INITIATION | COMMENT Tembec Inc. (TSX: TMB) - Investor Village
INITIATION | COMMENT 125 WEEKS Rel. S&P/TSX COMPOSITE INDEX
10OCT08 - 25FEB11 HI-11FEB11 211.91 LO/HI DIFF 720.43%
135.00 90.00
CLOSE
193.53
45.00 2008 2009 2010 ON D J F M A M J J A S O N D J F M A M J J A S O N D J F
LO-14AUG09 25.83
FEBRUARY 28, 2011
Tembec Inc.
(TSX: TMB)
Under the Radar of Investors, But Not for Long
HI-18FEB11 5.66 LO/HI DIFF1032.00%
5.00 4.00 3.00 2.00
CLOSE
4.95
LO-24JUL09
0.50
1.00
Outperform Above Average Risk Price:
3000
PEAK VOL. 4053.9 VOLUME 921.0
2000 1000
RBC Dominion Securities Inc. Paul C. Quinn, B.Sc.F. (Analyst) (604) 257-7048; [email protected]
Investment Opinion
2009E (2.04) NM (110.0) NM
Adj EPS - FD 2009 2010 2011 2012 EBITDA (MM) 2009 2010 2011 2012
Q1 Q2 Q3 Q4 (0.96)A (0.50)A (0.35)A (0.23)A 0.00A 0.58A 0.12A (0.15)A 0.05E 0.22E 0.12E 0.11E 0.11E 0.35E 0.46E 0.32E (9.0)A 36.0A 35.0E 74.0E
2012E 1.25 4.0x 235.0 3.1x
4.0A 11.0A 35.0E 61.0E
Results shown on a calendar basis. Tembec's fiscal year end is Sept 30.
All values in CAD unless otherwise noted.
100.0 0.00 3.53 80.0 39%
8.00 62% 495 0.0% 1.4x 722
We are initiating coverage on Tembec with an Outperform rating and $8 target.
FY Sep Adj EPS - FD P/AEPS EBITDA (MM) EV/EBITDA
(63.0)A (42.0)A 32.0A 60.0A 28.0E 45.0E 37.0E 63.0E
2011E 0.50 9.9x 143.0 5.0x
Shares O/S (MM): Dividend: BVPS: Float (MM): Debt to Cap:
Price Target: Implied All-In Return: Market Cap (MM): Yield: P/BVPS: Enterprise Val. (MM):
Event
Claire Huxtable, CFA (Associate) (604) 257-7610; [email protected] 2010E 0.55 9.0x 139.0 5.2x
4.95
With a major financial restructuring and a couple of difficult years behind it, we believe Tembec represents an attractive investment opportunity. We see significant upside in the company's: • Leverage to strong dissolving and chemical pulp markets - Tembec’s leading position in several grades of specialty pulp position it to benefit from current very strong prices and a longer term attractive growth profile. The company's lone NBSK mill should also contribute meaningfully in the near term. • Streamlined forest products operations – Tembec has reduced costs and closed underperforming lumber and specialty wood capacity over the past several years, bringing the segment closer to break-even levels despite the exceptionally weak demand environment. As the US housing markets firms through the back half of 2011 and into 2012, we believe improved North American lumber demand, combined with the exceptional growth in Asian markets, will likely lead to significantly higher prices and operating rates while lowering costs further. • Improving paper segment – Tembec's paperboard business is attractive with margins consistently in the mid-teens. The future of the company's newsprint mill is looking brighter with a change in Ontario electricity rules and represents an important home for wood chips produced by area sawmills. • Clean balance sheet – In August 2010, Tembec issued US$255MM of 2018 11.25% Sr. notes. While net debt-to-total capitalization is 39%, net debt to LTM EBITDA is low at 1.7x and we anticipate significant deleveraging in 2011. Our target on Tembec is $8 per share. • Attractive valuation on both short- and long-term metrics – Tembec trades at a discount to its peers on 2011 EBITDA multiples. Our current estimate of the company’s net asset value at $10 per share is roughly double the current share price. On a free cash flow basis, Tembec is trading at 7.7x 2011 FCFPS and only 3.3x 2012. • Earnings leverage is impressive – A US$20/mt change (2.2%) in the company's average realized pulp prices equates to over $24MM in EBITDA (18.0%) and adds roughly $1 to our target. Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Non-U.S. Analyst and Conflicts Disclosures, see page 27.
February 28, 2011
Tembec Inc.
Tembec is proving its worth We rank Tembec shares Outperform, Above Average Risk for the following reasons: • Leverage to strong dissolving and chemical pulp markets to increase cash flow – Tembec’s leading position in several grades of specialty pulp position it to benefit from very strong prices and a longer term attractive growth profile. The company implemented price increases across specialty pulp grades in early 2011 that should support a step-change in cash flow. Tembec’s lone NBSK mill should contribute meaningfully in 2011 and beyond as softwood pulp markets remain tight at near-record prices. • Streamlined forest products operations should generate substantial cash in the longer term – Tembec has reduced costs and closed underperforming lumber and specialty wood capacity over the past several years, bringing the segment closer to break-even levels despite exceptionally weak demand. We expect the US housing market to firm through the back half of 2011 and into 2012, consistent with the current consensus. Improving North American lumber demand, combined with the exceptional growth in Asian markets, will lead to significantly higher prices and operating rates and lowering costs further. We do not believe the current share price allocates any value to this future earnings stream. • Clean balance sheet reduces risk – In August 2010, Tembec took the final step to normalizing its financial structure with the issuance of US$255 million of 2018 11.25% Sr. notes. The note issue replaced the US$300 million term loan that had supported operations following the February 2008 recapitalization. While net debt-to-total capitalization is 39%, net debt to LTM EBITDA is low at 1.7x and we anticipate significant de-leveraging in 2011. There are no major maturities due before 2018. • Good liquidity affords flexibility – Cash balances were adequate at the end of FQ1/11 at $61 million and available credit was $78 million. We believe that Tembec will be able to significantly de-lever its balance sheet over the next two years. Financial flexibility will support capital investment across the platform. Investments in power generation at existing assets in 2011 should cut costs and boost third party energy sales, while shutdowns in Forest Products will trim higher-cost capacity and increase earnings leverage to the gradual recovery in US housing. • Attractive valuation on both short- and long-term metrics – Tembec trades at a discount to its peers on 2011E EBITDA multiples. Our current estimate of the company’s net asset value at $10 per share is roughly double the current share price. On a free cash flow basis, Tembec is trading at 7.7x 2011E FCFPS and only 3.3x 2012E. • Target is $8, representing 60% upside – Our 12-month target of $8 is based on a blended 4.5x valuation multiple on our trend EBITDA estimate of $230 million (85%) and our 2011 EBITDA estimate of $143 million (15%). This value is supported by our estimate of Tembec’s net asset value at $10. Exhibit 1: Pulp is the largest contributor to Tembec sales and EBITDA EBITDA by segment
2,500
300
2,000
200
1,500
100
$MM
$MM
Revenues by segment
1,000
-
500
(100)
-
(200) 2009 2010 2011E 2012E Specialty Pulp, High Yield Pulp & Chemicals Forest Products Paper
2009
2010
2011E
2012E
Specialty Pulp, High Yield Pulp & Chemicals Forest Products Paper
Results presented on calendar rather than fiscal basis. Source: Company reports, RBC Capital Markets estimates
2
February 28, 2011
Tembec Inc.
We believe Tembec has turned over a new leaf Tembec is a large North American manufacturer of dissolving and paper pulp, packaging and paper, lumber and silvichemicals. It operates 22 manufacturing facilities in North America and France and is a leading producer of several types of specialty dissolving pulps and high-yield pulp. Its products are used in the paper, construction, newsprint, packaging, and food and pharmaceuticals markets. The company has traded under the symbol TMB on the TSX since its recapitalization in March 2008. Tembec’s fiscal year ends September 30. Exhibit 2: Tembec at a glance Dissolving and Chemical Pulp F2010 Sales1
High Yield Pulp $829 MM
Share of total sales F2010 EBITDA
42% $117 MM
Margin
14.1%
Capacities
• 310 k mt of dissolving pulp capacity capacity in North America & France
F2010 Sales1
Forest Products $380 MM
Share of total sales F2010 EBITDA
19% $47 MM
Margin
12.4%
• 805 k mt hardwood BCTMP capacity • 3 mills in North America
• 270 k mt NBSK paper pulp • 3 mills (2 in NA, 1 France) • includes results of Chemicals ops,
F2010 Sales1
Paper $434 MM
Share of total sales F2010 EBITDA Margin
22% -$10 MM -2.3%
F2010 Sales
$348 MM
Share of total sales F2010 EBITDA Margin
17% -$2 MM -0.6%
• 425 Mmfbm stud capacity, 3 mills • 955 Mmfbm dimension lumber, 6 mills • 1 remanufacturing mill • 2 specialty lumber mills • 2 engineered wood mills (idled)
• 180 k st coated paperboard (SBS)
• operating at about 50% of capacity
• North American customers accounted
at one mill
• 330 k mt newsprint at one mill, one machine idefinitely idled
produces lignin, ethanol & resins
Description
• #1 producer of cellulous ethers pulp MCC pulp and nitrocellulose pulp
• leading producer of hardwood high yield pulp
for 95% of F2010 sales
• most international porfolio of customers, with over 80% of pulp sales offshore
Source: Company reports, RBC Capital Markets estimates
Exhibit 3: Production Capacity and Location % of North Product
Capacity
American market
Pulp
1,385 k mt
7%
Forest Products (SPF lumber)
1,405 mfbm
2%
510 k mt
na
Paper
Source: Company reports
3
February 28, 2011
Tembec Inc.
Dissolving and Chemical Market Pulp • Segment at a glance: F2010 Sales: $829MM │ Share of total sales: 42% │ F2010 EBITDA: $117MM │ EBITDA margin: 14.1% • Management of the two pulp grades has been split – At the end of F2010, management and reporting of pulp operations was split into two categories to better highlight the performance of the two grades. Specialty and chemical pulp operations, including three mills, were combined with the chemicals group, and high yield pulp operations were grouped together in a new segment. Specialty pulp includes about 300 k mt of specialty and commodity dissolving pulp, along with a small amount (~15 k mt) of fluff pulp. Chemical paper pulp (270 k mt) is produced at the Skookumchuck mill in British Columbia. Segment reporting was adjusted with the FQ111 results. Exhibit 4: Tembec’s dissolving and chemical pulp capacity and North American market share North American Specialty Pulp Producers
Tembec Dissolving & Chemical Pulp Capacity Chemical (paper) pulp
000 mt
NBSK - Skookumchuck, BC
Specialty Dissolving Pulp Market Company
270
Specialty Pulps
Capacity (k mt)
% share
1 Rayonier
476
34%
Specialty cellulose - Temiscaming, QC
160
2 Buckeye
308
22%
Specialty cellulose/fluff - Tartas, France
150
3 Tembec
252
18%
310 Dissolving and Chemical Pulp
Others
580
Total
364
26%
1,400
100%
Source: Company reports, Pulp & Paper Week, RBC Capital Markets estimates
Exhibit 5: Global dissolving pulp market structure and end uses Global dissolving pulp market - 5.2MM mt Specialty Tembec dissolving pulp - 300 kmt Commodity
26%
18% Specialty 82%
Commodity 74%
Global spec ialty DP market - 1.4MM mt Other Casings Industrial 4% 4% viscose
Global specialty DP market by producer
All others
Rayonier
26%
34%
5% Nitrocell. 7%
Acetate
MCC
49%
7% Ethers
Tembec
Buckeye
18%
22%
24% Source: Company reports, RBC Capital Markets
4
February 28, 2011
Tembec Inc.
• Tembec sells two types of dissolving pulp – Dissolving pulp fall into two categories: commodity and specialty, reflecting the degree to which the cellulose has been refined. Tembec’s focus is on specialty pulp, with more than an 80% weighting. Production of Tembec’s commodity dissolving pulp (Temsolv) is about 40-50 k mt and is used to produce rayon. The specialty dissolving pulp market is smaller, but demand and pricing are more stable with higher margins. Since 2008, the dissolving pulp market has grown by 1 million mt, with several further capacity conversions announced recently (Fortress’s Thurso mill conversion for mid-2011, the Gores’ Group resuscitation of the former Weyerhaeuser Cosmopolis mill for May 2011, Stora’s Enso’s likely Russian joint venture and Rayonier’s potential conversion at its Jesup mill). The majority of growth has been in the commodity (rayon) markets. • Barriers to entry into the specialty dissolving pulp market are prohibitive – Demand for specialty dissolving pulp is growing at 2%-3% per year. Tembec is the leading supplier of ethers, microcrystalline and nitrocellulose. Barriers to entry into specialty markets are high, reflecting not only steep capital investment and access to technology and technical know-how, but also longterm, established relationships with customers. End uses for specialty pulp are very specific and have narrow technical specifications. Expanding an existing customer relationship or introducing a new product takes years with incumbents, and would be extremely time consuming for new entrants. • Dissolving pulp markets are exceptionally tight – The vast majority of dissolving pulp is sold under long-term private agreements, making it difficult to reliably track and forecast prices. Commodity dissolving pulp prices are somewhat easier to track, while specialty pulp is particularly opaque. Early in 2011, spot commodity dissolving pulp prices in China (the primary market) topped out at US$2,600/mt as demand ballooned and supply remained flat. Demand for commodity dissolving pulp is driven by rayon production. With export restrictions (India) and poor harvests (Pakistan, China) reducing cotton supply, garment producers are increasingly turning to rayon. We expect demand for rayon will remain at higher levels given the long-term decline in cotton production and rising standards of living in Asia. Early in 2011, Tembec began the process of renewing all its dissolving pulp supply contracts, implementing a ~US$200/mt increase. We expect the increase will be applied to all 2011 dissolving pulp shipments, generating an additional $55 million EBITDA. • Prices for NBSK remain very strong – Tembec produces 270 k mt of NBSK paper pulp at its Skookumchuck mill in British Columbia. Benchmark NBSK prices have remained remarkably strong since hitting their peak of US$1,020/mt in mid-2010. February list prices of US$960/mt are down just US$60/mt, as demand remains robust and slower-than-expected incremental capacity ramp ups have kept inventories low. January softwood pulp stocks were 27 days, well below the ~30 days we believe indicates that supply and demand are in balance. Prices for softwood pulps have been rising in Asia since December and major producers have announced a US$30/mt increase for North America and Europe for March 1. While we forecast average prices of US$915/mt in calendar 2011 and $950/mt in 2012, just below the 2010 average of US$960/mt, we note that risk to these estimates is all to the upside. • Fluff pulp fundamentals are also strong – Tembec produces about 15 k mt of sulphite fluff pulp at its Tartas mill in France, which is marketed as “BioFluff” and earns a premium over benchmark sulphate fluff pulp. Benchmark fluff pulp prices have remained near peak levels of US$1,050/mt since July, falling just US$10/mt in December and remaining there through February. Prices remain strong despite the expected additional capacity in December from the Domtar Plymouth conversion. We expect global demand growth of about 4% per year as demand for hygiene products increases. • Most pulp is sold externally and sales are international – Of total pulp shipments of 1,418 k mt in F2010, just 56.8 k mt of BCTMP pulp and 17.7 kmt of NBSK was consumed by the company’s paperboard operations. The volume of internal consumption was down 11.7 kmt from the prior year. In 2010, 81% of consolidated sales were to customers outside of Canada and the US. This is a greater proportion of international sales than the other segments.
5
February 28, 2011
Tembec Inc.
Exhibit 6: Softwood Pulp market remains tight; fluff pulp running strong NBSK prices have declined modestly from their peak
Softwood pulp stocks are low, hardwood stocks are higher
$/mt
000 mt 2,900
1,100
$/mt 1100 1000
2,400
900
900
1,900
800
1,400
700
700
NBSK
Fluff
600 500
Softwood stocks
Hardwood stocks
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
400 Jan-02
Jan-11
Jan-09
Jan-07
Jan-05
Jan-03
300
400 Jan-01
900
Jan-99
500
NBSK price
Source: PPPC, RBC Capital Markets estimates
• Two mills in France sold in 2010 –The Tarascon (260 k mt, NBSK) and the St Gaudens (305 k mt, NBHK) mills were sold for €100 million, including €66 million cash and €31 million debt. The EBITDA impact of the sale is about $10MM annually. • We estimate Tembec’s average dissolving and chemical pulp cash costs are ~$800/mt, making current price levels very attractive – We believe current EBITDA margins are 21% (~$150/mt). We forecast 2011 segment EBITDA of $149 million. • Chemicals are a small but stable and profitable business – With the 2010 year-end reorganization, the Chemicals segment has been re-grouped with dissolving and chemical pulp operations. The majority of Chemicals operations transform waste from the pulping process into lignin and ethanol for use in the construction, food and pharmaceuticals industries. Lignin capacity of about 190 kmt is located at the company’s two specialty pulp mills. Ethanol is brewed at a plant in Temiscaming, with an annual capacity of about 12 million litres. The company’s resin production capacity is about 157 kmt located at three stand-alone facilities in Canada with an additional processing facility located in Ohio. • Lignin and ethanol are industrial chemicals – Lignin is used as a binder, dispersant and surfactant in industrial markets such as animal feed, concrete admixture and carbon black. These markets have experienced declines over the past few years. Tembec is a leading supplier of high-purity ethanol to the Canadian vinegar, hygiene and cosmetics markets. • Resin demand is down with the decline of US housing – Resin products are designed for oriented strandboard (OSB) production. OSB is a structural panel used in residential and commercial construction. With the collapse of the US housing market since 2005, demand for resins has declined. While we view the lignin and ethanol businesses as core as they are integrated in the company’s pulp production, we expect the company will look to sell the resin business as the US housing market recovers and demand for OSB improves. We expect the business could fetch $30 million to $40 million (about 4x annual estimated EBITDA). • Chemicals markets are primarily North American – In 2010, 76% of chemicals sales were to North American customers. • FQ1/11 downtime impacts results but clears the way to run hard in FQ211 – Segment EBITDA of $19 million (13% margin) showed a 37% drop from $30 million in the prior quarter (18% EBITDA margin) as chemical pulp shipments fell 13%. Operations ran at 79% of capacity, down from 89% as the company took 5,900 mt of maintenance downtime. Average costs increased 11% to $910/mt, primarily on planned and unplanned downtime. Maintenance at the Tartas mill in France, combined with an equipment failure after the shutdown increased costs by $10 million. Inventories were also built up from previously unsustainably low levels, reducing shipments by 6,500 mt. Inventories ended the quarter at 20 days, up one day from the end of the prior quarter. All-in average realizations increased 1% to $1,061/mt with a $165/mt margin. With planned maintenance downtime now out of the way, the mills are set to run hard in FQ2/11 as dissolving and chemical pulp markets remain very strong. We forecast EBITDA will return to $34 million in FQ2/11 as downtime drops, dissolving price hikes are implemented and chemical prices remain strong.
6
February 28, 2011
Tembec Inc.
Exhibit 7: Historical dissolving and chemical pulp sales, profit, shipments and costs Dissolving & Chemical Pulp
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's st)
($/st)
($/st)
($/st)
FQ110
$183
$14
$6
$15
232
$789
$65
$709
FQ210
$206
$30
$7
$37
241
$855
$154
$671
FQ310
$187
$28
$7
$35
198
$944
$177
$753
FQ410
$139
$24
$6
$30
132
$1,053
$227
$823
FQ111
$122
$14
$5
$19
115
$1,061
$165
$910
Source: Company reports, RBC Capital Markets
High-Yield Pulp Is a Hardwood Kraft Pulp Substitute • Segment at a glance: F2010 Sales: $380MM │ Share of total sales: 19% │ F2010 EBITDA: $47MM │ EBITDA margin: 12.4% • Tembec is the leading producer of high-yield pulp in North America – High yield hardwood pulp is produced at three mills in North America. Tembec is the leading producer of high-yield pulp or BCTMP (Bleached Chemi-Thermo-Mechanical Pulp), with a 35% market share in North America and 18% of the global total. High-yield pulp is produced by grinding down wood chips and producing pulp with heat and chemicals. The resulting pulp is weaker (and therefore cheaper) than pulp produced using heat & chemicals alone (ie chemical or kraft pulp) as all wood components – not just fibre – are retained in the process. However, yields are higher, with about 2 m3 of wood required for one tonne of pulp, against 4-5 m3 of wood required for one tonne of kraft pulp. Exhibit 8: Tembec’s High-yield pulp capacity and market share High Y ield Pulp
Tembec High-Yield Pulp Capacity 000 mt
High-Yield Pulp Market Share Company Capac ity % share
BCTMP - Temiscaming, QC
315
1 Tembec
805
18%
BCTMP - Matane, QC
250
2 West Fraser
550
13%
BCTMP - Chetwynd, BC
240
3 APP
380
9%
805
4 Canfor
325
7%
5 Millar Western
310
7%
Total
2,370
54%
Global total
4,360
Source: Company reports, Pulp & Paper Week, RBC Capital Markets estimates
• BCTMP prices have weakened – Benchmark BCTMP prices, in contrast to NBSK, have slid considerably since peaking in mid2010 at US$820/mt (China price). February BCTMP prices averaged US$660/mt, or US$90/mt below Bleached Eucalyptus Kraft (BEK, China) prices. BCTMP prices generally move in-line with BEK prices, but the discount to BEK has widened. We expect either BEK prices will decline or BCTMP prices will rise in the near term as the pricing differential reverts to the mean of US$50 to $60/mt. The company uses BEK delivered China prices as a benchmark. These prices averaged US$757/mt in FQ1/11, down 3% (US$26/mt) from the prior quarter but have stabilized at current levels. • Tembec’s high-yield pulp sales are primarily to China – The greater dependency on Chinese markets has resulted in lower realized BCTMP prices, while suppliers of BEK (primarily Brazilian producers) also sell to customers in Europe and North America. Tembec has recently increased its sales to Europe, but they remain a minority. While the current discount to BEK would support a price increase, the Chinese demand lull through the New Year holiday in February makes a near-term price hike unlikely.
7
February 28, 2011
Tembec Inc.
Exhibit 9: BCTMP and other pulp prices in China are volatile
900
700 US$/mt 500
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
300
NBSK del China BEK del China BCTMP del China
Source: Valois Vision, RBC Capital Markets analysis
• Shifting capacity also makes the near-term direction of prices unclear – We expect Fortress Paper’s Thurso mill’s mid-year exit from hardwood pulp production may tighten the North American market and lift prices in general, but this may be offset by the re-start of hardwood pulp capacity in Indonesia. We forecast rising BCTMP prices through 2011 with an average of US$720/mt. • Tembec has access to $24 million of Capex funding under the GTP – Based on the amount of black liquor (a pulping byproduct) burned in 2009, the company earned $24 million in credits under the Canadian Green Transformation Program. Credits must be used by March 2012, and applied toward investments that improve energy efficiency of environmental performance. Tembec has allocated $17 million to the Matane methane conversion. We expect returns of 20% on the $24 million total beginning in 2012. • We estimate Tembec’s average BCTMP cash costs are $425/mt– We believe current EBITDA margins are 7% (~$40/mt). We forecast 2011 segment EBITDA of $25 million. • FQ1/11 results were poor, reflecting pressure on the BCTMP market – Results weakened in FQ1/11, with EBITDA falling 46% to $7 million. Total sales increased 3% on 18% higher shipments, but average realizations fell 13% to $549/mt ($38/mt margin). Shipments increased with the Chetwynd, BC mill back in full production through the quarter. A fire in June had shut the mill for two weeks, with normal operations resuming in September 2010. Maintenance downtime in the quarter totalled 1,200 mt, well below 22.7 k mt in the prior quarter, which included 17.4 k mt of downtime at Chetwynd. Production costs declined $9 million, including the impact of a $5 million insurance deductible in the September quarter and the effect of higher productivity in the quarter. We expect BCTMP prices will remain near FQ1/11 levels, and forecast EBITDA of $5 million in FQ2/11. Exhibit 10: Combined relative pulp performance Improving markets have helped Tembec margins sinc e early 2009
50%
OSB EBITDA margin
40% 30% 20% 10% 0% -10% -20%
Tembec
Canfor Pulp
Mercer
Fibrek
Q410
Q310
Q210
Q110
Q409
Q309
Q209
Q109
Q408
Q308
Q208
Q108
-30%
Fibria
Source: Company reports, RBC Capital Markets research and analysis
8
February 28, 2011
Tembec Inc.
Exhibit 11: Historical high yield pulp sales, profit, shipments and costs High Yield Pulp
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's st)
($/st)
($/st)
($/st)
FQ110
$55
$5
$2
$4
109
$505
$37
$447
FQ210
$88
$9
$2
$11
153
$575
$72
$417
FQ310
$126
$17
$2
$19
200
$630
$95
$437
FQ410
$104
$11
$2
$13
154
$675
$84
$480
FQ111
$100
$5
$2
$7
182
$549
$38
$453
Source: Company reports, RBC Capital Markets
Forest Products are primarily lumber • Segment at a glance: F2010 Sales: $434MM │ Share of total sales: 22% │ F2010 EBITDA: ($10MM) │ EBITDA margin: (2.3%) • TMB has Forest Products operations across Canada – SPF (Spruce Pine, Fir) lumber capacity of 1.4 billion board feet is located at 10 mills in Ontario, Québec and British Columbia. Lumber production is split between dimension lumber (955 Mmfbm) and stud lumber (425Mmfbm). Stud lumber is used exclusively in North American new-home construction for walls and other framing, and is therefore the most exposed to weakness in US housing. In addition, the company has 30Mmfbm of specialty hardwood and 20Mmfbm of specialty softwood (flooring) capacity and two engineered wood mills (which have been idle since 2007). The segment also manages forest operations and wood procurement, harvesting 3.2 million m3 and purchasing 0.7 million m3 in F2010 from third parties. Exhibit 12: North American softwood lumber capacity Capac ity (Bln bf)
Market share
1
West Fraser
6.0
9%
2
Weyerhaeuser
5.4
8%
3
Canfor
5.0
7%
4
GP
2.4
3%
5
Tolko
2.4
3%
6
AbitibiBowater
2.2
3%
7
Sierra Pacific
2.0
3%
8
Hampton Affliates
1.9
3%
9 Tembec
1.4
2%
10 EACOM
0.9
1%
Top 10
29.6
42%
Source: Company reports, RBC Capital Markets estimates
• Low operating rates remain a drag – Shipments of SPF lumber were 787 Mmfbm in F2010, or 49% of capacity (up from 43% in 2009). Low demand with the collapse of the US housing market since 2005 has led to widespread industry rationalization and continuing low operating rates. We believe the industry operated about 60% of capacity in 2010 and will improve only modestly in 2011. U.S. housing starts, the largest single end market for lumber products, averaged 586,000 units in 2010 and we forecast they will rise 20% to 700,000 units in 2011. While this is a large percentage improvement, it will only bring starts to half their long term trend level of about 1.5 million units.
9
February 28, 2011
Tembec Inc.
Exhibit 13: Lumber prices have firmed as industry capacity has declined Lumber prices have recovered from their 2009 lows
Eastern stud premium vs W SPF lumber declined in FQ111
$/mfbm $600
$100
2,000
$500
$60
1,500
$400
$40
1,000
$300
$20
500
$200
-
$100
US Housing Starts
SPF Great Lakes
$80
$Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
$(20) Jan-99
Jan-11
Jan-09
Jan-07
Jan-05
Jan-03
Jan-01
Jan-99
000 units 2,500
Great Lakes studs vs Western SPF dimension lumber
Source: Bloomberg, Random Lengths, RBC Capital Markets analysis
• Export taxes reduce returns to the producer – Virtually all sales are to North American customers, with 65% to Canadian destinations (an unusually high proportion). All of Tembec’s softwood lumber exports to the U.S. are regulated by the Softwood Lumber Agreement. The agreement increases taxes on exports as the benchmark price falls, with taxes currently sitting at their maximum. The current benchmark price is US$297/mfbm, below the US$315/mfbm necessary to reduce the tax to 10% for Western exports and 3% with a 32% market share limit of US consumption for Eastern exports. In addition, Eastern Canadian producers will be subject to an additional 10% ad valorem tax until about mid-2011, reflecting an adverse ruling following a complaint by the US in 2009. A recent ruling by the LCIA (the Agreement’s dispute resolution body) will add another 2.6% ad valorem export tax to lumber shipped from Québec (and 0.1% on US-bound exports from Ontario) until $59 million has been collected. We do not expect a decision from the LCIA on the most recent challenge (initiated January 2011) before July, and anticipate any penalty would apply exclusively to lumber shipped from Western Canadian mills. We expect the penalty would be collected over an extended period of time, reducing its impact on Tembec. • Exports to China have boosted North American benchmark prices but have had less impact on other grades – Exports to China from Western Canadian mills have siphoned off some excess North American supply and have increased prices, particularly for exported grades. Exports to China were about 2.8 billion bf in 2010, up from about 1.1 billion bf in 2009 and virtually nothing in 2007. North American prices have tended to move together, so while Western lumber sales represented only 44% of total sales in 2010 (up from 28% in 2009), Eastern shipments have also enjoyed some benefit. Other grades, including wider lumber and shorter lengths, have not followed the benchmark prices up. • Stud lumber has not performed as well as dimension lumber in recent months – Eastern stud lumber prices were weak in FQ1/11, with the premium to Western SPF dimension lumber falling to just US$41/mfbm for the quarter, down from US$73/mfbm over the first nine months of the year and US$77/mfbm in calendar 2009. Very bad weather in the East brought demand to a standstill, with no upside from a pick-up in home improvement activity or export markets. We expect the premium to Western SPF to remain below historical averages through 2011. • Capex, depreciation are low – Capital expenditures for the segment have averaged less than $7 million over the past three years as the company has held back investing cash given low operating rates. Depreciation has declined steadily from $24 million in 2009 to $16 million in 2010 as capacity has been permanently closed and operating rates have fallen. We expect Capex to remain constrained through 2011. • FQ1/11 results disappoint – Forest Products EBITDA of ($11 million) was down from ($5 million) in the prior quarter despite flat sales. Shipments increased 4% but average realizations fell 4%. The segment operating rate remained very low, running at just 54% of capacity, about the same as 52% in the prior quarter. Reference prices for benchmark Western SPF increased 21% to US$269/mfbm and Eastern SPF was up 11% to US$350/mfbm. Eastern stud prices, however, were up just 5%. Given an unfavourable shift in product mix in the quarter, the total impact of higher prices was just $1 million or $5/mfbm. Costs increased $7 million, including a $3 million unfavourable impact from harvest operations. We forecast stronger lumber prices in early calendar 2011 and better cost control should lift results in FQ2/11 to breakeven EBITDA.
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Tembec Inc.
Exhibit 14: Comparative lumber margins Tembec lumber margins remain low er than peers'
30%
10% 0%
margin
Adjusted lumber EBITDA
20%
-10% -20% -30% Margins adjusted for export duties.
Tembec
Canfor
West Fraser
Q410
Q310
Q210
Q110
Q409
Q309
Q209
Q109
Q408
Q308
Q208
Q108
Q407
Q307
Q207
Q107
-40%
Interfor
Source: Company reports, RBC Capital Markets estimates
Exhibit 15: Historical Forest Products Sales, Profit, Shipments and Costs Forest Products
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's mfbm)
($/mt)
($/mfbm)
($/mfbm)
FQ110
$95
($11)
$4
($8)
177
$304
($45)
$242
FQ210
$100
($6)
$4
($3)
177
$323
($17)
$226
FQ310
$126
$2
$4
$6
224
$371
$27
$234
FQ410
$113
($9)
$4
($5)
209
$333
($24)
$246
FQ111
$113
($15)
$4
($11)
218
$311
($50)
$259
Source: Company reports, RBC Capital Markets estimates
Paper segment: a mixed bag and a small part of the picture • Segment at a glance: F2010 Sales: $348MM │ Share of total sales: 17% │ F2010 EBITDA: ($2MM) │ EBITDA margin: (0.6%) • Tembec operates two paper mills – With the permanent closure of the Pine Falls, Manitoba newsprint mill in September 2010 (the mill had been idled through 2010), the company has just one newsprint mill and one coated paperboard mill. The paperboard mill is partially integrated with the Temiscaming high yield pulp mill and also consumes NBSK pulp. The segment includes sales of electricity from a hydro-electric dam in Smooth Rock Falls, ON (a former mill site). Exhibit 16: Tembec Paper segment capacity Paper Coated paperboard
000 mt
Temiscaming, QC
180
Newsprint Kapuskasing, ON
330 510
Source: Company reports, RBC Capital Markets estimates
• North American newsprint demand declines have moderated – After two years of declines in the low double digits, the demand decline accelerated through 2009 to a staggering 25% drop. In calendar 2010, the North American decline moderated to 6.0%, with demand actually increasing 5.5% in calendar Q4/10 over Q3/10. We forecast North American demand will continue to decline 6%8% or 325-425 k mt annually over the medium term. We expect producers will be able to keep pace with demand declines by increasing exports, closing or converting about two average sized paper machines per year, which should support prices. • Increased exports have relieved pressure on the domestic newsprint market – Newsprint exports increased 44% to 2.5 million mt in 2010, taking pressure off domestic markets. Total industry exports represented about 32% of monthly shipments in 2010, up from an average of 23% in 2009 and 26% in 2008. Global demand for newsprint increased 1.1% in 2010.
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Tembec Inc.
Exhibit 17: North American vs. Global Newsprint Demand (million mt) MM mt
MM mt 31
14.0 Forecast
12.0
30
2.0
25
-
24
North America
Rest of World
2014E
26
2012E
4.0
2010
27
2008
6.0
2006
28
2004
8.0
2002
29
2000
10.0
Historical and forecast demand for newsprint North America 2000 13.1 2001 11.6 2002 11.4 2003 11.3 2004 11.0 2005 10.4 2006 9.7 2007 8.7 2008 7.7 2009 5.8 2010 5.4 2011E 5.2 2012E 4.8 2013E 4.5 2014E 4.2 2015E 4.0 2011 - 2014 CAGR
% y/y -0.4% -11% -2% -1% -2% -6% -6% -10% -12% -25% -6% -5% -6% -6% -6% -6% -6.0%
Rest of world 26.5 26.1 25.6 26.4 28.1 28.2 29.3 30.0 29.8 26.9 28.2 28.4 29.0 29.5 30.0 30.4
% y/y 6.6% -1.4% -2.2% 3.4% 6.1% 0.6% 3.8% 2.3% -0.5% -9.8% 4.7% 1.0% 1.8% 1.9% 1.5% 1.5% 1.5%
Source: RISI and RBC Capital Markets estimates
• Newsprint prices are stable – Prices for North American benchmark grades were flat at $640/mt in February, the seventh consecutive month at this level. Prices rose steadily for 12 months from their trough of US$435/mt in August 2009 as producers finally managed to curtail enough capacity to get ahead of demand declines. Prices averaged US$605/mt in 2010, up 7% from the prior year. We forecast average prices of US$665/mt in calendar 2011 and US$650/mt in 2012. • Newsprint costs to decline – At current prices we believe the newsprint operation is breakeven and falls in the third quartile of the cost curve. Under the new electricity pricing regime in Ontario, however, we expect costs to fall about $60/mt and the mill to move into the second quartile. The Ontario program offers a rate rebate on electricity consumed during off-peak hours. • Kapuskasing mill provides a home for residuals from four sawmill – While the newsprint operation is breakeven at recent levels and North American demand declines are expected to continue, closing the mill would entail finding a home for wood chip residuals from four sawmills. This would be difficult given low regional demand for chips. The loss of chip sales revenue would further impact the performance of the Forest Products segment. • Coated paperboard markets are strong – Industry order backlogs remained very high at over 4.5 weeks in calendar Q4/10, well above the average of 3.2 weeks over the prior five years. Operating rates averaged a healthy 97% in Q4/10 and full year 2010, up from the low 88% recorded in 2009. After falling off a cliff in Q1/09, quarterly production levels have now recovered to early 2008 levels. • Coated paperboard prices have climbed steadily – Benchmark SBS prices have performed remarkably well over the past two years despite major swings in demand. After orders declined in early 2009, benchmark prices for 16pt SBS dipped just US$20/st over two months to $1,230/st. They began to rise again in April 2010 and have increased 11% or US$130/st to US$1,360/st in February. The coated paperboard market is consolidated, with the top five producers controlling 84% of total capacity. We believe good producer discipline will continue to support prices, and forecast US$1,135/st in 2011 and similar levels in 2012. The type of coated paperboard produced at the Temiscaming mill is a lighter-weight, higher-end product that does not compete directly with products made by the two industry heavyweights, International Paper and MeadWestvaco. Growth for this type of product is typically in-line with GDP rates. • Paperboard sales focused on North American markets – North American customers accounted for 95% of segment sales in 2010, with the US accounting for 74%. All production is sold under longer-term contracts, with mill backorders running at 60 days. End uses include high-end packaging (think perfume), product displays, lottery tickets or other products that require good graphics. • Results improve slightly in FQ111 – Segment EBITDA of $4 million was in-line with the prior quarter, but represented a 4.6% EBITDA margin, up from 4.2% in FQ4/10. Sales revenues declined 9% as shipments of bleached board dropped 11% and newsprint fell 8%. The decrease in shipments was partially offset by an increase in the benchmark prices for both grades: benchmark SBS was up 4% (US$43/st) to US$1,150/st and newsprint was up US$5/mt to US$640/mt. The SBS shipments-tocapacity rate remained high at 92%, but was down from the unsustainable 100%+ rate recorded in the prior two quarters. For newsprint, shipments ran at 69% of capacity, up from 49% in FQ4/10 when the now-closed Pine Falls mill was included in the calculation. Newsprint downtime in FQ1/11 remained high, however, at 22.8 k mt, as one machine at the Kapuskasing mill is
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February 28, 2011
Tembec Inc.
indefinitely idled. We forecast higher SBS prices, as prior increases are rolled into longer-term contracts and higher newsprint prices, along with stable costs will generate EBITDA of $4 million in FQ2/11.
800
0.0 Jan-00
Prices Demand Exports as a percent of total shipments
SBS prices
weeks of backorder
1.0
Jan-11
900
Jan-10
0%
2.0
Jan-09
-
1,000
Jan-08
5%
3.0
Jan-07
200
1,100
Jan-06
10%
Jan-05
400
4.0
Jan-04
15%
1,200
Jan-03
600
5.0
Jan-02
20%
1,300
Jan-01
800
US$/st
25%
SBS prices have increased & backlogs have recovered 1,400 6.0
Jan-10
1,000
Jan-08
30%
Jan-06
1,200
Jan-04
35%
Jan-02
1,400
Jan-00
000 mt & newsprint price ($/mt)
Exhibit 18: Newsprint prices stable; SBS prices rising steadily
Weeks of backorder
Source: Company reports, RBC Capital Markets estimates
Exhibit 19: Historical Paper Sales, Profit, Shipments and Costs Paper
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's st)
($/st)
($/st)
($/st)
FQ110
$79
($3)
$1
($2)
93
$849
($22)
$744
FQ210
$77
($6)
$1
($5)
94
$819
($53)
$749
FQ310
$96
$0
$0
$1
113
$850
$9
$709
FQ410
$96
($3)
$0
$4
109
$881
$37
$699
FQ111
$87
$3
$1
$4
99
$879
$40
$699
Source: Company reports, RBC Capital Markets estimates
Increasing power production offers incremental cash flow • Tembec has invested in incremental green power projects, with potential for more – In addition to the existing, small-scale sales of energy from the Smooth Rock Falls hydro electric dam, Tembec is investing in energy projects to reduce costs and generate excess electricity to sell to the grid. The first of the projects to be completed was the biomass cogeneration project at the Skookumchuck NBSK pulp mill last year, with others either underway or under study. Exhibit 20: Current and potential energy projects Loc ation
Grade
Projec t
Capex
Start up Annual EBITDA
Skookumchuck, BC NBSK
25-30 MW Biomass cogen - new contract
$2MM
Aug-10
$10MM
Matane, QC
BCTMP
Methane biogas to displace fossil fuel
$25MM/Net $1MM
Jun-12
$6MM
Tartas, France
Specialty 8-9 MW Biomass turbine - new contract
$21MM
Jun-12
Approved or c ompleted
$8MM $24MM
Under Study Temiscaming, QC
Specialty 35-40 MW Waste liquor cogen - new contract $160-$170MM
TBD
$35-$40MM
Source: Company reports, RBC Capital Markets
• Green Transformation Program funds will support project at the Matane mill – The company is directing $17 million of its total $24 million Capex credits earned under the Canadian Federal Green Transformation Program to the Methane Biogas project in Matane. Combined with a contribution of $7 million from the provincial government, government funding will cover all but $1 million in project costs. The project will replace fossil fuels with methane, resulting in annual savings of about $6 million, or ~$8/mt of BCTMP production.
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Tembec Inc.
• The turbine upgrade at Tartas is the big project for this year – The company plans to invest $21 million in the turbine. The investment is supported by a new electricity sales contract with preferential green energy rates that will offset about $6 million to $8 million in energy costs at the mill. • The largest project under consideration has a two-three year timeframe – The potential cogeneration project at the Temiscaming mill has not yet been approved, and would not be completed before the end of 2014. It has been on the company’s list of potential project list for more than a decade, but will not go forward in the absence of a power purchase agreement with Hydro Québec. It appears progress has been made toward finally securing an agreement, with a provincial call for power generation proposals expected this summer, followed by contract negotiations in the fall. We anticipate power purchase rates under the contract would be ~$110/MWh, in-line with recent agreements. As part of the contract, Hydro Québec would support the necessary capital investments at the mill (about $160 million to replace three small boilers with one large high-pressure boiler). When complete, annual power sales would offset about $40 million in production costs, taking down unit cash costs by $200300/mt. We will not include the project in our model before the company indicates it has signed an agreement with Hydro Québec.
Potential non-core asset sales • Apart from some small exceptions, the majority of the company’s assets are core – Following a series of closures (and bankruptcies) of company assets and joint ventures around the time of the recapitalization, Tembec has reduced and narrowed its manufacturing base. • Resin business and Smooth Rock Falls hydro asset could be sold – Once the recovery in US housing is underway, we would expect the resin business to become more attractive to a potential acquirer. The business makes about $10 million EBITDA and could eventually be sold for about $40 million. The Smooth Rock 5MW hydro asset is located at the site of a now-closed mill. We believe the asset could be sold relatively easily, and expect its sale could generate about $15 million. • There is no timberland left to sell – The company sources the majority of its timber supply from public timberlands under long term licence agreements with provincial governments. While there are a few scraps of private timberland left, their sale would have to be under a sale-and-timber-purchase agreement with little real upside for the company.
Recapitalization • Tembec recapitalized in early 2008 – Given low cash flow and liquidity and little prospect for near-term improvement, in late 2007 the company announced it would recapitalize. The process was completed on February 29, 2008. • Recapitalization turned debt into equity – With the recap, the company traded US$1.2 billion in debt for new equity. Prior shareholders were squeezed down to 5% ownership, with the balance going to former debt holders. The exchange reduced interest on long-term debt from $117 million in F2007 to $33 million in F2009 and $27 million in F2010. The recap was supported by a US$300 million term loan, which was paid off and replaced with the current US$255 million 11.25% bond issue in August 2010. • Write downs, but no closures, accompanied the recap – The company took $804 million in asset write downs, which in turn led to a $33 million reduction in the annual depreciation charge. No capacity closures were announced at the time of the recapitalizations. • Since the recapitalization some assets have been shed – In April 2008, Tembec sold a 20% interest in its dissolving pulp joint venture to partner Aditya Birla for $9 million. Birla, a rayon manufacturer based in India, was the venture’s sole customer. Tembec retains a 5% stake. In February 2009, the Marathon Pulp 50/50 joint venture formed with Kruger in 2000 filed for creditor protection and closed permanently. In Forest Products, the company closed the Mattawa, ON hardwood sawmill, also in February 2009. More recently, it closed the Taschereau stud mill in February 2011, idle since October 2009. The company permanently closed the Pine Falls, Manitoba newsprint mill in September 2010. • April 2009 initiative to generate $100 million in additional liquidity was successful – As part of the initiative, the company reduced headcount by 100 staff positions and sold a number of non-core assets and businesses. Businesses sold included Tembec’s 50% interest in Temrex Forest Products Inc sawmill joint venture for $12 million in September 2009. The company’s sole coated paper mill in St. Francisville, LA, was idled before the recap (July 2007), but the site and assets were finally sold in April 2009 for $16 million. Tembec only received the cash portion of the sale price ($6 million) before the purchaser filed for creditor protection. The purchase of the mill (for $300 million in 2001) and its subsequent operating losses (~$200 million) were likely the single largest factor in forcing the company to recapitalize. • The most important step in the path to stronger finances was the sale of the French mills – The May 2010 sale of the St Gaudens and Tarascon mills for €100 million facilitated the US$255 million bond issue and brought net debt down to 38% at F2010 year end, below the 40% target.
Senior management team, board of directors and institutional ownership The senior management responsibilities were reorganized late in 2010, with high yield pulp operations forming a new segment and the dissolving pulp operations combined with the chemicals group. • James Lopez, President and Chief Executive Officer – Mr. Lopez joined Tembec in 1989 as Manager, Corporate Development. He has been President and Chief Executive Officer of the Corporation since January 2006. Prior to his appointment in January,
14
February 28, 2011
•
• • • •
Tembec Inc.
2006, he served as Executive Vice President and President of the Tembec Forest Products Group from August 2003 to January 2006. Mr. Lopez also holds a seat on the board of directors of the Forest Products Association of Canada (FPAC) and is a member of the Bi- National Softwood Lumber Council between Canada and the United States. He is currently chairman of the board of directors of FP Innovations and he sits on the President’s Board of Advisors for California University of Pennsylvania. Mr. Lopez is the former chairman of the board of directors of the Ontario Forest Industry Association (OFIA), of the Forest Engineering Research Institute of Canada (FERIC) and of Wood Works Canada Corp. Michel Dumas, Chief Financial Officer – Michel Dumas joined Tembec in 1985 as Controller for the High-Yield Pulp Mill in Temiscaming, Québec. In 1991, he became Vice President, Finance and CFO of Spruce Falls Inc., an affiliate of Tembec, and in 1997 was promoted to Executive Vice President, Finance and CFO of Tembec. Stephen J. Norris, Treasurer since 1994. Chris Black, Executive Vice President, Paper and High Yield Pulp Group, since May 2008 Yvon Pelletier, Executive Vice President, Specialty Cellulose and Chemical Group, since October 2006. Dennis Rounsville, Executive Vice President Forest Products Group, since 1999.
Exhibit 21: Management and institutional ownership Management and Board ownership Common shares
% of shares Options
Total
outstanding
Senior Management James Lopez
CEO
308,176
17,344
Michel Dumas
CFO
223,406
16,485
239,891
Yvon Pelletier
EVP, Specialty Cellulose & Chemical Group
146,342
1,315
147,657
Richard Tremblay Controller Chris Black
EVP, Paper & High Yield Pulp Group
Stephen Norris
Treasurer
Dennis Roundsville EVP, Forest Products Group John Valley
EVP, Business Development
325,520
52,930
4,327
57,257
107,637
1,020
108,657
1,359
2,440
3,799
126,800
2,863
129,663
69,805
10,638
80,443 1,092,887
1.1%
Board of Direc tors James Lopez
CEO
see above
James Continenza Chairman
323,240
Norman Betts
Director
118,764
323,240
James Chapman
Director
116,264
116,264
Francis Scricco
Director
216,264
216,264
Lorie Waisberg
Director
120,264
120,264
James Brumm
Director
119,361
119,361
Luc Rossignol
President, Local 233 CEWP Union
David Steuart
Director
258
119,022
93
93
116,264
116,264 1,130,772
1.1%
Warrants excluded.
Institutional ownership Shares held
% of shares
(MM)
outstanding
Institution #1
20
19.9%
Institution #2
10
9.7%
Institution #3
10
9.5%
Institution #4
9
8.8% 47.9%
Source: Company reports, Thomson One Analytics February 25, 2011, SEDI and RBC Capital Markets estimates
• Senior management and the board of directors hold a combined 2.2% share of Tembec stock. • The top four institutional investors hold a combined 48% of shares outstanding – The largest institutional owner holds a 20% share.
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February 28, 2011
Tembec Inc.
Capital investment, pension and tax pools • Capital investment has been constrained – Tembec invested $25 million in capital projects in fiscal 2010, a significant decline from $42 million in 2009. We believe annual Capex of $35 million to $40 million is required to adequately maintain current facilities. We expect the company to increase Capex spending to $36 million in 2011. • Several major projects are planned for 2011 & 2012 – The Tartas Biomass turbine project has been allocated $13 million in F2011. In addition, the company has planned $22 million in general and maintenance Capex for paper pulp, paper and forest products operations, along with $1 million for the Matane methane project. • Tembec has access to ample tax credits – Tembec’s tax assets are a legacy of the company’s losses prior to the 2008 recapitalization, and can shelter a total of $2.3 billion, or about $600 million in taxes payable. Of these assets, only $27 million related to the French operations appear on the balance sheet. Exhibit 22: Tax assets Expiry
Amount ($MM)
Loss carryforwards - Canada
2014-2030
R&D deductible pool - Canada
Unlimited
364
Tax value of fixed assets - Canada/France Unlimited
604
Loss carryforwards - France
Unlimited
Loss carryforwards - US
2028-2030
995
66 19 2,048
Source: Company reports
• Pension deficit funding an artefact of low interest rates, but not too onerous – As of the last measurement date, Tembec’s pension plan assets of $580 million fell $206 million short of liabilities ($786 million). Pension expense in 2010 was nil, compared to $19 million in the prior year. Over and above the normal pension funding of $10 million to $14 million in EBITDA, as a result of current abnormally low interest rates the company expects to make an additional $15 million excess contribution. The company is exploring potential modification of funding requirements, such as extending the period over which the shortfall must be funded, similar to the agreement AbitibiBowater recently secured from the Ontario and Québec governments. These types of agreements, however, often come with strings attached, and we believe Tembec will be wary of additional government restrictions or oversight. Contributions to other employee future benefit plans are expected to total $3 million in F2011.
Capital structure • The capital structure is uncomplicated – Tembec has one primary debt issue outstanding: the US$255 million 11.25% Senior Secured Notes due 2018. The notes were issued in August 2010, with funds and cash on hand used to repay the balance outstanding under the US$300 million Term Loan. The cash balance had been boosted by the sale of the two French pulp mills. Tembec’s unrestricted US subsidiaries and restricted French subsidiaries are not guarantors of the notes. Moody’s rates the note B3 and S&P has rated them B-. Exhibit 23: Long-term debt Long term debt ($ MM)
Change 2010
2009
Tembec Industries (US$255MM 11.25% Snr sec notes, Dec 2012)
261
-
Tembec Industries (US$300MM Term Loan)
-
328
Tembec Inc. (6% unsecured notes, Sept 2012) Tembec SAS debt
9
6
7
30
Tembec Energie SAS debt
-
Bioenergy debt
-
Other debt Total long term debt Less unamortized financing costs Current portion (included above)
12
14
Tembec Envirofinance SAS debt
8 8
10
10
301
402
13
2009-10
-
288
402
17
19
(114)
Source: Company reports
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February 28, 2011
Tembec Inc.
• The revolver matures at the end of 2011 – Tembec’s $205 million revolving working capital facility matures in December 2011. The facility is subject to permanent availability reserves of $25 million and US$50 million. The facility has a first priority charge over the receivables and inventories and a second priority charge over the remainder of the majority of North American assets. The company is in the process of replacing it with a new multi-year revolving working capital line. We expect the company will announce the signing of a new ABL agreement within the quarter. At the end of FQ1/11, $78 million of unused credit was available after the $75 million reserve, $34 million letters of credit and $3 million of borrowings. Total liquidity was $139 million with $61 million in cash. • The company has resolved to maintain net debt at or below 40% – As part of its long-term strategy, the company is committed to keeping its net debt below 40%. At FQ1/11 end, net debt was 39%. • French operations rely on separate arrangements – The French operations are supported by factoring agreements. As such, the borrowing base fluctuates periodically, depending on shipments and cash receipts. • There are 100 million shares outstanding – No shares were issued in fiscal 2009 or 2010. • Warrants - There are currently 11 million outstanding warrants. The warrants are convertible into an equal amount of common shares and expire on February 29, 2012. They would be automatically converted into common shares if the 20-day volumeweighted average trading price reaches $12, or immediately prior to any transaction that would constitute a change of control. Exhibit 24: Capital structure
Source: Company reports; Revenues & EBITDA at time of bond issue (Aug 2010)
Trading patterns •
Trading post Feb-2008 recapitalization is in-line with Paper & Forest Products Index – Tembec has moved with the S&P/TSX Paper & Forest Products Index since its February 2008 recapitalization.
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February 28, 2011
Tembec Inc.
Exhibit 25: Trading patterns Tembec value declined steeply between 2000 and 2008
But shares have moved with the S&P/TSX since 2008
$18
1,350
$16
1,200
$14
1,050
$12
900
$10
750
$8
600
$2.00
450
$1.00
350
$-
250
S&P/TSX Paper & Forest Products Index
TMB (LHS)
Dec-10
Sep-10
Jun-10
Mar-10
Dec-09
Sep-09
Jun-09
Mar-08
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
$Jan-03
550
Mar-09
150 Jan-02
$3.00
Dec-08
300
$2 Jan-01
650
Sep-08
$4
Jan-00
Adjusted R2 = .63 $4.00
450
Recapitalization
TMB (LHS)
750
Jun-08
$6
$5.00
S&P/TSX Paper & Forest Products Index
Source: Thomson ONE, RBC Capital Markets
Valuation • We value Tembec using EBITDA multiples within a range defined by its peer group – We believe a valuation based on a combination of trend earnings and 2011E EBITDA is most appropriate. Our valuation is intended to reflect earnings potential through the business cycle, with less emphasis on current conditions. Our trend EBITDA estimate is $230 million; Target $8.00 • Using mid-cycle pricing and cost assumptions, we arrive at a trend EBITDA estimate of $230 million – Tembec’s current financial performance is well below this level, but commodity prices are rising across the company’s business units. We forecast 2011 EBITDA of $143 million and $235 million in 2012. • We have applied a 4.5x multiple, which is at the low end of the range for Canadian paper & forest product companies (4.5x to 6.0x), to arrive at our target price of $8.00 per share. This target price implies a 7.2x multiple of our 2011E EBITDA and a 4.4x multiple of our 2012E EBITDA. Tembec is currently trading at 5.0x our 2011 estimate and 3.1x our 2012 estimate. These metrics are below Pulp (7.8x 2011, 5.8x 2012), Lumber (6.9x, 3.8x) and Paper (6.7x, 5.2x) companies. Exhibit 26: Range of Valuation Multiples for Tembec on 2011 EBITDA Company
AbitibiBowater
Mercer
West Fraser
Canfor
Catalyst
Canfor Pulp
Interfor
Fortress Papers
ND/ND+E
12%
75%
8%
4%
65%
8%
30%
0%
Dividend Yield
0.0%
0.0%
1.1%
0.0%
0.0%
8.7%
0.0%
0.0%
4.3x
5.4x
6.1x
6.6x
6.9x
7.0x
8.3x
11.5x
Valuation Multiple Implied Tembec EV
$646.4
$811.7
$916.9
$992.1
$1,037.2
$1,052.2
$1,247.6
less Net Debt
$235.0
$235.0
$235.0
$235.0
$235.0
$235.0
$235.0
$235.0
Implied Equity
$411.4
$576.7
$681.9
$757.1
$802.2
$817.2
$1,012.6
$1,493.6
$4.11
$5.77
$6.82
$7.57
$8.02
$8.17
$10.13
$14.94
Implied TMB per share
$1,728.6
Priced as of market close, February 22, 2011. Source: Company reports, Bloomberg, RBC Capital Markets estimates
• In looking at an appropriate valuation multiple for Tembec, we reviewed the current valuations for a number of similar forest products companies – In North America, Fortress Papers, Canfor Pulp, Mercer and West Fraser are the closest comparables. We note that Fortress Papers has exposure to dissolving pulps, but on the commodity dissolving side, not the specialty dissolving grades like Tembec. Fortress’s other businesses – banknote papers and wallpaper – would likely command a higher multiple than Tembec’s Paper, Wood Products and High Yield pulp segments. That said, the current valuation multiple of 11.5x is high as it reflects a dissolving pulp conversion in mid-2011. We believe pure NBSK pulp producers – Canfor Pulp (7.0x 2011 EBITDA) and Mercer (5.4x) – should have a valuation premium due to the limited future capacity additions on the softwood side. Mercer’s valuation is constrained by its high debt level. West Fraser is a large integrated forest products company, like
18
February 28, 2011
Tembec Inc.
Tembec, but with more lumber exposure and less in pulp. We believe that West Fraser should trade at a premium due to the company’s superior lumber margins and low debt level. • We believe West Fraser represents a decent benchmark in the valuation of Tembec – While the two companies are both integrated producers, in 2010 West Fraser’s lumber segment was 56% of sales and 47% of EBITDA while pulp contributed 30% and 41% respectively. Corresponding stats for Tembec would be 19% of sales and (9%) of EBITDA for lumber and 62% of sales for pulp but 125% of EBITDA. Exhibit 27: Net Asset Value for Tembec is $10 Tembec NAV - Based on Comparable Transaction Basis Capacity
Unit Value
Dissolving & Chemical Pulp (000's mt)
Asset Value ($MM)
Skookumchuck, BC
NBSK
270
$700
$189
Temiscaming, Quebec
Spec/vicose
160
$1,200
$192
Tartas, France
Spec/vicose Subtotal
150
$1,200
$180
580
$967
$561
High Yield Pulp (000's mt) Temiscaming, Quebec
BCTMP
315
$300
$95
Matane, Quebec
BCTMP
250
$300
$75
Chetwynd, B.C.
BCTMP
240
$300
$72
805
$300
$242
Subtotal Total Pulp
1,385
$803
Paper (000's mt) Spruce Falls, Ontario
Newsprint
330
$50
$17
Temiscaming, Quebec
Paperboard
180
$400
$72
510
$174
$89
Paper Subtotal Lumber (mmfbm) La Sarre, Quebec
Stud
200
$125
$25
Sennetarre, Quebec
Stud
150
$150
$23
Cochrane, Ontario
Stud
170
$150
$26
Kapuskasing, Ontario
Stud
105
$100
$11
$134
$84
Bearn, Quebec
Random Length
110
$125
$14
Chapleau, Ontario
Random Length
135
$150
$20
Subtotal
625
Timmins, Ontario
Random Length
100
$50
$5
Hearst, Ontario
Random Length
160
$150
$24
Canal Flats, BC
Random Length
180
$200
$36
Elko, BC
Random Length
270
$200
$54
$125
$119
$50
$1
$127
$204
Subtotal Cranbrook, BC
955
Finger-joint Lumber Subtotal
25 1,605
Misc. Wood Products - Engineered Wood plus Pine & Hardwood Misc. Wood Products Subtotal
$10
Chemicals Temiscaming & Tartas
$50
Ethanol/Resins/Lignosulfonates
Asset Value
$1,155
Net Debt (LTD+current debt-cash equivalents)
$227
Working Capital (less cash equivalents)
$228
Pension Deficit
$150
Net Asset Value Shares O/S (MMs) NAV/share
$1,006 100 $10.06
1 – Excludes joint venture capacity. Source: Company reports and RBC Capital Markets estimates
• Our net asset value of $10 per share is based on comparable transactions – We note, however, that a number of these transactions are quite dated and of limited value given changing market conditions. On the specialty pulp side, we understand that the recent sale of Neucel Pulp was done at $300 million or $1,785/mt. Given the current premium for commodity dissolving pulp, we have used a 35% discount on Tembec’s largely specialty dissolving pulp assets. Our NBSK value represents the average
19
February 28, 2011
Tembec Inc.
implied capacity value for pulp companies under our coverage. Using our ascribed asset values, we are effectively valuing Dissolving & Chemical Pulp at 4.6x 2010 segment EBITDA, 3.8x 2011E and 7.6x our estimate of trend EBITDA. • Capacity values imply reasonable EBITDA multiples for High Yield Pulp, Papers & Forest Products - For High Yield pulp, we assign a $300/mt value, which represents 4.8x 2010 EBITDA, 9.8x 2011E and 5.3x trend EBITDA. In using our ascribed asset values, we effectively are valuing Papers at 3.6x 2011E segment EBITDA and Wood Products at 20.8x 2011E segment EBITDA (but 2.1x trend EBITDA). Exhibit 28: Transaction-based asset values Date Pulp
Buyer
Asset
Price
Capacity
Price
(US$MM)
(000 mt)
(US$/mt)
Feb-11
Fulida Group Holdings
Port Alice, CB Specialty DP
300
168
1,785
Sep-10
Gores Group
Cosmopolis, WA, Specialty DP
160
140
1,143
Sep-10
Intl Grand Investments
Woodland, ME NBHK mill
60
395
152
Jul-10
Paper Excellence/APP
Howe Sound Pulp & Paper JV, NBSK mill
58
400
145
Jun-10
Georgia Pacific
626
985
636
May-10
Paper Excellence/APP
Parsons & Wittemore, SBHK & SBHK Tarascon & St Gaudens, FR, NBSK & NBHK
126
565
223
1,330
2,653
501
(C$MM) Lumber
(Mmfbm)
Domtar
EACOM
127
900
141
Jun-07
Domtar - Not completed
Conifex
285
1100
259
May-06
Arbec Forest Products
Jolina Capital
138
337
410
550
2,337
(US$MM) Newsprint
(C$/mfbm)
Jul-10
(000 mt)
235 (US$/mt)
Feb-08
Catalyst Paper
Snowflake, AZ recycled newsprint mill
161
375
Jan-08
White Birch
SP Newsprint
351
1,000
430 350
Feb-06
Public equity market
Catalyst Paper (Norske Skog stake)
376
579
561
888
1,954
454
Source: Company reports and RBC Capital Markets estimates
Exhibit 29: Comparative valuations Rating/
Share
Target
Shares
Market
Enterprise
Price/
Net debt/
Dividend
Risk
Price
Price
Outstanding
Cap
Value
Book (x)
Cap
Yield
EV/EBITDA (x) 2009A 2010E 2011E 2012E
North American and International Comparative Valuations Pulp companies Canfor Pulp
SP/AA
$16.50
$14.00
71.3
1,176
1,221
2.2
8%
8.5%
19.9
5.3
7.2
6.0
Fortress Paper 1 Mercer
SP/AA
$55.40
$50.00
12.0
747
824
3.7
0%
0.0%
32.2
28.4
10.7
6.0
O/Spec
$13.62
$15.00
43.0
426
1,286
1.8
75%
0.0%
Average
31.7
5.8
5.6
5.3
27.9
13.1
7.8
5.8
Lumber companies Canfor
SP/AA
$11.79
$11.00
142.6
1,682
1,739
1.2
4%
0.0%
nm
5.4
6.8
3.6
Interfor
SP/AA
$5.77
$5.50
47.1
272
423
0.8
30%
0.0%
nm
10.1
8.3
4.2
West Fraser
SP/Avg
$46.26
$53.00
42.8
1,981
2,129
1.1
8%
1.2%
Average
24.1
4.9
5.8
3.6
24.1
6.8
6.9
3.8
Paper companies AbitibiBowater (US$)
O/AA
$27.96
$35.00
97.0
2,824
3,344
0.4
12%
0.0%
nm
nm
nm
nm
Catalyst Paper
U/AA
$0.37
$0.10
381.8
139
893
0.3
65%
0.0%
7.3
12.5
6.7
5.2
7.3
12.5
6.7
5.2
nm
5.2
5.0
3.1
Average Tembec
O/AA
$4.95
$8.00
100.0
495
722
1.4
39%
0.0%
1 MERC share price in US$, Market Cap and Enterprise Value in euros. Priced as of market close February 25, 2011. Source: Company reports, RBC Capital Markets estimates
Sensitivities • Earnings are most sensitive to changes in pulp prices – A US$10/mt change in the price of dissolving pulp would change annual EBITDA by $3MM and EPS by $0.03. A similar change in BCTMP pricing changes annual EBITDA by $6MM and EPS
20
February 28, 2011
Tembec Inc.
by $0.06 (note that US$10/mt represents 0.7% of our forecast average 2011 dissolving pulp price and 1.3% of the BCTMP average price). A US$10/mfbm change in the price of lumber (representing about 3.5% of our 2011 forecast average) changes annual EBITDA by $11MM and EPS by $0.11. The impact of a 5% change in volume is more muted for BCTMP and lumber sales, but significantly higher than a US$10/mt price change for dissolving pulp. • Results are also quite sensitive to changes in the Canadian dollar – The company indicates a 1% change in the value of the US dollar against the Canadian dollar moves annual EBITDA by $10MM and EPS by $0.04, with a higher US dollar increasing results (all else being equal, which it never is). The vast majority of pulp, paper and solid wood products are priced in US dollars. The company’s relatively high proportion of lumber sales to Canadian customers moderates the influence of exchange fluctuations to a modest degree. We forecast the Canadian dollar will remain at or near parity through 2011 and 2012. Exhibit 30: Sensitivities Annual EBITDA sensivity to a $10/ton change in pricing or a 5% change in shipments C2011E EBITDA ($MM) Pricing Baseline assumptions
Volume
C2011E EPS ($/share) Pricing
143
Volume 0.50
Dissolving pulp
3
7
0.03
0.07
High yield pulp
6
2
0.06
0.02
11
2
0.11
0.02
Eastern SPF
Source: Company reports, RBC Capital Markets estimates
Risks and Price Target Impediments The primary risks to our forecast include the strength of the dissolving, chemical and high yield pulp markets in the medium term and the timing of the recovery in the US housing market in the longer term. • Pulp demand and prices – A decline in demand for pulp products or a sustained increase in supply would increase pressure on prices and lower forecast EBITDA. This risk is mitigated by the company’s long-term contracts covering ~80% of specialty dissolving pulp production, low global inventories of softwood chemical pulp and growing demand for most grades of pulp and the economic recovery continues to gain traction. With the sale of the two higher cost chemical pulp mills in France, the company has lowered its exposure to more volatile commodity kraft paper pulp grades. • Weak North American housing market – With housing starts of just 586 k units in 2010, demand for lumber and other building products has been reduced to generational lows. While we forecast starts to increase 20% to about 700 k units in 2011, the level of activity remains less than half the long-term trend of 1.5-1.6 million units. Despite the exceptionally low demand environment, Tembec has improved Forest Products segment returns in part through permanent closures of higher-cost capacity. Changes implemented to date should continue to limit losses while demand remains low but at the same time preserving potential to increase production as demand improves. • The pace of the economic recovery – A slower than expected economic recovery would reduce demand for all products. We note, however, that enormous government stimulus injected into the US and global economies has restored stability in credit and financial markets, and improved investor and consumer confidence. Leading economic indicators (including the manufacturing and non-manufacturing PMIs in the U.S.) have shown continuing improvement through early 2011. Demand and prices for pulp are strong and a slew of paper and packaging price increases have been announced, driven in part but increasing costs for energy and chemicals. Bank rates are being kept very low by central banks around the world to support economic activity. TMB’s strengthened balance sheet should support operations through conditioned difficult economic conditions.
21
February 28, 2011
Tembec Inc.
Appendix: Pricing deck Exhibit 31: Historical and forecast commodity prices Current
Previous
Last
Price
Week
Month
Year ago
2005
2006
2007
2008
2009
2010
2011
2011E
2012E
Random Lengths Composite
297
296
304
312
387
326
283
252
222
283
300
290
320
W. SPF 2x4s #2&btr (US$/mfbm)
287
288
307
287
354
296
250
221
182
256
300
260
300
E.SPF 2x4 G.L. (US$/mfbm)
385
379
390
353
419
368
329
305
270
341
383
340
380
SPF 2x4s 8' KD Studs (US$/mfbm)
270
265
268
294
361
289
264
212
185
246
266
250
290
SYP 2x4 West (US$/mfbm)
304
312
321
332
422
329
279
298
242
303
322
320
345
Baby Squares (US$/mfbm)
753
753
753
613
648
673
763
760
753
OSB (7/16", NC, US$/msf)
205
205
211
220
321
218
160
172
163
219
204
215
Plywood (3/8", US$/msf)
310
309
309
322
314
311
344
316
291
324
309
315
345
MDF (3/4", West, US$/msf)
535
535
535
436
416
452
456
513
463
524
535
525
540
NBSK (US$/tonne)
960
960
880
647
824
824
857
718
960
960
915
950
FOEX US NBSK (US$/mt)
960
960
963
864
647
717
819
861
715
955
961
Commodity Lumber
Panels
Pulp
Paper
Packaging
YTD
Forecasts
780 235
NBHK (US$/tonne)
820
820
770
610
656
719
788
608
856
820
780
835
Newsprint (US$/tonne)
640
640
550
610
668
593
701
564
606
640
665
650
FOEX US Newsprint (US$/mt)
627
626
532
580
634
581
672
574
583
626
22.5 lb Directory (US$/ton)
730
740
660
747
750
749
748
708
700
735
745
730
35 lb SC-A (US$/ton)
805
870
740
798
798
751
878
818
791
838
850
845
No.5 40 lb LWC (US$/ton)
855
855
730
861
843
773
950
805
767
855
820
870
20lb. Repro bond, 92 cut size
1,070
1,070
1,010
814
893
958
1,053
1,025
1,071
1,070
1,050
1,050
50 lb Offset, Rolls (US$/ton)
920
920
845
716
813
808
901
836
905
920
920
925
Linerboard (US$/ton)
635
635
575
423
498
527
577
542
620
na
665
675
Medium 26 lb (US$/ton)
605
605
545
392
473
507
556
512
590
na
635
645
627
US/Cdn Exchange Rate
$1.02
$1.02
$1.01
$0.95
$0.83
$0.88
$0.93
$0.94
$0.88
$0.97
$1.01
$1.00
$1.00
Euro/US Exchange Rate
€ 0.73
€ 0.73
€ 0.75
€ 0.73
€ 0.80
€ 0.80
€ 0.73
€ 0.68
€ 0.72
€ 0.75
€ 0.74
€ 0.75
€ 0.74
Source: Pulp & Paper Week, FOEX Indexes Ltd., Random Lengths, Pacific Exchange Rate Service, RBC Capital Markets estimates
22
February 28, 2011
Tembec Inc.
Appendix: Financial Summary Exhibit 32: Financial statements ($ million) Tembec Income Statement
(C$ Millions) To tal Revenue Freight & deductions
Q1 09
Q2 09
Q3 09
Q4 09
Q1 10
Q2 10
Q3 10
Q4 10
2011E
2012E
417
407
451
412
1,687
2009
476
545
444
422
1,887
2010
Q1 11E 458
Q2 11E 467
Q3 11E 476
Q4 11E 472
1,873
2,078 272
54
55
54
49
212
56
70
59
57
242
60
62
64
63
249
Export taxes
1
1
2
2
6
3
3
2
3
11
3
3
3
3
12
5
Cost of Sales
402
372
383
339
1,496
366
394
327
329
1,416
348
338
355
352
1,393
1,486
S,G & A
23
21
21
18
83
19
18
20
18
75
19
19
19
19
76
80
To tal Costs
480
449
460
408
1,797
444
485
408
407
1,744
430
422
441
437
1,730
1,843
EBITDA, adjusted
(63)
(42)
32
60
36
11
139
28
45
35
35
143
235
Depreciation EBIT
(9)
4
18
19
18
15
(81)
(61)
(27)
(11)
(110) 70 (180)
15
14
12
12
53
13
12
12
13
50
64
17
46
24
(1)
86
15
33
23
22
93
171
Interest Expense
5
16
15
13
49
14
14
10
13
Gain (loss) on long term debt
7
(25)
(20)
(16)
(54)
(11)
1
(1)
(6)
(17)
3
-
1
(15)
Income Taxes Other income
-
Earnings from continuing o peratio ns
(96)
Discontinued operations Net Income Average Diluted Shares O /S
(1) (52)
(3) (99) 100
-
1
-
1
(22)
13
2
(39)
(20)
100
100
4 -
(9)
(179)
(9)
(167)
-
12
100
100
-
(20)
-
1
14
4 -
51
11
-
(1)
-
14
50
11
-
51
67
(9)
66
(1)
100
10 -
0 -
(9) -
10 -
1 -
5 -
22 -
5
10 -
22
10 -
1 12 12
40 -
1
40 -
3
-
-
11
50
-
-
11
50
7 125 125
100
100
100
100
100
100
100
100
100
100
Earnings per share FD, reported
($0.99)
($0.38)
($0.17)
($0.09)
($1.63)
$0.00
$0.59
$0.02
($0.12)
$0.49
$0.05
$0.22
$0.12
$0.11
$0.50
$1.25
Earnings per share FD, normalized
($0.96)
($0.50)
($0.35)
($0.23)
($2.04)
$0.00
$0.58
$0.12
($0.15)
$0.55
$0.05
$0.22
$0.12
$0.11
$0.50
$1.25
Gross Margin
(15.1%)
(10.3%)
(2.0%)
1.0%
(6.5%)
6.7%
11.0%
8.1%
3.6%
7.6%
6.1%
9.6%
7.4%
7.4%
7.6%
11.3%
EBITDA Margin
(15.1%)
(10.3%)
(2.0%)
1.0%
(6.5%)
6.7%
11.0%
8.1%
2.6%
7.4%
6.1%
9.6%
7.4%
7.4%
7.6%
11.3%
58.7%
58.4%
57.0%
57.5%
58.2%
38.7%
37.7%
39.1%
43.4%
36.2%
31.2%
30.6%
30.6%
21.2%
8.4%
2.6%
Margins & Metrics
Net Debt/Net Debt + Equity
Source: Company reports and RBC Capital Markets estimates
23
February 28, 2011
Tembec Inc. Tembec Cash Flow Statement
(C$ Millions) Q1 09
Q2 09
Q3 09
Q4 09
2009
Q1 10
Q2 10
Q3 10
Q4 10
2010
Q1 11E
Q2 11E
Q3 11E
Q4 11E
2011E
2012E
Operating Activities Net Income
(99)
(39)
(20)
(9)
(167)
14
50
11
(5)
70
5
22
12
11
50
125
Depreciation, depletion and amortization
18
19
18
15
70
15
14
12
12
53
13
12
12
13
50
64
Other
27
(44)
(25)
(12)
(54)
(7)
(29)
(2)
(10)
(48)
Changes in working capital
14
92
46
(2)
150
(29)
51
-
5
27
(23)
27
16
(17)
(40)
28
19
(8)
(1)
(7)
86
21
2
102
(5)
61
40
7
Operating Cash Flow
-
-
-
-
-
1 3
103
189
Investing Activities (15)
(6)
(6)
(6)
(33)
(5)
(6)
(8)
(8)
(27)
(10)
(10)
Other
10
9
11
1
31
2
88
1
(1)
90
-
-
Investing Cash Flow
(5)
3
5
(5)
(2)
(3)
82
(7)
(9)
63
(10)
(10)
38
(10)
31
(20)
(88)
2
(105)
-
-
-
-
-
7
7
1
264
272
-
-
-
-
-
(3)
(19)
(1)
(3)
(311)
(2)
(317)
-
-
-
-
-
-
2
3
2
(10)
(13)
4
(17)
-
-
-
-
-
-
(100)
(59)
4
(167)
-
-
-
-
-
Capital projects
(8) -
(8) -
(8)
(8)
(36)
(40)
-
-
(36)
(40)
Financing Activities Change in bank loans
8
(5)
Issuance of debt
4
3
-
Reduction of debt
-
-
(13)
(3)
Other
2
(3)
2
Financing Cash Flow
1
(8)
40
(11)
Beginning Cash Change in the Cash Position Ending Cash
22
(12)
1 -
58
16
40
107
58
82
45
122
70
82
58
43
94
(42)
24
67
(25)
24
(37)
77
(52)
(12)
(24)
(15)
51
32
16
40
107
82
82
45
122
70
58
58
43
94
126
126 (1) 125
(3) -
(3) 58
125
67
119
125
245
Source: Company reports and RBC Capital Markets estimates
24
February 28, 2011
Tembec Inc. Tembec Balance Sheet
(C$ Millions) Q1 09
Q2 09
Q3 09
Q4 09
2009
Q1 10
Q2 10
Q3 10
Q4 10
2010
Q1 11E
Q2 11E
Q3 11E
Q4 11E
2011E
2012E
ASSETS Cash & cash equivalents
16
41
105
80
80
43
120
68
56
56
41
92
124
123
123
243
Other current assets
734
650
615
589
589
606
468
477
446
446
483
447
439
455
455
501
Total current assets
750
691
720
669
669
649
588
545
502
502
523
538
564
578
578
743
PP&E, less accumulated depreciation
657
641
626
617
617
605
506
498
494
494
491
489
485
480
480
456
Other non-current assets
10
22
20
19
19
31
61
61
63
63
25
25
25
25
25
25
1,417
1,354
1,366
1,305
1,305
1,285
1,155
1,104
1,059
1,059
1,039
1,052
1,074
1,083
1,083
1,224
Current liabilities
364
367
418
382
382
374
227
259
234
234
252
243
252
250
250
266
Long term debt
427
403
383
364
364
359
333
271
263
263
263
263
263
263
263
239
Other long-term liabilities
263
255
252
255
255
248
232
209
209
209
209
209
209
209
209
209
1,054
1,025
1,053
1,001
1,001
981
792
739
706
706
724
715
724
722
722
714
Total Assets LIABILITIES AND EQUITY Forest Products
Total Liabilities Shareholder equity Total equity Total Liabilities and Equity Book value per share (US$)
363
329
313
304
304
304
363
365
353
353
316
338
350
361
361
510
1,417
1,354
1,366
1,305
1,305
1,285
1,155
1,104
1,059
1,059
1,039
1,052
1,074
1,083
1,083
1,224
$3.63
$3.29
$3.13
$3.04
$3.04
$3.63
$3.65
$3.53
$3.16
$3.38
$3.50
$3.61
$3.61
$5.10
Source: Company reports and RBC Capital Markets estimates
25
February 28, 2011
Tembec Inc.
Valuation Our 12-month target of $8 is based on a blended 4.5x valuation multiple on our trend EBITDA estimate of $230MM (85%) and our 2011 EBITDA estimate of $143MM (15%). This value is supported by our estimate of Tembec’s net asset value at $10. Our target multiple is at the low end of the typical Paper & Forest Products trading range (4.5x to 6.5x) reflecting the company's small capitalization and the weakness in the US housing market.
Price Target Impediment Lower-than-expected global economic growth would result in weaker growth for all types of pulp. A slower than expected recovery in US housing start levels would result in decreased demand and pricing for lumber over the near and medium terms. A weaker-than-expected euro/U.S. dollar exchange rate would decrease potential pulp prices. A stronger-than-expected Canadian dollar would decrease Canadian dollar revenues as most products are priced in U.S. dollars.
Company Description Tembec is a large North American manufacturer of dissolving and paper pulp, packaging and paper, lumber and silvichemicals. It operates 22 manufacturing facilities in North America and France and is a leading producer of several types of specialty dissolving pulps and high-yield pulp. Its products are used in the paper, construction, newsprint, packaging, and food and pharmaceuticals markets.
26
February 28, 2011
Tembec Inc.
Required Disclosures Non-U.S. Analyst Disclosure Paul C. Quinn (i) is not registered/qualified as a research analyst with the NYSE and/or FINRA and (ii) may not be associated persons of the RBC Capital Markets, LLC and therefore may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
Conflicts Disclosures This product constitutes a compendium report (covers six or more subject companies). As such, RBC Capital Markets chooses to provide specific disclosures for the subject companies by reference. To access current disclosures for the subject companies, clients should refer to https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates.
Distribution of Ratings For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories - Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top Pick/Outperform, Sector Perform and Underperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the meanings are not the same because our ratings are determined on a relative basis (as described above).
Distribution of Ratings RBC Capital Markets, Equity Research Investment Banking Serv./Past 12 Mos. Rating BUY[TP/O] HOLD[SP] SELL[U]
Count
Percent
Count
Percent
699 591 64
51.60 43.60 4.70
201 135 10
28.76 22.84 15.62
Conflicts Policy RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to https://www.rbccm.com/global/file-414164.pdf or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.
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February 28, 2011
Tembec Inc.
suitable for all investors and have not been tailored to individual investor circumstances and objectives, and investors should make their own independent decisions regarding any securities or strategies discussed herein.
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28
10OCT08 - 25FEB11 HI-11FEB11 211.91 LO/HI DIFF 720.43%
135.00 90.00
CLOSE
193.53
45.00 2008 2009 2010 ON D J F M A M J J A S O N D J F M A M J J A S O N D J F
LO-14AUG09 25.83
FEBRUARY 28, 2011
Tembec Inc.
(TSX: TMB)
Under the Radar of Investors, But Not for Long
HI-18FEB11 5.66 LO/HI DIFF1032.00%
5.00 4.00 3.00 2.00
CLOSE
4.95
LO-24JUL09
0.50
1.00
Outperform Above Average Risk Price:
3000
PEAK VOL. 4053.9 VOLUME 921.0
2000 1000
RBC Dominion Securities Inc. Paul C. Quinn, B.Sc.F. (Analyst) (604) 257-7048; [email protected]
Investment Opinion
2009E (2.04) NM (110.0) NM
Adj EPS - FD 2009 2010 2011 2012 EBITDA (MM) 2009 2010 2011 2012
Q1 Q2 Q3 Q4 (0.96)A (0.50)A (0.35)A (0.23)A 0.00A 0.58A 0.12A (0.15)A 0.05E 0.22E 0.12E 0.11E 0.11E 0.35E 0.46E 0.32E (9.0)A 36.0A 35.0E 74.0E
2012E 1.25 4.0x 235.0 3.1x
4.0A 11.0A 35.0E 61.0E
Results shown on a calendar basis. Tembec's fiscal year end is Sept 30.
All values in CAD unless otherwise noted.
100.0 0.00 3.53 80.0 39%
8.00 62% 495 0.0% 1.4x 722
We are initiating coverage on Tembec with an Outperform rating and $8 target.
FY Sep Adj EPS - FD P/AEPS EBITDA (MM) EV/EBITDA
(63.0)A (42.0)A 32.0A 60.0A 28.0E 45.0E 37.0E 63.0E
2011E 0.50 9.9x 143.0 5.0x
Shares O/S (MM): Dividend: BVPS: Float (MM): Debt to Cap:
Price Target: Implied All-In Return: Market Cap (MM): Yield: P/BVPS: Enterprise Val. (MM):
Event
Claire Huxtable, CFA (Associate) (604) 257-7610; [email protected] 2010E 0.55 9.0x 139.0 5.2x
4.95
With a major financial restructuring and a couple of difficult years behind it, we believe Tembec represents an attractive investment opportunity. We see significant upside in the company's: • Leverage to strong dissolving and chemical pulp markets - Tembec’s leading position in several grades of specialty pulp position it to benefit from current very strong prices and a longer term attractive growth profile. The company's lone NBSK mill should also contribute meaningfully in the near term. • Streamlined forest products operations – Tembec has reduced costs and closed underperforming lumber and specialty wood capacity over the past several years, bringing the segment closer to break-even levels despite the exceptionally weak demand environment. As the US housing markets firms through the back half of 2011 and into 2012, we believe improved North American lumber demand, combined with the exceptional growth in Asian markets, will likely lead to significantly higher prices and operating rates while lowering costs further. • Improving paper segment – Tembec's paperboard business is attractive with margins consistently in the mid-teens. The future of the company's newsprint mill is looking brighter with a change in Ontario electricity rules and represents an important home for wood chips produced by area sawmills. • Clean balance sheet – In August 2010, Tembec issued US$255MM of 2018 11.25% Sr. notes. While net debt-to-total capitalization is 39%, net debt to LTM EBITDA is low at 1.7x and we anticipate significant deleveraging in 2011. Our target on Tembec is $8 per share. • Attractive valuation on both short- and long-term metrics – Tembec trades at a discount to its peers on 2011 EBITDA multiples. Our current estimate of the company’s net asset value at $10 per share is roughly double the current share price. On a free cash flow basis, Tembec is trading at 7.7x 2011 FCFPS and only 3.3x 2012. • Earnings leverage is impressive – A US$20/mt change (2.2%) in the company's average realized pulp prices equates to over $24MM in EBITDA (18.0%) and adds roughly $1 to our target. Priced as of prior trading day's market close, EST (unless otherwise noted). For Required Non-U.S. Analyst and Conflicts Disclosures, see page 27.
February 28, 2011
Tembec Inc.
Tembec is proving its worth We rank Tembec shares Outperform, Above Average Risk for the following reasons: • Leverage to strong dissolving and chemical pulp markets to increase cash flow – Tembec’s leading position in several grades of specialty pulp position it to benefit from very strong prices and a longer term attractive growth profile. The company implemented price increases across specialty pulp grades in early 2011 that should support a step-change in cash flow. Tembec’s lone NBSK mill should contribute meaningfully in 2011 and beyond as softwood pulp markets remain tight at near-record prices. • Streamlined forest products operations should generate substantial cash in the longer term – Tembec has reduced costs and closed underperforming lumber and specialty wood capacity over the past several years, bringing the segment closer to break-even levels despite exceptionally weak demand. We expect the US housing market to firm through the back half of 2011 and into 2012, consistent with the current consensus. Improving North American lumber demand, combined with the exceptional growth in Asian markets, will lead to significantly higher prices and operating rates and lowering costs further. We do not believe the current share price allocates any value to this future earnings stream. • Clean balance sheet reduces risk – In August 2010, Tembec took the final step to normalizing its financial structure with the issuance of US$255 million of 2018 11.25% Sr. notes. The note issue replaced the US$300 million term loan that had supported operations following the February 2008 recapitalization. While net debt-to-total capitalization is 39%, net debt to LTM EBITDA is low at 1.7x and we anticipate significant de-leveraging in 2011. There are no major maturities due before 2018. • Good liquidity affords flexibility – Cash balances were adequate at the end of FQ1/11 at $61 million and available credit was $78 million. We believe that Tembec will be able to significantly de-lever its balance sheet over the next two years. Financial flexibility will support capital investment across the platform. Investments in power generation at existing assets in 2011 should cut costs and boost third party energy sales, while shutdowns in Forest Products will trim higher-cost capacity and increase earnings leverage to the gradual recovery in US housing. • Attractive valuation on both short- and long-term metrics – Tembec trades at a discount to its peers on 2011E EBITDA multiples. Our current estimate of the company’s net asset value at $10 per share is roughly double the current share price. On a free cash flow basis, Tembec is trading at 7.7x 2011E FCFPS and only 3.3x 2012E. • Target is $8, representing 60% upside – Our 12-month target of $8 is based on a blended 4.5x valuation multiple on our trend EBITDA estimate of $230 million (85%) and our 2011 EBITDA estimate of $143 million (15%). This value is supported by our estimate of Tembec’s net asset value at $10. Exhibit 1: Pulp is the largest contributor to Tembec sales and EBITDA EBITDA by segment
2,500
300
2,000
200
1,500
100
$MM
$MM
Revenues by segment
1,000
-
500
(100)
-
(200) 2009 2010 2011E 2012E Specialty Pulp, High Yield Pulp & Chemicals Forest Products Paper
2009
2010
2011E
2012E
Specialty Pulp, High Yield Pulp & Chemicals Forest Products Paper
Results presented on calendar rather than fiscal basis. Source: Company reports, RBC Capital Markets estimates
2
February 28, 2011
Tembec Inc.
We believe Tembec has turned over a new leaf Tembec is a large North American manufacturer of dissolving and paper pulp, packaging and paper, lumber and silvichemicals. It operates 22 manufacturing facilities in North America and France and is a leading producer of several types of specialty dissolving pulps and high-yield pulp. Its products are used in the paper, construction, newsprint, packaging, and food and pharmaceuticals markets. The company has traded under the symbol TMB on the TSX since its recapitalization in March 2008. Tembec’s fiscal year ends September 30. Exhibit 2: Tembec at a glance Dissolving and Chemical Pulp F2010 Sales1
High Yield Pulp $829 MM
Share of total sales F2010 EBITDA
42% $117 MM
Margin
14.1%
Capacities
• 310 k mt of dissolving pulp capacity capacity in North America & France
F2010 Sales1
Forest Products $380 MM
Share of total sales F2010 EBITDA
19% $47 MM
Margin
12.4%
• 805 k mt hardwood BCTMP capacity • 3 mills in North America
• 270 k mt NBSK paper pulp • 3 mills (2 in NA, 1 France) • includes results of Chemicals ops,
F2010 Sales1
Paper $434 MM
Share of total sales F2010 EBITDA Margin
22% -$10 MM -2.3%
F2010 Sales
$348 MM
Share of total sales F2010 EBITDA Margin
17% -$2 MM -0.6%
• 425 Mmfbm stud capacity, 3 mills • 955 Mmfbm dimension lumber, 6 mills • 1 remanufacturing mill • 2 specialty lumber mills • 2 engineered wood mills (idled)
• 180 k st coated paperboard (SBS)
• operating at about 50% of capacity
• North American customers accounted
at one mill
• 330 k mt newsprint at one mill, one machine idefinitely idled
produces lignin, ethanol & resins
Description
• #1 producer of cellulous ethers pulp MCC pulp and nitrocellulose pulp
• leading producer of hardwood high yield pulp
for 95% of F2010 sales
• most international porfolio of customers, with over 80% of pulp sales offshore
Source: Company reports, RBC Capital Markets estimates
Exhibit 3: Production Capacity and Location % of North Product
Capacity
American market
Pulp
1,385 k mt
7%
Forest Products (SPF lumber)
1,405 mfbm
2%
510 k mt
na
Paper
Source: Company reports
3
February 28, 2011
Tembec Inc.
Dissolving and Chemical Market Pulp • Segment at a glance: F2010 Sales: $829MM │ Share of total sales: 42% │ F2010 EBITDA: $117MM │ EBITDA margin: 14.1% • Management of the two pulp grades has been split – At the end of F2010, management and reporting of pulp operations was split into two categories to better highlight the performance of the two grades. Specialty and chemical pulp operations, including three mills, were combined with the chemicals group, and high yield pulp operations were grouped together in a new segment. Specialty pulp includes about 300 k mt of specialty and commodity dissolving pulp, along with a small amount (~15 k mt) of fluff pulp. Chemical paper pulp (270 k mt) is produced at the Skookumchuck mill in British Columbia. Segment reporting was adjusted with the FQ111 results. Exhibit 4: Tembec’s dissolving and chemical pulp capacity and North American market share North American Specialty Pulp Producers
Tembec Dissolving & Chemical Pulp Capacity Chemical (paper) pulp
000 mt
NBSK - Skookumchuck, BC
Specialty Dissolving Pulp Market Company
270
Specialty Pulps
Capacity (k mt)
% share
1 Rayonier
476
34%
Specialty cellulose - Temiscaming, QC
160
2 Buckeye
308
22%
Specialty cellulose/fluff - Tartas, France
150
3 Tembec
252
18%
310 Dissolving and Chemical Pulp
Others
580
Total
364
26%
1,400
100%
Source: Company reports, Pulp & Paper Week, RBC Capital Markets estimates
Exhibit 5: Global dissolving pulp market structure and end uses Global dissolving pulp market - 5.2MM mt Specialty Tembec dissolving pulp - 300 kmt Commodity
26%
18% Specialty 82%
Commodity 74%
Global spec ialty DP market - 1.4MM mt Other Casings Industrial 4% 4% viscose
Global specialty DP market by producer
All others
Rayonier
26%
34%
5% Nitrocell. 7%
Acetate
MCC
49%
7% Ethers
Tembec
Buckeye
18%
22%
24% Source: Company reports, RBC Capital Markets
4
February 28, 2011
Tembec Inc.
• Tembec sells two types of dissolving pulp – Dissolving pulp fall into two categories: commodity and specialty, reflecting the degree to which the cellulose has been refined. Tembec’s focus is on specialty pulp, with more than an 80% weighting. Production of Tembec’s commodity dissolving pulp (Temsolv) is about 40-50 k mt and is used to produce rayon. The specialty dissolving pulp market is smaller, but demand and pricing are more stable with higher margins. Since 2008, the dissolving pulp market has grown by 1 million mt, with several further capacity conversions announced recently (Fortress’s Thurso mill conversion for mid-2011, the Gores’ Group resuscitation of the former Weyerhaeuser Cosmopolis mill for May 2011, Stora’s Enso’s likely Russian joint venture and Rayonier’s potential conversion at its Jesup mill). The majority of growth has been in the commodity (rayon) markets. • Barriers to entry into the specialty dissolving pulp market are prohibitive – Demand for specialty dissolving pulp is growing at 2%-3% per year. Tembec is the leading supplier of ethers, microcrystalline and nitrocellulose. Barriers to entry into specialty markets are high, reflecting not only steep capital investment and access to technology and technical know-how, but also longterm, established relationships with customers. End uses for specialty pulp are very specific and have narrow technical specifications. Expanding an existing customer relationship or introducing a new product takes years with incumbents, and would be extremely time consuming for new entrants. • Dissolving pulp markets are exceptionally tight – The vast majority of dissolving pulp is sold under long-term private agreements, making it difficult to reliably track and forecast prices. Commodity dissolving pulp prices are somewhat easier to track, while specialty pulp is particularly opaque. Early in 2011, spot commodity dissolving pulp prices in China (the primary market) topped out at US$2,600/mt as demand ballooned and supply remained flat. Demand for commodity dissolving pulp is driven by rayon production. With export restrictions (India) and poor harvests (Pakistan, China) reducing cotton supply, garment producers are increasingly turning to rayon. We expect demand for rayon will remain at higher levels given the long-term decline in cotton production and rising standards of living in Asia. Early in 2011, Tembec began the process of renewing all its dissolving pulp supply contracts, implementing a ~US$200/mt increase. We expect the increase will be applied to all 2011 dissolving pulp shipments, generating an additional $55 million EBITDA. • Prices for NBSK remain very strong – Tembec produces 270 k mt of NBSK paper pulp at its Skookumchuck mill in British Columbia. Benchmark NBSK prices have remained remarkably strong since hitting their peak of US$1,020/mt in mid-2010. February list prices of US$960/mt are down just US$60/mt, as demand remains robust and slower-than-expected incremental capacity ramp ups have kept inventories low. January softwood pulp stocks were 27 days, well below the ~30 days we believe indicates that supply and demand are in balance. Prices for softwood pulps have been rising in Asia since December and major producers have announced a US$30/mt increase for North America and Europe for March 1. While we forecast average prices of US$915/mt in calendar 2011 and $950/mt in 2012, just below the 2010 average of US$960/mt, we note that risk to these estimates is all to the upside. • Fluff pulp fundamentals are also strong – Tembec produces about 15 k mt of sulphite fluff pulp at its Tartas mill in France, which is marketed as “BioFluff” and earns a premium over benchmark sulphate fluff pulp. Benchmark fluff pulp prices have remained near peak levels of US$1,050/mt since July, falling just US$10/mt in December and remaining there through February. Prices remain strong despite the expected additional capacity in December from the Domtar Plymouth conversion. We expect global demand growth of about 4% per year as demand for hygiene products increases. • Most pulp is sold externally and sales are international – Of total pulp shipments of 1,418 k mt in F2010, just 56.8 k mt of BCTMP pulp and 17.7 kmt of NBSK was consumed by the company’s paperboard operations. The volume of internal consumption was down 11.7 kmt from the prior year. In 2010, 81% of consolidated sales were to customers outside of Canada and the US. This is a greater proportion of international sales than the other segments.
5
February 28, 2011
Tembec Inc.
Exhibit 6: Softwood Pulp market remains tight; fluff pulp running strong NBSK prices have declined modestly from their peak
Softwood pulp stocks are low, hardwood stocks are higher
$/mt
000 mt 2,900
1,100
$/mt 1100 1000
2,400
900
900
1,900
800
1,400
700
700
NBSK
Fluff
600 500
Softwood stocks
Hardwood stocks
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
400 Jan-02
Jan-11
Jan-09
Jan-07
Jan-05
Jan-03
300
400 Jan-01
900
Jan-99
500
NBSK price
Source: PPPC, RBC Capital Markets estimates
• Two mills in France sold in 2010 –The Tarascon (260 k mt, NBSK) and the St Gaudens (305 k mt, NBHK) mills were sold for €100 million, including €66 million cash and €31 million debt. The EBITDA impact of the sale is about $10MM annually. • We estimate Tembec’s average dissolving and chemical pulp cash costs are ~$800/mt, making current price levels very attractive – We believe current EBITDA margins are 21% (~$150/mt). We forecast 2011 segment EBITDA of $149 million. • Chemicals are a small but stable and profitable business – With the 2010 year-end reorganization, the Chemicals segment has been re-grouped with dissolving and chemical pulp operations. The majority of Chemicals operations transform waste from the pulping process into lignin and ethanol for use in the construction, food and pharmaceuticals industries. Lignin capacity of about 190 kmt is located at the company’s two specialty pulp mills. Ethanol is brewed at a plant in Temiscaming, with an annual capacity of about 12 million litres. The company’s resin production capacity is about 157 kmt located at three stand-alone facilities in Canada with an additional processing facility located in Ohio. • Lignin and ethanol are industrial chemicals – Lignin is used as a binder, dispersant and surfactant in industrial markets such as animal feed, concrete admixture and carbon black. These markets have experienced declines over the past few years. Tembec is a leading supplier of high-purity ethanol to the Canadian vinegar, hygiene and cosmetics markets. • Resin demand is down with the decline of US housing – Resin products are designed for oriented strandboard (OSB) production. OSB is a structural panel used in residential and commercial construction. With the collapse of the US housing market since 2005, demand for resins has declined. While we view the lignin and ethanol businesses as core as they are integrated in the company’s pulp production, we expect the company will look to sell the resin business as the US housing market recovers and demand for OSB improves. We expect the business could fetch $30 million to $40 million (about 4x annual estimated EBITDA). • Chemicals markets are primarily North American – In 2010, 76% of chemicals sales were to North American customers. • FQ1/11 downtime impacts results but clears the way to run hard in FQ211 – Segment EBITDA of $19 million (13% margin) showed a 37% drop from $30 million in the prior quarter (18% EBITDA margin) as chemical pulp shipments fell 13%. Operations ran at 79% of capacity, down from 89% as the company took 5,900 mt of maintenance downtime. Average costs increased 11% to $910/mt, primarily on planned and unplanned downtime. Maintenance at the Tartas mill in France, combined with an equipment failure after the shutdown increased costs by $10 million. Inventories were also built up from previously unsustainably low levels, reducing shipments by 6,500 mt. Inventories ended the quarter at 20 days, up one day from the end of the prior quarter. All-in average realizations increased 1% to $1,061/mt with a $165/mt margin. With planned maintenance downtime now out of the way, the mills are set to run hard in FQ2/11 as dissolving and chemical pulp markets remain very strong. We forecast EBITDA will return to $34 million in FQ2/11 as downtime drops, dissolving price hikes are implemented and chemical prices remain strong.
6
February 28, 2011
Tembec Inc.
Exhibit 7: Historical dissolving and chemical pulp sales, profit, shipments and costs Dissolving & Chemical Pulp
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's st)
($/st)
($/st)
($/st)
FQ110
$183
$14
$6
$15
232
$789
$65
$709
FQ210
$206
$30
$7
$37
241
$855
$154
$671
FQ310
$187
$28
$7
$35
198
$944
$177
$753
FQ410
$139
$24
$6
$30
132
$1,053
$227
$823
FQ111
$122
$14
$5
$19
115
$1,061
$165
$910
Source: Company reports, RBC Capital Markets
High-Yield Pulp Is a Hardwood Kraft Pulp Substitute • Segment at a glance: F2010 Sales: $380MM │ Share of total sales: 19% │ F2010 EBITDA: $47MM │ EBITDA margin: 12.4% • Tembec is the leading producer of high-yield pulp in North America – High yield hardwood pulp is produced at three mills in North America. Tembec is the leading producer of high-yield pulp or BCTMP (Bleached Chemi-Thermo-Mechanical Pulp), with a 35% market share in North America and 18% of the global total. High-yield pulp is produced by grinding down wood chips and producing pulp with heat and chemicals. The resulting pulp is weaker (and therefore cheaper) than pulp produced using heat & chemicals alone (ie chemical or kraft pulp) as all wood components – not just fibre – are retained in the process. However, yields are higher, with about 2 m3 of wood required for one tonne of pulp, against 4-5 m3 of wood required for one tonne of kraft pulp. Exhibit 8: Tembec’s High-yield pulp capacity and market share High Y ield Pulp
Tembec High-Yield Pulp Capacity 000 mt
High-Yield Pulp Market Share Company Capac ity % share
BCTMP - Temiscaming, QC
315
1 Tembec
805
18%
BCTMP - Matane, QC
250
2 West Fraser
550
13%
BCTMP - Chetwynd, BC
240
3 APP
380
9%
805
4 Canfor
325
7%
5 Millar Western
310
7%
Total
2,370
54%
Global total
4,360
Source: Company reports, Pulp & Paper Week, RBC Capital Markets estimates
• BCTMP prices have weakened – Benchmark BCTMP prices, in contrast to NBSK, have slid considerably since peaking in mid2010 at US$820/mt (China price). February BCTMP prices averaged US$660/mt, or US$90/mt below Bleached Eucalyptus Kraft (BEK, China) prices. BCTMP prices generally move in-line with BEK prices, but the discount to BEK has widened. We expect either BEK prices will decline or BCTMP prices will rise in the near term as the pricing differential reverts to the mean of US$50 to $60/mt. The company uses BEK delivered China prices as a benchmark. These prices averaged US$757/mt in FQ1/11, down 3% (US$26/mt) from the prior quarter but have stabilized at current levels. • Tembec’s high-yield pulp sales are primarily to China – The greater dependency on Chinese markets has resulted in lower realized BCTMP prices, while suppliers of BEK (primarily Brazilian producers) also sell to customers in Europe and North America. Tembec has recently increased its sales to Europe, but they remain a minority. While the current discount to BEK would support a price increase, the Chinese demand lull through the New Year holiday in February makes a near-term price hike unlikely.
7
February 28, 2011
Tembec Inc.
Exhibit 9: BCTMP and other pulp prices in China are volatile
900
700 US$/mt 500
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
300
NBSK del China BEK del China BCTMP del China
Source: Valois Vision, RBC Capital Markets analysis
• Shifting capacity also makes the near-term direction of prices unclear – We expect Fortress Paper’s Thurso mill’s mid-year exit from hardwood pulp production may tighten the North American market and lift prices in general, but this may be offset by the re-start of hardwood pulp capacity in Indonesia. We forecast rising BCTMP prices through 2011 with an average of US$720/mt. • Tembec has access to $24 million of Capex funding under the GTP – Based on the amount of black liquor (a pulping byproduct) burned in 2009, the company earned $24 million in credits under the Canadian Green Transformation Program. Credits must be used by March 2012, and applied toward investments that improve energy efficiency of environmental performance. Tembec has allocated $17 million to the Matane methane conversion. We expect returns of 20% on the $24 million total beginning in 2012. • We estimate Tembec’s average BCTMP cash costs are $425/mt– We believe current EBITDA margins are 7% (~$40/mt). We forecast 2011 segment EBITDA of $25 million. • FQ1/11 results were poor, reflecting pressure on the BCTMP market – Results weakened in FQ1/11, with EBITDA falling 46% to $7 million. Total sales increased 3% on 18% higher shipments, but average realizations fell 13% to $549/mt ($38/mt margin). Shipments increased with the Chetwynd, BC mill back in full production through the quarter. A fire in June had shut the mill for two weeks, with normal operations resuming in September 2010. Maintenance downtime in the quarter totalled 1,200 mt, well below 22.7 k mt in the prior quarter, which included 17.4 k mt of downtime at Chetwynd. Production costs declined $9 million, including the impact of a $5 million insurance deductible in the September quarter and the effect of higher productivity in the quarter. We expect BCTMP prices will remain near FQ1/11 levels, and forecast EBITDA of $5 million in FQ2/11. Exhibit 10: Combined relative pulp performance Improving markets have helped Tembec margins sinc e early 2009
50%
OSB EBITDA margin
40% 30% 20% 10% 0% -10% -20%
Tembec
Canfor Pulp
Mercer
Fibrek
Q410
Q310
Q210
Q110
Q409
Q309
Q209
Q109
Q408
Q308
Q208
Q108
-30%
Fibria
Source: Company reports, RBC Capital Markets research and analysis
8
February 28, 2011
Tembec Inc.
Exhibit 11: Historical high yield pulp sales, profit, shipments and costs High Yield Pulp
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's st)
($/st)
($/st)
($/st)
FQ110
$55
$5
$2
$4
109
$505
$37
$447
FQ210
$88
$9
$2
$11
153
$575
$72
$417
FQ310
$126
$17
$2
$19
200
$630
$95
$437
FQ410
$104
$11
$2
$13
154
$675
$84
$480
FQ111
$100
$5
$2
$7
182
$549
$38
$453
Source: Company reports, RBC Capital Markets
Forest Products are primarily lumber • Segment at a glance: F2010 Sales: $434MM │ Share of total sales: 22% │ F2010 EBITDA: ($10MM) │ EBITDA margin: (2.3%) • TMB has Forest Products operations across Canada – SPF (Spruce Pine, Fir) lumber capacity of 1.4 billion board feet is located at 10 mills in Ontario, Québec and British Columbia. Lumber production is split between dimension lumber (955 Mmfbm) and stud lumber (425Mmfbm). Stud lumber is used exclusively in North American new-home construction for walls and other framing, and is therefore the most exposed to weakness in US housing. In addition, the company has 30Mmfbm of specialty hardwood and 20Mmfbm of specialty softwood (flooring) capacity and two engineered wood mills (which have been idle since 2007). The segment also manages forest operations and wood procurement, harvesting 3.2 million m3 and purchasing 0.7 million m3 in F2010 from third parties. Exhibit 12: North American softwood lumber capacity Capac ity (Bln bf)
Market share
1
West Fraser
6.0
9%
2
Weyerhaeuser
5.4
8%
3
Canfor
5.0
7%
4
GP
2.4
3%
5
Tolko
2.4
3%
6
AbitibiBowater
2.2
3%
7
Sierra Pacific
2.0
3%
8
Hampton Affliates
1.9
3%
9 Tembec
1.4
2%
10 EACOM
0.9
1%
Top 10
29.6
42%
Source: Company reports, RBC Capital Markets estimates
• Low operating rates remain a drag – Shipments of SPF lumber were 787 Mmfbm in F2010, or 49% of capacity (up from 43% in 2009). Low demand with the collapse of the US housing market since 2005 has led to widespread industry rationalization and continuing low operating rates. We believe the industry operated about 60% of capacity in 2010 and will improve only modestly in 2011. U.S. housing starts, the largest single end market for lumber products, averaged 586,000 units in 2010 and we forecast they will rise 20% to 700,000 units in 2011. While this is a large percentage improvement, it will only bring starts to half their long term trend level of about 1.5 million units.
9
February 28, 2011
Tembec Inc.
Exhibit 13: Lumber prices have firmed as industry capacity has declined Lumber prices have recovered from their 2009 lows
Eastern stud premium vs W SPF lumber declined in FQ111
$/mfbm $600
$100
2,000
$500
$60
1,500
$400
$40
1,000
$300
$20
500
$200
-
$100
US Housing Starts
SPF Great Lakes
$80
$Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
Jan-03
Jan-02
Jan-01
Jan-00
$(20) Jan-99
Jan-11
Jan-09
Jan-07
Jan-05
Jan-03
Jan-01
Jan-99
000 units 2,500
Great Lakes studs vs Western SPF dimension lumber
Source: Bloomberg, Random Lengths, RBC Capital Markets analysis
• Export taxes reduce returns to the producer – Virtually all sales are to North American customers, with 65% to Canadian destinations (an unusually high proportion). All of Tembec’s softwood lumber exports to the U.S. are regulated by the Softwood Lumber Agreement. The agreement increases taxes on exports as the benchmark price falls, with taxes currently sitting at their maximum. The current benchmark price is US$297/mfbm, below the US$315/mfbm necessary to reduce the tax to 10% for Western exports and 3% with a 32% market share limit of US consumption for Eastern exports. In addition, Eastern Canadian producers will be subject to an additional 10% ad valorem tax until about mid-2011, reflecting an adverse ruling following a complaint by the US in 2009. A recent ruling by the LCIA (the Agreement’s dispute resolution body) will add another 2.6% ad valorem export tax to lumber shipped from Québec (and 0.1% on US-bound exports from Ontario) until $59 million has been collected. We do not expect a decision from the LCIA on the most recent challenge (initiated January 2011) before July, and anticipate any penalty would apply exclusively to lumber shipped from Western Canadian mills. We expect the penalty would be collected over an extended period of time, reducing its impact on Tembec. • Exports to China have boosted North American benchmark prices but have had less impact on other grades – Exports to China from Western Canadian mills have siphoned off some excess North American supply and have increased prices, particularly for exported grades. Exports to China were about 2.8 billion bf in 2010, up from about 1.1 billion bf in 2009 and virtually nothing in 2007. North American prices have tended to move together, so while Western lumber sales represented only 44% of total sales in 2010 (up from 28% in 2009), Eastern shipments have also enjoyed some benefit. Other grades, including wider lumber and shorter lengths, have not followed the benchmark prices up. • Stud lumber has not performed as well as dimension lumber in recent months – Eastern stud lumber prices were weak in FQ1/11, with the premium to Western SPF dimension lumber falling to just US$41/mfbm for the quarter, down from US$73/mfbm over the first nine months of the year and US$77/mfbm in calendar 2009. Very bad weather in the East brought demand to a standstill, with no upside from a pick-up in home improvement activity or export markets. We expect the premium to Western SPF to remain below historical averages through 2011. • Capex, depreciation are low – Capital expenditures for the segment have averaged less than $7 million over the past three years as the company has held back investing cash given low operating rates. Depreciation has declined steadily from $24 million in 2009 to $16 million in 2010 as capacity has been permanently closed and operating rates have fallen. We expect Capex to remain constrained through 2011. • FQ1/11 results disappoint – Forest Products EBITDA of ($11 million) was down from ($5 million) in the prior quarter despite flat sales. Shipments increased 4% but average realizations fell 4%. The segment operating rate remained very low, running at just 54% of capacity, about the same as 52% in the prior quarter. Reference prices for benchmark Western SPF increased 21% to US$269/mfbm and Eastern SPF was up 11% to US$350/mfbm. Eastern stud prices, however, were up just 5%. Given an unfavourable shift in product mix in the quarter, the total impact of higher prices was just $1 million or $5/mfbm. Costs increased $7 million, including a $3 million unfavourable impact from harvest operations. We forecast stronger lumber prices in early calendar 2011 and better cost control should lift results in FQ2/11 to breakeven EBITDA.
10
February 28, 2011
Tembec Inc.
Exhibit 14: Comparative lumber margins Tembec lumber margins remain low er than peers'
30%
10% 0%
margin
Adjusted lumber EBITDA
20%
-10% -20% -30% Margins adjusted for export duties.
Tembec
Canfor
West Fraser
Q410
Q310
Q210
Q110
Q409
Q309
Q209
Q109
Q408
Q308
Q208
Q108
Q407
Q307
Q207
Q107
-40%
Interfor
Source: Company reports, RBC Capital Markets estimates
Exhibit 15: Historical Forest Products Sales, Profit, Shipments and Costs Forest Products
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's mfbm)
($/mt)
($/mfbm)
($/mfbm)
FQ110
$95
($11)
$4
($8)
177
$304
($45)
$242
FQ210
$100
($6)
$4
($3)
177
$323
($17)
$226
FQ310
$126
$2
$4
$6
224
$371
$27
$234
FQ410
$113
($9)
$4
($5)
209
$333
($24)
$246
FQ111
$113
($15)
$4
($11)
218
$311
($50)
$259
Source: Company reports, RBC Capital Markets estimates
Paper segment: a mixed bag and a small part of the picture • Segment at a glance: F2010 Sales: $348MM │ Share of total sales: 17% │ F2010 EBITDA: ($2MM) │ EBITDA margin: (0.6%) • Tembec operates two paper mills – With the permanent closure of the Pine Falls, Manitoba newsprint mill in September 2010 (the mill had been idled through 2010), the company has just one newsprint mill and one coated paperboard mill. The paperboard mill is partially integrated with the Temiscaming high yield pulp mill and also consumes NBSK pulp. The segment includes sales of electricity from a hydro-electric dam in Smooth Rock Falls, ON (a former mill site). Exhibit 16: Tembec Paper segment capacity Paper Coated paperboard
000 mt
Temiscaming, QC
180
Newsprint Kapuskasing, ON
330 510
Source: Company reports, RBC Capital Markets estimates
• North American newsprint demand declines have moderated – After two years of declines in the low double digits, the demand decline accelerated through 2009 to a staggering 25% drop. In calendar 2010, the North American decline moderated to 6.0%, with demand actually increasing 5.5% in calendar Q4/10 over Q3/10. We forecast North American demand will continue to decline 6%8% or 325-425 k mt annually over the medium term. We expect producers will be able to keep pace with demand declines by increasing exports, closing or converting about two average sized paper machines per year, which should support prices. • Increased exports have relieved pressure on the domestic newsprint market – Newsprint exports increased 44% to 2.5 million mt in 2010, taking pressure off domestic markets. Total industry exports represented about 32% of monthly shipments in 2010, up from an average of 23% in 2009 and 26% in 2008. Global demand for newsprint increased 1.1% in 2010.
11
February 28, 2011
Tembec Inc.
Exhibit 17: North American vs. Global Newsprint Demand (million mt) MM mt
MM mt 31
14.0 Forecast
12.0
30
2.0
25
-
24
North America
Rest of World
2014E
26
2012E
4.0
2010
27
2008
6.0
2006
28
2004
8.0
2002
29
2000
10.0
Historical and forecast demand for newsprint North America 2000 13.1 2001 11.6 2002 11.4 2003 11.3 2004 11.0 2005 10.4 2006 9.7 2007 8.7 2008 7.7 2009 5.8 2010 5.4 2011E 5.2 2012E 4.8 2013E 4.5 2014E 4.2 2015E 4.0 2011 - 2014 CAGR
% y/y -0.4% -11% -2% -1% -2% -6% -6% -10% -12% -25% -6% -5% -6% -6% -6% -6% -6.0%
Rest of world 26.5 26.1 25.6 26.4 28.1 28.2 29.3 30.0 29.8 26.9 28.2 28.4 29.0 29.5 30.0 30.4
% y/y 6.6% -1.4% -2.2% 3.4% 6.1% 0.6% 3.8% 2.3% -0.5% -9.8% 4.7% 1.0% 1.8% 1.9% 1.5% 1.5% 1.5%
Source: RISI and RBC Capital Markets estimates
• Newsprint prices are stable – Prices for North American benchmark grades were flat at $640/mt in February, the seventh consecutive month at this level. Prices rose steadily for 12 months from their trough of US$435/mt in August 2009 as producers finally managed to curtail enough capacity to get ahead of demand declines. Prices averaged US$605/mt in 2010, up 7% from the prior year. We forecast average prices of US$665/mt in calendar 2011 and US$650/mt in 2012. • Newsprint costs to decline – At current prices we believe the newsprint operation is breakeven and falls in the third quartile of the cost curve. Under the new electricity pricing regime in Ontario, however, we expect costs to fall about $60/mt and the mill to move into the second quartile. The Ontario program offers a rate rebate on electricity consumed during off-peak hours. • Kapuskasing mill provides a home for residuals from four sawmill – While the newsprint operation is breakeven at recent levels and North American demand declines are expected to continue, closing the mill would entail finding a home for wood chip residuals from four sawmills. This would be difficult given low regional demand for chips. The loss of chip sales revenue would further impact the performance of the Forest Products segment. • Coated paperboard markets are strong – Industry order backlogs remained very high at over 4.5 weeks in calendar Q4/10, well above the average of 3.2 weeks over the prior five years. Operating rates averaged a healthy 97% in Q4/10 and full year 2010, up from the low 88% recorded in 2009. After falling off a cliff in Q1/09, quarterly production levels have now recovered to early 2008 levels. • Coated paperboard prices have climbed steadily – Benchmark SBS prices have performed remarkably well over the past two years despite major swings in demand. After orders declined in early 2009, benchmark prices for 16pt SBS dipped just US$20/st over two months to $1,230/st. They began to rise again in April 2010 and have increased 11% or US$130/st to US$1,360/st in February. The coated paperboard market is consolidated, with the top five producers controlling 84% of total capacity. We believe good producer discipline will continue to support prices, and forecast US$1,135/st in 2011 and similar levels in 2012. The type of coated paperboard produced at the Temiscaming mill is a lighter-weight, higher-end product that does not compete directly with products made by the two industry heavyweights, International Paper and MeadWestvaco. Growth for this type of product is typically in-line with GDP rates. • Paperboard sales focused on North American markets – North American customers accounted for 95% of segment sales in 2010, with the US accounting for 74%. All production is sold under longer-term contracts, with mill backorders running at 60 days. End uses include high-end packaging (think perfume), product displays, lottery tickets or other products that require good graphics. • Results improve slightly in FQ111 – Segment EBITDA of $4 million was in-line with the prior quarter, but represented a 4.6% EBITDA margin, up from 4.2% in FQ4/10. Sales revenues declined 9% as shipments of bleached board dropped 11% and newsprint fell 8%. The decrease in shipments was partially offset by an increase in the benchmark prices for both grades: benchmark SBS was up 4% (US$43/st) to US$1,150/st and newsprint was up US$5/mt to US$640/mt. The SBS shipments-tocapacity rate remained high at 92%, but was down from the unsustainable 100%+ rate recorded in the prior two quarters. For newsprint, shipments ran at 69% of capacity, up from 49% in FQ4/10 when the now-closed Pine Falls mill was included in the calculation. Newsprint downtime in FQ1/11 remained high, however, at 22.8 k mt, as one machine at the Kapuskasing mill is
12
February 28, 2011
Tembec Inc.
indefinitely idled. We forecast higher SBS prices, as prior increases are rolled into longer-term contracts and higher newsprint prices, along with stable costs will generate EBITDA of $4 million in FQ2/11.
800
0.0 Jan-00
Prices Demand Exports as a percent of total shipments
SBS prices
weeks of backorder
1.0
Jan-11
900
Jan-10
0%
2.0
Jan-09
-
1,000
Jan-08
5%
3.0
Jan-07
200
1,100
Jan-06
10%
Jan-05
400
4.0
Jan-04
15%
1,200
Jan-03
600
5.0
Jan-02
20%
1,300
Jan-01
800
US$/st
25%
SBS prices have increased & backlogs have recovered 1,400 6.0
Jan-10
1,000
Jan-08
30%
Jan-06
1,200
Jan-04
35%
Jan-02
1,400
Jan-00
000 mt & newsprint price ($/mt)
Exhibit 18: Newsprint prices stable; SBS prices rising steadily
Weeks of backorder
Source: Company reports, RBC Capital Markets estimates
Exhibit 19: Historical Paper Sales, Profit, Shipments and Costs Paper
Net Sales
Op Profit
D&A
EBITDA
Shipments
Sales/unit
EBITDA/unit
COGs/unit
($MM)
($MM)
($MM)
($MM)
(000's st)
($/st)
($/st)
($/st)
FQ110
$79
($3)
$1
($2)
93
$849
($22)
$744
FQ210
$77
($6)
$1
($5)
94
$819
($53)
$749
FQ310
$96
$0
$0
$1
113
$850
$9
$709
FQ410
$96
($3)
$0
$4
109
$881
$37
$699
FQ111
$87
$3
$1
$4
99
$879
$40
$699
Source: Company reports, RBC Capital Markets estimates
Increasing power production offers incremental cash flow • Tembec has invested in incremental green power projects, with potential for more – In addition to the existing, small-scale sales of energy from the Smooth Rock Falls hydro electric dam, Tembec is investing in energy projects to reduce costs and generate excess electricity to sell to the grid. The first of the projects to be completed was the biomass cogeneration project at the Skookumchuck NBSK pulp mill last year, with others either underway or under study. Exhibit 20: Current and potential energy projects Loc ation
Grade
Projec t
Capex
Start up Annual EBITDA
Skookumchuck, BC NBSK
25-30 MW Biomass cogen - new contract
$2MM
Aug-10
$10MM
Matane, QC
BCTMP
Methane biogas to displace fossil fuel
$25MM/Net $1MM
Jun-12
$6MM
Tartas, France
Specialty 8-9 MW Biomass turbine - new contract
$21MM
Jun-12
Approved or c ompleted
$8MM $24MM
Under Study Temiscaming, QC
Specialty 35-40 MW Waste liquor cogen - new contract $160-$170MM
TBD
$35-$40MM
Source: Company reports, RBC Capital Markets
• Green Transformation Program funds will support project at the Matane mill – The company is directing $17 million of its total $24 million Capex credits earned under the Canadian Federal Green Transformation Program to the Methane Biogas project in Matane. Combined with a contribution of $7 million from the provincial government, government funding will cover all but $1 million in project costs. The project will replace fossil fuels with methane, resulting in annual savings of about $6 million, or ~$8/mt of BCTMP production.
13
February 28, 2011
Tembec Inc.
• The turbine upgrade at Tartas is the big project for this year – The company plans to invest $21 million in the turbine. The investment is supported by a new electricity sales contract with preferential green energy rates that will offset about $6 million to $8 million in energy costs at the mill. • The largest project under consideration has a two-three year timeframe – The potential cogeneration project at the Temiscaming mill has not yet been approved, and would not be completed before the end of 2014. It has been on the company’s list of potential project list for more than a decade, but will not go forward in the absence of a power purchase agreement with Hydro Québec. It appears progress has been made toward finally securing an agreement, with a provincial call for power generation proposals expected this summer, followed by contract negotiations in the fall. We anticipate power purchase rates under the contract would be ~$110/MWh, in-line with recent agreements. As part of the contract, Hydro Québec would support the necessary capital investments at the mill (about $160 million to replace three small boilers with one large high-pressure boiler). When complete, annual power sales would offset about $40 million in production costs, taking down unit cash costs by $200300/mt. We will not include the project in our model before the company indicates it has signed an agreement with Hydro Québec.
Potential non-core asset sales • Apart from some small exceptions, the majority of the company’s assets are core – Following a series of closures (and bankruptcies) of company assets and joint ventures around the time of the recapitalization, Tembec has reduced and narrowed its manufacturing base. • Resin business and Smooth Rock Falls hydro asset could be sold – Once the recovery in US housing is underway, we would expect the resin business to become more attractive to a potential acquirer. The business makes about $10 million EBITDA and could eventually be sold for about $40 million. The Smooth Rock 5MW hydro asset is located at the site of a now-closed mill. We believe the asset could be sold relatively easily, and expect its sale could generate about $15 million. • There is no timberland left to sell – The company sources the majority of its timber supply from public timberlands under long term licence agreements with provincial governments. While there are a few scraps of private timberland left, their sale would have to be under a sale-and-timber-purchase agreement with little real upside for the company.
Recapitalization • Tembec recapitalized in early 2008 – Given low cash flow and liquidity and little prospect for near-term improvement, in late 2007 the company announced it would recapitalize. The process was completed on February 29, 2008. • Recapitalization turned debt into equity – With the recap, the company traded US$1.2 billion in debt for new equity. Prior shareholders were squeezed down to 5% ownership, with the balance going to former debt holders. The exchange reduced interest on long-term debt from $117 million in F2007 to $33 million in F2009 and $27 million in F2010. The recap was supported by a US$300 million term loan, which was paid off and replaced with the current US$255 million 11.25% bond issue in August 2010. • Write downs, but no closures, accompanied the recap – The company took $804 million in asset write downs, which in turn led to a $33 million reduction in the annual depreciation charge. No capacity closures were announced at the time of the recapitalizations. • Since the recapitalization some assets have been shed – In April 2008, Tembec sold a 20% interest in its dissolving pulp joint venture to partner Aditya Birla for $9 million. Birla, a rayon manufacturer based in India, was the venture’s sole customer. Tembec retains a 5% stake. In February 2009, the Marathon Pulp 50/50 joint venture formed with Kruger in 2000 filed for creditor protection and closed permanently. In Forest Products, the company closed the Mattawa, ON hardwood sawmill, also in February 2009. More recently, it closed the Taschereau stud mill in February 2011, idle since October 2009. The company permanently closed the Pine Falls, Manitoba newsprint mill in September 2010. • April 2009 initiative to generate $100 million in additional liquidity was successful – As part of the initiative, the company reduced headcount by 100 staff positions and sold a number of non-core assets and businesses. Businesses sold included Tembec’s 50% interest in Temrex Forest Products Inc sawmill joint venture for $12 million in September 2009. The company’s sole coated paper mill in St. Francisville, LA, was idled before the recap (July 2007), but the site and assets were finally sold in April 2009 for $16 million. Tembec only received the cash portion of the sale price ($6 million) before the purchaser filed for creditor protection. The purchase of the mill (for $300 million in 2001) and its subsequent operating losses (~$200 million) were likely the single largest factor in forcing the company to recapitalize. • The most important step in the path to stronger finances was the sale of the French mills – The May 2010 sale of the St Gaudens and Tarascon mills for €100 million facilitated the US$255 million bond issue and brought net debt down to 38% at F2010 year end, below the 40% target.
Senior management team, board of directors and institutional ownership The senior management responsibilities were reorganized late in 2010, with high yield pulp operations forming a new segment and the dissolving pulp operations combined with the chemicals group. • James Lopez, President and Chief Executive Officer – Mr. Lopez joined Tembec in 1989 as Manager, Corporate Development. He has been President and Chief Executive Officer of the Corporation since January 2006. Prior to his appointment in January,
14
February 28, 2011
•
• • • •
Tembec Inc.
2006, he served as Executive Vice President and President of the Tembec Forest Products Group from August 2003 to January 2006. Mr. Lopez also holds a seat on the board of directors of the Forest Products Association of Canada (FPAC) and is a member of the Bi- National Softwood Lumber Council between Canada and the United States. He is currently chairman of the board of directors of FP Innovations and he sits on the President’s Board of Advisors for California University of Pennsylvania. Mr. Lopez is the former chairman of the board of directors of the Ontario Forest Industry Association (OFIA), of the Forest Engineering Research Institute of Canada (FERIC) and of Wood Works Canada Corp. Michel Dumas, Chief Financial Officer – Michel Dumas joined Tembec in 1985 as Controller for the High-Yield Pulp Mill in Temiscaming, Québec. In 1991, he became Vice President, Finance and CFO of Spruce Falls Inc., an affiliate of Tembec, and in 1997 was promoted to Executive Vice President, Finance and CFO of Tembec. Stephen J. Norris, Treasurer since 1994. Chris Black, Executive Vice President, Paper and High Yield Pulp Group, since May 2008 Yvon Pelletier, Executive Vice President, Specialty Cellulose and Chemical Group, since October 2006. Dennis Rounsville, Executive Vice President Forest Products Group, since 1999.
Exhibit 21: Management and institutional ownership Management and Board ownership Common shares
% of shares Options
Total
outstanding
Senior Management James Lopez
CEO
308,176
17,344
Michel Dumas
CFO
223,406
16,485
239,891
Yvon Pelletier
EVP, Specialty Cellulose & Chemical Group
146,342
1,315
147,657
Richard Tremblay Controller Chris Black
EVP, Paper & High Yield Pulp Group
Stephen Norris
Treasurer
Dennis Roundsville EVP, Forest Products Group John Valley
EVP, Business Development
325,520
52,930
4,327
57,257
107,637
1,020
108,657
1,359
2,440
3,799
126,800
2,863
129,663
69,805
10,638
80,443 1,092,887
1.1%
Board of Direc tors James Lopez
CEO
see above
James Continenza Chairman
323,240
Norman Betts
Director
118,764
323,240
James Chapman
Director
116,264
116,264
Francis Scricco
Director
216,264
216,264
Lorie Waisberg
Director
120,264
120,264
James Brumm
Director
119,361
119,361
Luc Rossignol
President, Local 233 CEWP Union
David Steuart
Director
258
119,022
93
93
116,264
116,264 1,130,772
1.1%
Warrants excluded.
Institutional ownership Shares held
% of shares
(MM)
outstanding
Institution #1
20
19.9%
Institution #2
10
9.7%
Institution #3
10
9.5%
Institution #4
9
8.8% 47.9%
Source: Company reports, Thomson One Analytics February 25, 2011, SEDI and RBC Capital Markets estimates
• Senior management and the board of directors hold a combined 2.2% share of Tembec stock. • The top four institutional investors hold a combined 48% of shares outstanding – The largest institutional owner holds a 20% share.
15
February 28, 2011
Tembec Inc.
Capital investment, pension and tax pools • Capital investment has been constrained – Tembec invested $25 million in capital projects in fiscal 2010, a significant decline from $42 million in 2009. We believe annual Capex of $35 million to $40 million is required to adequately maintain current facilities. We expect the company to increase Capex spending to $36 million in 2011. • Several major projects are planned for 2011 & 2012 – The Tartas Biomass turbine project has been allocated $13 million in F2011. In addition, the company has planned $22 million in general and maintenance Capex for paper pulp, paper and forest products operations, along with $1 million for the Matane methane project. • Tembec has access to ample tax credits – Tembec’s tax assets are a legacy of the company’s losses prior to the 2008 recapitalization, and can shelter a total of $2.3 billion, or about $600 million in taxes payable. Of these assets, only $27 million related to the French operations appear on the balance sheet. Exhibit 22: Tax assets Expiry
Amount ($MM)
Loss carryforwards - Canada
2014-2030
R&D deductible pool - Canada
Unlimited
364
Tax value of fixed assets - Canada/France Unlimited
604
Loss carryforwards - France
Unlimited
Loss carryforwards - US
2028-2030
995
66 19 2,048
Source: Company reports
• Pension deficit funding an artefact of low interest rates, but not too onerous – As of the last measurement date, Tembec’s pension plan assets of $580 million fell $206 million short of liabilities ($786 million). Pension expense in 2010 was nil, compared to $19 million in the prior year. Over and above the normal pension funding of $10 million to $14 million in EBITDA, as a result of current abnormally low interest rates the company expects to make an additional $15 million excess contribution. The company is exploring potential modification of funding requirements, such as extending the period over which the shortfall must be funded, similar to the agreement AbitibiBowater recently secured from the Ontario and Québec governments. These types of agreements, however, often come with strings attached, and we believe Tembec will be wary of additional government restrictions or oversight. Contributions to other employee future benefit plans are expected to total $3 million in F2011.
Capital structure • The capital structure is uncomplicated – Tembec has one primary debt issue outstanding: the US$255 million 11.25% Senior Secured Notes due 2018. The notes were issued in August 2010, with funds and cash on hand used to repay the balance outstanding under the US$300 million Term Loan. The cash balance had been boosted by the sale of the two French pulp mills. Tembec’s unrestricted US subsidiaries and restricted French subsidiaries are not guarantors of the notes. Moody’s rates the note B3 and S&P has rated them B-. Exhibit 23: Long-term debt Long term debt ($ MM)
Change 2010
2009
Tembec Industries (US$255MM 11.25% Snr sec notes, Dec 2012)
261
-
Tembec Industries (US$300MM Term Loan)
-
328
Tembec Inc. (6% unsecured notes, Sept 2012) Tembec SAS debt
9
6
7
30
Tembec Energie SAS debt
-
Bioenergy debt
-
Other debt Total long term debt Less unamortized financing costs Current portion (included above)
12
14
Tembec Envirofinance SAS debt
8 8
10
10
301
402
13
2009-10
-
288
402
17
19
(114)
Source: Company reports
16
February 28, 2011
Tembec Inc.
• The revolver matures at the end of 2011 – Tembec’s $205 million revolving working capital facility matures in December 2011. The facility is subject to permanent availability reserves of $25 million and US$50 million. The facility has a first priority charge over the receivables and inventories and a second priority charge over the remainder of the majority of North American assets. The company is in the process of replacing it with a new multi-year revolving working capital line. We expect the company will announce the signing of a new ABL agreement within the quarter. At the end of FQ1/11, $78 million of unused credit was available after the $75 million reserve, $34 million letters of credit and $3 million of borrowings. Total liquidity was $139 million with $61 million in cash. • The company has resolved to maintain net debt at or below 40% – As part of its long-term strategy, the company is committed to keeping its net debt below 40%. At FQ1/11 end, net debt was 39%. • French operations rely on separate arrangements – The French operations are supported by factoring agreements. As such, the borrowing base fluctuates periodically, depending on shipments and cash receipts. • There are 100 million shares outstanding – No shares were issued in fiscal 2009 or 2010. • Warrants - There are currently 11 million outstanding warrants. The warrants are convertible into an equal amount of common shares and expire on February 29, 2012. They would be automatically converted into common shares if the 20-day volumeweighted average trading price reaches $12, or immediately prior to any transaction that would constitute a change of control. Exhibit 24: Capital structure
Source: Company reports; Revenues & EBITDA at time of bond issue (Aug 2010)
Trading patterns •
Trading post Feb-2008 recapitalization is in-line with Paper & Forest Products Index – Tembec has moved with the S&P/TSX Paper & Forest Products Index since its February 2008 recapitalization.
17
February 28, 2011
Tembec Inc.
Exhibit 25: Trading patterns Tembec value declined steeply between 2000 and 2008
But shares have moved with the S&P/TSX since 2008
$18
1,350
$16
1,200
$14
1,050
$12
900
$10
750
$8
600
$2.00
450
$1.00
350
$-
250
S&P/TSX Paper & Forest Products Index
TMB (LHS)
Dec-10
Sep-10
Jun-10
Mar-10
Dec-09
Sep-09
Jun-09
Mar-08
Jan-11
Jan-10
Jan-09
Jan-08
Jan-07
Jan-06
Jan-05
Jan-04
$Jan-03
550
Mar-09
150 Jan-02
$3.00
Dec-08
300
$2 Jan-01
650
Sep-08
$4
Jan-00
Adjusted R2 = .63 $4.00
450
Recapitalization
TMB (LHS)
750
Jun-08
$6
$5.00
S&P/TSX Paper & Forest Products Index
Source: Thomson ONE, RBC Capital Markets
Valuation • We value Tembec using EBITDA multiples within a range defined by its peer group – We believe a valuation based on a combination of trend earnings and 2011E EBITDA is most appropriate. Our valuation is intended to reflect earnings potential through the business cycle, with less emphasis on current conditions. Our trend EBITDA estimate is $230 million; Target $8.00 • Using mid-cycle pricing and cost assumptions, we arrive at a trend EBITDA estimate of $230 million – Tembec’s current financial performance is well below this level, but commodity prices are rising across the company’s business units. We forecast 2011 EBITDA of $143 million and $235 million in 2012. • We have applied a 4.5x multiple, which is at the low end of the range for Canadian paper & forest product companies (4.5x to 6.0x), to arrive at our target price of $8.00 per share. This target price implies a 7.2x multiple of our 2011E EBITDA and a 4.4x multiple of our 2012E EBITDA. Tembec is currently trading at 5.0x our 2011 estimate and 3.1x our 2012 estimate. These metrics are below Pulp (7.8x 2011, 5.8x 2012), Lumber (6.9x, 3.8x) and Paper (6.7x, 5.2x) companies. Exhibit 26: Range of Valuation Multiples for Tembec on 2011 EBITDA Company
AbitibiBowater
Mercer
West Fraser
Canfor
Catalyst
Canfor Pulp
Interfor
Fortress Papers
ND/ND+E
12%
75%
8%
4%
65%
8%
30%
0%
Dividend Yield
0.0%
0.0%
1.1%
0.0%
0.0%
8.7%
0.0%
0.0%
4.3x
5.4x
6.1x
6.6x
6.9x
7.0x
8.3x
11.5x
Valuation Multiple Implied Tembec EV
$646.4
$811.7
$916.9
$992.1
$1,037.2
$1,052.2
$1,247.6
less Net Debt
$235.0
$235.0
$235.0
$235.0
$235.0
$235.0
$235.0
$235.0
Implied Equity
$411.4
$576.7
$681.9
$757.1
$802.2
$817.2
$1,012.6
$1,493.6
$4.11
$5.77
$6.82
$7.57
$8.02
$8.17
$10.13
$14.94
Implied TMB per share
$1,728.6
Priced as of market close, February 22, 2011. Source: Company reports, Bloomberg, RBC Capital Markets estimates
• In looking at an appropriate valuation multiple for Tembec, we reviewed the current valuations for a number of similar forest products companies – In North America, Fortress Papers, Canfor Pulp, Mercer and West Fraser are the closest comparables. We note that Fortress Papers has exposure to dissolving pulps, but on the commodity dissolving side, not the specialty dissolving grades like Tembec. Fortress’s other businesses – banknote papers and wallpaper – would likely command a higher multiple than Tembec’s Paper, Wood Products and High Yield pulp segments. That said, the current valuation multiple of 11.5x is high as it reflects a dissolving pulp conversion in mid-2011. We believe pure NBSK pulp producers – Canfor Pulp (7.0x 2011 EBITDA) and Mercer (5.4x) – should have a valuation premium due to the limited future capacity additions on the softwood side. Mercer’s valuation is constrained by its high debt level. West Fraser is a large integrated forest products company, like
18
February 28, 2011
Tembec Inc.
Tembec, but with more lumber exposure and less in pulp. We believe that West Fraser should trade at a premium due to the company’s superior lumber margins and low debt level. • We believe West Fraser represents a decent benchmark in the valuation of Tembec – While the two companies are both integrated producers, in 2010 West Fraser’s lumber segment was 56% of sales and 47% of EBITDA while pulp contributed 30% and 41% respectively. Corresponding stats for Tembec would be 19% of sales and (9%) of EBITDA for lumber and 62% of sales for pulp but 125% of EBITDA. Exhibit 27: Net Asset Value for Tembec is $10 Tembec NAV - Based on Comparable Transaction Basis Capacity
Unit Value
Dissolving & Chemical Pulp (000's mt)
Asset Value ($MM)
Skookumchuck, BC
NBSK
270
$700
$189
Temiscaming, Quebec
Spec/vicose
160
$1,200
$192
Tartas, France
Spec/vicose Subtotal
150
$1,200
$180
580
$967
$561
High Yield Pulp (000's mt) Temiscaming, Quebec
BCTMP
315
$300
$95
Matane, Quebec
BCTMP
250
$300
$75
Chetwynd, B.C.
BCTMP
240
$300
$72
805
$300
$242
Subtotal Total Pulp
1,385
$803
Paper (000's mt) Spruce Falls, Ontario
Newsprint
330
$50
$17
Temiscaming, Quebec
Paperboard
180
$400
$72
510
$174
$89
Paper Subtotal Lumber (mmfbm) La Sarre, Quebec
Stud
200
$125
$25
Sennetarre, Quebec
Stud
150
$150
$23
Cochrane, Ontario
Stud
170
$150
$26
Kapuskasing, Ontario
Stud
105
$100
$11
$134
$84
Bearn, Quebec
Random Length
110
$125
$14
Chapleau, Ontario
Random Length
135
$150
$20
Subtotal
625
Timmins, Ontario
Random Length
100
$50
$5
Hearst, Ontario
Random Length
160
$150
$24
Canal Flats, BC
Random Length
180
$200
$36
Elko, BC
Random Length
270
$200
$54
$125
$119
$50
$1
$127
$204
Subtotal Cranbrook, BC
955
Finger-joint Lumber Subtotal
25 1,605
Misc. Wood Products - Engineered Wood plus Pine & Hardwood Misc. Wood Products Subtotal
$10
Chemicals Temiscaming & Tartas
$50
Ethanol/Resins/Lignosulfonates
Asset Value
$1,155
Net Debt (LTD+current debt-cash equivalents)
$227
Working Capital (less cash equivalents)
$228
Pension Deficit
$150
Net Asset Value Shares O/S (MMs) NAV/share
$1,006 100 $10.06
1 – Excludes joint venture capacity. Source: Company reports and RBC Capital Markets estimates
• Our net asset value of $10 per share is based on comparable transactions – We note, however, that a number of these transactions are quite dated and of limited value given changing market conditions. On the specialty pulp side, we understand that the recent sale of Neucel Pulp was done at $300 million or $1,785/mt. Given the current premium for commodity dissolving pulp, we have used a 35% discount on Tembec’s largely specialty dissolving pulp assets. Our NBSK value represents the average
19
February 28, 2011
Tembec Inc.
implied capacity value for pulp companies under our coverage. Using our ascribed asset values, we are effectively valuing Dissolving & Chemical Pulp at 4.6x 2010 segment EBITDA, 3.8x 2011E and 7.6x our estimate of trend EBITDA. • Capacity values imply reasonable EBITDA multiples for High Yield Pulp, Papers & Forest Products - For High Yield pulp, we assign a $300/mt value, which represents 4.8x 2010 EBITDA, 9.8x 2011E and 5.3x trend EBITDA. In using our ascribed asset values, we effectively are valuing Papers at 3.6x 2011E segment EBITDA and Wood Products at 20.8x 2011E segment EBITDA (but 2.1x trend EBITDA). Exhibit 28: Transaction-based asset values Date Pulp
Buyer
Asset
Price
Capacity
Price
(US$MM)
(000 mt)
(US$/mt)
Feb-11
Fulida Group Holdings
Port Alice, CB Specialty DP
300
168
1,785
Sep-10
Gores Group
Cosmopolis, WA, Specialty DP
160
140
1,143
Sep-10
Intl Grand Investments
Woodland, ME NBHK mill
60
395
152
Jul-10
Paper Excellence/APP
Howe Sound Pulp & Paper JV, NBSK mill
58
400
145
Jun-10
Georgia Pacific
626
985
636
May-10
Paper Excellence/APP
Parsons & Wittemore, SBHK & SBHK Tarascon & St Gaudens, FR, NBSK & NBHK
126
565
223
1,330
2,653
501
(C$MM) Lumber
(Mmfbm)
Domtar
EACOM
127
900
141
Jun-07
Domtar - Not completed
Conifex
285
1100
259
May-06
Arbec Forest Products
Jolina Capital
138
337
410
550
2,337
(US$MM) Newsprint
(C$/mfbm)
Jul-10
(000 mt)
235 (US$/mt)
Feb-08
Catalyst Paper
Snowflake, AZ recycled newsprint mill
161
375
Jan-08
White Birch
SP Newsprint
351
1,000
430 350
Feb-06
Public equity market
Catalyst Paper (Norske Skog stake)
376
579
561
888
1,954
454
Source: Company reports and RBC Capital Markets estimates
Exhibit 29: Comparative valuations Rating/
Share
Target
Shares
Market
Enterprise
Price/
Net debt/
Dividend
Risk
Price
Price
Outstanding
Cap
Value
Book (x)
Cap
Yield
EV/EBITDA (x) 2009A 2010E 2011E 2012E
North American and International Comparative Valuations Pulp companies Canfor Pulp
SP/AA
$16.50
$14.00
71.3
1,176
1,221
2.2
8%
8.5%
19.9
5.3
7.2
6.0
Fortress Paper 1 Mercer
SP/AA
$55.40
$50.00
12.0
747
824
3.7
0%
0.0%
32.2
28.4
10.7
6.0
O/Spec
$13.62
$15.00
43.0
426
1,286
1.8
75%
0.0%
Average
31.7
5.8
5.6
5.3
27.9
13.1
7.8
5.8
Lumber companies Canfor
SP/AA
$11.79
$11.00
142.6
1,682
1,739
1.2
4%
0.0%
nm
5.4
6.8
3.6
Interfor
SP/AA
$5.77
$5.50
47.1
272
423
0.8
30%
0.0%
nm
10.1
8.3
4.2
West Fraser
SP/Avg
$46.26
$53.00
42.8
1,981
2,129
1.1
8%
1.2%
Average
24.1
4.9
5.8
3.6
24.1
6.8
6.9
3.8
Paper companies AbitibiBowater (US$)
O/AA
$27.96
$35.00
97.0
2,824
3,344
0.4
12%
0.0%
nm
nm
nm
nm
Catalyst Paper
U/AA
$0.37
$0.10
381.8
139
893
0.3
65%
0.0%
7.3
12.5
6.7
5.2
7.3
12.5
6.7
5.2
nm
5.2
5.0
3.1
Average Tembec
O/AA
$4.95
$8.00
100.0
495
722
1.4
39%
0.0%
1 MERC share price in US$, Market Cap and Enterprise Value in euros. Priced as of market close February 25, 2011. Source: Company reports, RBC Capital Markets estimates
Sensitivities • Earnings are most sensitive to changes in pulp prices – A US$10/mt change in the price of dissolving pulp would change annual EBITDA by $3MM and EPS by $0.03. A similar change in BCTMP pricing changes annual EBITDA by $6MM and EPS
20
February 28, 2011
Tembec Inc.
by $0.06 (note that US$10/mt represents 0.7% of our forecast average 2011 dissolving pulp price and 1.3% of the BCTMP average price). A US$10/mfbm change in the price of lumber (representing about 3.5% of our 2011 forecast average) changes annual EBITDA by $11MM and EPS by $0.11. The impact of a 5% change in volume is more muted for BCTMP and lumber sales, but significantly higher than a US$10/mt price change for dissolving pulp. • Results are also quite sensitive to changes in the Canadian dollar – The company indicates a 1% change in the value of the US dollar against the Canadian dollar moves annual EBITDA by $10MM and EPS by $0.04, with a higher US dollar increasing results (all else being equal, which it never is). The vast majority of pulp, paper and solid wood products are priced in US dollars. The company’s relatively high proportion of lumber sales to Canadian customers moderates the influence of exchange fluctuations to a modest degree. We forecast the Canadian dollar will remain at or near parity through 2011 and 2012. Exhibit 30: Sensitivities Annual EBITDA sensivity to a $10/ton change in pricing or a 5% change in shipments C2011E EBITDA ($MM) Pricing Baseline assumptions
Volume
C2011E EPS ($/share) Pricing
143
Volume 0.50
Dissolving pulp
3
7
0.03
0.07
High yield pulp
6
2
0.06
0.02
11
2
0.11
0.02
Eastern SPF
Source: Company reports, RBC Capital Markets estimates
Risks and Price Target Impediments The primary risks to our forecast include the strength of the dissolving, chemical and high yield pulp markets in the medium term and the timing of the recovery in the US housing market in the longer term. • Pulp demand and prices – A decline in demand for pulp products or a sustained increase in supply would increase pressure on prices and lower forecast EBITDA. This risk is mitigated by the company’s long-term contracts covering ~80% of specialty dissolving pulp production, low global inventories of softwood chemical pulp and growing demand for most grades of pulp and the economic recovery continues to gain traction. With the sale of the two higher cost chemical pulp mills in France, the company has lowered its exposure to more volatile commodity kraft paper pulp grades. • Weak North American housing market – With housing starts of just 586 k units in 2010, demand for lumber and other building products has been reduced to generational lows. While we forecast starts to increase 20% to about 700 k units in 2011, the level of activity remains less than half the long-term trend of 1.5-1.6 million units. Despite the exceptionally low demand environment, Tembec has improved Forest Products segment returns in part through permanent closures of higher-cost capacity. Changes implemented to date should continue to limit losses while demand remains low but at the same time preserving potential to increase production as demand improves. • The pace of the economic recovery – A slower than expected economic recovery would reduce demand for all products. We note, however, that enormous government stimulus injected into the US and global economies has restored stability in credit and financial markets, and improved investor and consumer confidence. Leading economic indicators (including the manufacturing and non-manufacturing PMIs in the U.S.) have shown continuing improvement through early 2011. Demand and prices for pulp are strong and a slew of paper and packaging price increases have been announced, driven in part but increasing costs for energy and chemicals. Bank rates are being kept very low by central banks around the world to support economic activity. TMB’s strengthened balance sheet should support operations through conditioned difficult economic conditions.
21
February 28, 2011
Tembec Inc.
Appendix: Pricing deck Exhibit 31: Historical and forecast commodity prices Current
Previous
Last
Price
Week
Month
Year ago
2005
2006
2007
2008
2009
2010
2011
2011E
2012E
Random Lengths Composite
297
296
304
312
387
326
283
252
222
283
300
290
320
W. SPF 2x4s #2&btr (US$/mfbm)
287
288
307
287
354
296
250
221
182
256
300
260
300
E.SPF 2x4 G.L. (US$/mfbm)
385
379
390
353
419
368
329
305
270
341
383
340
380
SPF 2x4s 8' KD Studs (US$/mfbm)
270
265
268
294
361
289
264
212
185
246
266
250
290
SYP 2x4 West (US$/mfbm)
304
312
321
332
422
329
279
298
242
303
322
320
345
Baby Squares (US$/mfbm)
753
753
753
613
648
673
763
760
753
OSB (7/16", NC, US$/msf)
205
205
211
220
321
218
160
172
163
219
204
215
Plywood (3/8", US$/msf)
310
309
309
322
314
311
344
316
291
324
309
315
345
MDF (3/4", West, US$/msf)
535
535
535
436
416
452
456
513
463
524
535
525
540
NBSK (US$/tonne)
960
960
880
647
824
824
857
718
960
960
915
950
FOEX US NBSK (US$/mt)
960
960
963
864
647
717
819
861
715
955
961
Commodity Lumber
Panels
Pulp
Paper
Packaging
YTD
Forecasts
780 235
NBHK (US$/tonne)
820
820
770
610
656
719
788
608
856
820
780
835
Newsprint (US$/tonne)
640
640
550
610
668
593
701
564
606
640
665
650
FOEX US Newsprint (US$/mt)
627
626
532
580
634
581
672
574
583
626
22.5 lb Directory (US$/ton)
730
740
660
747
750
749
748
708
700
735
745
730
35 lb SC-A (US$/ton)
805
870
740
798
798
751
878
818
791
838
850
845
No.5 40 lb LWC (US$/ton)
855
855
730
861
843
773
950
805
767
855
820
870
20lb. Repro bond, 92 cut size
1,070
1,070
1,010
814
893
958
1,053
1,025
1,071
1,070
1,050
1,050
50 lb Offset, Rolls (US$/ton)
920
920
845
716
813
808
901
836
905
920
920
925
Linerboard (US$/ton)
635
635
575
423
498
527
577
542
620
na
665
675
Medium 26 lb (US$/ton)
605
605
545
392
473
507
556
512
590
na
635
645
627
US/Cdn Exchange Rate
$1.02
$1.02
$1.01
$0.95
$0.83
$0.88
$0.93
$0.94
$0.88
$0.97
$1.01
$1.00
$1.00
Euro/US Exchange Rate
€ 0.73
€ 0.73
€ 0.75
€ 0.73
€ 0.80
€ 0.80
€ 0.73
€ 0.68
€ 0.72
€ 0.75
€ 0.74
€ 0.75
€ 0.74
Source: Pulp & Paper Week, FOEX Indexes Ltd., Random Lengths, Pacific Exchange Rate Service, RBC Capital Markets estimates
22
February 28, 2011
Tembec Inc.
Appendix: Financial Summary Exhibit 32: Financial statements ($ million) Tembec Income Statement
(C$ Millions) To tal Revenue Freight & deductions
Q1 09
Q2 09
Q3 09
Q4 09
Q1 10
Q2 10
Q3 10
Q4 10
2011E
2012E
417
407
451
412
1,687
2009
476
545
444
422
1,887
2010
Q1 11E 458
Q2 11E 467
Q3 11E 476
Q4 11E 472
1,873
2,078 272
54
55
54
49
212
56
70
59
57
242
60
62
64
63
249
Export taxes
1
1
2
2
6
3
3
2
3
11
3
3
3
3
12
5
Cost of Sales
402
372
383
339
1,496
366
394
327
329
1,416
348
338
355
352
1,393
1,486
S,G & A
23
21
21
18
83
19
18
20
18
75
19
19
19
19
76
80
To tal Costs
480
449
460
408
1,797
444
485
408
407
1,744
430
422
441
437
1,730
1,843
EBITDA, adjusted
(63)
(42)
32
60
36
11
139
28
45
35
35
143
235
Depreciation EBIT
(9)
4
18
19
18
15
(81)
(61)
(27)
(11)
(110) 70 (180)
15
14
12
12
53
13
12
12
13
50
64
17
46
24
(1)
86
15
33
23
22
93
171
Interest Expense
5
16
15
13
49
14
14
10
13
Gain (loss) on long term debt
7
(25)
(20)
(16)
(54)
(11)
1
(1)
(6)
(17)
3
-
1
(15)
Income Taxes Other income
-
Earnings from continuing o peratio ns
(96)
Discontinued operations Net Income Average Diluted Shares O /S
(1) (52)
(3) (99) 100
-
1
-
1
(22)
13
2
(39)
(20)
100
100
4 -
(9)
(179)
(9)
(167)
-
12
100
100
-
(20)
-
1
14
4 -
51
11
-
(1)
-
14
50
11
-
51
67
(9)
66
(1)
100
10 -
0 -
(9) -
10 -
1 -
5 -
22 -
5
10 -
22
10 -
1 12 12
40 -
1
40 -
3
-
-
11
50
-
-
11
50
7 125 125
100
100
100
100
100
100
100
100
100
100
Earnings per share FD, reported
($0.99)
($0.38)
($0.17)
($0.09)
($1.63)
$0.00
$0.59
$0.02
($0.12)
$0.49
$0.05
$0.22
$0.12
$0.11
$0.50
$1.25
Earnings per share FD, normalized
($0.96)
($0.50)
($0.35)
($0.23)
($2.04)
$0.00
$0.58
$0.12
($0.15)
$0.55
$0.05
$0.22
$0.12
$0.11
$0.50
$1.25
Gross Margin
(15.1%)
(10.3%)
(2.0%)
1.0%
(6.5%)
6.7%
11.0%
8.1%
3.6%
7.6%
6.1%
9.6%
7.4%
7.4%
7.6%
11.3%
EBITDA Margin
(15.1%)
(10.3%)
(2.0%)
1.0%
(6.5%)
6.7%
11.0%
8.1%
2.6%
7.4%
6.1%
9.6%
7.4%
7.4%
7.6%
11.3%
58.7%
58.4%
57.0%
57.5%
58.2%
38.7%
37.7%
39.1%
43.4%
36.2%
31.2%
30.6%
30.6%
21.2%
8.4%
2.6%
Margins & Metrics
Net Debt/Net Debt + Equity
Source: Company reports and RBC Capital Markets estimates
23
February 28, 2011
Tembec Inc. Tembec Cash Flow Statement
(C$ Millions) Q1 09
Q2 09
Q3 09
Q4 09
2009
Q1 10
Q2 10
Q3 10
Q4 10
2010
Q1 11E
Q2 11E
Q3 11E
Q4 11E
2011E
2012E
Operating Activities Net Income
(99)
(39)
(20)
(9)
(167)
14
50
11
(5)
70
5
22
12
11
50
125
Depreciation, depletion and amortization
18
19
18
15
70
15
14
12
12
53
13
12
12
13
50
64
Other
27
(44)
(25)
(12)
(54)
(7)
(29)
(2)
(10)
(48)
Changes in working capital
14
92
46
(2)
150
(29)
51
-
5
27
(23)
27
16
(17)
(40)
28
19
(8)
(1)
(7)
86
21
2
102
(5)
61
40
7
Operating Cash Flow
-
-
-
-
-
1 3
103
189
Investing Activities (15)
(6)
(6)
(6)
(33)
(5)
(6)
(8)
(8)
(27)
(10)
(10)
Other
10
9
11
1
31
2
88
1
(1)
90
-
-
Investing Cash Flow
(5)
3
5
(5)
(2)
(3)
82
(7)
(9)
63
(10)
(10)
38
(10)
31
(20)
(88)
2
(105)
-
-
-
-
-
7
7
1
264
272
-
-
-
-
-
(3)
(19)
(1)
(3)
(311)
(2)
(317)
-
-
-
-
-
-
2
3
2
(10)
(13)
4
(17)
-
-
-
-
-
-
(100)
(59)
4
(167)
-
-
-
-
-
Capital projects
(8) -
(8) -
(8)
(8)
(36)
(40)
-
-
(36)
(40)
Financing Activities Change in bank loans
8
(5)
Issuance of debt
4
3
-
Reduction of debt
-
-
(13)
(3)
Other
2
(3)
2
Financing Cash Flow
1
(8)
40
(11)
Beginning Cash Change in the Cash Position Ending Cash
22
(12)
1 -
58
16
40
107
58
82
45
122
70
82
58
43
94
(42)
24
67
(25)
24
(37)
77
(52)
(12)
(24)
(15)
51
32
16
40
107
82
82
45
122
70
58
58
43
94
126
126 (1) 125
(3) -
(3) 58
125
67
119
125
245
Source: Company reports and RBC Capital Markets estimates
24
February 28, 2011
Tembec Inc. Tembec Balance Sheet
(C$ Millions) Q1 09
Q2 09
Q3 09
Q4 09
2009
Q1 10
Q2 10
Q3 10
Q4 10
2010
Q1 11E
Q2 11E
Q3 11E
Q4 11E
2011E
2012E
ASSETS Cash & cash equivalents
16
41
105
80
80
43
120
68
56
56
41
92
124
123
123
243
Other current assets
734
650
615
589
589
606
468
477
446
446
483
447
439
455
455
501
Total current assets
750
691
720
669
669
649
588
545
502
502
523
538
564
578
578
743
PP&E, less accumulated depreciation
657
641
626
617
617
605
506
498
494
494
491
489
485
480
480
456
Other non-current assets
10
22
20
19
19
31
61
61
63
63
25
25
25
25
25
25
1,417
1,354
1,366
1,305
1,305
1,285
1,155
1,104
1,059
1,059
1,039
1,052
1,074
1,083
1,083
1,224
Current liabilities
364
367
418
382
382
374
227
259
234
234
252
243
252
250
250
266
Long term debt
427
403
383
364
364
359
333
271
263
263
263
263
263
263
263
239
Other long-term liabilities
263
255
252
255
255
248
232
209
209
209
209
209
209
209
209
209
1,054
1,025
1,053
1,001
1,001
981
792
739
706
706
724
715
724
722
722
714
Total Assets LIABILITIES AND EQUITY Forest Products
Total Liabilities Shareholder equity Total equity Total Liabilities and Equity Book value per share (US$)
363
329
313
304
304
304
363
365
353
353
316
338
350
361
361
510
1,417
1,354
1,366
1,305
1,305
1,285
1,155
1,104
1,059
1,059
1,039
1,052
1,074
1,083
1,083
1,224
$3.63
$3.29
$3.13
$3.04
$3.04
$3.63
$3.65
$3.53
$3.16
$3.38
$3.50
$3.61
$3.61
$5.10
Source: Company reports and RBC Capital Markets estimates
25
February 28, 2011
Tembec Inc.
Valuation Our 12-month target of $8 is based on a blended 4.5x valuation multiple on our trend EBITDA estimate of $230MM (85%) and our 2011 EBITDA estimate of $143MM (15%). This value is supported by our estimate of Tembec’s net asset value at $10. Our target multiple is at the low end of the typical Paper & Forest Products trading range (4.5x to 6.5x) reflecting the company's small capitalization and the weakness in the US housing market.
Price Target Impediment Lower-than-expected global economic growth would result in weaker growth for all types of pulp. A slower than expected recovery in US housing start levels would result in decreased demand and pricing for lumber over the near and medium terms. A weaker-than-expected euro/U.S. dollar exchange rate would decrease potential pulp prices. A stronger-than-expected Canadian dollar would decrease Canadian dollar revenues as most products are priced in U.S. dollars.
Company Description Tembec is a large North American manufacturer of dissolving and paper pulp, packaging and paper, lumber and silvichemicals. It operates 22 manufacturing facilities in North America and France and is a leading producer of several types of specialty dissolving pulps and high-yield pulp. Its products are used in the paper, construction, newsprint, packaging, and food and pharmaceuticals markets.
26
February 28, 2011
Tembec Inc.
Required Disclosures Non-U.S. Analyst Disclosure Paul C. Quinn (i) is not registered/qualified as a research analyst with the NYSE and/or FINRA and (ii) may not be associated persons of the RBC Capital Markets, LLC and therefore may not be subject to FINRA Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
Conflicts Disclosures This product constitutes a compendium report (covers six or more subject companies). As such, RBC Capital Markets chooses to provide specific disclosures for the subject companies by reference. To access current disclosures for the subject companies, clients should refer to https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1 or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated by investment banking activities of the member companies of RBC Capital Markets and its affiliates.
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Distribution of Ratings RBC Capital Markets, Equity Research Investment Banking Serv./Past 12 Mos. Rating BUY[TP/O] HOLD[SP] SELL[U]
Count
Percent
Count
Percent
699 591 64
51.60 43.60 4.70
201 135 10
28.76 22.84 15.62
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February 28, 2011
Tembec Inc.
suitable for all investors and have not been tailored to individual investor circumstances and objectives, and investors should make their own independent decisions regarding any securities or strategies discussed herein.
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Any Canadian recipient of this report that is not a Designated Institution in Ontario, an Accredited Investor in British Columbia or Alberta or a Sophisticated Purchaser in Quebec (or similar permitted purchaser in any other province) and that wishes further information regarding, or to effect any transaction in, any of the securities discussed in this report should contact and place orders with RBC Dominion Securities Inc., which, without in any way limiting the foregoing, accepts responsibility for this report and its dissemination in Canada. To U.K. Residents: This publication has been approved by Royal Bank of Canada Europe Limited ('RBCEL') which is authorized and regulated by Financial ServicesAuthority ('FSA'), in connection with its distribution in the United Kingdom. This material is not for general distribution in the United Kingdom to retail clients, as defined under the rules of the FSA. However, targeted distribution may be made to selected retail clients of RBC and its affiliates. RBCEL accepts responsibility for this report and its dissemination in the United Kingdom. To Persons Receiving This Advice in Australia: This material has been distributed in Australia by Royal Bank of Canada - Sydney Branch (ABN 86 076 940 880, AFSL No. 246521). This material has been prepared for general circulation and does not take into account the objectives, financial situation or needs of any recipient. Accordingly, any recipient should, before acting on this material, consider the appropriateness of this material having regard to their objectives, financial situation and needs. If this material relates to the acquisition or possible acquisition of a particular financial product, a recipient in Australia should obtain any relevant disclosure document prepared in respect of that product and consider that document before making any decision about whether to acquire the product. To Hong Kong Residents: This publication is distributed in Hong Kong by RBC Investment Services (Asia) Limited and RBC Investment Management (Asia) Limited, licensed corporations under the Securities and Futures Ordinance or, by Royal Bank of Canada, Hong Kong Branch, a registered institution under the Securities and Futures Ordinance. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of any recipient. Hong Kong persons wishing to obtain further information on any of the securities mentioned in this publication should contact RBC Investment Services (Asia) Limited, RBC Investment Management (Asia) Limited or Royal Bank of Canada, Hong Kong Branch at 17/Floor, Cheung Kong Center, 2 Queen's Road Central, Hong Kong (telephone number is 2848-1388). To Singapore Residents: This publication is distributed in Singapore by RBC (Singapore Branch) and RBC (Asia) Limited, registered entities granted offshore bank status by the Monetary Authority of Singapore. This material has been prepared for general circulation and does not take into account the objectives, financial situation, or needs of any recipient. You are advised to seek independent advice from a financial adviser before purchasing any product. If you do not obtain independent advice, you should consider whether the product is suitable for you. Past performance is not indicative of future performance. .® Registered trademark of Royal Bank of Canada. RBC Capital Markets is a trademark of Royal Bank of Canada. Used under license. Copyright © RBC Capital Markets, LLC 2011 - Member SIPC Copyright © RBC Dominion Securities Inc. 2011 - Member CIPF Copyright © Royal Bank of Canada Europe Limited 2011 Copyright © Royal Bank of Canada 2011 All rights reserved
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