VANCOUVER, BC, 13 August 2015 (Viewpoint) - excerpt from RBC Dominion Securities
We maintain our Outperform rating but lower our price target to $17 (from $19) on reduced estimates, as we see the company focusing on preserving recent (impressive) market share gains.
Encouraging pricing developments for some producers - On the consumer side, KP Tissue highlighted that the leading US branded producer, P&G, has apparently begun to desheet in the US marketplace in recent weeks (effectively a price increase "under-the-roll"). One of our trade contacts estimated this represents a ~6% sheet count reduction on bath tissue. This development comes at the same time that some private label oriented tissue producers have explicitly announced pricing initiatives, with Clearwater out with an August hike in the US (we estimate CLW guidance implies it expects to eventually realize ~1.5% pricing improvement), and Cascades out with its own initiative (magnitude/timing unknown) on both sides of the border. On the away-from-home (AfH) side, while the July 2014 NA hike completed its partial implementation by June 2015, Wausau's recent increase in Canadian AfH (to partially offset the weaker loonie) suggests further potential pricing upside for some participants in the Canadian AfH market (where KP has ~27% share) over the next 12 months.
Strong case for a price hike in Canada (in addition to desheeting)...In our view, KP and other Canadian tissue producers have a strong case for raising prices. With the weaker loonie and elevated pulp prices also impacting the profitability of both Kimberly-Clark and P&G's Canadian businesses (as neither company has its own pulp mills), they would likely not stand in the way (their market share trends suggest they are already pulling back a bit from Canada). Although NA NBSK benchmark list prices have decreased by US$70/tonne (7%) since a year ago, the steep decline in the loonie has meant that C$ prices have actually risen by C$138/tonne (+12%) over the same period. With domestic tissue sales conducted in Canadian dollars, KP has seen margin pressure in its core Canadian business. By contrast, Canadian containerboard producers (a similarly consolidated market) began pushing an ~8% price increase in March/April to preserve margins and that hike has now largely gone through.
...but we worry that KP may focus on preserving share over gaining price - While we think that KP will likely follow P&G's lead and desheet in Canada over the next 2-3 months, we fear that it may prioritize maintaining market share, desheeting to a lesser extent than Procter, as the last time that it desheeted in Canada (following Kimberly-Clark's ~6% reduction in mid-2013) its biggest Canadian competitor, Irving (which has been gaining share as well), did not follow suit. As such, we are trimming our EBITDA forecasts for 2015 and 2016 by $11MM (-8%) and $12MM (-7%), respectively.
Valuation: Our $17/share price target is based on a sum of the parts. We value the legacy tissue operations (non-Memphis TAD) using an 8.25x EV/EBITDA multiple on our legacy asset 2016 EBITDA estimate of ~$97MM. We value the Memphis TAD project based on an NPV of ~$3.25/share. We adjust net debt for the ~US$312MM TAD Capex and the present value of the unfunded pension (~$90MM).
Price target impediments:
Primary impediments to achieving our price target include delays in ramping up production of the Memphis TAD machine and potential pricing weakness as North American nameplate tissue capacity expands more quickly than demand in 2015/16. A stronger-than-anticipated Canadian dollar or higher-than-expected fibre and energy costs would negatively impact operating margins.
Hamir Patel, RBC Dominion Securities