“I heard the price of cellulose is going up, so I came to stock up!” Elena Perova/iStock via Getty Images
Valuation
For a market leader, Rayonier (NYSE:RYAM) trades at a surprisingly huge discount to tangible book value. While the share price closed at $5.36 on Friday, the company’s tangible book value was $11.86 as per the company’s latest quarterly report.
Furthermore, the company expects adjusted EBITDA of more than $100 in the final two quarters of this year. Annualizing this number and comparing it to the company’s enterprise value of $1.1 billion provides an EV/EBITDA ratio in the neighborhood of 5.5x.
Because this is a cyclical industry (as discussed in the next section), however, I would rely less on current earnings when valuing this company versus, say, historical earnings through a cycle and equity value.
Industry
Cellulose is an important component of many products, including LCD screens, pharmaceuticals and diapers. Rayonier provides this cellulose (in varying degrees of purity) to its customers by starting with a tree, and applying various manufacturing processes to arrive at its final product.
Some portions of the company’s sales are highly specialized, where Rayonier is considered the premium producer. But the company also delivers less-pure commodity cellulose, and is able to shift its manufacturing between these two levels of specification in order to maximize returns.
For a few years now, the industry has been in turmoil. Following a banner year in 2018, cellulose producers stepped up production resulting in price competition and falling returns in 2019. COVID-19 in 2020 further curtailed demand (and, therefore, prices as well).
The Company
As the company’s inputs (wood, energy, chemicals) started to soar in price, cost inflation then hurt the company’s earnings. Supply chain issues further hampered the company in 2021 and early 2022.
Finally and more recently, the company is coming off of maintenance outages that have depressed production and thus sales.
Now that those outages are behind the company, management is guiding to $160 million in adjusted EBITDA for the full year, having accumulated only $54 million in adjusted EBITDA in the first half, suggesting a huge second half of the year is on the way.
Looking at the company’s historical financials prior to the beginning of the industry woes in 2019 shows Rayonier’s potential to earn: from 2011 to 2018, the company averaged earnings per share of $3.73, with return on capital consistently in the high single digits or double digits. Compare that average EPS of $3.73 to today’s paltry share price of $5.36. In 2018, the company’s share price traded well above $20.
Note that this is not exactly the same company it was back then. There have been asset sales (and purchases) that have moved the company in different directions over this period. But that EPS average is still helpful in describing what can happen over many years for Rayonier when the cellulose industry isn’t in the tank.
Management
Having gone through a few difficult years, the company finally made a change at the top, and so the company’s current CEO has only been there for one quarter. His stated focus as per the latest earnings conference call is “on EBITDA, increasing cash flow and reducing our leverage”.
The company has implemented a number of initiatives to increase pricing for its products, which should hit the bottom line in future periods. As one example, Rayonier announced they are implementing a 20% increase on the small sales volume of cellulose specialties that are not under contract, effective August 1.
The maintenance outages described earlier were aimed at reducing downtime and increasing productivity, which is expected to lead to higher production/productivity and better economies of scale.
Finally, the company has been selling down interests in adjacent businesses in order to pay down debt. For example, Rayonier sold its remaining ownership in GreenFirst Forest Products for $43 million and then repaid $20 million of senior notes and then $10 million of Canadian debt.
Capital Allocation
When asked what keeps him up at night, the new CEO answered the looming debt maturity. In 2024, the company owes $370 million of debt, and so the focus right now is generating cash flow and earnings that can 1) pay down as much of it as possible and 2) provide the company with good terms for the amount that needs to be refinanced.
The good news is there is ample time until that point, especially if the company is right about the back half of this year. Nevertheless, the fact that this is what concerns management is good news for shareholders, as it is likely to lead to keeping expenses and unnecessary (e.g. growth) capex low, and de-risking the company through debt paydowns.
Unfortunately, this also means dividends and share buybacks are unlikely for now, as management would probably want every last dollar applied towards debt. But this sets the company up better for the long term, and may help explain why the share price is so low, which is providing this opportunity to investors willing to wait a few quarters for the refinancing to play out.
Risks
The major risk the amount of debt the company carries, with over $700 million of net debt. As discussed above, management is focused on paying this down and refinancing the major tranche due in 2024. But if anything goes terribly wrong in either the company or capital markets, there isn’t a lot of wiggle room. The chance of bankruptcy is thus not zero, though I would still consider it fairly unlikely.
Conclusion
Rayonier has emerged from the problems that have plagued it over the last 3 years. But its market price is still in the dumps. This is an opportunity for forward-looking shareholders to buy before the improved business conditions start showing up on the bottom line. The 50%+ discount to tangible book value is the best indication that sentiment is still extremely poor relative to what this company has shown it can earn when things go right.
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