Schweitzer-Mauduit Is Not a Value Trap

It's an undervalued income stock paying a dividend of almost 6%

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Mar 17, 2022
Summary
  • Schweitzer-Mauduit is trading far below its estimated intrinsic value.
  • However, an examination of its financials shows the company has a healthy earnings capacity.
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Schweitzer-Mauduit International Inc. (

SWM, Financial) is a $950 million performance materials company. It operates through two segments, Advanced Materials & Structures and Engineered Papers. The Advanced Materials & Structures segment manufactures and sells resin-based rolled goods, such as nets, films and melt blown materials for filtration, transportation, construction and infrastructure, medical and industrial end markets. The Engineered Papers segment provides low ignition propensity cigarette papers that are designed to self-extinguish when not actively being smoked, reconstituted tobacco, wrapper and binder products used in machine-made cigars, alkaline battery separator papers and commodity paper grades for printing and writing, flooring laminates and food service packaging. The company is headquartered in Alpharetta, Georgia and operates globally. The AMS segment makes up about 70% of the total business and the EP segment about 30%.

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Schweitzer-Mauduit’s history dates back to the Renaissance, when its first paper mill (Papeteries de Malaucene) began operations in the south of France. Schweitzer was founder in 1908 in New Jersey and then acquired Papeteries de Malaucene in 1922. Operations were focused on fine writing papers and fine papers for the tobacco market, as well as the addition of the company's reconstitution capabilities.

Schweitzer was then acquired by Kimberly-Clark (

KMB, Financial) in 1957, but became an independent public company in 1995 following a spinoff. Schweitzer-Mauduit expanded its paper operations around the world with key acquisitions and openings in North and South America, as well as in Europe, including its European flagship operation in Poland. During this time, the company formed two joint ventures in China: China Tobacco Mauduit (paper) and China Tobacco Schweitzer (recon).

Expanding its reach beyond paper with organic growth strategies and acquisitions, Schweitzer-Mauduit established its Advanced Materials & Structures platform. The company acquired and integrated Argotec (2015), Conwed Plastics (2017) and DelStar Technologies (2013), specializing in market-leading netting and specialty TPU films. The company also created its in-house LeafLAB, which focused on botanical materials for beverage, packaging and cosmetic applications.

In February 2020, Schweitzer-Mauduit acquired Tekra, a business producing technical film for end markets that include medical, graphics, electronics and automotive. This gave it access to new customers and created opportunities to provide additional solutions to existing customers. In April 2021, the company acquired Scapa Group Ltd., a UK-based innovation, design and manufacturing solutions provider for the health care and industrial markets for $630.6 million. The acquisition was funded with debt.

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Below is an overview of the company's current balance sheet.

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Schweitzer-Mauduit's income statement over the past five years is shown below. While the top line has increased rapidly, net profits appears to be stagnant. This may explain the company's low price-earnings ratio, which is currently 10.61. However, the ratio has been in decline over the last decade due to value compression.

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The company's profitability has suffered from inflationary cost increases but slower progress in passing price increases on to its customers. Hopefully, this lag will be eliminated in the coming year.

The following diagram shows Schweitzer-Mauduit's cash flows. Free cash flow took a dive in the latest annual report, though this looks temporary and driven by one-off charges and acquisitions. The lower cash flow is mainly due to increased working capital (yellow bar) and loss in the disposition of assets (pink bar labeled "cash flow from others"). Another thing to note is the large amount of depreciation and amortization and relatively modest amount of capital expenditure used by the business. This has resulted in free cash flow being much higher than net income for most years (except the last).

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Dividend

The company pays a solid dividend with a current yield of about 5.9%. In previous years (except the last), free cash flow has covered the dividend. Once the company stabilizes, cash flow should be adequate to cover the dividend.

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Valuation

The company is currently at a price-earnings ratio of less than 11. Long-term earnings per share growth has been about 9% per annum. As such, this looks like excellent value to me.

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The negative is, of cours,e the high level of debt the company has taken on to fund its mergers and acquisitions.

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The earnings-based discounted cash flow calculator with the indicated assumptions given below generates a value of over $50. One caveat is that the company's business is increasingly cyclical as it moves into the industrial space and away from its non-cyclical tobacco segment.

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Conclusion

Overall, I think Schweitzer-Mauduit is selling at an appealing valuation. The stock market appears to be pessimistic about the company and rightly concerned about the high leverage. The GF Value Line is also showing deep value; so much so that it's triggering a value trap warning as the stock is trading far below its estimated intrinsic value. However, I think this is not correct (and confirmed by my DCF value estimate given above.) The company does not appear to be a value trap and the issues it is facing are temporary. The GF Value is an intrinsic value estimate from GuruFocus that uses the stock's historical price multiples, past returns and estimates of future business performance.

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Balancing the price is the high dividend yield and good prospect of its material science business, which the company continues to build with its acquisition strategy. The company also continues to produce excellent cash flow, so I expect it to bring its leverage down in the next few years.

Disclosures

I am/ we are currently short the stocks mentioned. Click for the complete disclosure
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