As the title of this column suggests, the results released by paper producer and Motley Fool Hidden Gems recommendation Neenah Paper (NYSE:NP) earlier this month weren't at all pleasant for its shareholders.
Belying analysts' expectations that the company would produce $0.17 in profits per share in the third quarter of 2005, Neenah produced a nasty surprise: $0.10 in losses. That has to hurt -- even when you consider that what analysts were really predicting was probably not "net profits" but rather "operating profits." (One knock I've raised against Yahoo! Finance's otherwise useful, free data summaries for investors is that they don't make clear just what kind of earnings it is that analysts are predicting.) Even if analysts were predicting "operating profits," however, they still got it wrong; on an operating basis, Neenah still produced only $0.10 worth of profits.
Thus, Nov. 3 marked the third consecutive announcement of disappointing results for Neenah. Even so, I'd normally be inclined to give this company the benefit of the doubt. It's got the endorsement of master value investor Tom Gardner -- no small feat. It possesses undervalued land assets, as fellow Fool Nathan Parmelee noted in a column back in March. Yet another fellow Fool, Stephen D. Simpson, pointed out that these assets alone might be worth more than the price the entire company currently commands.
But not to me.
In its latest 10-Q filing with the SEC, Neenah revealed that it generated just $28.3 million in free cash flow in the first nine months of 2005. That's down 42% from the equivalent year-ago period, when the company was still part of Kimberly-Clark (NYSE:KMB).
This negative trend alone bodes ill. But even if you assume the trend plateaus starting now, giving the company a free cash flow run-rate of $37.7 million through the end of this year, Neenah would have an enterprise value-to-free cash flow ratio of 16. That would be fine if Neenah were expected to grow at 16% over the long term, but so far, no analyst predicts that. Granted, analysts expect Neenah to rebound in 2006. But longer-term, I just don't see this company outperforming its industry average, which analysts predict will grow at 6.5% per annum.
As an investor, I'm humble enough to admit that there are some things I understand and others I don't. Predicting timelines for turnarounds in cyclical, low-margin paper businesses is one skill I lack. Valuing Nova Scotian real estate is another. What I do understand is basic math, based on a company's enterprise value and its free cash flow. And on this basis (and no other), I find Neenah Paper an unattractive investment at today's price.
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Fool contributor Rich Smith does not own shares of either company named above.
