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SFK Q3-2009 Earnings


SharperDingaan
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A subject we're sure is dear to many hearts!

 

A few initial thoughts, following which we'll post more fully in a weeks time  ;)

 

1) They could really use a better press agent; the numbers are actually quite solid, but you wouldn't know if from the headline.

 

2) There is 9,082 of very favourable one-time charges in here; 2,097 inventory write-up (Note 3), 2,570 immediate expensing of all deferred financing charges (Note 13), & 4,415 of OCI (IFRS related) which technically didn't have to occurr untill 03/31/2010. Conservative write-offs.

 

3) The recent black liquor subsidy is entirely off BS. Conservative vs some of the other pulp mills.

 

4) There's a 4,345 FX loss on translation, & another 4,415 FX loss in OCI? Worth a question!

 

SD

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Average Prices for NBSK was 693 and 730 in Northern Europe and America during the quarter.  If current prices persist, Q4 numbers should look far more solid! 

 

From MD&A:

Assuming full capacity, no market related downtime and the US exchange rate as at

September 30, 2009, a change of US$10 per tonne in the price of NBSK pulp has, on an

annualized basis, an impact of approximately CAN$3.9 million or $0.04 per Unit on SFK Pulp’s

net (loss) earnings (based on 90,472,708 Units outstanding, and before giving effect to the

conversion of the outstanding Debentures).

 

If current price conditions persist for a full year the current unit price looks very reasonable. 

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Did anyone notice that the press release was more interesting in what it didn’t highlight.

 

(1) Gross margin is now @ 8.6% - & in the low end of their ‘norm’; higher prices & greater throughput should widen it in Q4, & the 10% workforce reduction in 2010 should keep it up. A sustainable 12-13% margin is starting to look feasible. (2) Sales & Admin is again stable at aprox 2.9% of revenue. (3) The FX income & derivative effects are cyclical (as % of revenue), they are now trending upwards, & the adverse impact will further diminish as the revenue grows. EBITA is not just positive.   

 

(4) NBSK volume was an improvement over Q3-08, & materially higher than Q1-09. The revenue impact is primarily pricing, & the current Q4 price is now roughly $50/ton higher than Q3 was. RBK volume was lower than Q3-08, but the volume is also materially higher than Q1-09. They are gaining market share, & it is significantly improving the fixed cost/ton amortization.

 

(5) Booking OCI now, versus later, has made the P&L less volatile going forward - & set the FX rate at a fairly high .9327 going into Q4. If the 12/31/09 FX rate is lower, there will be FX gains in both OCI & the P&L (less so as the FX rate is averaged). The BoC has repeatedly stated the current FX rate is a problem, & aggressively brought it back down over October to the 09/30 level. Recent job loss reports would seem to favor a further F/X decline.

 

Lot of core strength starting to show, & the further we get into the quarter the more certain we can be of the FX impact. It will take very little to generate a surprise quarterly EBITA in the 6-10M range.

 

No wonder they’d like to keep it quiet ;)

 

SD

 

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Pulp prices increased again on the week! It is has been an incredible upward move in the price of PULP. The USD price is now $818 per ton. Canfor has said it will be charging $830 per ton for November...the last tme we had this type of move we got paid out .65 cents in distributions on the year! 2007..

 

SD,

 

It would be nice to get above the dollar mark which we agreed is a going concern price. After that we will have the fundamentals actually matter. It seems that SFk for the first time in a long time has momentum in their business. I agree that they need a PR director! However, if you see insider buys as we did in the 40 cent range you wil have your answer.

 

Aside.

Does it not make sense for Canfor Pulp to take out SFK? They have cheap wood chips so costs could be cut immediately....they could sell the US operations and it would be free to them. They would buying the assets at about 20 cents on the dollar in rising pulp price environment.

 

Dazel. 

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The reality is that SFKs revival isn't going to get taken seriously untill they post a solid quarter of strong earnings and a fat EBITA. The price will jump significantly, & the mantra will be 'how could we have missed it'. Good chance it'll be Q4, but the FX rate is the wild card.

 

We ultimately expect a US Steel type industry wide restructuring. All the existing players selling their best pulp plants into 2-3 Canada wide entities, with governmental assistance in the shutting down of old plant & the retiring of surplus workforce. Something loosely akin to how the East Coast fishing industry was shut down, & the current efforts in the auto industry. The global recession/depression being the driver that finally makes it possible.

 

Nobody is going to be stealing these companies with low bids.

 

SD

 

 

 

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  • 3 weeks later...

 

 

SD,

 

I agreed with your post earlier when you said that no one would be stealing these companies with low bids....However, the dynamic in Canada has changed somewhat with reference to Canfor pulp and SFK. Canfor pulp has a market cap of almost $300 million and a backing partner in Canfor. It appears they could easily steal SFk at even double their current market cap of $70 million...they would buying the assets at 50 cents on the dollar even at $140 million no matter how you look at it. Why would they not do this again? They have free capex from the cdn governemnet and they have cheap woodchips...Canfor the parent has operations in Quebec.

 

Dazel.

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Granted there's nothing to prevent Canfor from taking a shot at it, & in many ways its actually desirable, but it will not be a steal - & given the players, the currency will be CFX stock.

 

I want more because stock is riskier than cash, and because the entire cost will show up as new equity in our new BS, reducing our debt/equity ratio - and significantly improving our financial muscle. Yes we're financially better off together, than alone, but I still need an incentive beyond a tax free roll-over to change.

 

You can afford to, & want to pay more. As a new CFX shareholder I'm going to get stuck with a % of the consequence, there will plant consolidation savings, & new shareholders aren't going to be splitting their investment $ over 2 companies. More demand for the shares, & higher prices.

 

Geographic & market diversification, higher concentration of deep pockets, etc. are additionals. Given that a compromise is probably enevitable, 80-90% of BV seems reasonable.

 

SD

 

 

 

 

 

   

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  • 1 month later...

I don't believe it is available on the web. here is the article though:

 

SFK Pulp is increasing US prices on recycled bleached kraft, or market deinked (MDIP) pulp, contacts told RISI. Also, the firm and Northern Pulp Nova Scotia were among the many producers that told customers they'd raise northern bleached softwood kraft (NBSK) pulp prices, effective January 1, 2010.

 

Quebec-based SFK Pulp, the world's largest MDIP producer, told US customers it was increasing prices on the grade by $20-30/tonne, effective Jan. 1.

 

The firm, whose January price increase is the only known hike in MDIP, has increased prices every month since October, contacts said. Other producers in the small capacity MDIP sector may be moving to raise prices on a customer-by-customer basis.

 

NBSK hike list grows in US, Europe. Also, SFK Pulp and Northern Pulp Nova Scotia separately joined a long list of NBSK producers that slated $20-30/tonne price increases for Jan. 1. The firms told customers about their price hikes just before the Christmas holiday.

 

SFK Pulp and Northern Pulp Nova Scotia both told North American customers they were raising NBSK prices to $850/tonne, up $20/tonne. The companies also told customers in Europe their NBSK prices would be $830/tonne, up $30/tonne.

 

Those prices in the USA and Europe were the common levels set by various majors including Canfor Pulp, Domtar, and West Fraser as well as Botnia and Sodra, among others.

 

 

 

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  • 2 weeks later...

Sounds like there are further price increases in store for Feb. 

 

Mercer International (MERC) which owns 3 very productive plants, 1.4 million tons of production or roughly double SFK, carries over a billion dollars in debt and has a market cap of 120 million.  Mr. Market must really like leverage, pulp operations outside the U.S going forward either that or SFK is relatively worth  around 3$ a share right now. 

 

 

 

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An illuminating excercize is take todays CAD/USD FX Rate, & USD price for NBSK & BHK, then compare it to the same data the week before the long string of price rises begun. In effect you're isolating how much of the price rise is attibutable to USD depreciation, & how much is to the commodities fundamental demand/supply imbalance.

 

Per 'Paper Age' & the BOC.

01/19/2010 the CAD/USD FX rate was 1.0382, NBSK was 842.09/ton, & BHK was 725.97/ton

11/17/2009 the CAD/USD FX rate was 1.0592, NBSK was 818.84/ton, & BHK was 682.66/ton

Over the 2 mo period, the USD essentially depreciated 1.98% [(1.0382-1.0592)/1.0592], NBSK rose 2.84%, & BHK rose 6.84%. Or put differently - 70% of the NBSK appreciation (1.98/2.84), & 30% of the BHK appreciation is attributable to USD depreciation, & not demand/supply imbalance.

 

Makes us a very happy SFK shareholder, as irrespective of CAD/USD appreciation our contibution margins can only keep going up - & the US plants are getting fundamentally more profitable at 2 1/2x [70/30] the Canadian plant rate.

 

Fat margins for quite some time to come yet!

 

SD   

 

 

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  • 3 weeks later...

 

 

Canfor is up over 12% today...now paying a substantial payout....

Their market cap is $318 million....

 

Sfk pulp has a market cap of $79 million....Their earnings should be stellar....

First quarter should be the best in years and years...with US dollar strength and costs being contained with nat gas in the $5 range...and Pulp prices being exceptional.

 

 

At this price ($79 million) with these fundamentals Canfor or someone else would be able to steal these assets...sorry SD...I know you do not agree but the assets are almost free at this price...

 

It is very possible that the price to cashflow could be under 2 for the year if we continue this trend...Canfor like what they see in the pulp market...getting interesting

 

We own shares.

 

Dazel.

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We would be very dissappointed if CFX didn't place a call, but ....

 

Going from CFX's #'s we'd expect SFK to trade north of $2.00 almost as soon as they announce their Q4-earnings. We'd also expect to see the forward co-generation earnings priced in, & a healthy 'merger' premium attached. Then a discussion starting at something above the $5.00 range, so that deb holders can convert.

 

Most folk would likely sell if they saw $6.00 again by year-end, & use the opportunity to rebalance in 'new' CFX. Leaving a 6 bagger ((6.00-.85)/.85) on the table, doesn't make a whole lot of sense.

 

We're always hopefull ;D

 

SD

 

 

 

 

 

 

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We agree that SFK PULP  stock price is silly...

 

That is why we are baffled...that soneone in the industry is not taking a shot at them...They could buy them out at that $2 number right now  but will not get  a chance when the stock rebounds into the $4's and $5's...

 

I think you are correct about SFK's stock price...I am expecting a recycle trade....where those that made a lot of money in Canfor pulp will sell and move the profits into the depressed SFK stock...in hindsight I wish it was us doing it!!!

 

dazel.

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First of congrats to those that bought Canfor pulp...what a homerun!

 

SD,

 

It is my understanding that SFK is not going to pay out distributions until it is has straightened out its covenants with lenders. How does this work with regard to taxation of earnings from the CRA tax code? Will they have to make a distribution for 2009? Sorry not up on my income trust taxation...it is likely that first haf losses could negate this....

 

so...for 2010 they will have to resume distributions in some form any ideas on how that happens?

thanks.

 

As a speculative aside...they are much more attractive to a take over because they have not payed out distributions and should have significant working capital.

Dazel.

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They will need to bring their 2009 taxable earnings to zero, & do it via reserving or write-offs. Debt defeasement (qualifies as reserves) to retire debt early is the preferable route to draining off excess earnings.

 

They have to come out of the structure by 12/31/2010, & will probably deal with the 2010 build-up as a one-time payout on dissolution. Because they are effectively unable to distribute (covenants), they make an especially good (self financing) takeover candidate.

 

Unlikely we'll see distribution here, its going to be share price appreciation instead. $5-$6 on a take-out is quite realistic.

 

SD

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I bought my first 1000 shares of SFK in June 2005 at $5.03/share.  That was pre-Fairfax BTW.  I bought more off and on until 2008 then unloaded everything.  It has been my biggest all time dollar value loser to date UNTIL now. 

 

As of Monday when I bought my last shares at 0.88 (bought from 0.23 to 0.88) I now hold 65000 shares.  So $5.00 a share would suit me fine.  That would only bring it to adjusted book value should they pay some of the debt down along the way. 

 

I actually held a larger dollar value of cfx.un but I am thinning this one down a bit.  Should the price of pulp drop off they may get hit and there is also the pending conversion. 

 

I owe thanks to yourselves, SD, Dazel, and to Viking for helping me see different sides of these businesses than I would otherwise recognize myself. 

 

RE: the takeout potential.  After all this time I am not thinking that FFH would approve a takeout below $10 on sfk.un.  I believe they still hold the shares, unless I missed something. 

 

Al.

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Al

 

The working number is roughly 10x FCF of .45/unit, or market cap of 414M. At 5.50 the market cap is > 500M, starts to materially exceed CFX - & changes the buyer/seller. Good/bad depends on how soon CFX comes out of its trust, & in what form. Re SFK, it can only be good.

 

Its highly likely that fine minds will add value well beyond the $5 mark, but the days of < 2.00 are pretty much over. The problem is going to be safely managing the price expansion  :'(

 

SD

 

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"A herd instinct dominates the money management industry. ... if you were among the 5% who went against the herd and bought stock B, and it goes down, everyone says that you are a dummy. The reputational and career risk of being a contrarian is far greater than the risk of going with the flow."

 

Source: The Little Book of Value Investing, Chapt 20; You can lead a horse to water, Chris Browne, 2007

 

I'm pretty sure I know who the 5% are!

 

SD

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http://finance.yahoo.com/news/Mercer-International-Inc-pz-3269682288.html?x=0&.v=1

 

Mercer International Inc. Reports Improved Pulp Prices and Markets Result in Stronger 2009 Fourth Quarter Results

 

Subsequently, in January and February of 2010, producers implemented further price increases totaling $50 per ADMT bringing the European list price to $850."

 

"During the last quarter, we received the initial C$12.9 million of the C$40.0 million of Canadian government funding for the green energy project at our Celgar mill. We currently expect to complete the Celgar green energy project and commence generating excess power sales and revenues therefrom around September 2010. When completed, and based upon the Celgar mill operating at current levels, we estimate that this project will generate between C$20.0 to C$25.0 million in additional annual power revenues without any material incremental operating costs. In addition, our Celgar mill was awarded an additional C$17.7 million of Canadian government funding for other eligible capital projects."

 

In general, we are optimistic on the short-term outlook for pulp prices and believe that the sustainability of producer restarts and other high cost producers is possible only in a sustained higher pulp price environment."

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