Which Company Is the Best Tissue-Paper Play?

Source: Orchids Paper

According to historical data published by RISI, the U.S. tissue market has grown by a 1.85% compound annual growth rate, or CAGR, over the 17-year period from 1996 to 2012. In fact, domestic tissue-paper demand has increased in every single year of this period, excluding 2009. This reflects tissue paper's status as a defensive consumer staple whose demand is unaffected by economic volatility.

However, the steady growth in tissue-paper demand isn't shared equally by all market participants. Which of the tissue companies -- Kimberly Clark (NYSE: KMB  ) , Orchids Paper (NYSEMKT: TIS  ) , and Clearwater Paper (NYSE: CLW  )  -- is the best bet on such a defensive industry?

Branded tissue paper giant
Kimberly Clark produces products such as facial and bathroom tissue, paper towels, and napkins under prominent brands such as Kleenex and Scott under its consumer tissue-paper business. This business segment has experienced relatively flat revenue growth over the past three years. Its consumer-tissue segment revenue fell by 3.6% in 2012 to $6.5 billion before growing slightly by 1.7% to $6.6 billion in 2013.

In response, Kimberly Clark has introduced improvements to its existing products and also launched new innovative products. It has improved the quality of products such as Kleenex facial tissue and Cottonelle bathroom tissue so that consumers get bigger bang for the same buck, i.e. consumers need fewer sheets to perform similar functions. Kimberly Clark also rolled out a three-ply super-premium bathroom tissue under the Neve brand in Brazil.

Although Kimberly Clark did well in the first quarter of 2014, growing sales and expanding operating margins by 3% and 10 basis points, respectively, reasons for concern exist about the future prospects of its branded tissue-paper business.

The lackluster revenue-growth numbers for Kimberly Clark stem from a widespread consumer shift from branded to private label products across various product categories rather than just poor execution. Based on IRIWorldwide research, private label's U.S. market share of paper towels has increased from 18% in 2003 to 31% in 2013; private label bath tissue grew its share of the U.S. market from 15% to 23% over the same period.   

Source: Orchids Paper

Benefiting from increased private label penetration
Orchids Paper, a fully integrated manufacturer of private-label tissue products for the consumer "at-home" market, has been one of the key beneficiaries of consumers' migration to cheaper private label tissue paper products. It grew its revenue and net income by three-year CAGRs of 8% and 31%, respectively.

While other private-label tissue paper companies also compete for the market, Orchids Paper has several competitive advantages that keep its competitors at bay.

Firstly, Orchids Paper is only one of a handful of tissue paper companies (about five, according to the company) that operate in the northeast Oklahoma region. Given the scarcity of new locations available for similar manufacturing facilities and the high costs associated with transporting bulky tissue paper, Orchids Paper enjoys high barriers to entry. 

Secondly, Orchids Paper operates in the northeast Oklahoma region, which has historically boasted population growth higher than the national average. For example, the population of the northeast Oklahoma region grew by 1.34% in 2012, compared with 0.74% for the U.S. as a whole.

Thirdly, while Orchids Paper has traditionally focused on supplying value-tier products to the discount retail market, it has been moving up the customer value chain by penetrating higher-quality product tiers. In 2013, mid- and upper-tier tissue products accounted for 37.9% of its sales, compared with a corresponding revenue contribution of 6.8% in 2011.

Another private label tissue play
Clearwater Paper is another company which is a play on the growth of the private-label tissue market. However, it is a less attractive proxy than Orchids Paper for two reasons.

Firstly, Clearwater Paper isn't a pure proxy for private-label tissue market growth, as it generated 61% and 39% of its 2013 revenues from consumer-tissue products and pulp & paperboard products, respectively.

Secondly, Orchids Paper boasts relatively more resilient revenues than Clearwater Paper as it derives a high proportion of its sales (81%) from the discount retail channel. In comparison, about 70% of Clearwater Paper's consumer tissue products are sold through the grocery channel. This is a positive for Orchids Paper, because discount retail stores tend to attract more cost-conscious consumers who buy private-label tissue products.

Foolish final thoughts
Tissue-paper demand has historically remained stable and tends to correlate with population growth. Among the different tissue-paper segments, private label has been gaining market share over the years at the expense of its branded counterparts. This trend is set to continue, with Orchids Paper being the best proxy for the growing and resilient private-label tissue market.  

Which brand of tissue paper do you use in your living room?
If you are using private-label tissue products, you are one of many customers who contribute to the growth of Orchids Paper. You know cable's going away. But do you know how to profit? There's $2.2 trillion out there to be had. Currently, cable grabs a big piece of it. That won't last. And when cable falters, three companies are poised to benefit. Click here for their names. Hint: They're not Netflix, Google, and Apple. 


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Mark Lin

Mark is a private value investor and is the author of website which uses a systematic quantitative screening approach to filter the global stock markets for cheap cigar-butts and wide-moat compounders.

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