Grexit and the mysterious case of the near doubling of Fortress Paper shares

May 20, 2015

By: The Globe and Mail

A mysterious spike in the shares of a small Canadian pulp and paper stock is rumoured to foretell an exit of Greece from the euro zone.

Fortress Paper’s stock has taken off in recent days despite the lack of any material catalyst, aside from speculation the company is positioned for a deal to print new Greek banknotes.

Greece would only require such a service, of course, were it to withdraw or be expelled from the European Economic and Monetary Union, a fate the country may yet avoid.

Linking the stock’s near-doubling to the potential return of the drachma is pure conjecture, but it’s gotten some attention in the absence of any major improvement in Fortress’s operations, its financials or the market it serves.

“There isn’t any reason to get super-encouraged,” said Mark Kennedy, an analyst at CIBC World Markets who covers the stock.

A portion of the surge in share price may be explained by modest improvements in the woeful global market for dissolving pulp, Fortress’s core line of business.

But this is not the first time a spike in Fortress’s trading activity coincided with an escalation of the Greek debt crisis.

Now, as then, the country’s financial outlook is bleak.

The Greek government was recently rebuffed in both its requests for loan forgiveness on its €330-billion ($450-billion) debt load, and for the postponement of recent debt repayments.

This week, Greece resorted to emptying an emergency International Monetary Fund reserve account to make a €750-million loan repayment to the IMF itself.

Some economists have called for Greece to introduce a parallel currency or return to the drachma should it default on its debt and/or leave the currency union. Its tenuous financial position doesn’t preclude either outcome.

Which is where Fortress Paper could, conceivably, come in.

The company’s Swiss subsidiary Landqart AG makes the security paper on which the Swiss franc is printed and it has produced the euro for 10 different countries. “The product they make is phenomenal,” said Daryl Swetlishoff, an analyst at Raymond James. “It’s the best on the market.”

In June, 2012, Fortress’s stock jumped by 42 per cent over two trading days after it announced it “had a material banknote order reinstated.” At the time, the sovereign debt crisis was roiling and the term “Grexit” had just entered the global financial lexicon.

Fast forward almost three years: Greece is again nearly out of cash, and Fortress’s share price makes another big move. The website Zero Hedge noted the coincidence, leading to speculation that the Greek drama is fuelling a speculative rally in the stock.

At the request of the Investment Industry Regulatory Organization of Canada, Fortress issued a statement on Tuesday indicating it is “unaware of any reason” to substantiate a 92-per-cent increase in share price over the previous five trading days, its stock breaking through the $4-mark for the first time in more than a year.

Days earlier, Fortress had reported its first-quarter earnings, but there was little in there to ignite the passions of investors.

Fortress reported a net loss per share from continuing operations of $1.61, reflecting the perpetual disappointment that is the company’s dissolving pulp mill in Thurso, Que.

A repurposing of the Thurso mill a few years ago was supposed to vault the company to a position of global leadership in the production of dissolving wood pulp, the main ingredient in rayon.

Rayon can be used as a substitute for cotton, the price of which soared past previous record highs in 2011 after a series of global supply shocks. The clothing industry was eager for a lower-cost fibre to help meet new demand for textiles emerging from China.

Dissolving pulp prices rose to $2,500 (U.S.) per tonne, making Thurso a potentially lucrative undertaking once a $240-million retrofit was completed. It was a compelling story and investors pumped the company’s stock to a high of $62 in early 2011.

Then everything went wrong for Fortress. The mill conversion was a train wreck. New producers of dissolving pulp popped up, flooding the market with supply. China imposed duties on dissolving pulp out of Canada, the United States and Brazil of between 13 per cent and 24 per cent. Cotton fell back to its historical price range, and dissolving pulp prices plunged to the $800-per-pound mark.

All of which combined to crush Fortress’s stock, which lost 98 per cent of its value over the four years or so after peaking.

It’s a stretch to say things are looking up. Fortress is forecasting lower production costs, but the Thurso mill is still losing money. The economics of dissolving pulp may be improving slightly, but prices remain near trough levels.

So, could it be Grexit speculation lifting Fortress shares? “I don’t know if I can make that leap,” Mr. Swetlishoff said. Alternatively, since the company has “massive leverage” to the dissolving pulp market, even slight upticks in the commodity price can have disproportionate effects on share price, he suggested.

Ultimately, it’s impossible to rule out Greece as a catalyst for a stock move that seems to defy a dissolving pulp market in an indefinite slump.

“It’s more of a hope trade than anything else, I would say,” Mr. Kennedy said.

By: The Globe and Mail

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