The future outlook of the Nordic electricity market has made me reconsider becoming a UPM shareholder. I haven’t owned forestry industry companies before, as the basic dynamics of the sector don’t feel appealing. Roughly speaking, it has been an arms race among large plants, where growth investments are in reality just maintaining competitive positioning, since competitors will invest as well. Mainly due to this, Valmet has been a pleasing choice and still is, but that’s a different story.
UPM’s energy business potential is extremely interesting, and going through it is perhaps not all that sophisticated. Within 10 years, it will likely generate significantly higher cash flow than currently, and the market will probably also assign it a higher valuation than today. Energy - TASTES GOOD
However, UPM is not turning into an energy company, and a significant portion of the price paid for the share lies elsewhere. The pulp market is experiencing interesting times, as long-fiber seems to constantly lose its position in end products, and Chinese players are investing in integrated facilities, among other things. The Suzano presentation linked in the thread was, by the way, excellent! UPM is certainly in a fairly good position thanks to its Latin American plants, but indeed, the Finnish plants are a question mark. If older long-fiber plants in North America really start closing down, that could indeed bring relief to Finland (especially to the cooperative). If that doesn’t happen quickly, or regardless of it, UPM might make moves in Finland. I don’t have a good enough understanding of the industry and plant profitability, but I consider it likely that selling Pietarsaari to Billerud, for example, has been tossed around in management’s boardroom. With the Sappi joint venture collapsing, shutting down the entire Kymi mill at some point could be the other thing bounced around. In any case, UPM should be in a relatively good position regarding pulp, even though I generally dread the industry. My attitude towards the Pulp business is therefore relatively neutral, and I could pay a fair price for it at the current group valuation. Fibres - NEUTRAL (or satisfactory)
Specialty Materials and Adhesive Materials are very pleasing. One could go on and on discussing these, but I really only have positive things to say, so no need to use more characters at this point. SM & AM - TASTES GOOD
Communication Papers doesn’t spark shouts of joy, but I don’t have anything particularly bad to say either. Generating as much cash flow as possible for as long as possible makes it pretty fine as part of the group. Regarding this, it’s neutral, and perhaps even neutral+, if I reflect on my assumption of the average market participant’s (institutions/analysts) view on value. Communication Papers - NEUTRAL (or maybe even a plus after it)
But then we come to the segment that gives me the shudders, namely “Other operations” (Biorefining/Biofuels/Biochemicals). I would gladly pay someone to take that part out of my UPM ownership. In other words, if that didn’t exist, UPM probably would have already found its way into my portfolio. To be honest, it is of course important to remember that its impact on the group’s overall earnings performance is not overwhelmingly significant. The biggest problem (aside from burning money) I see is the lack of focus and, overall, a communicative distortion. It feels like the significance of these solutions is emphasized disproportionately outward. And even that wouldn’t be quite as bad if I believed that people within the company thought completely otherwise. Changing the segment to “Other business” gives a slight hope that at least not everyone considers it important for UPM’s future value creation. Losses could still be accepted if there were genuinely some outlook for a truly interesting financial opportunity. To my taste, there has been quite a bit of dishonesty regarding the segment (and Leuna), as it has been emphasized as somehow drastically revolutionizing the biorefining field, and because of this, burning money has been accepted. UPM says itself: “We are building the world’s first biorefinery in Leuna.” This is an alternative truth, to say the least, when compared to, for example, Borregaard, which has long achieved strong profitability with similar highly refined bioproducts. Someone from UPM might now come along to act wise about how they are somehow a more exceptional player and therefore can call themselves pioneers of such products. Biofuels & Biochemicals - DOES NOT TASTE GOOD AT ALL
At UPM, they like to highlight these highly refined products and their ability to innovate and produce such solutions. What if, however, they don’t have the muscle to respond to this? What if UPM is at its best “just” an efficient pulp producer and a massive-scale manufacturer of specialty papers/labels/packaging? Wouldn’t it be best for shareholders if the company just focused on creating value in its core competencies and communicated transparently about its operations to owners? I think it would. For example, I greatly respect Suzano because they are very openly an extremely efficient short-fiber pulp producer, whose communication radiates pride in their efficient mills and the opportunities they bring. Of course, they have also tried the so-called new world, like Spinnova in Finland, but they also knew how to keep it on the side and shut it down when they didn’t see a sufficiently interesting opportunity. Companies must try new things and look for new growth opportunities, but it still needs to be done on their own terms. Right now, it feels like Leuna and biochemicals are ruling UPM, and not the other way around. Biofuels & Biochemicals -Overall, one could say that Energy and SM/AM (Sawn Timber / Plywood) are really quite interesting. I can’t bring myself to be particularly fond of Fibres, but in all honesty, it is inevitably a part of the aforementioned, so it naturally comes with the package. Communication Papers tags along quite tolerably. It’s just that Biofuels & Biochemicals is a thorn in the side, even if it’s not that financially central. It’s possible that, despite its existence, I might end up becoming a shareholder if a suitable entry point appears. Perhaps a slight cultural shift could be sensed within UPM, in that its importance for future value creation is not seen as all that significant. If similar types of solutions interest you, I would turn my gaze to Borregaard or alternatively to some new companies emerging in the future, but as for UPM, I want to see something else. Among the traditional Nordic forest industry companies, Holmen is perhaps the most warming to the mind. Forest ownership is certainly at the core, but energy as well as packaging/specialty papers also bring in the money. I see the lack of their own pulp mill as purely a positive thing when one is able to buy from the current overcapacitated market. Perhaps UPM could fit in as the third interesting one, now that optionality has entered Energy. UPM is often considered a high-quality dividend payer, and in a way, it certainly has been. However, the reality is fairly well illustrated by the average free cash flow margin of 7% over the last 10 years. When revenue stubbornly stays around 10–11 billion, it practically translates to 700–800 million in free cash flow, meaning a 4–5% yield at the current valuation. One would have to believe in a lower investment need (and/or the dismantling of the current “machinery”) to build an interesting case out of this. On this basis, a margin of safety starting around the 20 euro mark would be desirable.