AVTG

Rayonier Advanced Materials (NYSE:RYAM) produces high-end paper products and is seeing strong pricing that will cause Q4 2022 results to be strong. This could result in strong EBITDA in 2023, following very back-end loaded EBITDA in 2022. The risks are declining volumes in a recession, and the necessity to refinance debt in the following 12 months.

2022 FCF

Let’s start with 2022. RYAM expects to exceed $175M of adjusted EBITDA in 2022, and up to date results are supportive of that, though EBITDA will likely be back-end loaded within the calendar 12 months.

The one issue the corporate saw in Q4 was a $4M “force majeure” cost for gas late in December as pricing spiked. To be conservative we’ll assume that is caused them to miss guidance by $4M. This could lead to negative free cashflow for 2022 as an entire of -$43M.

Note the corporate sold some GreenFirst Forest Products shares in 2022 and received a tax refund, which has enabled them to paydown debt in 2022 despite losing money operationally.

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EBITDA Progression in 2022

It is also value noting the adjusted EBITDA progression of business lines in 2022 and include what Q4 may appear to be based on recent guidance, by way of EBITDA in tens of millions of US dollars.

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Pricing

The corporate is aggressively taking pricing to enhance margins, this was evident in Q3 numbers, but there could also be more to come back as that is what the CEO said regarding pricing on the Q3 earnings call:

We implemented a $146 per metric ton cost surcharge effective April 1 and have maintained the surcharge as inflationary pressures continued.

More recently, we implemented a 20% increase effective August 1 on the small sales volume of cellulose specialties that usually are not under contract. Currently, we’re in negotiations with our cellulose specialty customers for 2023 pricing with the target to completely capture the fair value of those products.

And this was the impact on Q3 results…

Our revenues increased 25% from prior 12 months to $466 million consequently, a price increases in strong demand across all segments, reflecting a 25% increase for our cellulose specialty products, inclusive of our cost surcharge, and a 34% increase for our paperboard products.

Adjusted EBITDA for the quarter was $68 million, up 106% from the prior 12 months, as the worth and volume increases greater than offset cost inflation.

Medium-Term Model

Now let’s reflect the recent strength in pricing within the model, along with more normalized capex and potential normalized interest costs after refinancing. I assume that they will deliver around $86M of EBITDA in Q4 and assume that broadly holds, translating into $80M run-rate EBITDA for every quarter of 2023. Also they refinance their debt on barely less favorable terms at 10% interest. Taxes are low given past losses and capex follows depreciation, which has similarities to 2022 capex. Here’s what that gets us.

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That is interesting to equity investors, since the market cap of around $400M on the time of writing at just over $6/share suggests a price of 5.2x FCF. This type of performance would also enable the business to paydown debt materially over the following few years, especially if the softwood lumber duty rebate of around $112M is received.

Risks

• Pricing gains is probably not sustained and declining volumes on plants which can be primarily fixed costs could materially impact profitability. There is a danger that perhaps Q4 2022 is peak earnings for the business and short-lived, should volumes drop off.
• The impact of the spike in gas prices in December 2022 will not be fully known, the corporate estimates a $4M EBITDA impact (as captured above) but there could also be knock-on impacts.
• The shares sold off very sharply on January 10, 2023, it’s unclear on the time of writing why that is beyond perhaps a stretched valuation. Volumes were unusually high in the course of the sell-off. It might be a response to an analyst downgrade or a lagged response to the gas price spike of December 2022 and its economic impact, however the move could possibly be overdone. There could also be more news coming here, however the sell-off seems dramatic. Industry peer Borregaard, appears unimpacted. I’m not necessarily arguing that the decline can be corrected in short-order, but more that there is an affordable medium-term setup at this entry price.
• This can be a commodity business, management has done an awesome job, for my part, of timing disposals well and moving up the value-chain, but they’re still in an oligopolistic market, at best, with clear substitute providers. Also, as European gas prices normalize that will spur further competition from the region.

Catalysts/News flow

• Q4 ends in mid-February should confirm very strong EBITDA for Q4, gas prices in late December notwithstanding. This will cause analysts to re-evaluate the business in light of strong EBITDA and maybe more profits to come back into 2023.
• The corporate will likely refinance material debt in 2023, while this may likely increase interest expense, it is probably not as negative as some fear if positive operational trends, particularly pricing, proceed.
• The corporate can also receive a refund of as much as $112M of softwood lumber duties once a trade dispute between the U.S. and Canada is settled. There isn’t any defined timeline, however the receipt of funds is credible over the following few years.

Goal Valuation

If the corporate can deliver $77M of FCF in 2023 then on a 7x multiple (as a more cyclical, lower quality entity) that is a valuation of roughly $540M, including some lumber duty refunds within the medium-term takes the equity valuation to $650M. That is around $10.16/share, or roughly 65% upside from the present price.

In case you prefer to think about EV/EBITDA the corporate currently has $1.3B of EV against an expected $171M of 2022 EBITDA for 7.6x, but as indicated above, if EBITDA will be sustained at $320M in 2023, that is 4.1x EV/EBITDA.

I feel there’s a positive risk/reward here, especially if the ends in February are encouraging, by way of delivering on Q4 guidance and setting an optimistic tone for 2023. I imagine that operational trends based on improved pricing will proceed to be robust and the corporate will get its debt refinanced on reasonable terms.