Smurfit-Stone Container Corporation SSCC
July 02, 2010 - 12:06am EST by
todd1123
2010 2011
Price: 22.00 EPS $2.00 $3.00
Shares Out. (in M): 101 P/E 11x 7.3x
Market Cap (in $M): 2,222 P/FCF 6.25x 4.75x
Net Debt (in $M): 722 EBIT 365 515
TEV ($): 2,944 TEV/EBIT 8.0x 5.7x

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Description

I am recommending a long equity position in Smurfit-Stone Container Corp (new equity ticker = SSCC), an un-loved / mis-understood / under-valued post-reorganization opportunity which presents a compelling risk-reward proposition with a total return potential of >60% over the next 3 – 6 months (on a standalone basis) and >100% in the event of further containerboard industry consolidation.  As you may recall, Smurfit filed for bankruptcy in January 2009 and emerged in June 2010 (upshot was that ~$2.9Bln of general unsecured claims comprised mostly of pre-petition unsecured notes was equitized); the effective date for the equity was yesterday / July 1, 2010.  Given mgmt incentives (large part of comp package is driven off of restricted equity struck at the 30-day moving average price post emergence – July 1 – 30) and existing shareholders (largely distressed funds that have owned the bonds for the past ~1 year at lower prices), the equity has traded off from an equivalent price of ~$30 / share (bonds traded >par on couple occasions in the past few months) to its current $22 / share level (July 1, 2010 close). 

 

At current prices (~$22 / share), Smurfit trades for less than 3.4x 11E EBITDA, or >1.5x EBITDA discount to its closest peers, and >20% FCF yield.  Given Smurfit has >6.5MM tons of containerboard capacity, the enterprise currently trades for less than $450 / ton (EV / ton), which compares to its closest peers at >$1 - $1.25k / ton (so Smurfit trades for less than 40% of its peers’ based on capacity).  While the business is an attractive standalone investment (w/ 50 – 70% upside – FV target of around $35 / share), there is also the real possibility of an M&A trade (GP, TIN and PKG are the highest probability suitors).  More pragmatically, however, Street coverage will be rolled out on Smurfit over the next 2 – 8 weeks and I’d anticipate incrementally positive information.  In addition, more communication from Smurfit management  (effectively radio silent during the past 18 months) will likely be viewed favorably.

 

Summary Capital Structure:

 

Current Price

$22.00

Shares Out (MM)

101

Mkt Cap (MM)

$2,222

Net Debt (YE 10E)

$722

TEV

$2,944

Net Debt / TEV

0.2x

 

 

Capacity (tons)

6,504

 

 

EBITDA - 09A

500

10E EBITDA (conservative)

725

11E EBITDA (conservative)

875

 

 

Multiples:

 

EV / Ton

453

 

 

10E - EV/EBITDA

4.1x

11E - EV/EBITDA

3.4x

 

 

Implied 10E EBITDA / Ton

111

Implied 11E EBITDA / Ton

135

 

 

Summary thesis:

 

At the time of the June 2009 write-up, Smurfit was trading at a ~$1.8Bln valuation (around trough valuations) through the bonds which compared to a valuation of ~$5.8Bln 3-years ago (i.e. pre-Lehman levels – naysayers would argue BC age … and AD ain’t going to be BC).  While I’m not docking on reverting back to pre-Lehman valuation levels, at current prices (~$22 / share), Smurfit can be created for less than $2.95Bln based on 10E net debt of $722MM (or around ~50% of its pre-Lehman valuation levels).  Notably, this compares to Smurfit’s closest peers (TIN, IP and PKG) that currently trade at ~80 – 95% of its pre-Lehman levels. 

 

The investment opportunity is compelling on two fronts: (i) fundamentals and (ii) technicals (ironically, I’m more excited about the technicals).  First, the fundamentals are pretty basic.  Smurfit has taken early steps in improving their cost structure (head-count reductions, mill / plant closures, exiting punitive hedge contracts, reducing SG&A).  My sense is that SG&A will be >$150MM lower than prior years, which equates to 200 – 300 bps of margin improvement.  Regarding investor sentiment, Smurfit still is pretty much uniformly hated (creating a low hurdle).  In talking to other investors, most remain skeptical of the new CEO (Steve Klinger – the “wonder-kid” from GP).  My sense is that he’s a strong operator and probably has a keen sense of maximizing value. 

 

While Smurfit’s historical financials (past two years) are muddy, I’m using management’s 2009 EBITDA of ~$500MM as a starting point.  My 2010 takes into account the first two price increases (aggregate amount of ~$110 / ton) implemented across the containerboard industry this year.  In addition, I gave Smurfit partial credit for its cost initiatives (that were implemented during the bankruptcy process).  Notably, however, my 2010E EBITDA estimate of $725 - $750MM does NOT take into account the recently announced $60 / ton price increase (that GP / Rock-Tenn have kicked off w/ but should be supported by entire industry over the next couple days) for an August 1st implementation.  Regarding 2011E EBITDA, I believe an estimate of $875MM will prove conservative (and could see >$1Bln if the 3rd price increases stick).  Interestingly, my 11E EBTIDA estimate implies approximately $135 EBITDA / ton … in comparison, Smurfit’s peers are estimated to generate ~$200 EBITDA / ton based on consensus 11E estimates.

 

Regarding the technicals, there are notably three items I’m focused on (the first two create a 10 – 30 day window to build ownership positions in the Smurfit enterprise … and the third should help in realizing fair value over the next 3 – 6 months): (i) mgmt compensation (they are motivated to talk down the story over the next 30 days given ~75% of their initial equity is driven by restricted shares w/ a strike driven by the 30-day post-emergence / i.e. July 1 – 30th), (ii) existing shareholders (mostly comprised of large / distressed funds that owned the bonds / now equity at lower prices), (iii) and Street coverage (I’d expect 4 – 6 analysts to roll out coverage over the next 1 – 3 months  - my sense is that most analysts will be favorable on the name).  It’s also worth noting that further communications out of Smurfit management will likely be a positive catalyst (given management has effectively been radio silent for the past 18 months).  In talking to a couple investors, it sounds like a new IR team will be in place shortly at Smurfit … and an Investor Day is also being scheduled for the next couple months.

 

Catalysts:

 

New Ownership (30 – 90 days): mgmt Investor Day and new IR team should help in creating new interest

 

Mgmt Incentives fully aligned (30-days post July 1, 2010): >75% of mgmt’s current equity grant (in the form of restricted shares) is driven by the 30-day average trading price post emergence (i.e. July 1 – 30, 2010).  My sense is that they have every reason to “talk down” the story (or keep relatively quite) over the next 30 days.  More notably, assuming there is an Investor Day conducted over the next few months, I’d expect mgmt’s pulse to be more upbeat

 

Street rolls out new coverage (1 – 2 months): In talking to a couple analysts, my sense is that Smurfit will be viewed incrementally positively given its scale

 

Smurfit fundamentals (1 – 6 months): My sense is that consensus is skeptical and thinks anything >$600MM is a stretch for 10E EBITDA.  The reality is that >$700MM seems readily attainable.  More notably, investors are skeptical of any SG&A improvements (implemented during 2009) and are complacent around Smurfit’s recent / new business wins (in talking to couple industry folks, my sense is that Smurfit has picked up a couple large accounts that should help shift more production to higher-margin domestic customers vs the lower-margin / export business that Smurfit has done in the past)

 

Containerboard industry data (1 – 6 months): Inventory levels currently at 30-year low levels and 3rd price increase of $60 / ton expected to go through on August 1st

 

NOLs (1 – 3 months): While I don’t expect much on this front, I think there will be additional / incremental value through improved CF in 10E / 11E given less tax leakage

Maximizing the balance sheet (1 – 12 months): Given the conservative leverage levels (less than $725MM of net debt at YE 10E), there could be various opportunities to provide value to shareholders (share buybacks / special dividends, etc)

 

M&A optionality (1 – 18 months): Given Smurfit’s scale, could easily see TIN, PKG or GP reaping >$500MM of “synergies” from a Smurfit acquisition … assuming 11E EBITDA of $1.375Bln (PF for synergies), Smurfit currently trades at ~2x PF 11E w/ synergies

 

Risks:

 

Pension: Smurfit had a ~$1.2Bln under-funded pension at YE 2009.  When comparing Smurfit’s pension assumptions to IP, TIN and PKG, my sense is that Smurfit is being overly-punitive in the tune of $300 - $400MM given discount rates.  In addition, if I’m directionally correct w/ my 2010E estimates, I believe the pension risk will be significantly less by YE 10E.  More notably, given how conservatively leveraged Smurfit is (less than $725MM of net debt on its balance sheet at YE 10E per mgmt’s July 1st presentation), I don’t view the under-funded pension amount as a significant risk

 

Double-Dip Economic Scenario: Given containerboard is a pretty decent proxy of domestic GDP, a double dip scenario would be the key risk to volumes / pricing

Catalyst

New Ownership (30 – 90 days): mgmt Investor Day and new IR team should help in creating new interest

 

Mgmt Incentives fully aligned (30-days post July 1, 2010): >75% of mgmt’s current equity grant (in the form of restricted shares) is driven by the 30-day average trading price post emergence (i.e. July 1 – 30, 2010).  My sense is that they have every reason to “talk down” the story (or keep relatively quite) over the next 30 days.  More notably, assuming there is an Investor Day conducted over the next few months, I’d expect mgmt’s pulse to be more upbeat

 

Street rolls out new coverage (1 – 2 months): In talking to a couple analysts, my sense is that Smurfit will be viewed incrementally positively given its scale

 

Smurfit fundamentals (1 – 6 months): My sense is that consensus is skeptical and thinks anything >$600MM is a stretch for 10E EBITDA.  The reality is that >$700MM seems readily attainable.  More notably, investors are skeptical of any SG&A improvements (implemented during 2009) and are complacent around Smurfit’s recent / new business wins (in talking to couple industry folks, my sense is that Smurfit has picked up a couple large accounts that should help shift more production to higher-margin domestic customers vs the lower-margin / export business that Smurfit has done in the past)

 

Containerboard industry data (1 – 6 months): Inventory levels currently at 30-year low levels and 3rd price increase of $60 / ton expected to go through on August 1st

 

NOLs (1 – 3 months): While I don’t expect much on this front, I think there will be additional / incremental value through improved CF in 10E / 11E given less tax leakage

Maximizing the balance sheet (1 – 12 months): Given the conservative leverage levels (less than $725MM of net debt at YE 10E), there could be various opportunities to provide value to shareholders (share buybacks / special dividends, etc)

 

M&A optionality (1 – 18 months): Given Smurfit’s scale, could easily see TIN, PKG or GP reaping >$500MM of “synergies” from a Smurfit acquisition … assuming 11E EBITDA of $1.375Bln (PF for synergies), Smurfit currently trades at ~2x PF 11E w/ synergies 

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