The market is valuing premium paper company Neenah Paper, Inc. (NYSE:NP) at the same level as other packaging and paper-products companies with lower margins and ROAs.
With an ROA of 6%, double that of its paper-products peers, Neenah Paper, Inc. (NYSE:NP) is significantly undervalued with a forward P/E of 11 and an EV/EBITDA ratio of seven. In addition, it has delivered increasing margins and positive free cash flow for the past four years.
Headquartered in Alpharetta, Georgia, Neenah Paper, Inc. (NYSE:NP) is a leader in premium image and performance-based products. It’s organized into two business segments: a specialty, performance-based, technical products business and a premium fine papers business.
The technical products business deals with specialty, performance-based products and serves end markets such as filtration, industrial backings, labels, and other specialties. The fine paper business is focused on high-end textured and colored graphic papers, and supplies to end markets in the areas of premium print communications, luxury packaging, crafting and premium labels.
Moats that matter
For Neenah Paper, Inc. (NYSE:NP)’s technical products business, the qualification process with such customers as 3M Co (NYSE:MMM), Mahle, Saint-Gobain and Avery Dennison Corp (NYSE:AVY) serves as a strong barrier to entry. New entrants will have to go through an arduous process of qualification with customers — without any certainty of success — before they even earn the right to compete with Neenah Paper.
Furthermore, Neenah Paper, Inc. (NYSE:NP) enjoys a significant advantage over its peers and potential entrants as a result of long-term intimate customer relationships. This has also led to joint product development with its customers, which further strengthens Neenah Paper, Inc. (NYSE:NP)’s competitive position.
In its fine paper business, Neenah Paper’s products have strong brand recognition by printers and designers. This is reflected in its market leadership in the premium fine papers with an estimated market share of 60%, double that of its nearest competitor Mohawk Fine Papers, according to management estimates during the company’s most recent 4Q12 Earnings Conference Call.
Growth drivers
Filtration is the focal point of growth for Neenah Paper’s technical products division, with opportunities to expand into new geographic areas and profitable adjacent markets. The premium-paper company has traditionally focused on the European transportation filtration market, but considers the area of specialty filtration media as a potential new market.
For its fine paper business, Neenah acquired leading business paper brands from Southworth in January to penetrate the specialty-retail paper market segment. Until recently, stationery has been an unexplored area for Neenah Paper.
Peer comparison
Neenah Paper’s peers include Boise Inc. (NYSE:BZ), Domtar Corp (USA) (NYSE:UFS) and International Paper Company (NYSE:IP).
Of the four stocks, International Paper Company (NYSE:IP) is the most diversified in terms of geographical and customer segment exposure. International Paper Company (NYSE:IP) generated 75% of its fiscal 2012 EBITDA from North America, with Europe, Russia and Brazil contributing 8% each.
In fiscal 2012, the industrial packaging, printing papers and consumer packaging business segments’ contributed 55%, 31% and 12%, respectively, to EBITDA.
In comparison, Boise Inc. (NYSE:BZ) is primarily U.S. focused, as the third largest producer of un-coated freesheet in North America. It’s claimed an estimated 15% of market share in the pressure-sensitive market in the region. Boise is also less diversified in terms of business segments, deriving half of its fiscal 2012 EBITDA from paper, and the other half from packaging.
Domtar Corp (USA) (NYSE:UFS) designs, manufactures, markets and distributes a range of fiber-based products, including communication papers, specialty and packaging papers and adult incontinence products.
Neenah Paper is valued at similar levels to its peers using forward P/E and trailing- twelve-months EV/EBITDA metrics, despite boasting of a significantly higher ROA. Neenah Paper trades at a forward P/E of 10.7 and a trailing-twelve-months EV/EBITDA of 6.8.
In comparison, Boise and Domatar are valued by the market at 11-to-12 times forward P/E and five-to-six times EV/EBITDA.
International Paper Company (NYSE:IP) also trades at a similar forward P/E of 12, but has a slightly higher EV/EBITDA of 9.3 compared with the other stocks in the peer group.
Neenah Paper, however, deserves to trade at a premium valuation multiple, in my opinion, by virtue of its higher ROA of 6.5%. Comparatively, its peers delivered ROAs of 2%-to-3% for the last twelve months.
Both Neenah Paper and Domtar lead the group with a dividend yield of 2.3%. Neenah Paper is moderately geared with a gross debt-to-equity ratio of 90%, trumping Boise and International Paper Company (NYSE:IP) which have gearing ratios exceeding 100%.
Domtar has the strongest balance sheet of the four companies, with a gearing ratio of 42%.
Capital allocation
Neenah Paper has a decent capital return policy, supported by strong free cash flows. It has paid dividends in every single year since 2005 and currently sports a dividend yield of 2.3%.
It is also authorized to purchase up to $10 million of its stock annually. Neenah Paper achieved positive free cash flow for four consecutive years from 2009-to-2012, and has moderate capital expenditure needs, estimated at $10 million per year based on historical financials.
Conclusion
Investors typically group stocks in the industry together and assign similar valuations without differentiating between them. Neenah Paper’s undervaluation potentially falls under this scenario, as most of its direct competitors are unlisted.
Upon examination of Neenah Paper’s financial metrics, such as margins and ROA, however, it is easy to understand why it should command a higher valuation.
The article Buy This High-End Paper Company at Low-End Valuations originally appeared on Fool.com and is written by Mark Lin.
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