its Shelby NC plant by investing in a new paper machine, converting lines and warehouse. Clearwater anticipates the new 70,000-ton New Tissue Technology (NTT) machine should begin production in Q1 2019 and ramp over 18 to 24 months. Once the machine is fully productive, we believe Clearwater will close its least efficient plant in Neenah WI. Clearwater projects that once the NTT machine is fully ramped, the Shelby expansion will generate $60 to $65 MM of incremental EBITDA. For our base case, we anticipate that the Shelby expansion will generate $20 MM in additional EBITDA over the next twelve months.
In connection with the Shelby expansion, Clearwater added two converting lines in its Shelby plant in the 3rd quarter of this year, which should materially reduce their shipping costs. For 2018, transportation expenses have been a significant drag on operating margins for Clearwater. When the new converting lines are up and running, we believe that they will be able to discontinue producing converted tissue product (think plastic wrapped tissue from the store) in their Lewiston plant for shipment to the East Coast. Instead Clearwater will ship parent rolls (large rolls of paper to be converted into final product) to the Shelby plant for conversion and delivery to customers in the South East. This change would represent a significant reduction of transportation expense because it costs $180 per ton to ship parent roll tissue from Lewiston to Shelby vs. $800 per ton to ship converted cases. The company has indicated that 15,000-40,000 tons of converted capacity is shipped from Lewiston to the East Coast. We believe avoiding the cost of shipping converted product will yield an annual savings of $10 to $25 MM. We think those savings are included in Clearwater’s projected incremental products to be produced by the Shelby expansion.