Glatfelter Worth A Closer Look

By Stephen D. Simpson, CFA | February 10, 2012 AAA

Investors who are familiar with my writing know that I love companies that look like they should be just commodity companies, but actually have fairly interesting businesses under their roofs. Glatfelter (NYSE:GLT) is a good example - while this company still is largely a paper company, it has also worked hard to diversify and reinvest cash flow into higher-growth markets. Although the stock is not tremendously cheap today, it definitely merits a spot on investor watchlists.

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More Progress in the Fourth Quarter
Glatfelter is covered by just one sell-side analyst (Mark Wilde at Deutsche Bank), so discussions of financial performance relative to expectations have to be taken with more than just a grain of salt. That said, revenue growth of over 4% was fairly solid relative to its addressable markets.

Specialty paper sales grew about 2% on a half-point improvement in volume, while composite fiber sales rose nearly 7% on a similar volume performance. Last and not least, the advanced airlaid business saw over 8% revenue growth on a better than 6% volume growth.

Although Glatfelter had to absorb higher energy costs, profits improved nicely. Gross margin improved by 20 basis points, while reported operating income rose 15%. Margins improved in every reporting segment, with profits more than tripling in the airlaid business. (For related reading, see A Look At Corporate Profit Margins.)

New Businesses Continues to Grow
One of the features of Glatfelter's story is that the company has made a habit of using the cash generated by its paper business to expand into markets with better prospects for long-term growth and meaningful differentiation.

One of the best examples is the company's efforts in coffee and tea bags. Glatfelter has about 70% share in the market for the bags and filters that are used in K-cups produced by Green Mountain Coffee Roasters (Nasdaq:GMCR) and Sara Lee (NYSE:SLE), and shipments grew more than 5% this quarter. Better still, bagged coffee and tea is still a growth opportunity in a large part of the developing world where tea is quite popular.

Balancing Costs, Spending and Future Growth
Some investors may worry about the recent trend in free cash flow at Glatfelter, as it has not been very positive. Investors should realize, though, that these results include tax benefits related to alternative fuel credits. Investors also need to be aware that the company has been investing cash into capacity. Glatfelter is looking to add more capacity in its coffee and tea business in the coming year, and given that the airlaid materials business is running close to capacity, further investment here seems likely as well. (For related reading, see Free Cash Flow: Free, But Not Always Easy.)

Although capacity expansion clearly costs money, it's also necessary to support growth. Glatfelter has a good relationship with Procter & Gamble (NYSE:PG) supplying airlaid materials used in hygiene products, but if Glatfelter can't supply all of P&G's needs, they'll look to rivals like Buckeye Technologies (NYSE:BKI) to fill the gap.

Glatfelter will also need to manage its costs carefully. Whenever the housing recovery comes, it is likely to produce some upward pressure on fiber input costs. While Glatfelter's products are somewhat more specialized (and command higher prices), it's still a risk.

So too is obsolescence. Glatfelter has done well reinvesting in businesses with a bigger future, but the reality is that almost a quarter of the company's business comes from paper used in book publishing, and nearly one-fifth comes from "converting papers" used in applications like envelopes. Glatfelter may well be better-positioned than more traditional paper companies like International Paper (NYSE:IP) or Domtar (NYSE:UFS), but the fact remains that a lot of the company's business is on the slow boat to the museum.

The Bottom Line
I'm a big fan of this business, but I can't say quite the same about the stock. I do believe that Glatfelter will get back to solid free cash flow growth in a couple of years, but I still only see long-term free cash flow growth in the mid-single digits. At that rate, the stock is worth close to $19. That's not quite enough to tempt me to buy today, but a 10% pullback would make this a much more interesting opportunity.

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At the time of writing, Stephen Simpson did not own shares in any of the companies mentioned in this article.

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