Neenah Paper (NP) recently dropped about 11% from its 52-week high of over $57. The stock is now oversold and poised for new gains as the company continues to increase revenue and earnings. Neenah is experiencing double-digit sales gains for its technical paper products [10% gain for the first half of 2014] and a modest 4% increase over the same time frame for its fine paper products. The stock is now oversold and attractively valued, which sets it up nicely for where we are in the current business cycle. Paper companies typically perform well from the point of the Federal Reserve remaining neutral on interest rates until about the third time that interest rates are increased. The catalyst to drive Neenah's revenue increases will be increased demand for transportation filters, backings, specialty products, and premium fine paper products as the economy continues to grow.
Valuation
Neenah Paper is undervalued in relation to the Paper industry and the broader market. Neenah is trading at 14X next year's expected EPS of $3.63. The Paper industry and the S&P 500 are both trading at about 16X next year's expected earnings. This makes Neenah approximately 12.5% undervalued in relation to its industry and the broader market.
Neenah is also undervalued as compared to its small-cap industry competitors. Wausau Paper (WPP) and Mercer International (MERC) are trading at 40X and 16X next year's expected EPS respectively. Neenah is also undervalued as compared to these peers when taking taxes out of the equation with an EV/EBITDA of only 7.99. Mercer is close with an EV/EBITDA of 8.4, but Wausau trades much higher with an EV/EBITDA of 12.
Small-cap competitor, PH Glatfelter (GLT) does have a lower valuation than Neenah as it trades at 9.7X next year's expected EPS. However, Glatfelter missed its earnings estimates for the past four quarters, while Neenah exceeded its estimates for three out of its last four quarters. So, I feel more comfortable that Neenah will meet or exceed estimates going forward.
Neenah also looks undervalued from a discounted cash flow perspective. If Neenah can grow free cash flow at just 5% annually for the next 10 years, the stock is worth about $66 using a discount rate of 9%. This means that the stock should be about 29% higher than the current price. The stock price of $66 would give Neenah a forward PE of 18, which would be above the industry average. That might be a bit too high, so I think that a reasonable price for the stock is $58, which would give Neenah a forward PE of 16, in-line with the industry and the broader market. This is also only 50 cents higher than Neenah's 52-week high, reached before the recent sell-off.
The Stock is Poised to Increase in the Current Business Cycle
Paper companies typically perform well in the business cycle between when the Fed is neutral on interest rates and after a series of interest rate increases. Since the Fed is currently neutral on interest rates, I think that there is plenty of upside left for Neenah and the Paper industry. Neenah does tend to sell-off dramatically in the face of a recession, so a safe exit point for the stock would be after the third time the Federal Reserve raises interest rates.
What Will Catalyze Neenah's Growth
Neenah is growing revenue in both the Technical products segment and the Fine Paper segment. I mentioned earlier that Technical products are growing at double-digit rates, while Fine Paper is growing at single-digit rates. I think that Neenah will continue to experience strong demand for its automotive filter paper. The auto market in general should continue to remain strong as the economy improves and as consumers and businesses trade-in their older vehicles. Even if new vehicle sales slowdown, paper filters still need to be replaced on a regular basis, so that part of the Technical segment looks solid going forward. The other Technical products should also continue to experience growth. Sales of backings have been strong and should continue to experience strength as the economy continues to grow. I think that this segment will grow at about 7% - 10% year-over-year for 2014 and again in 2015.
The Fine paper segment should continue to see growth for premium products, labels, and luxury packaging. Premium products such as corporate packages and formal invitations should also continue to see growth as the economy strengthens. Neenah makes various packaging solutions such as paper for hangtags, bags, and boxes that are used by numerous businesses. As the economy continues to heat up, the demand for these items is also likely to increase. I think that this segment can grow in the mid-single digits in 2014 and in 2015.
Strong Balance Sheet
Neenah has a strong balance sheet with over 3X more current assets than current liabilities. This shows that the company can easily handle its short-term obligations. Although the total debt of $194 million exceeds total cash of $92 million, Neenah is sufficiently profitable to handle long-term obligations as well.
Conclusion
Neenah Paper is likely to thrive in this phase of the current business cycle. The stock is undervalued and oversold, which makes Neenah a good buying opportunity for the long-term. Analyst's earnings growth estimates of 16% for 2015 look reasonable when accounting for total revenue growth of about 6%, a gross margin of 19%, an effective tax rate of 35%, SG&A expenses of about 10% of total revenue, and lower interest expenses as a result of the refinance. I think that the current undervaluation and earnings growth will allow the stock to increase by 15% to 20% over the next year. The company has a knack for exceeding earnings estimates, so the stock will respond favorably if this trend continues. In addition to the capital appreciation, investors will also receive a dividend of 2% on Neenah's payout ratio of 28%.
