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Fortress Global Enterprises Inc - Class A FTPLF

Fortress Global Enterprises Inc produces paper pulp, security papers, and other security-related products. The company through its segments produces dissolving pulp which is primarily used for viscose/rayon manufacturers in Asia. Its business is spread across Asia where it generates most of its revenues, Europe, Canada, and International.


GREY:FTPLF - Post by User

Post by OptsyEagleon Feb 01, 2012 11:03am
351 Views
Post# 19473737

Confusion About Opportunity

Confusion About Opportunity

I think the TD analyst and quite a few others are perhaps misguided about the opportunity we are seeing here. I think the investment community is looking at Fortress Paper as just another company working in a historically bad industry that will be subjected to the boom and bust cycle, like most other commodity producing companies. Hence, they want to assign a much lower multiple of the earnings to that business.

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The basic opportunity here can all be found on pages 7 and 8 of this presentation:

https://specialtycellulose.com/wp-content/uploads/2012/01/LSQ_Announcement_Jan_31_2012.pdf

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Many companies in the forestry sector have found that it was very difficult to complete globally, from Canada. Because of this, they ended up in the top quartile of costs and since commodity pricing will usually gravitate to a price equal to the higher cost producers, they struggled. This price gravitates to this level, because when higher, new capacity usually comes along, itseverely hurts the higher cost producers. Now this is key.

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In slide 7, we can see that this is not the case in this particular instance. Fortress Paper has ensured their cost structure is in the lowest quartile of costs. This is because, for dissolving pulp, Canada has a distinct advantage. Large supply of good fibre (trees), excellent transportation systems, and plentiful, educated labour. Since labour is one of the lowest costs in the production of dissolving pulp (FTP will generate about $1,000,000 of revenue per employee making wage differences immaterial).

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I believe the TD analysts main concern is from the additional capacity that is currently coming on line. Although, there is reason to believe the demand for DP will be able to absorb all this new capacity, the most important point is ... it doesn't really matter. A question was asked on the conference call about whether the market could absorb another 236,000 tonnes of capacity. The answer is again... it doesn't matter. If it can, then the DP prices will be very high and profitability will far exceed even Fortress Paper's estimates. If it cannot, some other company on the upper end of the cost curve, seen on page 7 of the presentation, will start to have some financial difficulties.

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Since the production of dissolving pulp's costs are mostly variable, for instance, the tree fibre, I believe, makes up about 50% of the costs, with power being next in line and labour a very small component. If prices decline below a companies cost level, they will see very quickly that it makes more sense to shut down their capacity, then to keep producing. We have already seen this in the current cycle we are in. That being said, if you review page 7 of the presentation you will see that in order for DP prices to get down to the level of FTPs costs, it would take a reduction in about 70% of world capacity. That is very unlikely to happen.

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So in a nutshell, what Fortress Paper is finding, is that Canada has a considerable number of mills that cannot compete globally in the traditional pulp market, due to their higher cost structure, but converted to producing DP, they transform into a low cost producer. With that in mind, as long as they don't bring on more then about 4.2 million tonnes more of DP (70% of world capacity), they will simply be able to displace a higher cost producer, with their new supply and the prices of DP should not fall much below the $1,200 floor we have seen. Since the mills available are fixated on the previous business experience, they can be picked up very, very cheaply, as we have seen.

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I hope that makes sense. The currency issue is also in play here. Since DP is priced in $US dollars, but most of the producers and customers are not from the US, any decline in the $US, should simply result in a higher nominal sale price of DP. Keep in mind, the most important currency for dissolving pulp is the Chinese yuon and it has been rising lately and expected to continue to do so.

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All that being said, I would suspect, that as the investment community starts to realize this considerable difference, a much larger PE multiple will get assigned to this company. It may take them a while, but they will get there.

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