AVTG
Rayonier Advanced Materials (NYSE:RYAM) produces high-end paper products and is seeing strong pricing that may cause Q4 2022 results to be strong. This should lead to strong EBITDA in 2023, following very back-end loaded EBITDA in 2022. The risks are declining volumes in a recession, and the need to refinance debt in the next 12 months.
2022 FCF
Let’s start with 2022. RYAM expects to exceed $175M of adjusted EBITDA in 2022, and recent results are supportive of that, though EBITDA will likely be back-end loaded in the calendar year.
The one issue the company saw in Q4 was a $4M “force majeure” cost for gas late in December as pricing spiked. To be conservative we’ll assume that’s caused them to miss guidance by $4M. This should result in negative free cashflow for 2022 as a whole of -$43M.
Note the company sold some GreenFirst Forest Products shares in 2022 and received a tax refund, which has enabled them to paydown debt in 2022 despite losing cash operationally.
| Metric | Value ($, M) | Notes |
| EBITDA | 171 | Guidance less gas cost price spike |
| Interest | 64 | 4x Q3 interest |
| Tax | 0 | Tax losses should result no meaningful tax |
| Capex | 150 | High end of guidance |
| Resulting Equity FCF | -43M | Sum of the above |
EBITDA Progression in 2022
It’s also worth noting the adjusted EBITDA progression of business lines in 2022 and include what Q4 may look like based on recent guidance, in terms of EBITDA in millions of US dollars.
| Business Line | Q1 | Q2 | Q3 | Q4 | Calendar 2022 |
| High Purity Cellulose | 16 | 7 | 53 | ? | |
| Paperboard | 10 | 10 | 15 | ? | |
| High yield pulp | 0 | -2 | 6 | ? | |
| Corporate costs | -6 | -18 | -6 | ? | |
| Total | 20 | -3 | 68 | 86 | 171 |
Pricing
The company is aggressively taking pricing to improve margins, this was evident in Q3 numbers, but there may be more to come as this 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 are not under contract. Currently, we are in negotiations with our cellulose specialty customers for 2023 pricing with the objective to fully capture the fair value of these products.
And this was the impact on Q3 results…
Our revenues increased 25% from prior year to $466 million as a result, 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 year, as the price and volume increases more than offset cost inflation.
Medium-Term Model
Now let’s reflect the recent strength in pricing in the model, together with more normalized capex and potential normalized interest costs after refinancing. I assume that they can deliver around $86M of EBITDA in Q4 and assume that broadly holds, translating into $80M run-rate EBITDA for each quarter of 2023. Also they refinance their debt on slightly less favorable terms at 10% interest. Taxes are low given past losses and capex follows depreciation, which is similar to 2022 capex. Here’s what that gets us.
| Metric | Value ($, M) | Notes |
| EBITDA | 320 | Assume Q4 strength (est. $86M EBITDA) broadly persists into 2023 at a run rate of $80M |
| Interest | 73 | Est. $725M of debt at 10% interest rate |
| Tax | 30 | Relatively low tax rate given prior losses |
| Capex | 140 | Setting capex equal to depreciation (note they argue maintenance capital is ~$110M) |
| Resulting Equity FCF | 77 | Sum of the above |
This is interesting to equity investors, because the market cap of around $400M at the time of writing at just over $6/share suggests a price of 5.2x FCF. This sort of performance would also enable the business to paydown debt materially over the next few years, especially if the softwood lumber duty rebate of around $112M is received.
Risks
- Pricing gains may not be sustained and declining volumes on plants that are primarily fixed costs could materially impact profitability. There’s a danger that maybe 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 is not fully known, the company estimates a $4M EBITDA impact (as captured above) but there may be knock-on impacts.
- The shares sold off very sharply on January 10, 2023, it’s unclear at the time of writing why this is beyond perhaps a stretched valuation. Volumes were unusually high. It may be a reaction to an analyst downgrade or a lagged reaction to the gas price spike of December 2022 and its economic impact, but the move could be overdone. There may be more news coming here, but the sell-off seems dramatic. Industry peer Borregaard, appears unimpacted. I’m not necessarily arguing that the decline will be corrected in short-order, but more that there’s a reasonably medium-term setup at this entry price.
- This is a commodity business, management has done a great job, in my view, of timing disposals well and moving up the value-chain, but they are still in an oligopolistic market, at best, with clear substitute providers. Also, as European gas prices normalize that may spur further competition from the region.
Catalysts/News flow
- Q4 results in mid-February should confirm very strong EBITDA for Q4, gas prices in late December notwithstanding. This may cause analysts to re-evaluate the business in like of strong EBITDA and perhaps more profits to come into 2023.
- The company will likely refinance material debt in 2023, while this will likely increase interest expense, it may not be as negative as some fear if positive operational trends, particularly pricing, continue.
- The company may also receive a refund of up to $112M of softwood lumber duties once a trade dispute between the U.S. and Canada is settled. There is no defined timeline, but the receipt of funds is credible over the next few years.
Target Valuation
If the company can deliver $77M of FCF in 2023 then on a 7x multiple (as a more cyclical, lower quality entity) that’s a valuation of approximately $540M, including some lumber duty refunds in the medium-term takes the equity valuation to $650M. That’s around $10.16/share, or approximately 65% upside from the current price.
If you prefer to consider EV/EBITDA the company currently has $1.3B of EV against an expected $171M of 2022 EBITDA for 7.6x, but as indicated above, if EBITDA can be sustained at $320M in 2023, that’s 4.1x EV/EBITDA.
I think there’s a favorable risk/reward here, especially if the results in February are encouraging, in terms of delivering on Q4 guidance and setting an optimistic tone for 2023. I believe that operational trends based on improved pricing will continue to be robust and the company will get its debt refinanced on reasonable terms.