Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement. You can get a free copy here.
Fortress Paper Ltd. isn’t a big company but it has a big following. Investors have been net sellers lately, but after the stock shed half of its value in recent months, many wonder whether it’s time to buy.
From my perspective, the company is a “watch” – as in watch it but don’t buy it until you see concrete evidence of a turnaround.
What makes Fortress intriguing is its founder’s knack for a good story. Chad Wasilenkoff started out by buying a paper mill that quite literally makes money: the Swiss franc, the euro and others.
He then bought one of the biggest wallpaper mills in the world. Then he bought what no one else wanted: a pulp mill in Quebec. He figured that the mill could be retrofitted to produce dissolving pulp, a form of wood pulp that is the key ingredient in making rayon. Rayon is a substitute for cotton, and cotton prices were sky-high at the time.
I recommended the stock in this space a couple of years ago and it enjoyed a nice run. I’m cautious now; it’s becoming a real “show-me” story.
A money mill, wallpaper, contrarian buys – great stories all, and it’s not surprising that investors were enthralled. Fortress went public five years ago and quickly became a market darling. But things are tough these days.
The wallpaper division is doing just fine. The assets are carried on the books at about $60-million and last year produced $28-million in operating income on sales of $144-million. Those are pretty good figures, and although it can’t be much of a growth story when recession is gnawing away at Europe, where the mill is located, wallpaper is the company’s crown jewel right now.
The security business – which comprises the money mill in Switzerland and also a nimble R&D shop that dreams up nifty security features for other money printers – has had a very rough go of it. The assets are carried at $142-million but they bleed money – a $31-million loss last year after a smaller loss the year before. The business is also capital intensive. Fortress has had to pump more than $60-million into it over the past couple of years. That move hasn’t paid off yet, although that may soon change.
It’s Fortress’s big investment in dissolving pulp that constitutes management’s “bet the company” move. Although Mr. Wasilenkoff paid next to nothing for the first mill he acquired, Fortress had to spend a lot of money to retrofit it. The mill is producing now, having begun late last year, but it is still losing money.
Unfortunately, rayon prices have not held up. This hasn’t abated Fortress’s love affair with dissolving pulp – it just bought another mill in Quebec. Investors are still worried, though, because the company is burning money and has considerable debt: $160-million. Considering it has equity of $220-million and is losing money before interest payments, the risks aren’t negligible.
But there is good news, which is why you should watch this stock carefully. The security business won back a big order that had been unexpectedly cut last year. The mill also sold its real estate and a hydro-electric dam to free up cash.
The wallpaper mill is cranking out cash and, after Fortress invested some money into it, has become more efficient.
The dissolving pulp business seems to be coming together. There were problems with the process and the quality but the company says capacity is running close to what it promised and customers are happy with the product.
So it appears that a turnaround might be near. The trouble is that, despite its decline, Fortress’s stock isn’t necessarily cheap.
The company trades for considerably more than its book value. Maybe it should; Mr. Wasilenkoff is a shrewd buyer so it’s possible that the book value understates the true value of the assets.
But we won’t know until the financials start to show evidence that the company has all the parts working smoothly. I could easily argue that Fortress can earn $4 a share under the right circumstances, but that doesn’t mean it can, and I’d rather wait until I see signs that it’s true.
It’s usually best to buy a stock after the company’s fortunes have turned. You’ll pay more for it but you’ll minimize the risks that come with buying a falling stock.