This report is published by Research Dynamics, an independent research boutique
At the forefront of the sustainability
CPH hosted an annual investor day event and the key theme that emerged was the company's ability to leverage its competitive positioning in the Paper Division to mitigate the prevailing weak market for the print paper. Moreover, the group also showcased that reducing carbon footprint remains top on their agenda. We also took a tour of the Perlen Papier plant, which induced confidence in us about the group's preparedness about achieving carbon neutrality and to tide over the challenging market conditions.
Strategy 2020-2024 - Implementation progressing well
The strategy's objectives encompass balanced net sales composition between the three divisions, a higher share of net sales from outside Europe, and reducing exposure to the Swiss Franc to minimize currency fluctuations. Last month the company announced that the Packaging Division acquired the remaining 40% shares of Perlen Packaging Anápolis, Brazil, and invested a higher single-digit millions to expand its Brazilian production facility to provide a new PVdC film coating plant with a capacity of 6.500 tons a year which should commence its operations in the first quarter of 2022. In addition, the Perlen Packaging is providing a loan to its Brazilian business partner for the construction of a new mono PVC film manufacturing facility, with which the division will be able to cover the full supply chain with the local Brazilian production facilities, from mono films to coated blister pack films.
Paper Division well placed to mitigate challenges
CPH's Paper Division has been in operations since 1873 under the Perlen Papier name and is Switzerland's only producer of newsprint and magazine paper and the country's biggest wastepaper recycler. It operates two paper machines with a combined annual production capacity of 565,000 tons of newsprint and magazine paper. To manufacture the newsprint paper, it uses the PM7 machine since 2010, which is the most advanced machine in Europe.
The newspaper and magazine paper market has been bearing the brunt of twin challenges for many years. On one hand, the growing importance of digital channels has led to the falling consumption of print media by -8 to 10% a year; on the other hand, the excess capacities have had an adverse impact on the realizations. However, the company responded to market developments with key strategic thrusts. Through efficient structures and processes, it emerged as the most cost-efficient player in the region. Over 2009-2019, Perlen Papier has been able to reduce its variable costs by 32% and fixed costs by 49%. Over the same period, the cumulative productivity gains were +72%. With its direct customer contacts and efficient customer services, Perlen has been able to increase its market share in Western Europe from 2.5% to about 7%. Moreover, Perlen's focus on differentiation through modified and eco-efficient products also helped. All these measures have helped the division consistently deliver an EBITDA margin (for Perlen) higher than the competitors.
The lynchpin in reducing carbon footprint and sustainable production
Perlen Papier maintains a wastepaper sorting facility in Utzenstorf and is Switzerland's only paper recycler. The raw materials include 500,000 tons a year of recovered paper (75% of which comes from Swiss domestic sources), 100,000 tons a year of wood (85% from Swiss), and 2,000 tons a year of pulp. Perlen also founded the 'APS' brand in 2018 for the procurement, sorting, and trading of wastepaper. Moreover, in 2012, the Paper Division helped establish the Renergia waste incinerator facility in Central Switzerland, which is situated close to the Perlen paper factory. The Paper Division uses steam from the Renergia facility to dry its paper rolls, saving 30mn liters of heating oil and substantially reducing its carbon emissions by 90,000 tons. The energy generated from 250,000 tons of waste disposal is helping to generate 160 GWh of electricity, which is enough for 38,000 homes.
Having consistently reduced its fossil CO₂ emissions by 87% since 2013, Perlen Papier now has a carbon footprint that is 75% smaller than those of its European competitors. Last year, its Perlen factory emitted just 19kgs of CO₂ per ton of paper produced that was 16 times lower than the emission targets agreed with the Swiss Federal Office for the Environment. Perlen has been able to achieve almost carbon-neutral paper production by having short delivery journeys that minimized its carbon emissions on the transport front.
Domestically produced paper essential for sustainability
Interestingly, the proportion of the finished paper used in Switzerland imported from abroad rose 21-50% between 2017-19. The company is making efforts to keep populations and publishing houses informed that it makes less sense to export wastepaper that has been recovered in Switzerland to neighboring countries when it could easily be recycled domestically into new paper products. Moreover, the Covid outbreak has shown the importance of having raw materials such as recycled papers close to the operations, which would establish a sustainable and reliable domestic manufacturing chain.
Digital media lacks print in sustainability
The advent of technological changes has resulted in the massive adoption of the digital information channels that resulted in a gradual decline in demand for newsprints. It is pertinent to note that paper publication has superior ecological credentials as compared to digital channels. Based on the study conducted by the Institute for Further Studies and Technology Assessment (IZT), over the entire production cycle reading news online has a significant adverse impact on the environment than a printed newspaper. This is because far more energy gets consumed in storing and transmitting the data, and in manufacturing such devices. Also, the study found that paper is relatively softer on the environment.
Valuation and conclusion
We value CPH using DCF and relative valuation techniques. Our intrinsic value of CHF 87.2 per share is the same as our previous target price (CHF 87.2), implying an upside of 30.2% from current levels. For relative valuation, since the Group operates in three entirely different divisions, we compare each of CPH's divisions with different sets of relevant industry peers. We have employed three parameters - EV/EBITDA, P/S and P/E - to analyze the relative valuation of the Group. CPH currently trades at a P/S multiple of 1.3x (FY2020E), a ~33% discount to the weighted average multiple of division peers.
We remain encouraged by the management's focus on keeping the operations competitive even during the challenging times like we are facing at present. Most importantly, while doing so the group has not taken the focus off the commitment towards environmental sustainability, which has never been so important as the way it today is as the world goes through rapid climate changes. That said, in the short-term, we expect the uncertainty to continue in 2H2020 as economic activity is likely to pick up only gradually amidst the ongoing coronavirus pandemic. However, in the medium term, as business activity picks up steam, we expect the valuation discount to narrow and the stock to witness a revaluation.
We opine that the company's growth prospects in key markets, improved operating efficiencies from new production facilities, and expansion of the Packaging and Chemistry Divisions should lead to a valuation improvement. The Paper Division should benefit from the local market, cost leadership, cost-saving initiatives, advanced technology and continued operational improvements, although the business environment continues to remain challenging due to over-capacities and decreasing demand for newsprint paper. However, over time the tough operating environment may push marginal paper producers out of business which should lead to reduced capacities and aid recovery in paper prices. Moreover, we expect the group-level cost optimization initiatives to offer support to the company's stock price.