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June 26, 2014

At UPM Kymmene, Earnings Look Good On Paper

by Sridharan Raman.

Computers and the Internet were supposed to create the “paperless society.” Not any time soon. Check out Finnish pulp and paper products company UPM-Kymmene OYJ (UPM1V.HE), which seems to be unwrapping a ream of good news.

The company recently announced that it is targeting €200 million in EBITDA growth in the coming years by undertaking new initiatives to increase capacity at its existing pulp mill. It is also targeting €200 million in new cost-saving measures.

CEO Jussi Pesonen said on the last earnings call that the company is recording improving earnings despite a decline in paper demand, and it has developed tools to manage demand fluctuations.

One of those measures is a diversification to bio-diesel. These measures are likely to improve earnings in the coming years, but even in the current quarter, it looks like the company is set to report an earnings beat when it reports fiscal second quarter results on August 5. It currently has a positive StarMine Predicted Surprise of 5%.

UPM

Source: Eikon/StarMine

Turn the pages

As you can see in the chart above, analysts have continued to raise estimates for UPM, and the current I/B/E/S consensus estimate is at €0.25 per share, up from €0.22 just 90 days ago. The StarMine SmartEstimate, which puts more weight on the most recent estimates and the most accurate analysts, is even higher at €0.26, with a couple of 5-star analyst estimates above the consensus.

Analysts are not just optimistic about the current quarter; they’ve raised estimates for the full year by almost €0.15 to €1.00 per share. It looks like the expectations are for management to follow through on a goal to improve efficiency, with some of it already in place.

UPM 1

Source: Eikon/StarMine

Pulp non-fiction

After seeing return on net operating assets (RNOA) fall for two consecutive years, the last four quarters have seen a positive uptick. RNOA is a measure of how efficiently the company is generating returns on its assets

Just a year ago, the trailing 4Q RNOA was close to 0%, and since then has risen every quarter and is now at 5.9%, close to a five-year high. Based on management expectations, that is likely to continue to rise as more cost cutting measures are put in place. Although it does look like most of the improvements at UPM are coming due to cost cutting (analysts are revising earnings higher but not revenues), the stated goals of increasing production is likely also to help revenues and earnings in the future, and combined with an improved cost structure, it will likely put UPM in a strong position in the market. The fact that the company has been using its strong cash flows to reduce debt levels and strengthen its balance sheet is likely only to help in the coming quarters.

UPM 2

Source: Eikon/StarMine

Read the valuation story

The company has seen its stock price rise by more than 50% in the last year, but the stock still does not seem expensive. Using the Intrinsic Valuation model, StarMine calculates the growth required for the next five years to justify the current market price. We call that the market-implied growth rate, and for UPM that is 0.9%. That indicates that the market does not have high expectations for earnings growth at UPM. The StarMine 5-year growth estimate (the SmartGrowth) for UPM is much higher at 8.1% after systematically adjusting for known analyst biases. That may be closer to the actual growth rates that UPM is expected to enjoy over the coming years, considering that the company may be gearing up for an earnings beat in the coming quarter. Looks like profits won’t stay stationary at UPM.


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