13 Months Later And I'm Still Cautious On Orchids Paper Products

Summary

• Orchids Paper Products ended FY 2014 on a sour note.
• Orchids Paper Products saw improvement in its revenue and net income so far in FY 2015.
• Orchids Paper Products isn’t free cash flow positive in FY 2015.

Nearly 13 months ago, my first article was published on private label paper products company Orchids Paper Products (NYSE: NYSEMKT:TIS). In that article, I highlighted its spotty fundamentals including how capital expenditures served as a drag against free cash flow growth. I also discussed its unsustainable dividend payout ratio. At the time, Orchids Paper Products had on an ok balance sheet.

I told my readers that I was staying away based on its low revenue and free cash flow growth rate, small market cap and unsustainable dividend. Since then, the free cash flow situation hasn't improved that much. However, over the past 13 months Orchids Paper Products' stock has given its owners a 20% total return vs 10% for the S&P 500 (see chart below). Let's examine.

TIS Total Return Price data by YCharts

Sour note

A month later, my Q3 FY 2014 earnings review for Orchids Paper Products was published and things weren't looking much better. I reiterated my bearish stance on the grounds of further degradation in fundamentals. Orchids Paper Products' year-to-date Q3 FY 2014 net income declined 30% year-over-year. Increased costs, most notably stock option expenses drove net income down at the time. Increased capital expenditures drove year-to-date Q3 FY 2014 free cash flow down 39%. I also noted the company's volatile nature related to its free cash flow.

Orchids Paper Products ended its FY 2014 on a sour note. FY 2014 revenue increased 23%, year-over-year, while its net income declined 29%. The acquisition of Fabrica accounted for most of the top line increase. I like to see companies grow by increasing customer demand. The company registered a free cash flow deficit of $5.6 million vs a positive free cash flow reading of $8.6 million in FY 2013. Higher raw material costs, lower parent roll selling prices, acquisition costs and sales commission costs all contributed to lower net income. Increased capital expenditures contributed to the free cash flow deficit.

Paper profits

While Orchids Paper Products ended its FY 2014 on a sour note, it's a slightly different story for FY 2015. So far in FY 2015, Orchids Paper Products has grown its year-to-date revenue and net income 25% and 40%, respectively, year-over-year. However, Orchids Paper Products registered a free cash flow deficit of $22.3 million vs a positive reading of $2.5 million the same time last year.

It looks like Orchids Paper Products' comparisons are still being affected by the Fabrica acquisition. Management hinted at organic growth as well, "Converted product tons shipped increased due to higher shipment volumes from our Pryor location" and "The increase in parent roll tonnage shipped was due to the start-up of our new Oklahoma paper machine in March 2015." Orchids Paper Products didn't have acquisition costs, which contributed to net income expansion. However, the company still doesn't generate cash. Orchids Paper Products saw a 166% spike in capital expenditures driving free cash flow into the negative range.

Orchids Paper Products' balance sheet remains in the same relative condition. In the most recent quarter, it clocked in a cash balance of $8.5 million, which equates to 6% of stockholder's equity; the same as it was 13 months ago. Its long-term debt equates to 33%, which is only slightly higher than the 31% of 13 months ago.

Dividends

I like to see companies pay out less than 50% of their free cash flow in dividends. Orchids Paper Products' negative free cash flow means that its dividend is unsupported. Currently, the company pays its shareholders $1.40 per share per year translating into an annual yield of 5.6%.

Valuation

Orchids Paper Products' valuation resides in a higher range than it did 14 months ago. The company currently trades at a P/E ratio of 23 vs 19 when my first article about the company was published. The S&P 500 also trades at a P/E ratio 19, which is a 10 year high according to Morningstar. This make Orchids Paper Products overvalued in an expensive market.

Conclusion

Orchids Paper Products has definitely made some improvements, and it's even starting to show signs of organic growth. However, I would still like to see some free cash flow generation before I would consider making an investment. Also, its private label product portfolio represents another check in my minus column for this company. Branding provides a name distinction that consumers can identify with. It's possible that this company will still outperform the market if it consistently beats low expectations set by the market. Personally, I'm taking my investing dollars elsewhere.

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.