- Ranking 853 low EV/EBIT stocks on multiple value metrics shows Stora Enso is cheap. Simultaneously it has a good combination of strong and smooth momentum. This predicts good statistical returns.
- Stora Enso is transforming from a paper business to a renewable materials business. This transformation seems to be progressing well.
- Investors seem to take the new, more specialized products into account in their valuation of Stora Enso: up from the lower multiples for a commodity producer.
- There is a slow trend: replacement of conventional packaging materials by paper. Also land for growing trees will only get scarcer.
- Much of the new demand will come from developing countries, with fast growing consumption.
Stora Enso Oyj (OTCPK:SEOAY) is a big investor in tree plantations and companies processing these trees into paper and other wood products. Apart from on the OTC the shares also trade in Helsinki, Finland and in Stockholm, Sweden. The primary listing is in Helsinki. The shares traded in Stockholm are similar to the ADRs traded on the OTC in the US.
What piqued my interest in this company are the huge land holdings. Could they be worth more than book value? It is difficult to say, but I assume the difference is not so big. The company has 2 minority stakes in more pure play forest companies and gives some insight in their profitability. I noticed these 2 other companies do not have a high return on equity. So at least these stakes are probably not worth more than book. I will discuss one of these stakes in more detail later in this article.
Another reason for why I find this company interesting is most stocks from quantitative screening are unnoticed small caps. I find it interesting that this stock is a well-known large cap. What could be different for this well-known large cap to be cheap enough to appear in my quantitative value/momentum screen?
To find this company I have compared valuations of 853 selected momentum stocks. These stocks have been selected on momentum criteria and fundamentals (mainly EV/EBIT < 20). Among these selected stocks 82% of the stocks has a less favorable rank on a combination of value factors than Stora Enso. In particular Stora Enso is relatively cheap based on the ratios EV/Gross Profit and Retained Earnings from 8 years/Market cap.
BTW, I use several quantitative methods to source investment ideas. One of them is similar to Trending Value described in the book What Works on Wall Street. The strategy I employ here is actually one of the best of the 300 strategies described in the book.
This strategy ranks US stocks with positive momentum on various value factors. One of the biggest differences with the book is that I rank on smooth momentum instead of on raw momentum. Smooth momentum suggests many knowledgeable investors are slowly buying into the stock.
Please see this free overview article of mine for more details on the 4 different quantitative strategies I use.
Going back to Stora Enso, ignoring recent momentum which is subject to mean reversion the 1-year momentum is indeed good and reasonably smooth:
Momentum is also backed by a high Piotroski score of 7. This metric is based on year over year improvements in among others earnings, share count and the balance sheet. So independent from momentum it confirms fundamentals are improving.
Business description of Stora Enso Oyj
Stora Enso harvests wood and processes into products like building materials, pulp, paper, corrugated fiberboard, packaging boxes and packaging paper and solutions for consumer products. For those who would like to read more about Stora Enso I recommend reading the financial report over 2017 and the "Progress Book" over 2017.
Assets are mainly land with trees and factories. Most assets are in Sweden and Finland, but the company also has large assets in China and Uruguay. Though the company owns and leases massive amount of land most of the book value of Property, Plant and Equipment is in buildings and equipment, or factories.
Currently Stora Enso has a 49.28% stake in Swedish forest company Bergvik Skog, with huge land holdings. This stake has a book value of about 1.3 billion euro and generated earnings of almost 60 million euro. See here. Leverage of this business is similar to leverage of Stora Enso's other businesses: Total Assets/Equity is about 2. Currently there are talks about Stora Enso increasing its stake to 70%. Shareholders may see this as a positive for the stock. Bergvik Skog is not so profitable and that might improve if Stora Enso takes control. I expect some improvement but not a huge improvement.
The balance sheet of Stora Enso shows low leverage with Total Assets/Equity about 2. Included in the liabilities is 1 billion euro of current debt and 2 billion euro of non-current debt. With 600 million euro of cash and net profit plus depreciation plus impairments above 1 billion euro the company is not distressed.
Large shareholders are the Finnish state and the Wallenberg family. They have 27.3% of the votes each. Also the Social Insurance Institute of Finland has 10.1% of the votes. The economic interest of these 3 shareholders together is only 26% because of special shares with 10 votes per share. Because of these shares with extra voting rights the company is unlikely to be acquired.
The company has 5 business segments (apart from a small business segment "Other"): Consumer Board, Packaging Solutions, Biomaterials, Wood Products and Paper. As I understand it Consumer Board is for producing consumer (disposable) packaging for staple products, Packaging Solutions corresponds to bigger paper and corrugated fiberboard boxes, Biomaterials is pulp for paper but also for many other end products such as diapers, Wood Products are mostly for building materials and Paper is mainly paper for magazines and newspapers. The contribution to EBIT from each of these business segments is approximately the same size.
The company provides very detailed financial information on each business segment. The best business segments in terms of EBIT are Consumer Board and Biomaterials. EBIT in each of the business segments except for Paper has been growing mostly due to increasing production capacity. EBIT of the paper business declined much because of lower newspaper sales. I think this is a secular trend. Paper production was also smaller than in 2016 because of an accident in one of the factories and several divestments in 2016. As a result the company's remaining dependency on the paper business is small.
In terms of operating capital these 2 segments are bigger than the others: Consumer Board and Biomaterials. Another measure for comparing business segments is Return on Operating Capital or ROOC. ROOC can vary much with operating leverage. All business segments have low leverage except for Paper. The Paper segment has moderate leverage with Operating Assets/Operating Capital just above 2. Therefore I do not think leverage is very important when comparing the ROOC of the different business segment.
The segment Consumer Board has 15% ROOC and Biomaterials has 10% ROOC. In terms of operating capital Packaging Solutions is about half the size than the Consumer Board division but has an ROOC of 20%. The Wood Products segments also has an ROOC of 20% but this is the smallest business in terms of operating capital. Therefore the most important business segments are Consumer Board and Packaging Solutions. Biomaterials is also very important because this segment supports the other business segments.
The importance of these 3 business segments aligns perfectly with the company's long-term ambitions. These are transforming "from a traditional paper and board producer to a customer-focused renewable materials growth company." The company has done many restructurings and disposals to align its business with this objective. I expect better margins from more consumer oriented businesses. Clearly producing new innovative paper-based packaging in the segments Consumer Board and Packaging Solutions is more directly focused on consumer than the paper business.
The growth of each business segment except for the Paper segment suggests good progress in this transformation. A long list of US-patents also confirms the company seriously tries to develop innovative products and to optimize production processes. I count 115 patents expiring in more than 10 years.
What the good momentum could mean
Usually smooth price momentum is related to fundamental changes or significant improvements. With Stora Enso profits have indeed increased much. With Stora Enso other factors might also have contributed to the good momentum. Until the fourth quarter of 2016 investors might have viewed Stora Enso as a commodity play in a shrinking paper market. But now investors might be seeing the company as a more innovative player in packaging solutions and packaging for consumer staples products. In fact, the numbers over last year confirm this.
These 2 businesses have better margins and may be better protected by patents than the paper business. As a result investors might change the multiples they give to this stock. For example right now the EV/EBIT multiple is about 14. This might increase to the higher multiple of better known companies in the consumer staples sector, such as Unilever (UN). The multiple could even become higher if profit keeps growing at the current rate.
Lastly, yet entirely different factors may have contributed to Stora Enso's momentum. Humans do not like trees. Since our existence we have reduced the number of trees. We have been extremely successful in this. In an ever growing world economy however we need trees for all kinds of things. Wood is a renewable basis ingredient of many materials. They are a substitute for less environmentally friendly materials such as plastic or steel. In the mean time land for growing trees is getting scarcer.
I think consumption of Stora Enso's new paper products will be growing fastest in developing countries. Of course in developed countries plastic containers and alike are also being replaced by paper and fiberboard. And there are also other developments. In particular ever growing deliveries by webshops are a tailwind for the Packaging Solutions business.
So after the multi-year slump in paper usage Stora Enso's new products could see multi-year increases in demand. Finally investors seem to be anticipating on multiple slow trends contributing to this.
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