Clearwater Paper: Not All Is Clear (NYSE:CLW)

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Just three weeks ago, I offered a few words of praise for shares of Clearwater Paper (NYSE:CLW) as it looked as if the company was making an impressive transformation. The company initially made an acquisition to double-down on its paperboard business, while (announcing) the divestment of the tissue business.
Pro forma debt looked to be manageable, with earnings power looking solid, making me constructive on the shares, although I was looking to learn more on the pro forma implications of dealmaking and organic operating performance.
A dramatic shortfall in the second quarter results, with no quick avail, rightfully sent shares lower, as the transition is a bit risky, at least until the tissue divestment closes.
On Clearwater – A Huge Change Coming Up
Clearwater Paper was a $2 billion business in 2023, comprised out of a roughly equally large paperboard and consumer products business.
With its paperboard business, the company is among the top 5 producers. These activities make cartons, cups & plates, and accessories, with total sales seen around $1.06 billion on which EBITDA margins of 19% were reported, with segment margins reported at 16%.
The consumer products business entail tissue products. These activities include towels, bath products, napkins, among others. With a $1.02 billion revenue contribution, this segment is equally large, yet EBITDA margins of 15% and segment margins of 6% lag that of the paperboard business considerably. Moreover, a market share of 6% gave Clearwater a small share to compete against mighty producers like Kimberly-Clark (KMB) and Procter & Gamble (PG).
Combined, Clearwater posted $2.1 billion in sales, operating profits of $177 million (for margins of 8.5%), with GAAP earnings seen at $107 million, for earnings of $6.30 per share based on a share count of just 17 million shares. Net debt of $463 million was equal to 1.7 times EBITDA of $281 million.
A $40 share price meant that equity was valued at $680 million, for a $1.14 billion enterprise valuation. This valued equity of the business at a mere 7 times earnings multiple.
Two Massive Deals
At the start of the year, Clearwater announced a huge $700 million deal to acquire Augusta, the paperboard manufacturing facilities from peer Graphic Packaging (GPK). The deal could immediately add about $100 million in EBITDA, a number set to rise towards $150 million by 2026. With an acquisition multiple of 7 times EBITDA, or 4.5 times post synergies, this marked a premium compared to a 4 times prevailing multiple at which the business traded itself.
Net debt of $1.16 billion was substantial, yet this was about to reverse. In July, the company announced a $1.06 billion deal to sell the tissue business to Sofidel, although net proceeds were seen at just $850 million, with pro forma net debt seen around $300 million.
As irony will have it, the company saw weakness in the paperboard business in the first quarter. Revenues were down 12% to $244 million as margins were cut in half to 10%, in part due to adverse weather impact at production facilities. On the other hand, the consumer product (tissue) business saw sales up 2% to $253 million, with margins reported at 12%, comparing to a rather break-even result this time last year.
With many moving parts, I found it hard to see the true impact. Shares rose to the $55 mark upon the sale announcement, granting the business a $935 million equity valuation, and $1.2 billion enterprise valuation. This was applied to a $1.06 billion pulp and paperboard business (of its own) as well as the acquired activities from Georgia Pacific.
Based on its $169 million standalone profit contribution in 2023, a similar $78 million corporate cost allocation and profit contribution from Georgia, I believed that the company could post pre-tax profits around $150 million, translating into earnings of $6 and change per share. This would translate into a modest high single digit earnings multiple, amidst low leverage and more focused activities.
With quite some good news priced into the shares and the pro forma implications not all known, I was upbeat on the business, but cautious as well, leaving me to take a wait-and see approach.
A Huge Plunge
Early in August, shares of Clearwater have come into free fall, with shares down from the mid-fifties to $32 at this point in time, resulting in a whopping 40% loss in just about a week’s time.
This came after the second quarter results were highly disappointing. The company grew second quarter sales by 12% to $586 million, in part aided by the acquisition of Augusta which closed in May, midway in the quarter.
The underlying cadence was far less promising. Paperboard sales volumes rose by 46%, while revenues were up just 23% to $334 million on the back of significant pricing pressure, with prices down another 5% on a sequential basis. This meant that segment losses were posted at $12 million (versus a profit of $42 million this quarter last year). Lower prices weighted on margins as well as maintenance efforts.
The consumer products business posted flattish sales at $253 million, with segment operating income of $27 million increasing in a modest fashion. The company continues to guide for the sale of the tissue business in the fourth quarter, with a gradual recovery in the paperboard business seen in the remainder of the year and into 2025.
The company posted GAAP losses of $1.55 per share, with adjusted losses posted at $0.51 per share, even as the second quarter results benefited from a $9 million insurance recovery benefit.
A Nosedive
Shares lost some 40% in response to the earning report, about $22, which is equal to a very sizeable $375 million plunge in the market value. The market value stands now at $550 million, or $1.65 billion on the current enterprise valuation, and about $800 million if we factor in the net proceeds from the pending sale of the tissue business, only set to close in the fourth quarter.
This values the remaining business at around $800 million, with the risks of the deal still having to close, of course. There is a good reason for the plunge as the second quarter performance was very soft, with adjusted EBITDA posted at just $35 million, after a $62 million performance in the first quarter this year, and a $71 million number this time last year.
Second quarter EBITDA was impacted by a $32 million maintenance charge relating to the Idaho plant, set to impact third quart results in part as well, although a bit less with overall EBITDA seen at $58-$68 million. Based on this EBITDA performance, I peg EBIT at just around $10 million in the third quarter, not sufficient to be able to pay the interest bill (at least not until the divestment of the issue business closes).
All this creates quite some uncertainty and debt overhang until the deal closes, as this is not what the company promised in its transformation strategy. It is especially painful to see that the company has doubled down on the assets which are now seeing a painful operating performance, while the divested assets hold up just fine.
And Now?
Having been constructive on the transformation strategy, I am shocked to see the huge shortfall in the results here, as the second quarter was very soft, the third quarter will only show a modest recovery, with the pending sale of the tissue business creating a leverage overhang until that deal will close.
Given all this, I am performing a balancing act. While the pullback in the shares looks enticing, frankly, I am surprised by the operating shortfall in the performance, making me still a bit cautious to buy the dip.