KP Tissue Inc. made a December debut on the Toronto Stock Exchange with little fanfare. Odd, really, because KP Tissue is one of Canada’s leading consumer-product companies, with plans to declare a healthy dividend.
A nice combination, certainly. And investors still have the chance to get in on the company before it emerges from obscurity.
At the same time, however, a potential buyer of KP Tissue would be well advised to look closely at a number of warnings in the company’s prospectus. KP Tissue may be undiscovered, but it may not be an undiscovered gem.
The “K” in “KP” stands for Kruger Inc., the family-controlled Quebec company that acquired decades-old Scott Paper from Kimberly-Clark in 1997.
Kruger’s brands now include Cashmere and Purex toilet paper; Scotties face tissues; and White Swan and SpongeTowels paper towels. Citing ACNielsen data, KP Tissue says the Kruger brands are No. 1 in the Canadian toilet paper and face tissue markets, with about a one-third share, and second among branded paper towels, behind Procter & Gamble’s Bounty, with just over 20-per-cent share.
More than 70 per cent of the Kruger paper-products business comes from its brand-heavy Canadian operations. About 25 per cent of sales are in the United States, where the bulk of its revenue comes from a private-label paper business making tissues and towels for retailers.
As it happens, current trends make this split providential; KP Tissue says Canadians have been moving more toward brand-name products in recent years, while shell-shocked U.S. consumers have been moving downstream to cheaper private-label products.
To gain share in the United States, KP Tissue is spending $322-million (U.S.) to upgrade its Memphis, Tenn., plant with more “through-air dried,” or TAD, capacity to make higher-quality products. Most TAD paper products in the U.S. are sold with brand names; KP Tissue sees an opportunity to bring higher quality to the private-label market.
KP Tissue plans (but does not promise) an annual dividend of 72 cents (Canadian), with the first quarterly instalment in April. At recent prices around $19 a share, that’s a yield that approaches 4 per cent. (KP Tissue estimates the paper products business generated about $164-million in operating cash flow in the 12 months ended in September, which works out to more than $3 a share.)
So, place that “buy” order? Consider a few things first.
One is the curious structure of the company. KP Tissue isn’t actually the company that’s selling all these paper products or upgrading that plant. That would instead be Kruger Products LP, or “KPLP.” KP Tissue holds 16.9 per cent of the partnership units of KPLP, with a subsidiary of Kruger Inc. holding the remainder.
The prospectus says KPLP was formed to “optimize the financial and tax structure of the operating business,” which one supposes, means optimizing it for Kruger Inc. (KPLP accounted for 43.5 per cent of Kruger Inc.’s $2-billion in 2011 revenue.)
The prospectus doesn’t make terribly clear, however, why public shareholders get such an indirect route to the business. (I asked the company this and other questions Jan. 14; it didn't respond until after deadline. See the response at the bottom of the article.)
Intriguingly, the prospectus also warns that Kruger Inc. operates in industries that “are presently experiencing difficulties that may materially adversely affect the financial condition of Kruger.” Important, because the prospectus warns Kruger Inc. has granted liens on its KPLP units as part of its borrowing and “there can be no assurance that Kruger will not default” and that its creditors won’t take control of KPLP. (The prospectus provides no balance sheet for Kruger Inc. that would let us estimate how large a risk this is.)
And, as KPLP builds its Memphis TAD plant, two competitors are also erecting similar machines to target the same customers at the exact same time, KP Tissue notes.
All told, the prospectus seems to suggest Kruger Inc. realized it needed to spend massively to keep up in the U.S. market, but wouldn’t or couldn’t do so without money from public shareholders. (The company didn’t respond to this assertion.) Shareholders are then rewarded with an unnecessarily complicated corporate structure and more risks than might first be apparent.
Let’s just say KP Tissue looks good on paper. In practice, we’ll just have to see how this works out.
Editor's Note: After deadline, Mike Baldesarra, KP Tissue's director of investor relations, said the LP structure allows 100 per cent of KPLP’s taxable income to flow to Kruger Inc. Since Canada’s Specified Investment Flow-Through rules prevent taking an LP public, he says, Kruger Inc. created KP Tissue. Mr. Baldesarra notes Kruger Inc.’s financial statements “are not required” in a KP Tissue prospectus. And Mr. Baldesarra notes that while $50-million from the IPO will be used for the TAD project, its financing, a stand-alone credit facility for which KPLP is not ultimately responsible, “was in place in 2011, well prior to the IPO.”
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