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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More...)
Neenah Paper (NP) looks intriguing as an undervalued dividend-paying company with a market cap of only $508 million. The company operates two segments: technical products and fine paper. Neenah's products are found in many consumer goods, but are not commonly known to most. The company sells its products in over 70 countries worldwide. The undervaluation, recent acquisitions and company strategy give the stock a high reward, moderate risk potential for investors.
About the Company
The technical products segment comprises 50% of the company's revenue according to the first quarter 2013 report. Net sales from technical products are spread over 500 customers worldwide. This segment offers paper for filter media, specialty tape, medical packaging, paper backings for labels & abrasives, non-woven wall coverings, image transfers, furniture veneer backings, and for durable print & cover applications. Neenah's filter media products are used in high-performance filters for oil, fuel, air, and cabin air in the transportation industry.
The fine paper segment comprises 47% of Neenah's revenue. The latest annual report conveys that Neenah is the leading supplier of premium writing, text, cover papers, bright papers, and specialty papers in North America. These premium papers are used in commercial printing, invitations, imaging applications for corporate identity packages, personal stationary, corporate annual reports, premium labels, and luxury packaging. The company's bright papers are used in numerous applications such as flyers, direct mail, advertising inserts, scrapbooks, etc.
Neenah's products are in the cars that we drive, the wedding invitations that we mail out, the printed advertising inserts that we read, the beverage and food labels that we purchase, the bacteria resistant medical packaging that is critical to the healthcare industry, etc. Many of these products are taken for granted, but are essential in our everyday lives and in the course of business.
Earlier this year, Neenah completed its purchase of certain premium business paper brands from Southworth. These brands are sold in major retail chains such as Wal-Mart (WMT), Staples (SPLS), Office Depot (ODP), and OfficeMax (OMX). This is a nice expansion for Neenah, as it extends its presence in the retail space with products that mesh well in its fine paper segment.
Neenah currently pays a dividend of 2.5%, based on four quarterly payments of 20 cents per share. The 20 cent per share quarterly payment represents a 33% increase over the prior 15 cents per share quarterly payment. The increased dividend will be paid on September 3, 2013 to shareholders on record as of August 16, 2013. The dividend payment is a nice feature for a small-cap company as it shows Neenah's commitment to shareholders. The company paid a dividend since 2005, where the payments remained the same until 2011. The payments have been increased every year since 2011.
Valuation
The company has an enterprise value (EV) of $690 million versus a market cap of $508 million. If the market cap increased to equal the enterprise value, the stock price would be $43 instead of $31. This represents a 39% increase in price. The enterprise value can be thought of as a potential takeover price. The EV takes into account the debt, cash, and minority interests of a company. In this regard, Neenah is trading at a 39% undervaluation. Theoretically, if a larger company were willing to pay $43 a share for the company, then investors should be willing to pay only $31.
The trailing PE ratio of 10.5 and forward PE of 10.3 are both undervalued relative to the overall S&P 500. The company's earnings have grown annually at 23.9% for the past five years and the stock price has not kept up with that growth. Organic growth into new specialized niche markets is a primary reason for the earnings growth. The Wausau acquisition, which was completed by January 31, 2012, gave Neenah the Astrobrights, Astroparche, and Royal brands. It also provides Neenah with about $100 million in additional annual sales. Diluted earnings per share have grown 48% in 2012 over 2011, but the stock price has not kept up with that growth. The PE ratio has subsequently fallen from 15 over a year ago to its current level of 10.5. Overall, the company is valued attractively for long-term investors.
Catalysts
The acquisition of Southworth and Wausau brands certainly adds value to Neenah's future growth. The acquisitions are expected to add about $120 million to annual sales ($100 million from Wausau and $20 million from Southworth). However, I think that these acquisitions are bigger than the $120 million in additional sales. These acquisitions also provide the company with Wal-Mart as a large new customer. This provides an opportunity for Neenah to grow with Wal-Mart into new regions, which is a part of Neenah's strategy. As retailers like Wal-Mart and others add new stores and expand their online presence, Neenah will benefit from the resulting increased sales. For example, Wal-Mart is planning to open 100 new stores in China in the next three years.
Neenah has a mission of creating value by improving the image and performance of everything it touches. This is a continuous improvement strategy that, when implemented on a consistent basis, should allow the company to successfully grow revenue and earnings. Neenah focuses on specialty niche markets where it can expand its current product offerings into new regions and markets that are profitable and growing. The company has identified the following products for growth: performance-based fiber, non-woven media production, coating and saturating, premium papers, labels, and luxury packaging. Neenah works to provide innovative, high-performance products that help customers' products perform better.
The company has strong operating cash flow. For the past twelve months, the figure was $56 million. Neenah's first priority is to use that cash to grow organically. The company's strategy to grow organically involves improving the performance or image of its products. It also involves increasing the portfolio growth rate and diversification as the company expands into higher value products and growth markets.
Neenah also has its eyes open for new strategic acquisitions. Its disciplined approach focuses on only purchasing companies that will certainly add value and fit well with the business. Neenah looks for these four criteria that provide synergies and barriers to entry through technology, products, customers, and geographies. By sticking to this strategy, Neenah should be successful in discovering new potential acquisitions that add revenue and earnings growth for the long term.
Another catalyst is the company's commitment to shareholders. The company has a focus on operating in a disciplined financial manner that ultimately delivers consistent and attractive returns for shareholders. This includes minimizing operating costs to drive earnings growth. It also involves directly rewarding shareholders. In addition to the recent dividend increases mentioned earlier in the article, Neenah is implementing a $10 million stock buyback program. This program will repurchase $10 million of its outstanding common stock over the next year. This creates value for shareholders as the supply of outstanding shares is reduced, the stock price should increase. The dividend payments have been increased for three years in a row. The dividend payout ratio is 17%, which looks sustainable as one year of dividends costs $12.8 million, which is about 23% of operating cash flow.
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Risks
The primary risk for the company is that it is highly economically sensitive. The 2008 financial crisis took the stock from the $40s down to the low single digits. The stock also took a 25% dive during the European debt crisis in 2011. Neenah obtains about 40% of its revenue from Europe. With these issues in the rearview mirror and the global economy slowly making increases, Neenah is on much better footing to make gains in the next few years. It's just an issue that investors should be aware of.
Another primary risk is the potential for increased costs of raw materials. Specialty pulp, specialty latex, and cotton fiber are essential to Neenah's business. If costs of these materials increase significantly, Neenah's profitability could be reduced.
Conclusion
Taking the company's expected annual earnings growth of 12.5% and the yield of 2.5% into account, investors who reinvest dividends should achieve a 15% CAGR for the next five years. At that rate, investors should approximately double their money in five years when dividends are reinvested. The undervaluation of the stock should also help support these gains. The company's strategy of growing organically and making shrewd acquisitions should catalyze that growth.
