Neenah Stock: Hitting The Papers (NASDAQ:NP)

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Neenah (NYSE:NP) has not seen much coverage as of late, but a big announcement on the corporate front warrants an update here. Neenah has been transforming its business over the past couple of years, but these efforts still have to translate into real capital appreciation for investors, besides the fat dividend.

Just as the results were looking to get better, the company is plagued by macroeconomic challenges, as the entire investment thesis has shifted overnight as M&A is the name of the game now.

The Business

Neenah is a manufacturer of specialty materials. The company generates just over a billion in sales with revenues reported across two segments. Technical products comprise two thirds of total revenues, generated from filtration, specialty coatings and engineered materials.

Fine paper & packing is responsible for the remainder of sales, with revenues generated from commercial, consumer and packaging solutions. The business has activities in North America and Europe.

The company has been actively repositioning the portfolio over the past years and actually decades. In the 2000s the company has divested its pulp and timberland operations, generally commodity like operations, with proceeds and retained earnings used to expand into specialty markets.

Despite these strategic ambitions, the results have been not too convincing in recent years. Revenues have been coming in around the billion line since 2017, with the pandemic of course being an exception. EBITDA margins have been flattish at 12-14% over the same period of time.

If we look at the actual results in 2021, it is evident that the adjusted numbers require some clarification. Revenues rose nearly 30% to $1.03 billion amidst easy comparables following the pandemic and thanks to the purchase of Itasa, but at the same time an $11.8 million GAAP operating loss was reported. This resulted in net losses of $24.9 million, equal to $1.49 per share based on GAAP reporting. At the same time, the company posted rather flattish adjusted earnings of $2.53 per share, after making an aggressive $4 per share in adjustments relating to impairment and restructuring costs, acquisition related costs, and pension related costs, among others.

Net debt stood at $417 million, equal to 3.6 times EBITDA reported at $117 million. The 16.8 million shares ended 2021 around the $50 mark, for a $840 million equity valuation, or $1.25 billion enterprise valuation. This valuation has dropped considerably as the shares fell to $35 in March amidst raging inflation and concerns related to the war, reducing the equity valuation just below the $600 million mark, while the enterprise value fell to roughly a billion.

Reassuring Outlook

Early in March, Neenah outlined a comforting outlook for the current year. The company sees 15-25% growth in EBITDA, with adjusted EBITDA set to come in between $135 million and $145 million. The direct exposure to Ukraine and Russia is limited to less than a percent, but the indirect costs relating to higher energy prices and inflation are bigger concerns for the business.

At the midpoint of the guidance, that suggests some $30 million in additional EBITDA versus 2021, or likely $25 million in additional adjusted EBIT. If this is realistic, that works down to $1.50 per share on a pre-tax basis, suggesting that adjusted earnings of $2.50 per share could rise to $3.50 per share, or numbers alike in what is a difficult year. On the other hand, history has shown that the adjusted earnings at Neenah are quite adjusted indeed.

I must say that the combination of a sluggish share price and improved performance is compelling, but Neenah does not have a great value creating track record, despite the transformation of the business. Amidst all these moving parts, there is of course a major event taking place, a merger with a peer.

Merging With Schweitzer-Mauduit

Amidst all these trends, Neenah announced a big deal as it has reached an agreement to be merged into Schweitzer-Mauduit International (NYSE:SWM). Investors in Neenah will receive 1.358 shares in Schweitzer, giving them a combined 42% stake in the business.

The rationale behind the deal is driven by greater scale and capabilities with costs synergies pegged at $65 million. Schweitzer is a bit bigger than Neenah with $1.4 billion in revenues, as it is much more profitable with $209 million in adjusted EBITDA, indicating that its margins are quite a bit higher. In terms of the 2021 pro forma results, Neenah is responsible for 36% of pro forma EBITDA and 42% of pro forma revenues, yet real growth is seen in Neenah´s operations this year, as the 42% exchange ratio seems fair.

Market Reaction

Shares of Schweitzer are trading virtually unchanged upon the deal announcement, but have lost some ground in the days thereafter. This is despite the fact that the deal does not involve new debt as the $65 million in promised synergies look sizable with Schweitzer supporting a roughly $900 million market value here. Even if we factor in the equity valuation of Neenah, the synergy number looks sizable in relation to a combined $1.5 billion equity valuation.

This seems like quite an underreaction as the market is of course fearful about the continued restructuring of such a business and continued transformation costs, but scale is important in this business.

Concluding Thoughts

The market is not really upbeat on the deal, despite the promise of synergies, as the macro environment is uncertain amidst raging inflation which likely hurts the economy as well. On the other hand, the combination supports a decent 6% dividend yield as the deal looks fine, with no incremental leverage concerns being imposed on the combined business.

Amidst these moving parts, the deal for Neenah’s shareholders seems pretty much set here, as the exchange ratio seems fair. The combined operations support a steady, but high 6% dividend yield here, as focus should be in integration and managing inflation in what is a tricky environment.

Nonetheless, I think this is a net positive for shareholders in both companies, yet the issue is that both companies have been kind of dogs in terms of their long-term value creating track record. While some consolidation will take place, the combination will likely not enjoy sufficient market power to really alter this into the future.

Hence, I am positive on the deal and while valuations look reasonable, I see no reason to get involved here.

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