Orchids Could Bloom Again After Withering Competitive Pressure

Orchids Paper Products (TIS) has been an awful call for me over the past 18 months, as this manufacturer of primary private-label tissue products was hit hard by pricing moves from the competition and its own elevated costs and challenges tied to getting a new plant up and running. At the worst, the company saw revenue drop more than 20% year over year, leading to its first quarterly operating losses in a decade, serious liquidity pressures, and the suspension of the dividend. With all that, the shares are less than half the price they were the last time I wrote about this company.

On the positive side, the company's new Barnwell facility is up and running, the company has been successful in targeting more premium business, and the book of business over the next year would suggest record revenue and EBITDA. On the negative side, price and cost pressures remain a risk and the company must do something about its liquidity situation, as there is little room for error here.

I believe a lot of things went wrong for the company all at the same time, but I don't believe the story is broken. If the new business comes through as expected, Orchids should be back on a path toward high-single-digit/low-double-digit revenue growth and a return to operating and free cash flow margins in the mid-teens. Those, in turn, support a fair value in the mid-to-high teens, making Orchids a high-risk story that does at least offer some upside.

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Orchids Could Bloom Again After Withering Competitive Pressure

Orchids Wilts In The Summer Heat

The second quarter results from Orchids Paper Products (NYSEMKT:TIS) are a case-in-point as to why I always drone on about "margin of safety" and risk/reward when talking about whether or not to buy a stock. I continue to believe that Orchids is a very well-run paper products company with a bright future and significant growth potential, but the second quarter was a pretty significant example of how "stuff happens" that can't always be fully modeled or predicted.

Based upon what management said on its call, the third quarter (and perhaps the fourth quarter as well) is likely to be more challenging than previously expected, so it is quite possible that these shares go into the penalty box until nice, predictable (hah!) growth comes back into the financials. For my part, an off quarter or two caused by things that just happen in the course of business is no real reason to panic and I think the valuation on the shares is now quite a bit more interesting.

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Orchids Wilts In The Summer Heat

Seeking Alpha: Orchids Executing Well, But The Valuation Already In Bloom

Orchids Paper Products (NYSEMKT:TIS) continues to be a company that has rewarded investor patience with solid execution. As a growing player in the large private label market for paper personal care products (paper towels, toilet paper, tissues, etc.), Orchids has not only been focusing on expanding its geographical reach and customer base, but also its product line up. Even more importantly, at least from my point of view, the company has continued to find ways to drive costs out of its processes and improve operating efficiencies.

Management's performance has not gone unrewarded, with the shares up another 20% since my last write-up and up close to 50% over the past year. Better still, there are solid reasons to feel good about the company's future - the expansion into the West Coast with Fabrica has gone better than expected, a new plant in Barnwell will be coming on line (in segments) this year, and Orchids is still only a small player in a large market (annualized revenue in the $200 million range out of a total private label addressable market opportunity in excess of $3 billion). Moreover, this is not a company I'd bet against when it comes to finding better ways to make better margins from its business.

All of that said, the valuation is no longer what I'd call a clear bargain. I never like to bet against good companies, and I'm definitely NOT recommending exiting a position here, but even double-digit annualized revenue growth and mid-teens FCF margin projects don't support a substantially higher fair value. I'll be the first to acknowledge that good companies deserve premiums and that a company like Orchids can outperform expectations, but I think the margin of safety here is smaller than I personally like for new positions.

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Orchids Executing Well, But The Valuation Already In Bloom

Seeking Alpha: Orchids Paper Products Continues To Blossom

It's always encouraging to see stories develop in line with your expectations, and I really have nothing to complain about when it comes to Orchids Paper Products (NYSEMKT:TIS). The shares are up about 30% from April, when I wrote that the company's strategy of "controlled aggression" toward geographic expansion and its cost consciousness could serve investors well as a GARP story.

The story here continues to center around the growth potential of private label tissue products, the company's geographic expansion, and management's prudent approach to costs. Valuation is a more interesting topic to me though, as I think an argument can be made that a FCF-based target in the high $30s is not unreasonable. While that works back to a 10x multiple on 2016 EBITDA, a high multiple for a paper company, it might not be so unreasonable relative to the three-to-five year growth potential.

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Orchids Paper Products Continues To Blossom

Seeking Alpha: Orchids Paper Products Taking Big Swings To Become A National Player

Say what you will about Orchids Paper Products (NYSEMKT:TIS), but you can't accuse the company of lacking ambition. When I last wrote about this manufacturer of private label paper products like towels, toilet paper, and napkins, the company was a regional operator focused on serving customers (largely dollar stores and Wal-Mart (NYSE:WMT)) within 500 miles of the company's Oklahoma facility. About a year later the company is now pursuing plans that will have it operating as a national player (or at least very close to it) within a year.

There is certainly risk with Orchids' strategy, as the company will be adding meaningful debt to its balance sheet and the private label market has ample competition from the likes of Clearwater Paper (NYSE:CLW), Cascades (OTCQB:CADNF) (CAS.TO), and First Quality just to name a few. I'm also a little concerned about the potential disruption to the business over the next couple of years from this ambitious expansion plan, as well as the aggressive free cash flow efficiency assumptions baked into the price. All of that said, I don't think a $30-$31 fair value is unreasonable at this point and that would argue that this is a name worth following.

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Orchids Paper Products Taking Big Swings To Become A National Player

Seeking Alpha: Orchids Paper Products A Paper Tiger, But In A Good Way

When I last wrote about Orchids Paper Products (TIS) in October, I expressed a lot of respect and admiration for this well-run paper products company, but thought the valuation was a bit steep. I'm not going to claim that I got that part right; the shares rose another 20% or so from where I wrote and it was only a sharp three-day drop in Orchids' stock that brought it back down again. I still do not believe that these shares are all that cheap, but it's hard not to like a company with a credible growth plan and a solid dividend.

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Orchids Paper Products A Paper Tiger, But In A Good Way

Seeking Alpha: Orchids Paper Products Is Small And Solid, But Not So Cheap

Small, illiquid, and under-followed companies can be above-average alpha generators, as they are often overlooked by analysts and institutional investors or outright disqualified due to their low liquidity and so on. It's not always the case, though, that these small gems are cheap. In the case of Orchids Paper Products (TIS), I believe this is an interesting paper products manufacturer with an opportunity to further diversify its customer base and go up-market. I also believe, though, that despite a lack of sell-side coverage and institutional ownership, it's really not as cheap as I'd hoped it might be.

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Orchids Paper Products Is Small And Solid, But Not So Cheap