P.H. Glatfelter Company (NYSE:GLT)
Deutsche Bank Global Industrials and Basic Materials Conference Call
June 12, 2013 4:40 pm ET
John P. Jacunski – Senior Vice President and Chief Financial Officer
Mark Wilde - Deutsche Bank
Mark Wilde - Deutsche Bank
All right everyone, we are going to move on to our next presenter here from Pennsylvania, we’ve got Glatfelter, this is a company that’s undergone tremendous change over the last decade. Essentially, doing some of, much of what you heard Domtar talk about a couple of presentations ago, which is to take cash from the paper business and invest in other businesses. In Glatfelter’s case, it’s gone primarily into two businesses, Composite Fibers where they were leading producer among other things of coffee filter and tea bag paper in the world and the other is Airlaid Materials, which they got into about three years ago.
Here to talk with us about Glatfelter and that transformation they’ve engineered in the company is John Jacunski, the CFO. John has been with Glatfelter I think about 10 years now.
John P. Jacunski
Okay thanks Mark, thanks for joining us this afternoon, to cover a bit about Glatfelter. So Glatfelter today is about $1.7 billion revenue business. We have three businesses; we have our legacy specialty papers businesses here in North America that makes communication papers, as well as a number of other highly engineered paper products. Our Composite Fibers business that Mark referenced makes lightweight materials that go in to filtration applications like tea and single-serve coffee.
We also have a business that makes the non-woven substrate for wallpaper, we just acquired a business April 30, and I’ll talk a little bit about that acquisition in a minute. And then our Advanced Airlaid Materials business, this business produces superabsorbent very thin materials for the feminine hygiene and adult incontinence product markets. We have 11 production facilities around the world primarily in North America and Western Europe with the raw material facility in the Philippines.
So as we think about the evolution in Glatfelter as Mark referenced, we have been over time migrating our portfolio mix to give us more exposure to growth markets. So you can see some of that here on this slide and in the last three years in 2010 we made the acquisition of Concert Industries that established our Airlaid Materials business. And then this year we completed the Dresden Papier acquisition that gave us exposure to the growing non-woven wallpaper substrate market, as well as just completing a $50 million expansion in our Composite Fibers business, this expansion will give us additional capacity to serve our, the growing markets in tea and coffee and technical specialty. So the things we've done over the last three years have certainly pushed us more towards growth businesses.
And as you could see on this slide, we have about 50% of our revenue, and a little over 50% of our EBITDA is now coming from these growth businesses. So our strategy has been as Mark mentioned, we have improved our specialty papers business to the point that it’s generating in the $60 million to $70 million pretax free cash flow per year, and we've taken that cash flow and we've used it to do a number of things. One, is to grow our growing global businesses of Composite Fibers and Advanced Airlaid Materials. We've also put our balance sheet in very good shape, which give us the flexibility to continue to pursue both organic as well as acquisition growth and this has driven a significant growth in earnings of 17% [company’s] [ph] growth rate in earnings per share over the last five years and has allowed us to return cash to shareholders. So in 2011, primarily in 2011, we completed a $50 million share repurchase program and earlier this year in March, we announced an increase, 11% increase in our dividend which was the first time in 20 years that we were able to do so. So with the condition of our balance sheet, we believe that we can continue to do these things, we can continue to both grow our business, make the investments to grow our business, as well maintain a very healthy balance sheet to give us the flexibility to do that and return cash to share holders as we have excess cash and we expect we will as we go forward.
So as we look at the markets that we serve specialty papers, we have generally number-one or number two positions in leading markets. The engineered products if you look at the pie chart in the lower left. The engineered products section of his business where we make things like food grade applications, high speed inkjet products, greeting cards, playing cards, posted notes those of things. Those, that portion of our business tends to be growing at above GDP. The other three portions of this business are generally in decline and about the rate that the uncoated free-sheet markets decline. We've been able to outperform them and you will see that in a few slides that we've been able to outperform the broader uncoated free-sheet markets and we think we can continue to do so.
If you look at the other two portions of our business, we have leading positions in these global growth markets. So in tea bags we think, we are the number one producer, we have about 55% global market share and we think the market is growing about 3% annually. In single-serve coffee, this market we think is growing above 12% globally, the heaviest growth rate is here in North America with things like the Green Mountain Keurig Coffee System that has been growing substantially, little more mature in Europe growth rates there in the 4% to 5% range, they were a little bit earlier to the single-serve market than U.S. was, the penetration rates there are still much higher.
So penetration rates could be in the 25% to 30% range in Europe, whereas in the U.S. they are in the low double digits 11% to 12%. So I think there is still a significant opportunity for growth the single-serve coffee markets here in the U.S. And we think we have a great opportunity to continue to grow with that market.
The non-woven wallcovering market, this business makes substrates for wallcovering, wallpaper and I’ll talk about the performance characteristics of that in a minute. But the business that we acquired in April has the number one share in the world, they have about 50% of the global market and that market is growing about 10% a year. So the broader wallpaper market is growing slower than that, but there is a conversion from the traditional paper-based wallpaper into the non-woven substrate, because of its performance characteristics. So it's been growing at least 10% per year and we think it continue to do so for some time.
Look at the Advanced Airlaid Materials business, again this business has a number one position in the feminine hygiene market with about a third of the market around 35% market share and this market is growing about 5% to 6% per year. So these two businesses we think continue to give us significant growth opportunities as we go forward.
We take a look at each of our businesses in our Specialty Papers business if you look in the lower left hand corner of the slide you see that Glatfelter shipments for the last eight years have outpaced the broader market. The broader markets generally have been in decline in the last few years that's been about 3% to 4% per year. We've been growing; we grew every year in this eight year period except for 2009, when the market was down 16%, we were down less than a percent. There is a couple of things that I think are important to understand with this business, we are able to bring certain things to the market that we think our competitors are not able to and its things like our customer service, our ability to develop new products quickly for our customers has given us an advantage in the market.
The context of the broader market is also important, this market is 8.5 million tons to 9 million tons declining 3% to 4% per year, we represent a little under 800,000 tons of that market, so we are less than 10% and if our business were to have 3% attrition per year that creates a gap for us of about 25000 tons per year, that’s a manageable gap for us to be able to target new business and win new business.
And as you could see from our track record we've been able to do that and we generally have been running our facilities at capacity, and we think the combination that I talked about of customer service ability to bundle products to customers and develop new products will give us the opportunity to continue to run our assets full.
When we combined that with our continuous improvement initiatives and these are initiatives that are based on the concepts of Lean and Six Sigma, Kaizen that we use to improve the efficiency and cost structure of our business, we've been able to generate improvements in both our margins as you see in the upper right as well as our operating profit.
So last year our operating profit at $67 million was up 17% over the prior year and with capital expenditures and depreciation about equal, we’re able to generate $67 million of pretax cash flows from this business. So as we go forward we’d expect this to continue to be a significant cash flow generator for the company.
Composite Fibers, again this business, the markets its serving is allowed it to significantly grow its operating profit from 2009 to 2011. We nearly doubled our operating profit to $41 million, so little bit of a decline in 2012, largely driven by foreign currency translation, the weakening of the euro reduced operating profit by about $3.2 million. We also saw a little bit inventory management issue by our customers that reduced the shipping volume that we had.
Our end markets continue to perform quite well, last year given the economic circumstances, however our customers were reducing their inventory levels and that reduced our shipments. We expect that had run its course as we went through the fourth quarter and we did see a good rebounding shipments in the first quarter, our shipments were up 7% over the fourth quarter and we expect to be able to see continued improvement in our shipments as we go through 2012.
Again you see that our $50 million investment to expand our capacity in this business, we have, we took this machine down in late February, so we had one flat wire machine in our portfolio. We are upgrading that to an inclined-wire machine and these inclined-wire machines are necessary to make the lightweight substrates for tea and single-serve coffee and or the technical specialties.
The machine has taken down late February and perform the upgrade, we've recently started that machine up and we’re in the process of going through the start-up phase and taking care of the punchless items to get it up to its expected operating capacity. And as I previously mentioned, we completed the Dresden acquisition, I'll cover that in a few minutes.
Our Advanced Airlaid Materials business, this is a business we acquired in early 2010, you could see the operating profit in the lower left, we got off to a little bit of difficult start when we first acquired this business, but we’ve seen significant improvements since that time driven by a strong growth in shipments, we have grown shipments of an 8% [company] growth rate growing faster than the market since our acquisition.
And again our continuous improvement initiatives have improved our cost structure, so we've gotten our margins up to about 11% in 2012 an $18 million of operating profit. We continue to expect to be able to improve these margins, the margins were about 12% when we purchased the business and we expect to be able to get in the near-term get to the 12% mark and we expect to able to push beyond that.
So I'll spend a few minutes on our Dresden acquisition. This business has produced 60,000 tons per year of non-woven wallcovering base, so it had a $150 million of revenue in 2012 with EBITDA $38 million so it had about 25% EBITDA margins. They’re the leader in this position with about a 50% market share. The product characteristics that it has make it superior to the traditional paper-based wallpaper, which is giving it the opportunity to grow faster than the market.
So if you've worked ever with the traditional paper-based wallpaper you know it's flimsy when it's gets wet it expands and then when it dries it shrinks, so you need to be careful when you install it. And if you ever had a pulled off a wall, you need to wet it, you need to tear it off the wall often involves scraping and lot of pain and fighting with your spouse. So this substrate has a much stronger – it's a much higher tear resistance, it allows you to apply the paste to the wall and put the wallpaper directly to the wall it doesn't shrink or expand when it's get wet and it also allows what's called dry stripability, so you can pull this off the wall and just peel it right off like it is posted note.
So these performance characteristics have made it a much more popular product in Europe where they have significant market share in Russia, in Ukraine and we expect as we go forward that we’ll continue to see this migration from traditional paper-based to this non-woven substrate. We paid $210 million for the business, so about 5.5 times and we expect that it will be nearly accretive to earnings by about $0.25. So last year we earned $1.25 so this will be significantly additive to our earnings per share as we go forward.
This slide gives a little bit more, look at the wallpaper market, you can see the performance of the broader wallpaper market that had been declining through 2009 and has turned around and started growing gain. You can also see the growth in the non-woven part of this market and so even in 2009, during the global recession, the non-woven market grew despite a pretty substantial decline in the broader markets and we’ve continued to see that.
So as shown here, we have significant demand in Europe, Russia, Ukraine there is significant growth potential in Asia; we do have a small position in Asia. But the position in that the capacity position we have and the demand we have in Europe and in Russia is such that we don’t need to reach out all that much farther. So we have a small position, we know what’s happening in the Asian market, but we can better serve customers with better proximity to our facility. So we will expect that the market will continue to grow in excess of 10% per year.
So from a financial perspective I think Glatfelter has generated a track record of being able to grow both our net sales and our EBITDA, we’ve seen improvements in our margins, generating a 9% compounded growth rate on EBITDA over the last five years, certainly the acquisition of Dresden and the addition of the inclined-wire capacity and Composite Fibers, it gives us an opportunity to continue this track record of healthy earnings growth.
From an earnings per share perspective, our growth rate is somewhat higher, at 17% on a five-year compounded growth rate basis, again the growth in earnings or the EBITDA the business, but also our share repurchase program where we repurchase 7% percent of our shares in 2011 has helped the growth. We also show this with and without our pension, our pension plan is over funded, we’ll see that in a minute, but it is a very significant drag on our earnings per share, and I think it's important that investors understand the funded status for that plan, and the impact on earnings as they look at our earnings per share. So I'll cover that in a minute. But I wanted to show that here as well.
From a cash flow perspective, Glatfelter, you can see in this 2003 through 2008 timeframe, we had (inaudible) cash flows. 2006 is when we made two acquisitions and shut a facilitate down, but it's been a significant area of focus for us to be able to both improve the cash flows and generate consistent free cash flow year-to-year.
So in 2009, we generated a $108 million of free cash flow that includes $47 million of working capital. We had a very intensive working capital program in 2009 we took $47 million off the balance sheet. In the 2010 through 2012 period we’ve taken another $20 million of working capital off the balance sheet, but that's what drove 2009 to be much higher. So if we adjust the working capital out, we are generating in the $70 million to $80 million of free cash flow per year.
When we add in Dresden, Dresden with $38 million of EBITDA and CapEx that's around $5 million or $6 million per year in net a little bit of interest and taxes we ought to be able to generate another $15 million to $20 million of free cash flow from that business, so we think we can get in that $90 million to $100 million of free cash per year with our normal level of CapEx.
So to it sort of comminutes with return on invested capital and certainly a very important measure for Glatfelter, we think is probably the single most important measure to make sure that we are earning appropriate return on all of our investments. And again, as you’ve seen with our improvements in EBITDA, our improvements in cash flow, we’ve seen our return on invested capital go from below 4% to over 9% and now exceeds our weighted average cost of capital that's in the low 8%. Again, we expect as we go forward we’ll continue to maintain returns that are in excess of our weighted average cost of capital.
So a few more words on our pension plan. If you go back one year prior, what we've show here, our pension plan was over funded by about $200 million as we came into 2008. The significant declines in the debt and equity markets, as well as declines in the discount rate essentially made the funding go down to $40 million. So that's call it $200 million loss is hung up on the balance sheet and amortizing the future.
So despite the fact that our pension plan is over funded it's not a cash flow or economic issue for us. It is translated into a significant earnings hit for us. So in 2008 we had about $0.22 of income from our pension plan in our P&L. In 2013, we expect to have $0.22 of the expense. So it’s been a $0.44 per share shift, despite the fact that we have not had to make a contribution during that period. We don’t expect to have to make a contribution for the foreseeable future. So I think as you look at our company, consider the earnings it’s important to understand where the pension plan, what’s the status of the pension plan is and take that into consideration.
From a balance sheet perspective, our balance sheet has been in good shape for some time, we intend to keep it that way. Over the last 18 months or so we have refinanced all of our debt, so we have a $250 million bond issued at [5.38%] outstanding that’s due 2020. We have a revolving credit facility that as of March 31 had no outstanding [side], it is matures in 2016. And so in April, we placed a fully $2.7 million, tenure term loan in Germany at a fixed rate of 2.05%. This was a Green Financing program we qualified for with some investments we have been making.
We also used our revolving credit facility as well as some cash to complete the Dresden acquisition. So pro forma for the Dresden acquisition our leverage is about 1.9 times, so still, we still have plenty of capacity to, continue to grow our business and make investments. But we still have low risk in the balance sheet and we have no near-term maturities.
So just to wrap up, we think the leading positions we have in our markets that are growing in that 5% to 10% range in our Airlaid and Composite Fibers businesses give us a significant run rate for continued cash flow and earnings growth. Our track record, I think supports the things that that we think we can accomplish as we go forward in generating the terms that are greater of our cost of capital and the strong cash flow profile that we’ve built and the condition of our balance sheet gives us the opportunity to continue to execute our strategy.
Last thing I’ll to mention is our timberlands. We do have 72000 acres of timberlands remaining. We've been monetizing our timberland portfolio since about 2003; given the impact to the real estate markets with the 2008 financial crisis that program had slowdown. With the condition of our balance sheet, we can take our time, we well allow the markets to improve and when we can get good pricing then we will sell the land. We sold about $10 million last year, we’ll probably sell a little bit this year, but it will be little bit (inaudible) until we see the markets recover a little bit better.
So with that I'd be happy to take some questions.
Thanks John. I'll throw the first one out. Since we spent a lot of time talking about Dresden and there was a big old picture in The Economist this weekend of flooding in Dresden. Can you just update us what the state is there, are we under water?
John P. Jacunski
Sure. Lot of the area was under water, we had, this facility had some significant flooding about 10 years ago, with that flooding they moved much of the critical equipment above grade, above the 500 year flood stage. So and they also put in place a very good flood risk mitigation plan and fortunately they also executed it very well. So we did need to take some downtime last week, we needed to move motors out of basements and control equipment, but they did very effectively in return to production on Saturday. So other than a little bit of downtime no real impact to the business.
Okay, I guess the other question where we're about to kind of - we’re ramping up on that $50 million machine rebuild. Can you just give people a sense of how that may flow sequentially, as it goes from kind of start-up cost, starting to really generate some leverage for you.
John P. Jacunski
Sure. What we said about the cost is that we expected that the impact of the downtime and the upgrade will be about $1 million to $2 million per quarter in each of the first and second quarters. It was about a $1 million in the first quarter, I expect it will be more towards the upper end in the second quarter, because that’s when the bulk of the start-up took place.
What we’ve said is that over the next three years, we expect to be able to achieve 15% to 20% after tax return within that three-year period. It’s not sort of an even we are moving away from the low end composite laminate market that we were serving, and moving to the higher profit and higher revenue products. So we expect we will start that ramp up, we do have some contracts in place that give us some certainty of growth and then obviously with market growth in some of these other products, we think that we will ramp this up over the next three years.
Mark Wilde - Deutsche Bank
On the non-woven substrate stuff, what is the pricing of the non-woven wallpaper relative to standard? And second are there any design limitations of non-woven versus the other? My wife has been trying to beat into me the nice texture you get from wallpaper. And is there any kind of limitation to that versus standard?
John P. Jacunski
No. It’s actually the non-woven can give you some different textures because of the heavier basis weight of it. You can do different textures with it. So it’s probably a little bit more flexible than the traditional paper-based. It is a little bit more expensive than the paper-based when you consider just the paper cost. If you take into consideration the installation cost, particularly if you need to first remove wallpaper and then put it up the install cost is likely going to be less with non-woven than it is with the traditional paper-base. If you don't have to remove something then it's not going to be as different. But there is not a substantial cost difference to the consumer in using the non-woven base because of that.
Price per ton that you would realize?
John P. Jacunski
The price per ton $2600.
Okay. And John you actually, just while we are on that, you’ve talked publicly about roughly a 20% capacity ramp in that business, what will lead to earnings power, what's the cost of the capital you're having to put in, you’re going to go from 60,000 tons somewhere between 70,000 tons and 74,000 tons as I recall?
John P. Jacunski
That's right. That's right. So we are, the markets growing about 10% a year, so this is the modest investments, it’s a few million dollars and the issue is improving the capacity of this machine and the throughput is less on that cost of the equipment and more on just figuring out how to do it. And so they taken that machine that used to produce 30,000 tons and they've gotten it to 60,000, and we think we can get it to 74,000 tons in the near term with a few million dollars of investment.
The flow through there, the raw materials are significant cost components of these products, so it's in the 70% range of the cost of goods sold. So there isn't as much leverage perhaps, because the overall labor costs and energy costs are a lower component, but certainly it's higher than the 25% EBITDA margin that they have been generating, but I would say it's not substantially higher.
Just talk about uses of cash going forward.
John P. Jacunski
Sure, uses of cash. I’d say it hasn’t changed a whole lot. The fact that we now do have some pre-payable debt on our revolving credit facility, means that in the near term, we are likely to pay down some debt. But our priorities are making sure we maintain a balance sheet that gives us a capacity to continue to make organic and acquisition type investments to grow our business. We will likely in the near term pay down a little debt and then its return cash to shareholders, whether it be through share repurchases, or dividends. We believe we should keep a competitive dividend. We’ve said, we think that’s in that 2% to 3% range. We are lower than that today, because the share price has moved up. So there is an opportunity for us to continue to return some value to shareholders and still maintain a pretty healthy balance sheet.
Other questions, John can you just on the specialty paper business, is that market declines. Is there a point at which in the next three to five years you would foresee having to actually take some capacity out yourself? And along with that I think there is a pretty significant difference between sort of the margins that you’re generating at the two different facilities, can you talk about whether margins can move up or whether that sort of a 11.5%, 12% we’re looking at right now is what we’re going to have going forward?
John P. Jacunski
Sure. I think it’s hard to say whether we would have to take capacity out. I mean, we think that our current level, shipment level and capacity level is something that we can continue to maintain. As we are able to continue to improve the productivity of these machines, so if we create incremental capacity, I guess it is possible that we could be in a position down the road where we could say, look we can get the same throughput from eight machines instead of a nine that we are running and we could shut a machine down.
Ultimately that would be good for us that would be a lower cost way to get the same number of shipments out the door. I don't foresee in the next, in the near term that we would need to shut down a facility or a machine, because we can’t sell the capacity we are at today, I think it's more, it would be more determined by our ability to improve productivity on certain machines that give us more capacity than we have today. And that could drive that.
With respect to margins, the gap on the margins between the two facilities has shrunk overtime much of the improved operating profit that we’ve generated in the specialty papers as come from Chillicothe, which is the facility we acquired in 2006, that was not a very profitable facility when we acquired it, and had a lot of cost reduction opportunities and that's part of what to drove our earnings improvement.
I think that when you look at the broader market dynamics and even more recently the pricing that in the uncoated free-sheet market has drifted lower. I think saying that we will be able to improve margins to any great degrees is a little aggressive, I think that given where we are today, our ability to maintain margins, maintain operating profit in the cash flows is a good target for us.
Any other questions out there. You want to finally just talk about any kind of expansion in the Airlaid business?
John P. Jacunski
Sure. I mean when we look at M&A organic growth, it will be Composite Fibers management team has their hands full, they've just done an acquisition, they have the capacity expansion that they are just starting up, they’ve got a number of new products they are working on, we made this announcements earlier this year of this partnership with the company called Dreamweaver, that produces substrates, that get into things like lithium-ion batteries, so there is a lot of product development work with that electrical market.
So that management team has its hands full, we’ve talked about specialty paper; acquisitions are probably less likely in that scenario. So that leaves us with Airlaid and I do think that with the $260 million business, which is our smallest business, building some scale in that business I think would be helpful for us. And certainly there are a number of different companies and targets out there that could fit us. And so we as we had been we will continue to be disciplined in how we look at businesses and companies. But I expect that there could be some opportunities and it’s the right kind of business for us to start working at to grow again.
I guess the one other thing you might have wanted to just mentioned, I mean when I started to deal with this company in the 1990s, the family the Glatfelter family owned almost 40% of the equity. You might want to talk about where that number is today.
John P. Jacunski
And the fact that there are no more Glatfelter family members in the company.
John P. Jacunski
Yet that’s right. So George Glatfelter was our CEO from ‘98 through the end of 2010, he retired in 2010 and retained the Chairman role through May of that year and then he left the Board. So Dante Parrini was promoted to CEO he’s our currently CEO, he has been with the company since 1997, so he has a long track record with the company. He was a part of, an integral part of building this strategy and executing this strategy that we have today. And there are no other Glatfelter family members in the business at all, at any level of management.
As Mark mentioned family had a substantial stake as late as 2004. In 2004 the company went through a managed secondary offering of the family’s shares that reduced their holdings to around 11%and since that time they continued to sort of wiggle it down, so today they may hold 2% to 3% and I mean no positions on the board and no positions in management, so its, we operate no different than any other public company.
Okay, very good. Thanks John.
John P. Jacunski
Thanks a lot.
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