Heavy Investment Cycle And Wood Supply Risks Will Pressure Returns For Years

Catalysts

About UPM-Kymmene Oyj

UPM-Kymmene Oyj is a Finland based forest industry group that produces pulp, paper, plywood, label materials, biofuels, biochemicals and CO2 free electricity.

What are the underlying business or industry changes driving this perspective?

• The heavy investment cycle into assets like Paso de los Toros and the Leuna biochemical refinery is largely behind the company. If future capital spending stays close to maintenance levels, any slowdown in end markets for pulp, biochemicals or advanced materials could leave these large assets underutilized and pressure group EBIT and returns on invested capital.
• The planned closures of Kaukas and Ettringen paper mills remove 13% of current Communication Paper capacity and target €70 million in annual fixed cost savings. However, ongoing structural decline in paper demand and tariff related trade frictions could erode volumes faster than costs come out, limiting any uplift to EBIT margins.
• Biofuels is currently around breakeven at EBIT level and depends on country implementation of RED III and qualification of sustainable aviation fuel. Slower regulatory rollout or delays in SAF approvals would risk weaker pricing power and keep earnings and cash flow contribution from Decarbonization Solutions below expectations.
• Fibres North has been slightly EBIT negative at cycle low pulp prices and peak wood costs. Although wood prices in Finland have started to ease, a smaller or shorter than hoped reduction in wood costs would keep this platform close to break even and cap improvement in group EBIT and net margins.
• The Versowood partnership and measures to secure more pulpwood and chips increase reliance on a concentrated Finnish wood supply at a time when local wood availability has already been challenging. Any disruption or weaker than planned supply benefits would sustain higher input costs and weigh on EBITDA and free cash flow.

Assumptions

How have these above catalysts been quantified?

• This narrative explores a more pessimistic perspective on UPM-Kymmene Oyj compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming UPM-Kymmene Oyj's revenue will remain fairly flat over the next 3 years.
• The bearish analysts assume that profit margins will increase from 5.7% today to 9.6% in 3 years time.
• The bearish analysts expect earnings to reach €930.1 million (and earnings per share of €1.74) by about July 2029, up from €538.0 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as €1.5 billion.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 13.7x on those 2029 earnings, down from 22.3x today. This future PE is lower than the current PE for the GB Forestry industry at 22.3x.
• The bearish analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.59%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Advanced Materials, including Adhesive Materials and Specialty Papers, reported higher EBIT year on year and resilient quarter-on-quarter performance. The segment is targeting growth in higher margin and higher growth areas with relatively modest additional capital needs, which could support revenue and EBIT if this trend continues.
• Decarbonization Solutions, covering Energy and Biofuels, saw improving conditions, with higher electricity prices in Finland, robust power demand and recovering renewable fuel prices. UPM has 12 terawatt hours of CO2 free electricity capacity and is working to get Biofuels back to profit, all of which could support group earnings and cash flow.
• Fibres South in Uruguay generated €80 million EBIT at cycle low pulp prices with a 22% EBIT margin. Management is targeting further cost reductions per tonne as plantations mature and logistics are optimized, which could improve net margins and group EBIT if pulp markets stabilize or operating costs fall.
• Management is actively cutting fixed costs in Communication Papers through mill closures that remove 570,000 tonnes of capacity, aiming for €70 million in annual fixed cost savings. It has taken downtime in Finnish pulp mills to avoid the most expensive wood, which could support EBIT margins and cash flow if these measures are effective.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for UPM-Kymmene Oyj is €19.4, which represents up to two standard deviations below the consensus price target of €25.98. This valuation is based on what can be assumed as the expectations of UPM-Kymmene Oyj's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €32.0, and the most bearish reporting a price target of just €19.4.
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be €9.7 billion, earnings will come to €930.1 million, and it would be trading on a PE ratio of 13.7x, assuming you use a discount rate of 7.6%.
• Given the current share price of €22.75, the analyst price target of €19.4 is 17.3% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.