As I've written before, the paper market is a tough business these days. Demand and pricing seem to favor users over producers, while high energy and chemical costs have added unwelcome pressure to the expense side of the equation. Nevertheless, plucky little Neenah Paper
The second quarter was a challenging one for Neenah. Revenue dropped 9% as lower pulp sales more than offset a modest performance from the fine and technical papers business. On the margin side of things, a strong Canadian dollar and incremental expenses experienced as a stand-alone company further hurt results. Operating income fell about 60% (including a restructuring charge), and net income dropped 71% for the quarter.
In the fine papers business, slight improvements in volume and price led to a 1% increase in revenue, while higher fiber costs and higher allocated corporate expenses stung operating income. For technical paper, volumes were up 3%, but pricing was lower on a mix shift, and total revenue dropped 1%. Operating income here was almost cut in half due to higher energy and latex costs, not to mention allocated overhead.
For the pulp business, sales were down 16%. Volumes dropped about 18% due to an announced mill closure, and operating income fell into the red due to higher operating expenses and the Canadian dollar.
Though I've followed the paper trade for a while now, Neenah is still a puzzle to me in some respects. While this year won't be very good from a strict operational or financial sense, the company still has margins and internal rates of return that compare well to industry standards, and its free cash flow is positive so far this year.
I like the fine paper business -- it's relatively high-margin and produces the majority of the company's operating income -- and I think management could make it even better. I'm a bit more cautious about the technical paper, but I see room for positive contributions.
However, the pulp business concerns me. Pulp is a brutally competitive sector, and I'm just not sure that Neenah can compete with the likes of Aracruz
Investors should also note that management appears to be considering options for reaping value from the company's timberland assets. Neenah owns about a million acres of timberland in Nova Scotia. Predicting prices for timber transactions is more voodoo than finance, but I'd say that this land could be worth $500 million to $700 million -- maybe more.
The "motley" in Motley Fool means that we sometimes disagree with each other. I think Neenah has a lot of potential and a reliable management team at the top, but I'm not buying the shares. At present, I'm more interested in Finnish paper maker UPM-Kymmene
Unfold further Foolishness:
Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).
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