Fedrigoni - Litter or Luxury, what's the difference? - Initiation
All,
Sarria | Fedrigoni - Client Call
Wednesday, 12 November
3 pm UK time | 10 am EST
REGISTER HERE
Please find our initiation on Fedrigoni here.
There must have been a period when Italians produced only paper; such is their density of abandoned paper mills. Particularly, the north of the country is littered with forgotten sub-scale sites that went out of business long ago. We may be biased, but we struggle to think of any paper/packaging HY issuer that has never been in trouble. Please let us know if you can think of one.
Fedrigoni is quite a niche player in the luxury and labels segments, a positioning that affords it better margins. But these margins having already been leveraged against, this case is now about volatility. To understand its development to date and extrapolate the volatility going forward, we have pro-forma grossed up its historical P&L by division for recent acquisitions, and the picture has become clearer. It’s a yield play.
Investment Rationale:
- We are not taking a position in Fedrigoni yet, but are considering the name from the long side. At 84c/€, or a near 17% yield, the HoldCo Notes are not cheap enough, given they are PIK Toggles, while the SSNs should also trade around 90c/€ - closer to 8-9% YTM, giving them another 5 points of downside. How quickly they will get there? The November Q325 reporting might prove neutral or negative, as does the May event on FY25. So we don't see a need to jump in now, but should the bonds trade to above indicated levels, we'd be tempted to build a position in a mix of SSNs and PIK Toggles for the longer term.
- In the long-term we see Fedrigoni able to grow into its capital structure. The current weakness seems primarily cyclical and without (major) maturities before 2029 and sufficient liquidity, we see no reason why the company should be in so much trouble as to endanger its investors.
Key Conclusions:
- Fedrigoni’s H1 2025 results show both divisions in cyclical decline, and management has signalled no near-term recovery. The weakness is merely masked by still-annualising acquisitions (Recent Trading).
- A historical pro-forma consolidation of recent acquisitions reveals how the deterioration is accelerating - and in both divisions. We therefore expect this weakness to persist through 2026 (Model).
- However, margins are improving, evidencing raw material pass-throughs and management’s cost-cutting efforts, supporting delivery on 2025 guidance. (Recent Trading). On a consolidated basis, next year’s P&L will therefore appear flat as the new assets annualise. For 2027, our model assumes a 5 % revenue rebound and a +1% gross-margin gain, reflecting the increasing confidence in the down-market luxury sector, but even so, Fedrigoni should only just cover interest expense, and the leverage covenant is not far off (Model). Overall, our forecast aligns with management’s this year but unmasks a less constructive organic trajectory (Model).
- On these assumptions, EBITDA remains too low to translate into free cash flow as much as it normally would. Even with a 2027 assumed rebound in sales and considerable margin uplift, DCF valuations fail to reach a weighted average of peers such as Stora Enso, UPM or Avery Dennison (DCF). Debt-carrying capacity is likewise cyclically limited at a poor 60% of the SSNs, though with good liquidity and no imminent maturities, balance-sheet pressure remains contained (DCF).
- The group’s fragmented footprint and ongoing bolt-on M&A obscure profitability by site and dilute scale efficiencies (by the usually more commodity oriented industry standards), limiting investor visibility and confidence (Company and Industry). Fedrigoni’s niche exposure to premium papers and specialty labels provides partial insulation from commodity-paper cyclicality, yet demand remains closely tied to packaging, luxury and print—markets tied to consumer sentiment.
- Finally, despite its 2000 pages worth, documentation analysis reveals weak structural creditor protection. Numerous baskets offer only limited cumulative capacity, but should the company need to reduce leverage, permissive asset-sale clauses and a low 75 % super majority amendment threshold (typical for Italy) are virtually begging for drop-down and uptiering transactions (Game Theory).
Moving parts to look out for:
- The luxury sector has been confident of late. Unlike other paper manufacturers, Fedrigoni is volatile, but more in tune with the fortunes of the luxury sector, rather than general consumer sentiment. Fedrigoni does experience demand weakness, but it may not prove as pronounced as elsewhere.
- November and May reportings of Q325 and FY25 should make for neutral to negative catalysts. We see little chance of showing materially positive performance (flat would be positive) and a fair chance of underperformance. However, our base case broadly mimics management guidance for the year.
- Leverage is high, and the covenant is close. The bonds share a 4.6x net consolidated leverage covenant with various other credit facilities. We forecast (on a forgiving IFRS16 basis) leverage of 4.5x. Note that IFRS 16 flatters the leverage situation enormously. We calculate leverage of 5.7x on a pre-IFRS 16 basis.
Here to discuss this name with you,
Wolfgang
E: wfelix@sarria.co.uk
T: +44 203 744 7003
www.sarria.co.uk