I wrote about Fortress Paper (TSX:FTP, Financial) on Oct 18. Since then, the price has dived from $6 to $4.2, a 30% drop in a month.
There has been a stream of bad news coming our way, meaning it is time to give an update on the thesis.
Fortress is a dissolved pulp (DP) maker which is used in making rayon, a substitute of cotton. It sells almost all of its produce to China under long-term contracts. Fortunately, the quality of timber it can get for the production in Canada, coupled with experienced labor, offers Fortress a cost advantage compared to other DP makers which are not based in Canada. It has two mills, Thurso (operational) and LSQ (not operational). Fortress also owns and operates a facility in Landqart, Switzerland. This factory is the sole manufacturer of Swiss francs and also manufactures euros for 10 countries.
The first significant piece of information is the result of the China anti-dumping probe investigations. Fortress will have 13% duty on its products from Thurso, going forward. LSQ, when up and running, will have to pay a crippling 50.9%. This will for sure shelve the plans for converting the LSQ facility to a DP plant. In the meantime, Fortress is spending around $100,000 every month on the upkeep of LSQ.
The company's third quarter report is out. The improvements at the Landqart plant continue. Year to date, the plant has an EBITDA of $0.1 million as opposed to $17.5 million loss in the prior year. The improvements are especially heartening because the Swiss Franc is still historically quite high and is hurting the business at the mill.
The company has $102 million in cash and $227 million in debt, for a net debt position of $125 million. Adding it to the current market cap of $60.9 million we have an EV of $186 million.
Fortress also sold “non-core” land property at LSQ for $5.4 million in this quarter, for a realized gain of $4.1 million. Also, given the situation with the Chinese duty, the company is not going to start the conversion at LSQ anytime soon.
Let us come back to the valuation of the assets of Fortress Paper. Assume that the LSQ mill is worth $0. Then, we have to make an estimation of the value of Landqart mill and the Thurso mill.
The following is the result of the DP segment.
Here is a graph of the prices of DP until 2010. Fortress mentions that in the last quarter the average price of DP was $880 per tonne.
Historically, this is the floor for the DP pricing. Assuming a $100 per tonne increase in price, the Thurso mill will make an additional $31 million per quarter, wiping out the operating loss and making a operating profit of $22 million. A conservative multiple of 10 times operating profit leads to a value of 10x4x22=$880 million!
The management thinks that the Landqart mill can produce an EBITDA of $13 million (it was their target for 2012). In 2010, a similar mill as Landqart received 10 times EBITDA. Even assuming a conservative multiple of 5, we get a value of $65 million.
Hence, Fortress, as a sum of parts, is worth at least $940 million, an almost 500% upside from here.
The question one has to ask is, what are the chances of it going bankrupt before the prices of DP recover? This is a good question to ask, and let us try to make an estimate.
The company has $100 million in cash and the management has mentioned that the maintenance capex is $10 million a year. Let us for the sake of safety assume that the company bleeds $20 million a year instead. The company also has to pay interest of $12 million on the debt a year. This is a cash expense of $32 million a year. The first debt which comes due is in December 2016 worth $40 million. This means that the company can survive until the end of 2016.
The question is, are the DP prices likely to stay around $900 million for the next three years? The graph above suggests that it is likely. I estimate the likelihood to be around 70% (the amount of time they have stayed below $900 in the above graph). In this case, the downside is 100%. Otherwise, the upside is 500%. The expected return is hence 80%. Not great, but not bad either. I have decided to put at most 3% of my portfolio in this asymmetric bet on the price of DP.
There has been a stream of bad news coming our way, meaning it is time to give an update on the thesis.
Fortress is a dissolved pulp (DP) maker which is used in making rayon, a substitute of cotton. It sells almost all of its produce to China under long-term contracts. Fortunately, the quality of timber it can get for the production in Canada, coupled with experienced labor, offers Fortress a cost advantage compared to other DP makers which are not based in Canada. It has two mills, Thurso (operational) and LSQ (not operational). Fortress also owns and operates a facility in Landqart, Switzerland. This factory is the sole manufacturer of Swiss francs and also manufactures euros for 10 countries.
The first significant piece of information is the result of the China anti-dumping probe investigations. Fortress will have 13% duty on its products from Thurso, going forward. LSQ, when up and running, will have to pay a crippling 50.9%. This will for sure shelve the plans for converting the LSQ facility to a DP plant. In the meantime, Fortress is spending around $100,000 every month on the upkeep of LSQ.
The company's third quarter report is out. The improvements at the Landqart plant continue. Year to date, the plant has an EBITDA of $0.1 million as opposed to $17.5 million loss in the prior year. The improvements are especially heartening because the Swiss Franc is still historically quite high and is hurting the business at the mill.
The company has $102 million in cash and $227 million in debt, for a net debt position of $125 million. Adding it to the current market cap of $60.9 million we have an EV of $186 million.
Fortress also sold “non-core” land property at LSQ for $5.4 million in this quarter, for a realized gain of $4.1 million. Also, given the situation with the Chinese duty, the company is not going to start the conversion at LSQ anytime soon.
Let us come back to the valuation of the assets of Fortress Paper. Assume that the LSQ mill is worth $0. Then, we have to make an estimation of the value of Landqart mill and the Thurso mill.
The following is the result of the DP segment.
Here is a graph of the prices of DP until 2010. Fortress mentions that in the last quarter the average price of DP was $880 per tonne.
Historically, this is the floor for the DP pricing. Assuming a $100 per tonne increase in price, the Thurso mill will make an additional $31 million per quarter, wiping out the operating loss and making a operating profit of $22 million. A conservative multiple of 10 times operating profit leads to a value of 10x4x22=$880 million!
The management thinks that the Landqart mill can produce an EBITDA of $13 million (it was their target for 2012). In 2010, a similar mill as Landqart received 10 times EBITDA. Even assuming a conservative multiple of 5, we get a value of $65 million.
Hence, Fortress, as a sum of parts, is worth at least $940 million, an almost 500% upside from here.
The question one has to ask is, what are the chances of it going bankrupt before the prices of DP recover? This is a good question to ask, and let us try to make an estimate.
The company has $100 million in cash and the management has mentioned that the maintenance capex is $10 million a year. Let us for the sake of safety assume that the company bleeds $20 million a year instead. The company also has to pay interest of $12 million on the debt a year. This is a cash expense of $32 million a year. The first debt which comes due is in December 2016 worth $40 million. This means that the company can survive until the end of 2016.
The question is, are the DP prices likely to stay around $900 million for the next three years? The graph above suggests that it is likely. I estimate the likelihood to be around 70% (the amount of time they have stayed below $900 in the above graph). In this case, the downside is 100%. Otherwise, the upside is 500%. The expected return is hence 80%. Not great, but not bad either. I have decided to put at most 3% of my portfolio in this asymmetric bet on the price of DP.
