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Shareholders come first, say analysts and CEOs

BEYOND NUMBERS: What financial analysts really want to know about your company was the theme of the Investor Relations Forum on Thursday morning of PaperWeek at the Bonaventure Hilton.

With CPPA president Lise Lachapelle running the proceedings, an audience of about 200 heard from three analysts about how they go about their deliberations. They were followed by the CEOs of three Canadian companies who gave their perspectives on the role of analysts and how they influenced the CEOs’ jobs.

Mark Wilde stepped up first with a US perspective on evaluating Canadian forest companies. Wilde is managing director and lead pulp and paper sector analyst for BT Alex Brown, New York.

His primary clients are institutional investors such as mutual or pension funds who handle money on other people’s behalf. Analysts, he said, “are always being measured by performance of their stock picks.”

Why would anyone care about investing in paper stocks anyway? It hasn’t been a pretty picture since 1988 either in Canada or the US. They form an ever-decreasing part of the market with 0.5% of over-all equity in the US and about 2% in Canada. He showed comparative market capitalization figures for Microsoft ($US404 billion) and the world’s largest pulp and paper company, International Paper ($US12.9 billion). In Canada, the highest capitalization is for Northern Telecom at $C55.9 billion compared with Donohue at $C2.2 billion.

According to Wilde, the big issues include increasing maturity in North America with growth at or just below GDP. Oversupply is also a big theme, and has cropped up in several of this year’s Open Forum’s. The geographic centre of the industry is shifting south from Norscan countries. Investment decisions are often distorted by government decisions all over the world.

He explained how he would go about recommending a paper stock. On industry calls he would look for good cyclical timing and any structural shifts such as government intervention. On company calls, he said he has no hard and fast rules when it comes to large versus small companies, whether commodity or specialty or even whether domestic or off-shore markets are involved.

Wilde said, “I’d rather buy a bad company well than a good company poorly. It’s hard to do well with bad industry fundamentals.”

He said company management matters tremendously. There’s lots of hidden asset value and things haven’t been well run over time. But, good management can “unlock value over time — if an analyst can spot good management moves, he’ll help the investor.”

Management can help in several ways, he said: By re-appraising the business and assets, monetizing non-core assets (e.g. timber holdings and power sources); through disciplined use of capital; avoiding over- engineering. Buy rather than build, Wilde suggested, and buy at the bottom (he noted Michael Smurfit who started with one machine in Ireland 35 years ago). Return excess cash or capital to the shareholders he said — in the US stock buybacks are the most tax efficient.

Finally, Wilde said, be willing to be a seller. “Consolidation is sorely needed in the industry, it is not a panacea but unless it is done, capital will flow away from the industry.”

Stephane Gagnon, portfolio manager for the Caisse de depot said that he looks for a well-articulated cost reduction program and a disciplined use of cash. He said investors are skeptical about how reasonable are the assumptions used in planning. Mill managers must be able to understand what their customers need and should be aware of the strengths and weaknesses of not only their own companies but also their competitors. He said a recent survey of mill manager’s priorities showed management of the safety program was at the top of their list; improving shareholders’ returns was in sixth place and strategic planning in seventh.

Gagnon suggested linking mill managers’ remuneration to stock performance: “There’d be some changes then.”

In Gagnon’s view, the industry still behaves as it did in the 1970s with a “Build it and they’ll buy it mentality. “A low-cost strategy is only half the equation.” Investors are far less optimistic on pricing scenarios than management, he said. Another survey he quoted showed that only 23% of companies had their production in line with demand in 1999. Production rather than profitability drive the industry, he said.

The safe path to growth is to concentrate on the main activity and provide achievable synergies. Be immediately accretive and have realistic assumptions. Get rid of non-core assets quickly and efficiently. Be funded by a reasonable level of debt.

Gagnon concluded by noting that the market is very efficient and under-performance requires a change in business strategy. “Free cash flow is king,” he said, capital spending is not the solution.”

Hamish Kerr said the topic was interesting to him because he normally talks about the forest products industry and not the one he works in.

Kerr is a former forester who is now vice-president and director, forest products analyst with Goepel McDermid, Vancouver, BC. There are two groups, he said: The capital markets group which works with institutional investors and the corporate finance side which has companies as its primary clients. “The analyst is caught in the middle and makes money for both sides.”

An analyst needs to be a “knowledge box”, said Kerr. He should be able to tell a story, be a born optimist and be opinionated. In his opinion, brokers have made a lot of money from the forest industry in the last decade but the investment and corporate finance clients have made very little.

Kerr said that success is not tied to size, timber supply or higher value products. For example, the challenge for Donohue now is for it to perform as well as a large company as it did as a small one. Donohue and Primex of BC have superior Earnings Before Income Tax, Depreciation and Amortization (EBITDA) margins, he said, and get good return on capital through “wise re-investment of cash.”

Kerr said it was important for senior management to remember that not all stakeholders are equal. “Only shareholders can replace the board of directors and management.” (But he recommended that they be nice to everyone else to get the share price up.)

“Canada could be leading the way to increase shareholder value in the industry because share prices have been so low for the last 10 years that the shareholders are pressing for change.”

During the Q&A period, the three analysts added more to their comments. For example: 75% of the acquisitions don’t generate expected savings (Kerr). Economies of scale are at the mill level: Consolidation is not the entire solution (Wilde). Environmental concerns shouldn’t affect the value of a stock; one assumes the company will comply with laws (Gagnon).

Following the analysts presentations, three ceos were asked to give their perspectives on the work of analysts. Pierre Monahan, ceo of Alliance Forest Products said it is fundamental to communicate the company’s strategic plan. “It’s very hard to do this without spending some money.” The bottom line is the key issue, he said. “My job as a financial guy is to stop the technical people from spending money!”

K.Linn Macdonald, president and ceo of Nexfor Inc., said that break even is not a good investment. Analysts help investors to interpret the information to assess effects on share prices. He criticized “sell-side” analysts for changing their minds too quickly. Share prices depend on performance, not analysts’ reports, he said. Earnings forecasts are frequently wrong.

As senior managers, we are playing with other people’s money. It is our obligation to do it carefully for the shareholder’s benefit. As managers, we use key performance indicators, such as tonnes/hour and so on.

The ultimate measure of success is the share price, and we can’t influence that directly. Managers must focus on long-term success using minimum capital, said Macdonald. Focus on goals not share-price, that will come, he said.

Jim Shepherd, currently president and coo of Crestbrook Forest Industries Ltd. and soon
to move to a similar position with Slocan said he’d hoped for more controversy from the analysts. “I learned as an engineer about overspending. Now EBITDA is a big word in my company’s running,” he said.

“The low cost guy is always successful,” he believes. “We must understand that the shareholders are the number one priority.-