- Suzano is a play that aggressively leverages the pulp price opportunity due to its almost total exposure to the commodity.
- While there has been a run-up in pulp prices recently, it doesn't coincide much with Suzano's recovery, which occurred primarily in line with the recovery in the general market.
- Suzano is very levered, which magnifies the upside in pulp price run-ups.
- With several supply-side forces stepping in to raise pulp prices, and demand side forces incoming with reopening, we are bulls on Suzano in the short, medium, and long term.
The recovery is underway at different rates for different companies. Much of paper and packaging has seen a huge rally of late as activity has picked up in these sectors, with a total recovery of manufacturing paper, corrugated packaging and consumer paper. However, there is a lot of heterogeneity in the sector. While you might have mills like International Paper (IP), which are pretty close to the end-market consumer, you'll also have companies like Suzano (NYSE:SUZ) which lie at the opposite end. Suzano's exposure is almost entirely to the commodity of pulp, however, while Suzano has rallied in price of late, it hasn't gone ahead of the rest of the sector. This seems to indicate that while input prices will be hampering the recovery in the rest of paper and packaging due to higher oil costs and regulatory developments in China, Suzano has an open runway. As such, we are bullish on Suzano in the near term, both as an absolute trade or a relative trade against the broader paper and packaging space.
Understanding the Trade
The Suzano trade is based on several fundamental movements. First of all, Suzano is highly exposed to pulp prices.
(Source: Annual Report 2020 SUZ)
Pulp prices have been in a gully since mid-2019, but after floundering in a trough during the initial March lockdowns and the worst of the pandemic they have suddenly shot up.
There are three reasons for this run-up, where two help substantiate the thesis. The unhelpful one is that demand is up in pulp end-markets. The reason this is unhelpful is because this does not explain the lack of differential stock performance between Suzano and the likes of International Paper.
The other two reasons for why pulp prices have rallied relate to the supply side, and these effects will be detrimental to Suzano's downstream peers while positive for Suzano. The first is that with oil prices rising, Suzano can charge higher prices on pulp as logistics and export becomes more expensive. The second is related to a dislocation of recycled paper in the market. Long-story short is that China no longer will use as much recycled paper in its very substantial paper production industry. As such, Suzano's pulp production has become more essential to supply the greater capacity that needs it.
How Suzano Becomes A Longer-term Holding
The run up in pulp is not reflected in the differential performance of Suzano against downstream peers. While before late 2020, the run-up of both IP and Suzano could be explained by a movement back into the sector, which was presumed to be overbought due to pantry-loading, in the last couple of months pulp prices have shot up and should be discounting IP and others like it while benefiting Suzano. Instead both have traded up.
This is why we think that Suzano could be a good buy in the short term, either as a pair trade with a short on IP, or Packaging Corporation of America (PKG) which is even less vertically integrated with no pulp hedges, or as a unidirectional bet. However, we think there's good reason to hold on after this initial horizon as well.
First there is a commodity thesis here, where the long-pressured pulp price might start reclaiming its previous heights. But a more sophisticated idea for a medium to long-term Suzano purchase is that even if supply side support to pulp prices declines, such as greater capacity coming on the market to meet the new Chinese demand, the demand side of uncoated fine paper and other specialty papers still pressured by lock-downs should recover upon reopening, which is coming soon to major markets. Therefore the supply side pulp thesis would be handed over to demand-side forces.
Conclusion and Risks
Like any commodity-based thesis, there are certainly risks. China is a wild-card, and their regulation could reverse or develop in all manner of ways. Moreover, Suzano could end up footing the bill for higher oil prices, thus not able to capture as much of the price increase. Finally, Suzano carries some FX risk as about 15-20% of its top-line is the Brazilian market, where the BRL has been very weak. Nonetheless, the massive rise in pulp prices of late is a powerful lever for Suzano's commodity focused business, and with the company also being financially leveraged, they could benefit intensely from this recent run-up, where downstream peers surely won't. Potentially as a pair-trade, but even as a longer-term simple equity holdings, we see pulp strength carried now by supply, and later by demand factors, as a clear reason to be bullish on Suzano.
This article was written by
Formerly Bocconi's Valkyrie Trading Society, seeks to provide a consistent and honest voice through this blog and our Marketplace Service, the Value Lab, with a focus on high conviction and obscure developed market ideas.
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