Cascades Inc. (TSX: CAS) is a paper and packaging company that produces, converts and sells packaging and tissue products composed primarily of recycled fibers. The company operates through four segments: Containerboard, Boxboard Europe, Specialty Products (which constitutes the Company's Packaging Products) and Tissue Papers. Under the Containerboard segment, it manufactures containerboard and converter of corrugated products in North America. The Boxboard Europe segment is engaged in manufacturing coated boxboards in Europe. The Specialty Products Group manufactures industrial packaging, consumer packaging products and is also involved in recovery and recycling. The Tissue Papers segment operates units that manufacture and convert tissue papers for the Away-from-Home and consumer products markets.

Investment Rationale

• Provider of Essential Daily Products to its Customers: As a producer of innovative, eco-friendly tissue and packaging solutions, the company's products play a vital role in the everyday lives of businesses, families, and individuals. The importance of this role was heightened in 2020 and continuing in 2021 as well, as apprehensions related to the pandemic led to an even greater need for the essential products. The substantial investments made in the platforms, equipment and technology over recent years meant the company was well prepared to meet the changing needs of its customers throughout the year. In addition to reinforcing the resiliency of the company's operations and the quality of the products, its strategic investments have equipped Cascade to be a reliable and essential partner for the customers not only during periods of great need but every day.

• Increase in Boxboard Shipment Value: During the first quarter of 2021, shipments of recycled boxboard increased by 42,000 s.t., or 16%, compared to the prior quarter, while shipments of converted boxboard also increased 1,000 s.t., or 20%. These increases were primarily a reflection of higher shipments in Western Europe and the usual seasonal production shutdowns taken during the holidays in Q4 2020. Further, on a sequential-quarter basis, higher sales reflect the increase in shipment volumes, slightly offset by the 2% appreciation of the Canadian dollar compared to the Euro.

• Increasing Capacity Utilization: The capacity utilization rate is an important indicator for companies because it can be used to assess operating efficiency and provides an insight into cost structure. It can be used to determine the level at which costs per unit go up or fall. When there is a rise in output, the average cost of production decreases. It means that the higher the capacity utilization, the lower the cost per unit, allowing a business to gain an edge over its competitors. In the case of Cascade, the capacity utilization regained its pre-COVID level at 91% at the end of the Q1FY20. Also, a higher capacity utilization would bolster Cascade's margin profile and profitability in the mid-term.

• Robust Financial Risk Profile: Cascades risk profile continued to remain strong, with healthy cash flow expected in fiscal 2021. Also, the debt protection metrics have significantly improved, with Net Debt/Adjusted OIBD stood at 2.5x, well below the standard 4x, which is considered stronger financial strength to manage debt. The interest coverage ratio stood at 6.5x, which is decent. These debt protection metrics show negligible balance sheet risks for the company.

• Offering a Decent Yield Income Opportunity: Cascades Inc. yielding higher compared to the risk-free rate of 1.39% on the Canada 10-Year Government Bond Yield. At the last traded price, Cascades Inc. shares were yielding 2.1%.  Given the current market conditions, lower interest is expected to remain in position for an extended period, and we believe that Cascades Inc. shares are offering a decent yield. Further, the company has a consistent track record of dividend payment over the past five years.

• Positive Outlook: In light of continued uncertainty regarding the COVID-19 pandemic, the group is maintaining a cautiously optimistic view of its near-term performance. Sequential results from the Tissue business are expected to remain stable, with performance over the longer term expected to improve as consumer tissue demand normalizes once inventories are re-balanced. Away-from-Home demand increases as the economy and businesses reopen, and benefits are realized from the high single-digit price increase announced for consumers and Away-from-Home tissue products beginning in the third quarter.

• Risk Associated to Investment: The company is exposed to a variety of risks ranging from an increase in the raw material prices, currency fluctuation risks, and general market condition risks as well. Further, rising crude oil prices could weigh on the company's margin profile.

Recent Update:

On July 5, 2021, the company announced that it has entered into an agreement with an affiliate of funds managed by affiliates of Apollo Global Management, Inc. to sell its 57.6% equity interest in Reno De Medici S.p.A. for an all-cash price of €1.45 per share, corresponding to a total net cash consideration of approximately €315.3 million (approximately CAN$461 million). The transaction is expected to be completed in the third quarter of 2021 and is subject to customary closing conditions, including required merger control approvals.

Financial Highlights: Q1FY21

• During the quarter under consideration, the company’s Sales of CAD 1,182 million decreased by CAD 83 million, or 7%, compared with the same period last year. This was driven by lower volumes in the Tissue segment attributable to continued COVID-19 related market softness in the Away-from-Home segment and an important contraction in consumer retail product volumes as customers rebalanced inventory levels that had been built up in response to elevated Covid-19 demand. This was partially offset by stronger volumes in all packaging segments, most notably in the Containerboard segment, which benefited from strong demand on both the manufacturing and converting sides.
• The Corporation generated an operating income before depreciation and amortization (OIBD) of CAD 128 million in the first quarter of 2021, down from CAD 157 million in the first quarter of 2020.
• On an adjusted basis, the first quarter OIBD totalled CAD 141 million, a decrease of CAD 16 million, or 10% from the CAD 157 million generated in the same period last year. This decrease was largely attributable to lower Tissue results, which reflected difficult year-over-year comparisons following elevated COVID-19 related demand in the year-ago period and customer inventory management in the current period that impacted retail consumer demand levels.
• European Boxboard adjusted OIBD levels also decreased from the year-ago period, as material cost inflation more than offset the benefits from improved volumes. Good results from the North American packaging segments partially counterbalanced these headwinds.
• Results from the Containerboard segment increased 9% year-over-year, with higher volumes and beneficial selling price and sales mix mitigating the impact of higher raw material prices, while those of Specialty Products increased 50% compared to the prior-year period, driven by higher volumes and better realized spreads.
• Results also benefited from lower SG&A costs as a CAD 10 million expected credit loss provision on accounts receivable amounts was recorded in 2020 in relation to the COVID-19 pandemic.
• For the 3-month period ended March 31, 2021, the Corporation posted net earnings of CAD 22 million, or CAD 0.22 per share, compared to net earnings of CAD 22 million, or CAD 0.24 per share, in the same period of 2020.
• On an adjusted basis, the Corporation generated net earnings of CAD 29 million in the first quarter of 2021, or CAD 0.29 per share, compared to net earnings of CAD 39 million, or CAD 0.42 per share, in the same period of 2020.
• The Board of Directors of Cascades declared a quarterly dividend of CAD 0.08 per share to be paid on June 3, 2021, to shareholders of record at the close of business on May 19, 2021.

Top-10 Shareholders

Top-10 shareholders in the company held around 42% stake in the company. Lemaire (Laurent), and Letko, Brosseau & Associates Inc are among the largest shareholder in the company and carrying an outstanding position 12.18% and 9.82%, respectively. The institutional ownership in “CAS” stood at 33.37%, and ownership of the strategic entities stood at 18.19%.

Valuation Methodology (Illustrative): EV to Sales Based Valuation Metrics

Note: Premium (discount) is based on our assessment of the company’s growth drivers, economic moat, competitive advantage, stock’s current and historical multiple against peer group average/median and investment risks.

Stock Recommendation: In the mid-term, we expect Containerboard performance to reflect good demand and cumulative benefits from announced price increases, counterbalanced by raw material price inflation and planned maintenance downtime at the two Niagara Falls facilities in the second quarter.

Also, near-term results for the Specialty Products are forecasted to remain stable sequentially, with higher volume and average selling prices offsetting slightly higher raw material costs. Moreover, sequential performance from the European Boxboard segment is expected to remain stable as good volumes and higher average selling price because of announced price increases should mitigate higher raw material costs.

Further, the group has continued to focus on its margin improvement program, with several initiatives expected to contribute annually to the consolidated adjusted OIBD. The company is focused on advancing its Bear Island containerboard project and finalizing modernization investments in tissue converting operations.

Further, the company is maintaining a robust risk profile with debt protection metrics has significantly improved with Net Debt/Adjusted OIBD stood at 2.5x, well below standard 4x, which is considered stronger financial strength to manage debt.

Therefore, based on the above rationale, considering the risk associated and valuation done, we recommend a “Buy" rating on the stock at the closing price of CAD 15.14 on July 02, 2021.

Technical Price Chart (as on July 02, 2021). Source: REFIITIV, Analysis by Kalkine Group

*The reference data in this report has been partly sourced from REFINITIV.

*Recommendation is valid at July 5, 2021 price as well.

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