International Value Investing: PaperlinX (PPX:AU) – Australia

by Geoff Gannon


A reader responded to my post asking for stock ideas from other countries, with this email:

Hi Geoff,

Below is a quick and simple analysis of one of the stocks in my portfolio which your readers might be interested in.

Regards, 

Danny

PaperlinX (PPX:AU) – Reports

Below is Danny’s write-up on PaperlinX…

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PaperlinX is the world’s largest paper merchant. It sources and distributes fine paper ranges, specialty paper, sign and display and graphics solutions and industrial packaging materials worldwide. PaperlinX is based in Melbourne, Australia and listed on the Australian Stock Exchange with a market capitalization of A$253m. The current share price is A$0.42 which is close to its all-time low and compares with a peak share price of approximately A$5.85 in 2003. PaperlinX is a deep value idea trading at 0.9x net tangible assets with a 49% margin of safety to my intrinsic value of $0.82.

The paper industry is highly competitive and PaperlinX has undergone significant transformation over the years, closing and selling its manufacturing facilities.  Volumes in the paper industry have been impacted by the weakening global economy and the structural decline in paper use with increased use of electronic communication. Industry participants have responded to the industry downturn by cutting capacity which has mitigated the fall in prices. As you can see below, PPX price/tonne increase in 2009 although dropping again in 2010. I have ignored the impact of the rising A$ which has a negative impact on PPX earnings.

PaperlinX’s very low margins are evidence of the highly competitive industry and its business model has significant operating leverage (a 25% decline in volume from 2006-10 led to a 70% decline in EBIT/sales margin). Increased volumes from current depressed levels will generate significant earnings growth. I have only shown the operating earnings from the Merchant business above which excludes the discontinued manufacturing business, various asset sales and restructuring costs. 

An estimate of normalized earnings would be to take an average of the trading EBIT for the last four years which is A$126.1m. This is of course very simplistic and ignores price forecasts, foreign exchange, the benefit of the cost reduction programs etc which have both negative and positive impacts of earnings. If we assume that corporate costs are A$30m (in line with historical numbers), interest expense is A$20m (estimate from company) and corporate tax is 35%, applying a 10x PE multiple, the implied valuation is A$0.82 which represents a 49% margin of safety to the last share price of A$0.41.

The main catalyst for PaperlinX is an improvement in the economy. The Company’s most recent results announcement shows that leading indicators are improving however remain volatile.

I believe that at the current price level, downside risk is limited.  The EBIT implied by the current share price, applying the assumptions above and a 10x PE is approximately A$89m which is half FY2008 EBIT. In addition, at the current share price, PPX is trading at 0.9x net tangible assets.

The risk is a prolonged delay in the recovery of the economy. Furthermore PaperlinX has a significant amount of net debt at A$440m (cash A$137m, debt A$557m) compared to its market capitalization. The debt was refinanced earlier this year and consists of a number of regional asset backed facilities.

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