Stora Enso is set to outperform over the long-term

Company overview

Stora Enso is an integrated paper, packaging and forest products company headquartered in Helsinki, Finland. The company operates in more than 40 countries and in 2017 total sales amounted for over 10 BEUR. Stora Enso’s operations are divided along five segments offering a variety of products including pulp, paper, wood products and fiber-based packaging. Its main market is Europe, accounting for almost 75% of the

total sales.

Investment thesis

The selloff that began after the release of Q2/18 report caused a big sell off and investors saw the share price to drop almost 40% from its year highs in June 2018. The reaction by the investors was mainly due to concerns about the fall in prices for pulp and weaker forward-looking statements provided by the company, which didn’t satisfy investors’ high expectations. Before the release, Stora Enso was trading at 16.5€/share and has now fallen to 11€/share. The market currently values Stora Enso lower relative to its competitors, even though in my opinion the company is set to outperform its peers and the industry over the long-term. Using estimates for 2019 the p/e * p/b multiple comes to 10.62. I believe the recent selloff has largely been an overreaction caused by irrational behavior of investors and have strong belief that the company and its management will continue to deliver solid results going forward.

Main catalysts

Diversification

Once the biggest paper supplier in Europe, Stora Enso has made a significant shift from paper to biomaterials and biochemicals during the past few years due to falling demand and weaker margins within the paper industry. Although paper still accounts for around 30% of their sales, the company now has a more diversified portfolio of products with higher margins and opportunities for further growth. Some of the largest investments during the transformation included building a new mill in Beihai, China and the conversion of the Varkaus mill in Finland from fine paper to light-weight containerboard. The Beihai mill has a capacity of producing 450,000 tons of high-grade carton board and reached operational EBITDA in Q4/17. The divestment of paper is still ongoing and in June the company announced that they are looking into the possibility to convert the Oulu mill from paper into packaging board production. This is the same mill that recently reached headlines as the company announced that they are considering temporary layoffs due to weaker demand for coated fine paper and higher raw material costs. The study is expected to be done by the end of the year and is an important part of the strategy of going forward. Conversion of the mill would cost the company 700 MEUR and would reduce Stora’s paper capacity by 20% (projected to be completed by the end of 2020).

This graph clearly shows how the company has decreased exposure in paper and diversified its portfolio.

Growth opportunities:

Global megatrends such as increasing eco-awareness due to global warming, growing middle-class in Asia, urbanization and changing lifestyles will increase demand for raw material that is renewable, reusable and fossil free. The biggest growth opportunities for the company are within Asia, which now only accounts for about 10% of the sales. Especially biomaterials, packaging solutions and consumer board are likely to benefit from these trends and with the new mill in Beihai, the company is well-positioned to meet increasing demand in Asia. Companies like Tesco and Nestle have announced that they want all packaging to be recyclable or compostable by 2025. With a strong position on the market and a long history of excellence, Stora Enso could be on the forefront of innovation as more companies join the goal to reduce usage of fossil-based products. Growing e-commerce also contributes to increased demand for container-board and light-weight packaging and in early 2017 Stora Enso partnered up with the German e-commerce company Zalando to develop smarter and lighter packaging solutions. Compared to its main competitors, Stora Enso invests much more into R&D for further innovation and the company expects 15% of sales to come from new products and services over the long-term. These factors contribute to the sustainable, profitable growth which the company has estimated to annually 4-6%.

Stora Enso's R&D spending/sales compared to its main competitors

Financial strength:

The company has invested quite heavily in the transformation of its business model and capital spending over the last four years totaled 3.2 BEUR, which was well over the depreciation of 2.1 BEUR. Although the firm has burned through a lot of cash during its transformation, it has also managed to strengthen its balance sheet and pay off debt. Debt/equity has decreased from 0.65 in 2014 to 0.38 in 2017 and the leverage ratio is below the 2x target (which was lowered from the previous target of 3x). Most of the expenditures have been non-reoccurring (such as the building of the Beihai mill which cost the company 800 MEUR) and in the coming years, the company expects annual capital expenditures to be around 550-600 MEUR.

Risks

Going forward, I see three main risks for the company. Firstly, Stora Enso is operating in an industry which is widely considered as cyclical and investors have increasing fears that we are now coming to the end of the cycle. However, with a more diverse product portfolio and higher exposure to consumer products, I believe the company is better hedged against the market cycles as demand for consumer board and packaging is not as exposed to it as paper. This said, as the company has changed its business model quite radically and developed new product lines during the last ten years, there is no previous data to predict how they would perform in a recession and what the demand for their products would look like. Secondly, the price of pulp has been at historically high levels for the past year. Pulp is produced by the company for sale as well as used for production of carton board. Demand is highly dependent on China, but with no significant increase in the supply of pulp in the coming years I believe the price will stay above the levels of 2016-2017, even though it might decrease a bit. Thirdly, access to wood is a growing problem within the industry and even though Stora Enso is one of the largest forest owners globally, they are still exposed to risks of large forest fires and improper management of the assets. The majority of the land they own is in Sweden and Finland.

Pulp prices between 2003-2018

Conclusion

The fact that the senior management has recently been buying stocks of the company on the open market, including the chairman of the board Jorma Eloranta, confirms my belief that the company is undervalued and increases trust for the management. With all this said, I continue to stay bullish and strongly believe in the growth of the company over the long-term.