Sylvamo Stock: Potential Increase in Future Payouts (NYSE: SLVM)

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If ever there was an industry that could truly be considered boring due to its combination of maturity profile, descending consumer demand and lack of long term growth prospects one offering a commodity type product and just kind of boring i think paper should be seen as a strong candidate especially paper for copier and printing. It’s not exactly state-of-the-art and digital technologies have quickly replaced many of its uses, a trend amplified by the pandemic with virtual schooling and working from home. Still, with all the stars seemingly aligned against it, the paper isn’t going away altogether anytime soon, and for a certain type of investor could be a great place to hunt for value.

I became a stock owner in such a company, Sylvamo (NYSE: SLVM) last fall following being spun international paper (NYSE: intellectual property), leaving containerboard and other businesses that may have higher growth prospects to the parent company. Sylvamo has released results for the third and fourth quarters of 2021, with enough information to begin to get an idea of ​​its performance and valuation. In addition to my Sylvamo position, I continue to hold my original long position at International Paper, an investment I spoke about in the summer of 2020.

The workings of Sylvamo, 2021 and 2022

Sylvamo is not in the shipping packaging business, but rather limited to printer and copy papers under brands such as Hammermill and Hewlett Packard (NYSE: HPQ) and more, as well as products such as envelopes, paper bags, and food-grade paper packaging, to name a few. The company, which benefits from the size of its former parent company, operates truly worldwide, with production sites in North America, France, Russia and Brazil, where it also owns some 100,000 hectares of forests to be exploited and conserved. Across the footprint, the company employs some 7,500 people, capable of to push 2.8 million tons of uncoated paper sheets each year and 0.58 million tons of paper pulp. The company is run by European Jean-Michel Ribiéras, who has more than 30 years of experience in the industry and comes from the senior management of International Paper.

Converting some of these facts and figures into financial results over the past year really helps things come into focus. For all of 2021, on a stand-alone basis, Sylvamo would have earned $3.5 billion in revenue, with gross margins of 66% and net income of $331 million, or EPS of $7.53. More importantly, in my view, is that Sylvamo generated nearly $0.55 billion in operating cash for the year and has manageable debt. It ended 2021 with $0.042 billion in debt maturing the following year and $1.358 billion in long-term debt, most of which is not due until 2027 and beyond. In 2021, the company paid down $124 million of its debt in the 4th quarter alone and $130 million in total in 2021, while converting $400 million from floating rates to fixed rates, a timely decision.

For 2022, management expects to spend approximately $180 million in capex, $150 million in one-time inventory and transition costs, so $330 million of cash in 2022 is already planned. Assuming cash from operations is only $500 million this year due to rising input costs, that would still leave $170 million for debt reduction and shareholder distributions, and in 2023, these specific one-time costs will disappear, freeing up more for debt reduction. and distributions (or capex as needed), and that’s not counting the $180 million in cash already on the balance sheet.

Dividend valuation and growth

In terms of traditional forward earnings valuation, with a forward PE of 4.5, Sylvamo looks quite cheap compared to its parent company International Paper, as well as WestRock (NYSE: WRK) which is comparable to International Paper, and Ennis (NYSE:EBF)which is not a paper company, but a printing company whose overall health could be seen as linked to the health of the paper industry.

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Data by YCharts

While Sylvamo is getting more results to help the market decide how to fairly price it, the shares have already had a nice recent run, falling from an initial market price of $33.00 on October 1 and falling in the middle of $20 and now up to $39; those buying at $33 have seen around an 18% gain on paper so far, easily outperforming the S&P 500 index (NYSEARCA: SPY) over this same period, which is essentially flat.

Guided by management’s comments on the Q4 earnings call, which made it clear that shareholder returns were being discussed, we can try to figure out where the dividend might start. First, management has been very clear that it expects to be able to start returning something to shareholders by 2022, so it has set the stage for expectations now. Just what it might look like to begin with and where it could possibly go from here is guesswork, but educated guesswork.

First, I’m using a starting estimate of $680 million in total cash available to work in 2022 ($500 million in cash from operations plus $180 million in cash available). Clean up $330 million of capex and one-time costs as shown, leaving $350 million in cash to allocate to debt reduction and dividends. To be on the safe side, I guess the company doesn’t want to take the cash balance below $100 million, now leaving $250 million. Using the $130 of debt reduction achieved in 2021 as a benchmark for 2022, there could be up to $120 million to return to shareholders, although I think that would be the very high end and not at all likely, because I think the priority through the first half of the year or so will be debt reduction. To be at an annual dividend rate of $50 million on 44 million shares would be about $1.14 per share, or $0.285 per quarter. I expect such a return to begin in the 4th quarter of 2022, and at the current share price of around $40, an initial return of 2.85%.

However, as these one-time costs fade after 2022 and debt declines, I believe there will be a story of dividend growth that will play out through 2023 and beyond. At a payout of $1.14, that would only reflect a 15% payout ratio to 2021 earnings, which is certainly a conservative number; while 2022 may be higher or lower than 2021, even a massive 50% earnings cut, hypothetically, would still only put a 30% payout ratio on a $1.14 dividend. The overall point is not the specific calculation of this example, but how safe it is to start at this level and have room for growth even if earnings suffer. Of course, there’s no dividend policy yet, so any investor at this point will have to be prepared to be patient for a few quarters for a dividend to start, and accept that while I think my estimates are conservative, the dividend may well start at an even lower rate than I suggest.

Final Thoughts

Although the paper is not very interesting conceptually, from an investment point of view, it is just as interesting to analyze as any other opportunity that presents itself. While I find a lot to like here, both based on relative valuation and shareholder return, there are clearly long-term risks associated with the underlying industry. The inescapable reality is that the worldwide needs and usage of the types of paper goods that Sylvamo specializes in are the same, in slow but steady decline. There will be individual ups and downs on volume sales quarter-over-quarter and year-over-year, and Sylvamo may find stretches or organic growth, but the writing is on the wall, dating back even before the time of the pandemic.

Matt Elhart, writing for a blog at international fisherman in April 2020 (just as the reality of the pandemic was setting in) noted that uncoated thin paper capacity was declining an average of 1% per year since 2012, and with more work from residence becoming permanent deals, demand could fall even faster as people tend to print less at home. Nonetheless, demand has returned strong in 2021 and management believes 2022 will continue to show higher than expected growth, largely due to the overall improvement in economic health. When asked to provide rationale during the recent call to be positive about this year’s performance, CEO Ribieras responded in part by saying:

I think they have more and more requests for free uncut sheets. One of the things that surprised us is, for example, direct marketing. . . direct mail from USPS numbers, for example, in North America has increased by more than 40%. You therefore have an activity on the economy, even with a pandemic or post-pandemic which is very favorable to the use of our product. . . So there are also specific things like going from loose sheet to uncoated loose sheet. We have seen this with many of our customers. . . much of the work that used to be done on coated fine paper moved to uncoated fine paper and created additional demand that we hadn’t anticipated.

In other words, there is a sort of combination of greater economic activity overall and a tendency to uncoated fine paper paper in which Sylvamo specializes.

Despite the risks, and even with the recent favorable price action on equities, I think there remains real value here. Nevertheless, I realize that Sylvamo will probably never be a type of multi-bagger investment, but a relatively defensive investment that is preparing well to pay back its shareholders in the very near future, and to be able to increase these payments for a degree in the years to come.