Description

Klabin (KLBN11 BZ) is a short. The name trades at 11.6x ev/2017 ebitda and 11.8x ev/2018 ebitda vs its historical average multiple of 10.7x. Consensus numbers for 2017 and 2018 are 22% and 30% too high.

Thesis: Chinese hardwood pulp prices are going to drop $50/ton over the next 6 months driven by the ramp of APPs Oki mill in south sumatra. As this happens, pulp prices for Klabin's newly constructed Puma mill output will fall, pressuring ebitda. Longer term, the company has said they want to expand production of liquid packaging board by constructing a new mill, however Fitch has said if they build the mill they'll downgrade the company. Klabin is leveraged 5.1x net debt/LTM ebitda. In fact, Fitch has said they could take negative actions against Klabin if their leverage remains above 3.5x in 2017 vs the company's guidance of 3.2x, which is too optimistic. I believe a downgrade is likely - with or without the construction of the new consumer board mill. If they do build the mill, it will help the diversify away from falling pulp prices, however the company admits the liquid packaging board market is oversupplied and another mill would weigh on global prices. I estimate 18% of global LPB demand is set to come online over the next 3 years assuming a Klabin LPB mill ramp. The company's EVA spread has been negative HSD/LDD and I expect it to remain so for the forseable future.

Risk/Reward

How do we get paid?

1) ebitda misses/ street resets numbers lower, 

2) ramp of APP's oki mill pressures pulp prices

3) company delays ramp of new consumer board mill

4) Fitch downgrades the company's debt, sending borrowing costs higher and further pressuring their already negative EVA spread

5) company builds new consumer board mill, adding debt to structure, forcing downgrade, and sending LPB prices lower

What is the street missing? 

Street numbers are 50% too high in the company's forestry segment due to a spike in wood prices early in the year due to abnormally high rainfall/flooding - they assume largely flat prices. For those that don't, they are missing the fact that the company has had to repurpose their forestry segment to feed their new pulp mill, which is goign to result in lower external wood volumes going forward. 

Street also models flat pulp prices, while in reality pulp prices are going to be falling due to the ramp of APPs mill. Klabin's mix shift to fluff pulp will help offset some of the headwind, but not all of it - i am 15-20% below on pulp ebitda looking out the next few years. 

Street price targets of 20 BRL/unit assume a 10.5x multiple - in line with the company's historical multiple - despite 30% of the company's EBITDA now coming from pulp, and pulp comps (Fibria, Suzano) trading at 7x EBITDA. Weighting the company's new mix the street should be assuming a 9-9.5x multiple. I see 40% downside to Klabin's share price assuming a 9x multiple and 2.6bn BRL in 2017 EBITDA. This assumes a hardwood pulp price of 477, softwood price of 577 and a fluff price of 627, fluff production ramping to 75% by the end of 2017 and spot USDBRL. 

APPENDIX:

Global Pulp Supply-Demand
'000 tonnes
		2013A	2014A	2015A	2016E	2017E	2018E	2019E	2020E
Capacity
Total BHKP		30,280	31,115	32,680	34,305	36,383	39,826	41,923	43,250
Total NBSK		25,860	26,025	26,130	27,300	27,865	28,520	28,730	28,630
Total capacity		56,140	57,140	58,810	61,605	64,248	68,346	70,653	71,880
% change		2%	2%	3%	5%	4%	6%	3%	2%
Consumption
North America		7,555	7,535	7,599	7,633	7,646	7,638	7,631	7,625
% change		4.5%	-0.3%	0.8%	0.4%	0.2%	-0.1%	-0.1%	-0.1%
Europe		17,285	17,525	17,593	17,701	17,795	17,973	18,000	18,023
% change		1.3%	1.4%	0.4%	0.6%	0.5%	1.0%	0.2%	0.1%
Latin America		3,150	3,310	3,418	3,520	3,626	3,722	3,820	3,897
% change		1.8%	5.1%	3.3%	3.0%	3.0%	2.6%	2.6%	2.0%
China		14,580	15,240	16,741	18,247	19,525	20,891	22,354	23,471
% change		6.2%	4.5%	9.8%	9.0%	7.0%	7.0%	7.0%	5.0%
Others		9,380	9,160	9,251	9,390	9,484	9,544	9,605	9,667
% change		-1.2%	-2.3%	1.0%	1.5%	1.0%	0.6%	0.6%	0.6%
Total consumption		51,950	52,770	54,602	56,491	58,075	59,768	61,410	62,683
% change		2.6%	1.6%	3.5%	3.5%	2.8%	2.9%	2.7%	2.1%
Global Pulp Utilization Rate		92.5%	92.4%	92.8%	91.7%	90.4%	87.5%	86.9%	87.2%
Year to year change (bps)		20bps	-18bps	49bps	-114bps	-131bps	-294bps	-53bps	29bps

Global Liquid Packaging Board Supply-Demand

Annual global demand growth: LSD

Catalyst

1) ebitda misses/ street resets numbers lower, 

2) ramp of APP's oki mill pressures pulp prices

3) company delays ramp of new consumer board mill

4) Fitch downgrades the company's debt, sending borrowing costs higher and further pressuring their already negative EVA spread

5) company builds new consumer board mill, adding debt to structure, forcing downgrade, and sending LPB prices lower