Segezha Group - Uncovering the Potential of Russia's Forests

We initiate coverage of Segezha Group, a leading vertically integrated player in the Russian timber industry. The company covers the whole cycle, from logging to producing a diverse range of paper, package and wood products. In our view, the stock has solid upside potential, underpinned by a pipeline of large value-accretive investment projects, recent M&A deals and the bright long-term outlook for the sector, which should benefit from the ongoing economic recovery, the green agenda and the shift away from plastic. Our target price of R14.36 per share implies more than 30% upside from the current price. We rate the stock a BUY. > High cost efficiency and profitability. Segezha has some of the lowest cash costs in the global timber industry thanks to its relatively cheap forest resources and 80% wood self-sufficiency. Its softwood log mill gate prices and sawmill cash costs are just 33-40% of those of European companies. Its adjusted EBITDA margin expanded from 23% in 2020 to 30% in 9m21, supported by higher prices and the changing sales mix. We expect margins to soften a bit in 2022 on softening prices but to recover to 30% and above in the longer run.> Strong growth profile. Segezha's adjusted EBITDA jumped by 121% between 2017 and 2020 as a result of capacity expansion and modernization projects. With the ongoing acquisition of IFR and future launch of investment projects, we see adjusted EBITDA climbing to R49.2 bln in 2025, up 75% from the R28.1 bln we expect in 2021. > State strategy for the industry is supportive. The government's policy for the sector is aimed at increasing exports of higher value added wood products, meaning a shift away from round wood. Segezha, with its processing projects, should benefit from this.> Dividends to be moderate over 2021-25, increase after 2025. With its focus on growth and hence sizable capex outlay, we project a moderate dividend yield of 4-5% over 2021-25. However, we see the dividend yield rising to the double digits after 2025.> Solid upside. Our DCF-derived 12-month target price of R14.36 per share implies more than 30% upside from the current level. Segezha is trading at a 7.6 2022E EV/EBITDA and 6.1 2023E EV/EBITDA, or discounts of 38% and 48% to global diversified players. > Key risks. The main risks to Segezha's investment case include a deeper than expected correction in prices, ruble strengthening (exports account for more than 70% of revenues), potential changes in sector regulation or forest lease rates, project execution risks (delays, cancellations, budget overruns) and trade protection measures.