SFK pulp

[triedtestedand]

Sharper:

 

Welcome back!  I figured there was a reason we hadn't heard from you.  As always, looking forward to your review.

[SharperDingaan]

 

Couple of first impressions:

- Q4, & 2009, looked a lot worse than we expected - but an awful lot of it is cosmetic. Suspect they've taken every provision/write-down possible to get the taxable income to zero. Great going forward, not so hot for the current quarter/year.

- Conversion timing is pretty much dictated by CFX & resources. There are only so many appropriately qualified accountants to go round (200+ trusts converting over 2010), & SFK can't afford to have CFX convert before they do (accessing new capital that will virtually guarantee a raid).

- Tone, messaging, focus on charge-off vs capitalization, forthrightness have changed. Long overdue, but judging from the MD&A content its highly likely that SFK is 'in-play'. Too early to assess eventual outcome, but they seem to be listening to this board.

- Don't knock the analysts. Worst case we lose $ if we're wrong, they will lose their jobs - a very different risk/return profile. Their impact will become obvious once results start showing.

- Interestingly there's no discussion around their sensitivity to interest rates. The conversion timing makes it highly unlikely that they'll be paying higher rates from July 2010 onwards, & virtually all the debt could be refinanced at much lower rates (assumes no major interim changes). Given the demonstrated charge-off vs capitalization preferance, a Q2 'refinancing penalty' charge-off on conversion - & a 75-150bp interest saving going forward?

 

SD

 

[Nnejad]

Included in OTTI are Level 3 ($226 million), Torstar ($175 million), Canwest ($121 million), Frontier Communications

($84 million), Dell ($65 million), U.S. Gypsum ($61 million), Brick Group ($40 million) and SFK Pulp

($31 million). Included in the mark-to-market losses are Abitibi ($336 million), California state bonds ($67 million)

and Mega Brands ($37 million). While Canwest is a permanent loss, the game is far from over on the other

impairments and mark-to-market losses. However, our balance sheet is very sound as we have written down these

investments to market value.

 

Anyone still following Abitibi in bankruptcy?  If I'm reading the reports correctly, it seems like they've generated 100 million in cash in each of the last two months??!??

 

http://sec.gov/Archives/edgar/data/1393066/000119312510047901/0001193125-10-047901-index.htm

[Cardboard]

NBSK is now at $900 U.S. and still climbing with 8% of worldwide pulp capacity taken out by the Chilean quake and some more by the strike in Finland. BHK is also following which drives up the price of RBK.

 

http://www.paperage.com/foex/pulp.html

 

SFK must be generating cash at these prices. The quarter is getting to an end, so it would be nice for management to come out and indicate how much cash they generated so far and what can we expect in terms of debt repayment. A necessary guidance IMO, considering the big miss vs market expectations in Q4.

 

Cardboard

[SharperDingaan]

 

Very impressive numbers going forward, but you really have to treat 2009 as an outlyer.

 

If nothing else happened in 2010 there will 4.8M of savings/yr (4.0 operating, 0.8M pension). Given their now much stronger financial position, we think they can also refinance the 156M of LTD upon conversion at roughly 150-200bp less than they currently pay  (2.3M/yr, or 1.1M over the last ½ of 2010), & they will also make some healthy savings on the commodity inputs (assume 0.85M). Net result is a fairly reliable 6.75M saving, or $0.07/unit.

 

They have tight inventory & both Chile & Norway will be out of service for a while. If NBSK averages 880/ton for 12 months they’ll take in an extra 22.8M [(880-820)/10x3.8]; if RBK averages an extra $20/ton, there’s an additional 7.6M. If you assume FX parity for 6 months there will be roughly <8.5M> of offsetting FX loss [(.0563/.01)x3x6/12]. Assuming no production ramp-up - a net incremental 21.9M of revenue, or $0.24/unit.

 

Most bankers would negotiate a sliding scale penalty for refinancing. Assuming that the debs end up extended/re-opened/’re-termed’ during the process – an incremental 4-6M charge on conversion is a distinct possibility. Charging vs capitilize also reduces thepotential need to pay a balancing distribution on conversion. If they ran the plants flat out to capitalize on the Chilean & Norwegian misfortunes, much of the penalty charge would be covered by incremental margin(s).

 

Notable is that we’ve excluded any electricity margins, & have used a ‘low’ 2010 average price for NBSK. If we got $900/ton for 9 months, there would be an extra $5.7M [(900-880)/10x3.8x9/12]. IE; there’s a healthy margin of error.

 

Assuming  base 2010 CF of $.44/unit, adding the $.31 (.07+.24) of increment produces $.75/unit. At $1.25/unit we’re only paying 1.67x CF; we should be paying at least 6-8x. Notable is that 7x CF is $5.75/unit, & above the debs conversion price.

 

Re disclosure. We hold long positions in both the debs & common at cost bases materially below the current market values.

 

We live in interesting times ;D

 

SD

 

[Myth465]

SD thanks for the update. Very compelling.

[T-bone1]

Pulp Price Surges on Chilean Quake, Finnish Strike

 

By Chad Thomas and Matt Craze

    March 11 (Bloomberg) -- Chile’s earthquake and a Finnish

port strike may propel pulp prices to a record, hastening a

tightening of inventories after papermakers cut output.

    The price of European benchmark pulp rose to $875.62 a ton

this week, the biggest seven-day increase in almost six years,

according to Helsinki-based FOEX Indexes Ltd. Pulp in Europe

could top $1,000 a ton, higher than 1995’s peak, within a few

months, said Kurt Schaefer, who analyses the fiber industry at

Bedford, Massachusetts-based paper researcher RISI.

    Mills have ground to a standstill in Chile and Finland,

which together account for 12 percent of world pulp sales. The

spiraling pulp price, which in turn boosts paper prices, marks a

turn in the market for papermakers including Stora Enso Oyj of

Finland and Norske Skog ASA of Norway, which have both spent

years cutting output to restore depressed paper and pulp prices.

    “The pulp market has never seen a disruption this sudden

and this large,” Schaefer said. “The market is so tight at

this point that every disruption is magnified 10-fold.”

    The stoppages come after average pulp stocks fell to 20

days, from 50 days at the height of the financial crisis, as

papermakers lowered inventories, Schaefer said. The 20-year

average is 32.6 days.

 

                      Strongest in 50 Years

 

    Last month’s 8.8 magnitude earthquake in Chile, the

country’s strongest in 50 years, killed hundreds, destroyed

thousands of homes and hammered pulp and timber producers in the

country’s central southern region, close to the epicenter.

Pulpmakers affected include Empresas Copec SA’s Celulosa Arauco

y Constitucion SA unit and Empresas CMPC SA, the two largest.

    Stora Enso fell as much as 1.1 percent to 4.93 euros and

was down 0.3 percent as of 1:08 p.m. in Helsinki trading today.

CMPC and Copec have lost 2.1 percent and 5 percent since the

earthquake, while Brazil’s Fibria Celulose SA is up 8.1 percent

    Only one of 35 pulp plants and sawmills owned by Celulosa

Arauco is currently operating, spokesman Andres Moran said. Part

of the Mutrun sawmill was swept out to sea and pools of water

remain in log stores, he said. A third tidal wave also flooded

an area where it stores timber in southern Chile.

    “We are still in a first stage of clearing away the

debris,” Moran said. “Following that we will begin an

evaluation process of determining in what condition the

machinery is.” The company said it probably won’t produce in

March.

    Norske Skog, Norway’s biggest newsprint supplier, said its

Concepcion paper mill is closed and a force majeure claim is in

place over failed supplies. The closure will last for “some

time,” said Tom Bratlie, the Lysaker-based company’s spokesman.

 

                        Finnish Strike

 

    In Finland, Stora Enso and UPM-Kymmene Oyj, Europe’s two

largest papermakers, have closed mills and cut production as a

strike by port workers that started March 4 has cut off 90

percent of the Nordic nation’s exports. The Helsinki-based

companies have said it’s only a matter of days before they halt

production fully as they run out of space to store inventory.

    Stevedores and port operators are set to meet with a

government mediator this afternoon to try and resolve the week-

old dispute, the Transport Workers’ Union said.

    “It’s a perfect storm,” Cesar Perez, a managing director

at brokerage Celfin Capital SA in Santiago, said in a telephone

interview. “There’s not much availability of fiber in other

parts of the northern hemisphere, so that’s going to push prices

even higher in the following months,” he said.

    CMPC, owned by Chile’s billionaire Matte family, said March

2 it halted production at its plants because of a lack of power

and water supply. The company owns three pulp plants in Chile

and Argentina, where it also makes paper products.

 

                        Effects on Paper

 

    Pulp is the main raw-material for paper, and a shortage in

supply will have knock-on effects in that market too, said Timo

Jaakkola, a Helsinki-based analyst with Oehman.

    “Higher pulp prices will translate to higher paper prices

when the paper market balance is tight enough,” Jaakkola said.

“The pulp shortage will likely send pulp prices quite a bit

higher for the next few months.”

    M-real Oyj raised paper prices twice this month, citing the

pulp shortage and cold weather in northern Europe. Finland’s

third-largest papermaker announced price increases of as much as

15 percent this month, to take effect in April.

    “We see these increases in paper prices as very

important,” M-real Chief Executive Officer Mikko Helander said

in an interview. “There’s going to be a shortage of pulp, and

prices will continue to increase.”

 

                    Biggest Price Rise

 

    One Chinese paper producer introduced Asia’s biggest price

increase ever this week, raising prices by $150 to $1,050 a ton,

said Sandy Lu, a Shanghai-based paper economist at RISI. It’s

unclear whether the price hike will stick, she said. Lu didn’t

identify the Chinese producer.

    Chile’s outages “are tightening the situation and

supporting a rising price trend,” Ilkka Haemaelae, chief

executive officer of Metsae-Botnia Oy, a Finnish pulp producer,

said in a telephone interview. “Raw materials have no other

drivers than the balance of supply and demand.”

[SharperDingaan]

 

http://www.foex.fi/

 

NBSK forwards indicate global prices > 900 for at least the next 6 months, peaking at a little over 940 in April-2010. You have to think that if they have any spare production capacity at all, they will selling forwards - & using that surplus capacity to meet their commitments.

 

Maximum throughputs & rock-bottom cost of sales coming up ?

 

SD

[Alekbaylee]

More on the same lines...

 

Laprade and Paul Quinn of RBC Capital Markets said the beneficiaries include Canfor Pulp (TSX: CRX-UN.TO), Tembec (TSX: TMB.TO) and SKF Pulp (TSX: SFK-UN.TO), Domtar (TSX: UFS.TO) and West Fraser Timber (TSX: WFT.TO).

 

http://ca.news.finance.yahoo.com/s/12032010/2/biz-finance-canadian-pulp-producers-expected-benefit-prices-rise-due.html

[Alekbaylee]

"Market conditions for coated groundwood paper are challenging and despite the best efforts of our employees -- and these efforts have been commendable -- the mill continues to suffer from a weak cost position," Chief Executive John Williams said in a statement.

 

http://ca.news.finance.yahoo.com/s/16032010/6/finance-domtar-close-mississippi-paper-mill-cut-jobs.html

[oldye]

http://www.vancouversun.com/business/Chile+earthquake+boosts+pulp+prices/2687711/story.html

 

"When you get a surprise move like this, the weakest players get the biggest bang for their buck. And right now the Canadians, financially, are generally the weakest players on the world stage. They are the biggest beneficiaries from this run on pulp. It's going to buy them time to repair their balance sheets and generate a huge amount of cash."

 

Mason said he's hearing tales from brokers that buyers are phoning and asking how much more they have to pay to outbid other customers. "A lot of people are scrambling and they are willing to pay more than the current price."

[txlaw]

Great thread folks.  I initiated a small position in SFK at $1.20 after the capacity in Chile and Finland got taken out. 

 

I'm a little worried though about the supply and demand dynamics going forward.  Is it reasonable to assume a floor in NBSK price of around $CAD 780.  I'm worried that when the iPad and other slate computers start coming out, the demand for "reinforcing pulp" will drop much faster than supply does.

 

Also, do you guys see labor issues being a possible impediment to a combination between say an SFK and a CFX?  I don't know much about labor relations in Canada.

 

Finally, how much output do you guys think SFK can sell forward?  A whole year's worth?  Two years worth?

[Alekbaylee]

High volume today. hum... Institutional buyers or insiders?

[SharperDingaan]

 

$1,000/ton for NBSK may be a little closer to reality than was peviously believed ;)

 

SD

[Guest Dazel]

 

SD,

 

You have been very right here. It looks like you will have your $2 handle soon...the $5 one is a little tougher

to see...However, you are correct pulp is in a perfect storm!

I am intrigued by the difference between Canfor pulp's almost half billion dollar market cap compared to SFK's

lowly $142 million...I sound like a broken record but come on...something has to give...Canfor could pay for

the acquisiton with this years cashflow after the savings of a combination!

 

Would you take Canfor shares?

 

Dazel.

[SharperDingaan]

 

In practical terms SFK should move up, simply because of higher pulp prices & the global shortage of pulp. A higher average sales price, & a lower fixed cost/ton from higher throughput; should have increased margin quite a bit. Add the CM from additional volume, plus labour & pension savings, & we should have enough of a good Q1 to go > $2.00/share.

 

But they aren't going to run-up until they can show positive earnings, a healthy EBITA, & an end to the 'kitchen sink' charge-offs. An early end to the charge-offs will a game changer, & go some way to demonstrating managements intent & confidence.

 

We would actually prefer to take CFX stock - but not until we know the outcome of the reorg & whether they've been able to refinance at a lower cost (Q3). In theory a 1:50 yr cycle should have legs, so merging now is to sell out too early; alternatively a merger soon after re-org (for CFX stock) would maximize short-term value (direct P/E comparisom if SFKs post re-org structure is the same as CFX's), & extract consolidation savings/security of supply benefits for all (shareholders, management, & labour force).

 

If nothing changes; > $2/share post the Q1-2010 earnings announcement. If the charge-offs stop; > $3/share.

 

SD       

 

 

[Myth465]

is anyone continuing to add. I have been adding up to 1.20 or so, and so far so good. I have a healthy amount right now, is anyone  overweight?

[SharperDingaan]

 

We hold both common & debs, in a concentrated portfolio. By definition, we're overweight.

The positions were added to some time ago, & we have not added since.

 

SD 

[Rabbitisrich]

SharperDingaan, is an NBSK price above $750 USD necessary to your thesis? Do you feel that NBSK demand will improve in North America and Europe, or are do you believe that emerging markets will provide a long runway for pricing?

 

 

I've never been able to get over SFK's working capital, capex, and sourcing risks. It seems like a business whose capital structure and model requires a firm view on the commodity.

[txlaw]

SharperDingaan, is an NBSK price above $750 USD necessary to your thesis? Do you feel that NBSK demand will improve in North America and Europe, or are do you believe that emerging markets will provide a long runway for pricing?

 

 

I've never been able to get over SFK's working capital, capex, and sourcing risks. It seems like a business whose capital structure and model requires a firm view on the commodity.

 

I'm interested in hearing Sharper's and other people's thoughts about the commodity pricing going forward too. 

 

SFK should generate a ton of cash over the next few quarters, and if the market values the company at, say, 8 times cash flow, that would be great -- and ridiculous at the same time.  On the other hand, if debt is meaningfully reduced, and industrial capacity continues to be rationalized, then maybe we're looking at a good long term entry point around $1.20. 

 

But I'm worried about how low the price of NBSK can go once the cycle turns downwards again.  I don't know enough about the worldwide dynamics of pulp demand and supply to get comfortable with adding to my very small position.

[SharperDingaan]

 

Keep in mind that P&P is a cyclical commodity business; no different to mining, oil/gas, etc. It is inherently unstable, & you're really investing in the current cycle (point within it, relative strength) versus the individual coy. Its buy & sell; not buy & hold.

 

However were the industry to restructure & consolidate there would be a sizeable & permanent capital gain, over & above this cyclical gain. But to get this gain you had to be institutional, have bought in sufficient quantity to effect change, & bought some time ago. Its a small club, & the players know each other.

 

We`re comfortable as we`ve long recognized that there are 2 cycles here; & todays pulp prices & conversions are making it far easier to execute. We`re not that concerned with todays model (other than its sufficiently profitable at current levels) as we don`t expect SFK to still be independent over the next down-turn.

 

As we can easily hedge, we also don`t need either of a merger or a high pulp price. However, we do need to be able to recognize when the cycle is turning; & we think we have some time yet.   

 

SD   

 

 

 

[txlaw]

 

Keep in mind that P&P is a cyclical commodity business; no different to mining, oil/gas, etc. It is inherently unstable, & you're really investing in the current cycle (point within it, relative strength) versus the individual coy. Its buy & sell; not buy & hold.

 

However were the industry to restructure & consolidate there would be a sizeable & permanent capital gain, over & above this cyclical gain. But to get this gain you had to be institutional, have bought in sufficient quantity to effect change, & bought some time ago. Its a small club, & the players know each other.

 

We`re comfortable as we`ve long recognized that there are 2 cycles here; & todays pulp prices & conversions are making it far easier to execute. We`re not that concerned with todays model (other than its sufficiently profitable at current levels) as we don`t expect SFK to still be independent over the next down-turn.

 

As we can easily hedge, we also don`t need either of a merger or a high pulp price. However, we do need to be able to recognize when the cycle is turning; & we think we have some time yet.   

 

SD   

 

 

 

Thanks for your input, SD. 

 

Will probably just hold on to my position and sell out at $2 if we get there.  Does anyone know what FFH's cost basis is for their entire SFK investment?

[Myth465]

I think the run has legs, at least 2 quarters worth. Unlike say natural gas I dont think its that easy to increase supply and everyone has a bad taste in there mouth from the last downturn.

[Rabbitisrich]

I appreciate the reply, SharperDingaan, but it only supports my intuition that I should remain an interested and ignorant spectator.

[oldye]

I like to think about the company as if the conversion will dilute by 20% or roughly 108 million shares outstanding. 

Assuming conversion after Q2 net debt should be around 100 mil.  If you buy/hold(not an endorsement) at 1.40 you own the rbk mills (150 mil bought from bankruptcy 20 mil ebitda +-)+ working capital+ 360,000 nbsk mil. 

 

At the current price, Mr. Market is selling the nbsk mil+working capital for 65 million, 180$/ton..when replacement cost is north of 1200$ per ton.  The nbsk mil is old but its well maintained and worth quite a bit more.  I never invest expecting a buy out,  I think there is a healthy MOS up to 5-6x normal ebitda which is about what it would sell for out of bankruptcy.    Who knows how long it'll take Mr. Market to fully value a stock, I think it can take way more than 3 years but there are certainly some near term catalysts that should be beneficial. 

 

SFK's profits are more than a simple function of the price of nbsk, if the can $ was at parity, 750$ nbsk price things at SFK would get kinda hairy.  But who knows, maybe wood chip prices would fall.