UPM Kymmene Part 2: Earnings Power Value (EPV)
After the replacement value analysis for UPM in part 1, let’s move to an EV analysis based on free cash flows:
Interestingly, UPM’s standard cashflow reporting makes life relatively easy for my free cashflow analysis.
I will start with a rather big table and then explain
Starting with the operating Cashflow as stated, one can quickly see that working capital is relatively volatile, however over 7 years the effect was more or less neutral.
Next, the capex line is really interesting (Capex ex M&A and sale of assets). We can clearly see that UPM drastically reduced capex from 2009 on. UPM’ paper mills seem to be relatively new and don’t require a lot of maintenance cost in the foreseeable future.
Also interesting is the fact that although UPM is still relatively “asset rich” and despite having invested more than 500 mn EUR into the Uruguyan pulp mill in 2008, over the last 7 years ~ 1.8 bn EUR of net assets have been sold.
So in total, UPM generated ~ 4.9 bn cash, thereof 3.1 bn free Cash flow plus 1.8 bn assset sales over the last seven years. More than half of this has been used to pay dividends and buy back stock, the rest has been used to pay down net debt.
This corresponds nicely ith the communicated goals of the company:
UPM intends to pay as an annual dividend at least one third of net cash flow from operating activities less operational capital expenditure. To promote stability in dividends, net cash flow will be calculated as an average over a three-year period.
Remaining funds are to be allocated between growth capital expenditure and debt reduction. The net cash flow from operating activities for 2010 was EUR 982 million and operational capital expenditure EUR 186 million.
So how does this translate into EPV ? Based on the 7 year average free cashflow of 0.92 EUR and a standard discount rate of 10%, this would only result in an EPV of 9,2 EUR or roughly 10% undervaluation.
Now the big question is: are those 7 years really “average” years or has something changed? In particular it is crucial to understand if capex will go up again in the future or remain at the current low level.
A quick glance into the Q3 report shows that “normal” capex has remained at a relatively low level, at a run rate of around 300 mn EUR for 2011.
If we assume this as a representative Capex going forward, UPM could deliver under a “no growth” scenario around 1 bn of operating cash minus 300 mn for Capex which would result in a recurring free cash flow of 700 mn EUR or ~ 1.35 EUR per share p.a., which would give us an EPV of around 13.5 EUR, relatively close to the Replacement Value of 14.26 EUR.
So summarizing this I would state the following:
– UPM seems to have greatly reduced Capex over the last 2 years
– if those reductions are to a large extent permanent, a “fair” EPV could be around 13.5 EUR per share (no growth), if not, the stock would be only slightly undervalued
– management clearly communicates and delivers on the use of free cash flow (very positive in my opinion)
In the upcoming final post for UPM I will focus on the qualitative aspects and the business itself