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Mondi plc £MNDI – A Valuation on 19th July 2021 : UKInvesting


Summary

Mondi is a Europe focused paper and packaging business that has developed a cost advantage over its peers. Online consumerism and sustainability trends will help this market grow modestly, while their cost advantage will help them defend market share and return margins to the historical average.

Market Price = €22.80
Estimated Value = €27.31
Price/Value = 83.5%
Monte-Carlo Price Percentile = 28%
Rating At Current Price = ADD

The Company

Mondi manufactures and sells paper and packaging products. It is a multinational business with 104 production sites across over 30 countries.

The company has four segments:

  1. Corrugated Packaging27.7% of Revenue and 21 production sites — Leading containerboard producer with an integrated, well-invested, cost-advantaged asset base. Containerboard, corrugated solutions, pulp.

  2. Flexible Packaging39.1% of Revenue and 62 production sites — Offering customers a range of sustainable, flexible packaging solutions using paper where possible and plastic when practical. Kraft paper, paper bags, consumer flexible, pulp.

  3. Engineered Materials11.6% of Revenue and 15 production sites — Produces a range of products for recycling and using recycled content. Functional papers and films protect adhesive surfaces or provide barriers against moisture, oxygen and aroma across a range of applications. Personal care components, functional paper and films.

  4. Uncoated Fine Paper21.7% of Revenue and six production sites — Range of environmentally sound home, office and professional printing papers. Uncoated fine paper, newsprint, pulp.

The company serves customers in the agriculture, automotive, building and construction, chemicals and dangerous goods, food and beverages, graphic and photographic, home and personal care, medical and pharmaceutical, office and professional printing, paper and packaging converting, pet care, retail and e-commerce, and shipping and transport industries.

Mondi is a global business but gets the bulk of its revenue from Europe (>70%).

Mondi gets more than 70% of revenues from Europe.

Mondi is a vertically integrated business. It grows wood, manufactures pulp and paper, converts packaging papers into corrugated cardboard and other packaging and recycles paper and resins.

Of the wood that the company procures for pulp production, 4Mm³ comes from company-owned forestry assets (22.2% of total lumber procured). Moreover, the company can ramp this up and has a maximum allowable cut of 9Mm³ (50%). This input resource ownership and control make the company less dependent on external lumber and pulp prices — furthermore, 22.4% of pulp produced comes from paper for recycling (1.3Mt) rather than lumber.

The Financials

Mondi is a large, mature company growing slowly by steadily expanding production at existing sites and opening new facilities. LTM revenues, which were €5.7B in 2012, are now €6.6B. However, they have been steadily declining since they peaked above €7.5B through June 2019.

Revenues peaked in mid-2019 and have been declining since.

Operating margins, which were in steady decline until 2010, have been improving since and are now industry-leading. Margins were c.5% in 2010 and are now above 14%.

In addition, there appears to be a relationship between growth and margin expansion. This relationship suggests that the economies of scale have been improving at Mondi over the last ten years. A lower proportion of fixed costs and increased bargaining power helps drive increased profitability.

Economies of scale have helped the company expand margins as they’ve grown.

These economies of scale, the vertical integration, and the focus on cost-advantaged locations and assets have helped the company produce the highest margins and returns on capital of its major competitors.

Mondi has developed a cost advantage that has helped it produce leading margins.

This competitive advantage has also produced higher returns on capital than competitors.

Despite this cost advantage that the company has built, shareholders have only realised a total return of 350% over the last ten years compared to 713% for Smurfit Kappa Group. But, this is better than the 258% for DS Smith and 193% for the International Paper Company.

Moreover, because Mondi has focused exclusively on cost-advantaged locations and assets at the expense of rapid expansion, its production volumes remain relatively small compared to its global peers. The ten largest companies in this space by production are International Paper (US), Nine Dragons Paper (China), WestRock (US), Oji (Japan), DS Smith (UK), UPM (Finland), Stora Enso (Finland), Smurfit Kappa (Ireland), Nippon Paper (Japan) and Lee & Man Paper (China).

The Story

Mondi is a multinational but Europe focused paper and packaging business that has developed a cost advantage over its peers. Online consumerism and sustainability trends will help this market grow modestly, while their cost advantage will help them defend market share and return margins to the historical average.

Total Market — The global paper packaging market is currently worth €303.8M, and economists forecast it to grow at a CAGR of 3.87% over the medium term. Due to the increase in online consumerism and the need for lightweight, reusable packaging, the corrugated packaging industry will proliferate. Over the years, this trend will continue to evolve, and economists expect the demand for packaging solutions (especially corrugated cardboard) that allow companies to transport goods more sustainably to grow.

x Market Share — Mondi’s current revenue gives them roughly 2.2% of the market. They are a relatively small player in a large global market. But, I think the cost advantage they have developed will help them maintain and even marginally expand their market share over the medium-term.

= Revenues — I have modelled a medium-term CAGR of 3.9%.

Less: Costs — The company’s cost advantage, recycling plan, and vertical integration help keep costs low and help somewhat to reduce the impact of lumber and pulp price fluctuations.

= Operating Income — I have modelled margins to gradually return to their five-year historical average of 15%—these margins are significantly above the global industry average of 7.8% over that time.

Less: Taxes — I have modelled for the tax rate to go from the current effective tax rate of 21.8% to my estimate of its underlying marginal tax rate based on its geographic breakdown.

Less: Reinvestment — Mondi, as with most paper and packaging businesses, is capital intensive. The company has been generating €1.09 of revenue for each €1 invested capital, and I have modelled this to continue. I think that Mondi will continue investing in its forestry assets and production facilities and possibly expanding its presence in smaller markets.

= Free Cash Flows — Based on these forecasts, I expect the company to remain FCF positive and not need to raise capital.

Adjust For: Time Value & Risk — Mondi is a global paper and packaging business getting revenue from Western Europe (38.2%), Eastern Europe & Russia (32.5%), North America (10.6%), Asia & Australia (9.2%), and South America (1.6%). I estimate the firm’s operating leverage ratio to be 0.54 and D/E of 21.5%. Moody’s has assigned Mondi a Baa1/BBB+ credit rating — lower than my synthetic rating of Aa3/AA-. I have gone with their rating because I agree with their reasoning:

“The Baa1 issuer rating is primarily constrained by Mondi’s exposure to the cyclical paper and packaging product industries; the secular decline in the use of graphic paper in mature markets; its exposure to volatile input costs; and the risk of debt-funded growth or extraordinary dividends, given the lack of public commitment to a specific leverage target.”
Moody’s, 17 May 2021

As usual, the credit rating drives the distress likelihood, which I have placed at 2.3%. Finally, my estimate of the company’s cost of capital is 5.17%.

Add: Non-Operating Assets — Mondi has some investments carried at fair value and some under the equity method. I have valued these at €54.7M in total.

Less: Debts & Other Claims — Mondi has a €215M retirement benefit deficit and debts and leasehold commitments with an estimated NPV of €2.38B. There are also non-controlling interests that I have valued at €520.6M.

The Valuation

The company reports in Euros. Accordingly, I have valued it in Euros.

Growth Rate: 3.9%
Stable Margins: 15.0%
Cost of Capital: 5.17%

Valuation summary output

Valuation Model Output:
Estimated Intrinsic Value/Share = €27.31

Monte-Carlo Simulation Intrinsic Value Percentiles:
90th = €40.29
75th = €34.51
50th = €28.09
25th = €21.67
10th = €15.89

Market Price & Rating

Market Price = €22.80
Estimated Value = €27.31
Price/Value = 83.5%

Stock price & MC simulation distribution

Monte-Carlo Price Percentile = 28%
Likelihood Overvalued = 28%
Likelihood Undervalued = 72%

Rating At Current Price = ADD

I am a value investor searching for undervalued stocks.
See more of my valuations and research here.

Disclaimer:
This publication is not financial or legal advice. This research is an independent analysis.



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