Predictable revenue stream. Check.
Company’s product will never be obsolete. Check.
Company is the dominant brand leader and has held that position for years. Check.
Company prudently invests in projects that will expand its revenues in the future. Check.
Company has been pressured by temporary cost inflation that should subside. Check.
Company generates excess free cash and has limited maintenance capital requirements. Check.
Finally, company’s stock price has underperformed but you are getting paid a fat dividend while waiting for the sentiment to change. Check, check and check.
What is this wonderful investment? KP Tissue of course. KP Tissue? Never heard of it? Well here’s why you should. KP Tissue is the largest branded toilet paper, facial tissue and paper towel producer in Canada. The company also has significant private label tissue relationships in both Canada and the U.S. Best of all, KP’s stock has seriously underperformed, delivering a total negative return since going public in late 2012.
So what’s wrong? First, KP has been affected by higher input costs and bad weather. Rising natural gas prices and rising prices for pulp have hurt its margins. KP has recently instituted price hikes on its products but they will take a few quarters to kick in. Second, the company has made a large investment to manufacture private label tissue in the U.S. but has been slow to fill the order backlog. The company is investing for the future but the payback period has been slow. Finally, many investors are confused about the company’s structure. KP Tissue owns a 16.6% interest in a Limited Partnership that owns the business that manufactures the tissues. The fact that investors are one step removed from the actual operating business has raised some concerns.
No investment is perfect but we see better days ahead for KP Tissue. KP Tissue went public to raise cash to build its private label manufacturing facility. That spending is now over. And the rewards are about to begin. KP believes it will generate an additional $25M in EBITDA during 2014 as it fills its private label order backlog. We believe by 2017, KP will have over $60M in additional free cash flow or over $1 a share extra that it can return to shareholders via dividends, share buybacks or acquisitions. That is what you call a cash flow machine. We believe that KP’s current dividend of 72cents a year is set to expand each year.
When one of your investments under performs it becomes a challenge to stay focused. First doubt starts to set in. Then as the stock ticks lower you start to feel the pain. Whether it keeps you up at night or makes you sick to your stomach, we have all been there. Your colleagues, peers, clients and the overall market compound your stress until finally, you can’t take it anymore and give up. But if you’ve done your homework and your thesis hasn’t changed, then there is no reason to give in, in fact, you should buy more. KP’s stock has underperformed since we’ve owned it but we are confident that our tears of pain will be wiped away with tears of joy in the coming months.
Disclosure: The author and clients of Baskin Financial Services own shares in KP Tissue Inc.
