don't miss the forest for the trees.
Altri
don't miss the forest for the trees. Part 2
By Manuel Maurício
April 6, 2022
A few weeks ago I wrote about Altri, the Portuguese paper pulp manufacturer. If you haven’t read that write-up, I strongly recommend that you read it here.
My father, who doesn’t know anything about fundamental analysis, owns Altri’s stock. Just the other day he told me with a mix of satisfaction and pride that “Altri had raised (pulp) prices again” as if Altri had in its hands the power to dictate the prices; as if this wasn’t a commodity business where the price is dictated by supply and demand forces.
And then he said, still referring to Altri, “I think this is a stock to own for many years to come“. My blood started boiling almost immediately and I quickly began to tell him about how Altri is a cyclical business, how it doesn’t have control over the pulp prices, how this price rise was obviously driven by the largest pulp manufacturer in the world – Suzano, from Brasil – but he shook his head like “You might be right, but I’m not changing my mind“. That was the end of our conversation about Altri 😏.
But, despite the fact that my father chooses to ignore the dynamics of a cyclical industry doesn’t make it less cyclical. Altri doesn’t have control over its pricing power. As I mentioned on Part 1, it has control over its cost and that’s just about all it can do. If the price of pulp goes bellow $750/Ton, Altri will be losing money.
And where the price of pulp will go next, no one can tell you. No one saw a pandemic, a global lockdown, or an invasion of Ukraine.
So – and I’ve mentioned this before – in a cyclical industry what you want to do is to invest when all the news are bad.
Why then am I looking at Altri when the price of paper pulp is at all-time-highs?
Well, maybe I shouldn’t. But this time might be different. This time we’re facing a special situation like the ones Joel Greenblatt wrote about in his amazing book “You can be a stock market genius“.
* Before we proceed, I would like to thank Gonçalo Garcia for his help. He has done extensive work on Altri and he has been very kind in sharing the results of his research with me. Without his help, I would be missing a lot of relevant stuff.
Altri's business
Altri’s core business is transforming wood (mostly Eucalyptus) into paper pulp to be used as raw material in the paper manufacturing industry. To a lesser extent, the company also produces dissolving pulp for the textile industry.
But the industrial process of making pulp also creates byproducts such as black liquor that can be burnt to generate energy. This is called co-generation.
It took me a while to understand this – Altri makes money in several ways: by selling pulp, by co-generating energy through its industrial process and selling it to the grid, and also through its stake in GreenVolt, which sells energy generated, not by burning black liquor, but by burning biomass (bark, branches, leaves…). Got it? Pulp, co-generation, and GreenVolt.
Altri has 3 pulp mills in Portugal with an installed capacity of around 1.1 million tones:
Celbi (Fig. da Foz) manufactures pulp to be used (mostly) for writing paper and other printing paper, Celtejo (Vila Velha de Ródão) manufactures pulp mostly for tissue paper, and Caima (Constância) manufactures soluble pulp to be used in the textile industry.
Altri represents roughly 3-5% of global hardwood market pulp production.
If you drive around Portugal, you’ll notice that there are eucalyptus trees everywhere. Some of those trees belong to Ramada, a company that was spun-off from Altri a few years back. Altri now manages 88 thousand hectares of eucalyptus plantations belonging to Ramada. These 88 thousand hectares ensure Altri a self-sufficiency rate of 15-20% – which serves as narrow moat in the event of any supply chain disruptions.
About 75-80% of the wood is sourced from Portugal with the remaining 20-25% being imported from overseas.
By the way, the largest shareholders of Altri are still the largest shareholders of Ramada so the agreement between the two shouldn’t change going forward.
And, of course, Altri also owns a 59% stake in GreenVolt, a renewable energy company that is about to be spun off – the reason why I’m writing.
End Segments
A large part of Altri’s pulp is used to make tissue paper (think napkins and toilet paper) which is a growing market. 8% is sold to the textile industry…
…located in China, whereas 74% of the total production is sold to European customers.
Supply
In Europe, many paper manufacturers were built in a non-integrated manner, meaning that they don’t make their own pulp. This means that Europe is a net importer of pulp (importing more than it produces).
Now, as with most comodity products the market price of the end-product (paper pulp) is a result of supply and demand. If supply goes up and demand doesn’t keep up, prices will go up and vice-versa.
Because the great majority of the pulp mills function at full capacity, thus not adjusting their output volumes to the variations of demand, one of the most important factors to assess the supply-demand balance and the future price of the pulp is the level of inventory in (European) ports, which is currently at recent year lows. Part of this is explained by the supply chain constraints, and part of it explained by the healthy level of demand from European customers.
This has led Suzano to increase prices several times in the past few months. This is good for Altri because the entire industry follows Suzano’s steps.
Now, the first thing that comes to mind is “how easy it is for a competitor to build a new pulp mill“? Not that easy.
A new mill capable of producing 1.000 tons per year would cost around $1 billion to build. But it’s not just about the money. It would need to be located near wood supply (forests) and also near water (pulp mills are high water intensive). Not only that, but communities aren’t exactly asking for new factories on their backyards so one could say that there are significant barriers to entry in this industry.
Especially so in Europe where there aren’t enough forests to source wood from. According to Altri’s Investors Relations, in Iberia there is still some wood available for new projects, but the only mill that is planned is Altri’s new mill in Galicia (more on that later).
The other relevant geography to keep under close watch is Latin America. Suzano is building a new project called Cerrado, which will be increasing its capacity by 20-25% to something around 13 billion tons. It’s currently expected to start production in 2024.
New Factory in Galicia
The fact that there are relatively high barriers to building new mills benefits those who can build them.
Altri recently signed a Memorandum of Understanding (MoU) to exclusively study the construction of a manufacturing facility in Galicia with an annual production capacity of 200.000 tons of dissolving pulp and textile fibers.
Galicia and the north of Portugal is where Inditex (the owner of Zara) and other clothing manufacturers have most of their factories so they have been exerting their power over the local authorities to build this new factory.
Now, you might’ve heard about Altri’s Spanish competitor, Ence, and you might be thinking why isn’t Ence getting this opportunity? Well, there are several factors, one of which is the fact that Altri already has experience running a very efficient dissolving pulp facility. Another reason might be related to the fact that the local authorities are in litigation with Ence regarding its Pontevedra factory which has been given notice of closure because it’s located in the coast – a protected area.
Income Statement
In the early 2000’s Altri saw its production go up considerably due to the buying of Celbi, Altri’s largest manufacturing facility, and also due to improvements in the other two facilities.
Just recently, the company has been making incremental improvements to its factories that have led it to slowly increase capacity.
There is still the possibility to increase capacity by some 100.000 tons with “minor” updates, but that will be dependent on the availability of wood in Iberia or the possibility of importing wood from Latin America at attractive prices.
You see, there’s enough wood in Spain for Altri to expand capacity, but the problem is that it’s scattered over many small producers and that’s why Ence has many more sourcing people than Altri. If Altri is to source the 20% of wood that it currently imports from Latin America from Spain instead, it will have to grow its sourcing team considerably.
Now, Altri is one of those companies that has changed so much over the years that looking at its Income Statement might lead investors into taking the wrong conclusions.
Given that Altri will be spinning off GreenVolt, the best thing to do is to isolate the revenue coming from the pulp business.
But even by looking at the pulp business we’ll be comparing apples to oranges because the company includes the revenues coming from the sale of biomass and the co-generation of energy in its pulp revenue. I was on the phone for one hour with the Investor Relations and couldn’t get a satisfactory answer as to how much comes from each sub-segment.
Let’s take 2021 as an example. By looking at the chart below one would think that the prices of pulp went through the roof.
They did go up, but that’s not the only reason why the revenue from the pulp business went up.
Because of consolidation rules, now that Greenvolt is an entity of its own, Altri recognizes some revenue that wasn’t recognized before in the pulp segment, like the sale of biomass.
This will make the revenue go up, but it will probably make the margins come down (as biomass has a lower margin than pulp).
Add to that the fact that energy prices are going up which will likely lead the revenue to go up.
Interesting Technicalities regarding the energy business
The management recently disclosed that, given its status of surplus energy producer, Altri was switching to a market price mechanism.
Previously, the company was selling all of the energy it produced to the grid at €95 KW/h while at the same time buying electricity from the grid at market prices (called pool prices) at €65 KW/h. Altri was making €30 per each KW/h. This is so because the Portuguese State, as many others, wants to incentivize the production of renewable energy.
But as the price of energy went up due to the invasion of Ukraine, in the fourth quarter of 2021 Altri was buying electricity, not at €65 Kw/h, but at €180 KW/h. In other words, it was losing money.
The existing legislation allowed for Altri and other energy producers to switch to market pricing, meaning that they could start selling energy at the prevalent market prices so they wouldn’t lose money. But that same legislation required that the energy producers would remain, for at least 2 years, in market pricing modality before coming back to regulated energy prices.
Now, I don’t know what forces got into play here, but the legislation was changed in December 2021 and now Altri and the other co-generators can remain in market pricing modality for 1 year (instead of 2) and then come back to regulated energy prices if they wish so (which will be dependent on the price of energy coming down).
Learning this has left a bittersweet taste in my mouth. On the one hand, that’s good news if I’m to invest in Altri. On the other hand, as a regular purchaser of energy, I can’t help but to think that these guys always come out on top while the small fish gets fried.
Why should Altri be allowed to make even money now at the cost of the general population? I guess this is the price to pay for a greener future.
Now, back to the Income Statement.
Since a lot of Altri’s costs are fixed and its factories are always working at full capacity, its revenue and margins will wobble around according to the market price of pulp.
Balance Sheet
Now, this is where it starts to get interesting.
At the end of 2021, Altri had a leverage ratio of around 1.5x (Net Debt / EBITDA). The last time it got to such a low leverage ratio, it paid roughly $150 million in dividends. What we want to find out is if the company will be doing the same again.
When we normalize all the numbers to mid-cycle levels, the leverage ratio goes up to 2x – still manageable. The management’s goal is to be in between 2x and 3x so there’s plenty of room to issue a dividend.
What does GreenVolt do exactly?
Given that buying Altri today means buying a stake in GreenVolt, a quick overview of GreenVolt’s business is needed.
GreenVolt started as a 50/50 Joint Venture with EDP back in 2006 and in 2018 Altri bought EDP’s stake.
GreenVolt’s original business is/was the generation of electricity achieved by burning biomass sourced from Altri in 5 power plants in Portugal.
But GreenVolt has evolved from its biomass roots into being a developer of solar and wind energy projects as well as having a foot in the distributed generation of electricity (photovoltaic panels on rooftops).
Unlike other companies that actually build and operate the solar and wind farms, GreenVolt does all the work up until the moment where the construction begins. It secures the land, handles regulation, subsidies, and permits, and then it finds the future clients and secures the revenues. When the project gets to that ready-to-build stage, GreenVolt sells it for others to take care of the construction and operations. It aims to sell 80% of the projects and keep the other 20%.
Just so you learn the technical terms (as I did) this is called a farm-down approach (or asset rotation). After the project is sold, the capital is freed up for future projects. Rinse and repeat.
Management and Ownership
I haven’t talked about management and ownership. Altri’s largest shareholders are a well-known trio in Portugal. They’re not only the major shareholders of Altri, but the major shareholders of Ramada and Cofina. They are widely regarded as one of the best management teams in Portugal having given proof of that time and time again.
They’ve been slowly buying shares of Altri over the years. Maybe, some day, they’ll take it private when the stock comes down low enough.
Just recently, Paulo Fernandes increased his stake in Altri by €1.8 million. Some believe that was the reason why the company didn’t announce the dividends at the recent conference call 🤔.
Valuation
GreenVolt’s IPO’ed back in 2021. Altri kept 71 million shares which, at today’s prices, represent €562 million.
Although we still don’t know all the details regarding the spin-off, Altri’s managers have mentioned that they’re looking to spin off 43% of the total shares outstanding of GreenVolt after which Altri will retain a 15% stake (they’re not spinning off these 15% due to legal and tax technicalities – the shares are inside a subsidiary of Altri).
For simplicity sake, I’m considering that Altri is going to distribute all of GreenVolt’s shares.
Altri’s is currently trading at €6.23 per share, of which, at today’s market prices, €2.74 are relative to GreenVolt’s stock.
This means that the underlying shares of Altri are trading for $3.49 (post-spinoff). Is this cheap or expensive?
If you compare it to 2022’s Earnings-per-Share of €0.6, the Price/Earnings ratio would be 5.7x. It seems cheap, but cyclical companies will look the cheapest at the top of the cycle, right before the profits go down.
One of the many ways to value a cyclical company is by estimating its mid-cycle cash flows and compare those cash flows to the price that you’re paying.
According to Ence, the average net price of pulp for the past 10 years has been $605/Ton or €551/Ton. I’ll be using €500 to stay on the conservative side.
At such prices, Altri could be making €0.5 in Free Cash Flow per share (it will likely be making a lot more in 2022).
That would mean a normalized Price/FCF multiple of 7x or a FCF yield of 14% (the FCF yield is calculated by inverting the Price/FCF formula). In a world with interest rates in the low single digits this is pretty good.
But the thing is, if Altri issues a fat dividend as it did in the past, a “bet” on Altri would be further de-risked.
Let’s say that Altri issues a $100M dividend or €0.5 per share. If this were to happen, we would be recouping 52% of our initial investment (38% if you account for a 28% tax rate) through the cash dividend plus GreenVolt’s shares (I’m well aware that the math doesn’t work exactly like this because Altri is keeping 15% of GreenVolt, but still..).
After being handed those 2 dividends, we would have paid $3 per each share of Altri meaning a normalized FCF yield of 16% while the company would still be at a leverage ratio just under 2.6x. This is really good!!!
If the pulp prices and the energy prices remain high, we could be talking about even better returns.
*I’m leaving my math here so you can pick it apart.
Risks
The two biggest risks I see here (apart from a fire in one of Altri’s facilities) are the price of pulp coming down to below mid-cycle levels or GreenVolt’s stock coming down.
How likely are these two to happen simultaneously? Hard to tell.
I like to believe that the current rush to secure energy independence will keep GreenVolt’s share up for some time and the fact that the inventories at European ports were at recent lows just a month ago gives me confidence that we won’t be seeing the price of pulp going down significantly anytime soon.
There is yet another risk. There are significant maturities coming in the next 5 years. I believe that Altri will be refinancing them (issuing more bonds to pay for the ones that will mature), but there’s the risk of it being done at higher interest rates, thus lowering the profits.
Conclusion
After having spent a few days researching GreenVolt I’ve come to the conclusion that it sits well outside of my circle of competence. Due to the fact that it’s developing projects in diverse geographies in an industry so dependent on regulation, incentives, and other people’s decisions, it just isn’t for me.
I see GreenVolt as a high maintenance stock. I would need to keep track of the always shifting tides of the renewable energy industry.
Now, if you were to tell me that its shares are super cheap, I might pause for a minute and reassess my opinion, but GreenVolt is trading for 60x earnings (depending on how you count).
At that price, it better deliver on its growth plans or else we’ll be seeing the stock getting murdered.
I’ve recently had Miguel Martins telling me that “You should look into renewable energy sources as there will be lots of money flowing into that space now“. I have no doubts about that, especially after Russia invaded Ukraine, but the recent trajectory of GreenVolt’s share price suggests that everybody is thinking the same right now.
On the other hand, it looks like Mr. Market is expecting that the pulp prices will go down dramatically in the near future so he’s offering us Altri’s stock at what appears to be an attractive valuation. There are a lot of moving parts and a good return is far from guaranteed, but I believe that the odds are in my favour.
That’s why Altri is entering the Portfolio today, at close, with €6.740, or 5% of the total funds.
Now, there’s a lot of stuff that I haven’t mentioned here just for the sake of simplicity. The industry is quite fun actually and there are a lot of quirks to it. If you’re interested in knowing more about it or if you’d just like to give your opinion, that’s exactly what the Forum is for. I encourage you to engage in it as it will greatly increase the value you get from your subscription.
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