Small-Cap Glatfelter Is Heading To $30

| About: Glatfelter (GLT)
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Glatfelter still has not reached its full potential.

The company has the capabilities and management to capitalize on the growing demand all three of its businesses.

Factoring in management's plans to grow long-term margins, there is plenty of untapped value here.

With the stock trading at around $26, it is likely to reach $30 by the end of the year.

Whenever I'm looking for small-cap companies worthy of my hard-earned investment dollars, I start by assessing the quality of the company's management. Warren Buffett often reminds, "when a management team with a reputation for brilliance takes on a business with a reputation for poor economics, it is the reputation of the business that remains intact."

To that end, it's hard to find a management team with a stronger track record than those at specialty paper company Glatfelter (NYSE:GLT), a company that continues to prove that growth is still possible even amid maturity. Not only has management worked to produce consistent EBITDA growth, but they've done this in a industry with a reputation for weak volumes and compressing margins.

And if the company's first-quarter earnings report served as indication, management plans to reshape the company in a way to drive long-term growth and return capital to shareholders in the form of dividends and buybacks. Even more impressive, is the fact that management seem unafraid to redeploy the company's capital to secure its position in its core segments of tea, single serve coffee, hygiene and non-woven wall covering. All told, this is one of the best company's you've likely never heard of.

The company delivered revenue of $455.7 million, which represents roughly 13% increase year over year, topping last year's mark of $405.2 million. Recall, I mentioned above that management has been fearless when it comes to using its cash flow to acquire growth. So organic revenue, which measures performances using only internal resources and excluding things like acquisitions, is a worthwhile metric.

In this case, Glatfelter continues to benefit from its strong demand from its primary growth businesses of Composite Fibers and Advanced Airlaid Materials, which, when combined, delivered 6% organic revenue growth. And on an organic basis, total revenue increased 2.3% year over year. It's not an entirely robust number. But it does show progress is being made to bring synergies to the company's recent deal for Dresden.

In the third aspect of the business, Specialty Papers, the results were not as glowing. Recall, the company closed out 2013 with several challenges, not the least of which was issues related to pulp mill in Ohio. And when you consider weather-related factors that has impacted almost every other industry, management didn't have much on the positive side to day about that business. But the disappointment shouldn't last beyond this quarter.

When describing the production outlook, management talked about things returning to "more normalized levels." Absent and clearly picture and specific targets, it's tough to get too optimistic about Specialty Papers. But as I've said, this team has established a reputation for brilliance. And by "normalized levels," I'm looking for growth in the low to mid-single digit range, assuming that demand perks up. And when it does, no one is better positioned to capitalize on improving pricing conditions.

From an operational perspective, the company deliver a profit of $14.6 million, or which equated to 33 cents per share. On an adjusted basis, that was down 1 penny to $14.1 million. Not surprisingly, profitability was led by both Composite Fibers and Advanced Airlaid Materials business, which posted operating profit of 65% and 30%, respectively, over the prior year. And it looks as if those businesses are just getting heated up.

Unlike in 2013, there are positive signs suggesting that business conditions across the globe in improving for Composite Fibers. And given the fact that this business has greater capacity to meet growing markets, I expect management to raise guidance once or twice in the next couple of quarters. Not to be outdone, demand should also pickup for Advanced Airlaid Materials, which has already established a leadership positions the global hygiene markets. And that market has show no meaningful signs of slowing down.

While Glatfelter stock is not cheap after 121% gains over the past two years, good company ever trade below their fair market value. But consider, even at a multiple of 17, these shares are trading at just 12-times fiscal 2015 estimates, which makes Glatfelter one of the best hidden gems in the entire market.

Although the paper industry has become largely commoditized, there's always been something to love with Glatfelter's well-diversified business, which, according to market cap of $1.13 billion, sits in third place behind International Paper (NYSE:IP) and Domtar (NYSE:UFS) in the paper industry. As it stands, Glatfelter's management is not under the sort of microscope as the heavily covered stocks. This means they have the freedom to execute their business absent the daily pressure to move the stock price.

Management is working to drive higher margins. And management has executed with surgical precision by re-investing cash flow into these higher-growth markets. As noted above, one of these moves was Glatfelter's $209 million acquisition of Dresden Papier last year. Management made the point that it wanted to grow the company's presence internationally, particularly in areas like China and Russia.

To the extent that Dresden can grow Glatfelter's share in areas like Russia, Germany and China, this deal will yield long-term double-digit profit growth for the next five year. Not to mention, mid-to-high double-digit revenue (14% to 16%) growth annually. Note, with consolidate revenue surging 13% year over year, some of the synergistic benefits from Dresden have begun to emerge.

What's more, Dresden's proprietary manufacturing techniques will continue to drive lower production costs for Glatfelter. Investors should then expect reaccelerated growth in cash flow. At that point we expect management to redeploy its excess cash on more strategic acquisitions to leverage Dresden with higher-growth initiatives.

What this means is that Glatfelter remains strongly undervalued on the assumption that margins will improve as Dresden, which is known for its innovative capabilities, drives efficiencies higher. So even though International Paper and Domtar may produce twice the annual revenue of Glatfelter (and in some cases higher), we are confident that Glatfelter's earnings growth will continue to outperform.

All told, Glatfelter still has not reached its full potential. The company has the capabilities and management to capitalize on the growing demand all three of its businesses. And when you factor management's initiatives to grow margins, there is plenty of untapped value here. With the stock trading at around $26, it is likely to reach $30 by the end of the year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by Wall Street Playbook's consumer sector analyst. Wall Street Playbook is not receiving compensation for it (other than from Seeking Alpha). Wall Street Playbook has no business relationship with any company whose stock is mentioned in this article.