CIBC commentsCASCADES INC.
Delayed Tissue Rebound Keeps Us Cautious Our Conclusion Maintaining our Neutral rating on Cascades but reducing our price target to $10 (from $11) on lower estimates given another quarter of disappointing performance, and uncertainty about the timing and magnitude of the guided recovery in tissue profitability.
At the same time, we have some doubts about whether current peak containerboard prices can be sustained in 2023 given the expected deterioration in industry operating rates as more containerboard capacity comes online (including CAS’ own Bear Island project by early Q1/23). We expect the shares to remain challenged over the near term given investor concerns on leverage (highest level in nearly nine years at 5.4x) and lingering questions about the company’s ability to execute a turnaround in tissue.
Key Points
Reducing Estimates (Again): We are lowering our Q3 EBITDA estimate by 14% to $108MM largely on weaker tissue assumptions (with a modestly higher specialty products forecast largely offsetting slightly more cautious containerboard assumptions). We have reduced our full-year estimate by 9% to $382MM given the challenges in tissue and somewhat more conservative assumptions for containerboard profitability in the fourth quarter as demand wanes. As the contribution from CAS’s upcoming containerboard addition at Bear Island builds over next year, and tissue market price hikes are fully realized, we see EBITDA of $476MM in 2023 (lowered by 6%) and $568MM in 2024 (decreased by 4% on lower tissue/containerboard assumptions). For the tissue business, our 2022E EBITDA estimate of $18MM is below the company’s reduced guidance range ($25MM-$40MM) as we have some doubts of the pace of the rebound in profitability in Q4 implied by the guidance parameters. While Cascades should benefit from price hikes flowing through across its Retail and Away-from-Home (AfH) product volumes, we suspect the full benefits may not be realized until H1/23 given timing of some AfH contracts. Our 2024 segment estimate of $113MM is well below the company’s reiterated ~$150MM target.
FCF May Be Consumed By Containerboard Integration Investments: While we remain positive on the Bear Island project (465K tpy) despite project costs rising by 9% to US$470MM-US$485MM, we have been surprised by recent trade reports that the facility will also be producing runs of kraft paper (typically lower margin) as this suggests customer demand for the mill’s linerboard may be a bit lower than expected given competing startup capacity adds. We suspect leverage peaked in Q2 at 5.4x and should fall to 3.6x by the end of 2023 and 2.9x by the end of 2024 as the new mill ramps up further. That being said, we suspect the pace of the projected balance sheet improvement may be delayed as the company may announce additional box plant investments (US$100MM+ per facility) to increase its integration rate closer to its objective of 85% (from the current 72%).
Price Target (Base Case): C$10.00 Our $10/share price target is based on sum-of-the-parts multiples (2023E EV/EBITDA), less the value of Cascades' forecasted net debt position. We apply 5.5x for Containerboard, 5.0x for Tissue and 6.0x for Specialty Products. Over the cycle, we expect Cascades businesses to generally trade at a discount to segment peers in the United States given the company's recycled asset base, weighting to Canada and limited shareholder liquidity.
Upside Scenario: C$14.00 Our upside scenario assumes containerboard prices can be sustained through 2023 despite industry capacity addtions.
Downside Scenario: C$7.00 Our downside scenario assumes the fall 2021/spring 2022 containerboard hikes erode over the subsequent 18 months. We also assume tissue margins contract. This translates to downside scenario 2023E EBITDA of $356MM (with $315MM in containerboard and $34MM in tissue). We use higher multiples for containerboard (6.5x) and tissue (6.0x) in this scenario given below mid-cycle profitability.