from an analyst report from Sep (slightly more postive sentiment...

from an analyst report from Sep (slightly more postive sentiment than mine but highlights the issues faced by the company)...


It’s tough being a paper wholesaler in a world where paper usage is in both cyclical decline and, in all likelihood, structural decline.

PaperlinX (PPX) has found it difficult to make any money over the last 3 years, and this is before abnormals have been taken into account. Sales volumes have been in what seems like a perpetual decline, whilst at the same time pricing has been weak. This is a recipe for disaster for a business whose EBIT margins at the best of times were less than 3%, and whose balance sheet carries a big chunk of debt.

To be fair, the business has undergone a major transition over the last few years, shedding its manufacturing operation and looking to focus solely on its merchanting business. But as we stated above, this has not stopped the losses.

This is not to say that PPX is not a big business. The company still generated revenue of $5.66 billion in 2011, however this was significantly down on its peak of $7 billion. $5.66 billion is an enormous amount of turnover, only to be left with a loss at the end of it all.

Obviously management are looking to remedy this, principally through an attempt to realign the cost base to the reduced revenue base, which will hopefully bring margins back to their average level of approximately 2.5%.

Our view is that 2.5% does not currently look achievable, unless industry paper volumes start to pick up and pricing strengthens. At the very least, margins will need to reach half this level in order to cover corporate costs, interest and capital requirements. Otherwise, what is the point?

Onto its stock.

The company’s stock price has fallen to a low of 10c from a high of $5.85 reached in 2003. This is always something that catches our eye. However in this instance, it is the company’s preference securities (code: PXUPA) that are of more interest.

These securities have a par value of $100 but are trading at $31 and are quite complex instruments, the terms of which are not particularly attractive. However, in respect of access to cash distributions or capital in the event of a wind-up, they rank above the ordinary shares.

The last 3 half-yearly distributions have been paid on the PXUPA, which are yielding more than 20% at current prices, however we are not certain that distributions will continue to be made given that the company continues to make losses. Distributions are made at the discretion of the directors and are non-cumulative in nature.

Orbis Investment Management, the largest shareholder in PPX, has urged the company to suspend dividends to PXUPA holders and use the savings to buy back the instruments instead. In our view, this would not be an altogether terrible outcome for holders of both classes of securities.

The company currently has 12c per share in net current assets, after the PXUPA have been paid back in full at par. This implies a margin of $260 million in further current asset write downs or operating losses before the asset backing of the PXUPA starts to get eaten into, since they currently trade at $31. That’s a fairly substantial margin, considering that the company reported an underlying loss after tax of (only) $23 million this year.

So, where do we stand?

The company operates in a horrible industry with terrible economics. in our view, it is at or near the bottom of the earnings cycle. The company’s stock is trading as if it will continue on the same path for the next 10 years, before finally disappearing into bankruptcy. However, we do not believe that this will be the case. PPX has significant upside leverage to any cyclical recovery and should by then have brought its costs back into line in order to earn a reasonable margin on its sales.

Either that, or it should continue to wind itself down and return its capital, most of which is currently invested in inventory and receivables, to owners (first to debt holders, then preference shareholders then, if there is anything left over, to the ordinary shareholders). The bottom line is that the current PXUPA price of $31 is discounting an extraordinarily pessimistic outcome for this company over the next few years, however one that we do not believe will come to pass.