In SKAGEN Focus we apply a strict bottom-up, value-based investment philosophy whereby we require a substantial discount to fair value for any position to make it into the fund's portfolio. As contrarian and price-driven investors, we focus on identifying assets that trade substantially below our estimate of fair value with tangible catalysts for re-rating from a mid-term investment perspective.
We believe our investment in Cascades fulfils both these requirements. In addition, we view the company as an undiscovered and ignored gem from an environmental investment perspective as its operations are largely circular, which we think deserves a valuation premium over time.
Cascades is a Canadian mid-tier manufacturer that offers sustainable, innovative, and value-added solutions for packaging, hygiene and recovery needs. The company employs approximately 10,000 women and men working in almost 80 facilities across North America. The company is positioned as a second-tier producer, behind larger peers, and its main operations are managed in three segments: Containerboard, Specialty Products (Packaging Products) and Tissue Paper.
A circular company
In many respects, Cascades was a pioneer of the circular economy long before people understood the value of sustainability in the way that they do today. The company has been demonstrating the potential in all kinds of residual materials since 1964, recycling and transforming them into new products, and this continues to underpin their business model today.
Today the company is a leading paper collector in Canada, which enables them to derive more than 80% of their fibre input from recycled fibre. For the third consecutive year, Cascades has been recognised as one of the world's 100 most sustainable corporations, according to the Global 100 index by Corporate Knights. It ranked 18th out of the world's 6914 public companies with more than USD1 billion in revenues and first among the 34 other organisations in the Packaging category.
Cascades' currently depressed equity valuation and discount to peers is striking in light of the substantial structural progress that the company has made over the past decade. Cascades has concentrated its portfolio, sold off non-core assets, de-risked its balance sheet and boosted the dividend pay-out. Despite these achievements, the stock trades at roughly the same levels as at the beginning of 2016. We believe this unwarranted discount to fair value of the company's share price is still a result of an overly diversified operating structure with sub-par returns and scale prospects in specific lines of the business.
Several ways to win
There are numerous opportunities for the company to make improvements, as well as potential tailwinds from a post-pandemic normalisation. This could improve profitability in line with the peer group average and drive a rerating of its shares. While internal cost improvements are ongoing, we believe there is an opportunity for the company to address the currently suboptimal operating structure by separating the Tissue and Containerboard businesses, similar to successful transformations that we have seen elsewhere in the industry.
One of the most recent examples is the break-up of the Swedish forestry giant SCA, which sold its Containerboard business and separated its Tissue and Hygiene operations ("Essity") from its Forest Product operations. Given Cascades' smaller size, we do not believe the company has the financial power or operational capability to simultaneously invest in both businesses successfully, especially as larger investments and/or acquisitions may be required in the Tissue segment. A separation of these businesses could therefore unlock higher operating efficiency as well as substantial value for shareholders. Our research also indicates that the current value of the company's real estate portfolio represents a third of their entire enterprise value, which we think adds an additional valuation backstop and offers further possibilities to crystallise value.
We initiated our position in Cascades towards the end of 2020 and have spent a year in dialogue with management and fellow shareholders, during which time our conviction in the attractiveness of the current risk/reward has increased. We recently stepped up our engagement towards the company. As one of Cascade's ten largest owners, we approached the company regarding its current strategy and drafted a letter to its board of directors expressing our view on the opportunities that lie ahead. We therefore welcome the company's recent announcement that they will hold a strategic update for investors following their next earnings release at the end of February 2022 to discuss the strategic path ahead.
Yet to be discovered
Our position in Cascades serves both to illustrate our investment process – whereby we strive to identify ignored assets that trade at a substantial discount to fair value and offer tangible catalysts for re-rating in the midterm – as well as our active ownership and engagement activities. While shares currently trade at a significant discount to fair value and peers, we believe that Cascades is in a unique position to increase shareholder value through various self-help measures and a focus that we believe will be gradually recognised by the market. Given investors' growing interest in sustainability and solution-providers, Cascades is a company that is yet to be discovered and rewarded for its significant progress and leading position in recycling and sustainability, which is a core part of their circular business model and identity.