Why This Tissue Paper Company Is a Safe Investment

In the past century, many must-have products and stable industries have disappeared into oblivion. Examples include mainframe computers, integrated steel mills, and buggy-whip manufacturers. Therefore, the best investment ideas are often found in products that we unconsciously use everyday without fail. Tissue paper stands out as a striking example of a product associated with long-term, stable demand.

Stable consumer staple
Tissue paper products have shown remarkable stability in demand for the past 17 years from 1996 to 2012. During this period, total tissue market growth has largely tracked the U.S. population growth of 2% annually. From this set of data, the economics of tissue paper demand are pretty obvious. Everyone uses tissue paper in everyday life, because there are simply no economically viable substitutes for this consumer staple.

The financial numbers of the tissue paper companies pretty much tell the same story. Orchids Paper has increased its revenue every single year since 2004, except for 2010, when its top line dropped by only 3%. In fact, Orchids Paper's 10-year revenue compound annual growth rate, or CAGR, of 6.6% is much higher than the average population growth rate because the company serves customers in faster-growing regions of the country. As an example, the population in Orchids Paper's targeted area of operations, approximately 500 miles around its manufacturing facility in northeast Oklahoma, grew by 1.38% in 2010, which easily beats the national average of 0.84%.

The financial track records of Orchids Paper's peers Clearwater Paper and Wausau Paper may not be appropriate for comparison, as they aren't perfect proxies for the tissue-paper industry. Apart from its core consumer-products tissue paper business, paperboard manufacturing also accounts for close to 40% of Clearwater Paper's sales. Even so, Clearwater Paper has also been consistently profitable for the past five years, including the 2008-2009 global economic crisis.

In Wausau Paper's case, it only became a focused tissue paper company in 2013 after divesting its other non-tissue businesses. Moreover, unlike Orchids Paper and Clearwater Paper which serve the at-home tissue market, Wausau Paper primarily serves commercial customers. Even though the dynamics of the away-from-home tissue market are not exactly identical to those of the at-home tissue market, Wausau Paper also claims that this market is growing consistently at 1%-2% per year.

Choice of product and customer segments
Furthermore, both Orchids Paper and Clearwater Paper supply private-label tissue, the fastest growing segment of the market. In the past decade, private-label tissue has been gaining market share at the expense of its branded-tissue counterparts. For example, private label's market share of total U.S. bath tissue has grown from 15.4% in 2003 to 23.2% in 2013. Similarly, private-label paper towels now make up 31.4% of the market, compared to a market share of 18% ten years ago.

In addition, Orchids Paper's revenues have been even more resilient than those of Clearwater Paper because of its customer base. Discount retailers such as Dollar General and Family Dollar accounted for 81% of Orchids Paper's fiscal 2012 revenue. In contrast, Clearwater Paper sells 71% of its tissue paper products through the grocery channel. When economic conditions are poor, consumers tend to be more budget-conscious and they do more of their spending at discount retailers. This further enhances the defensiveness of Orchids Paper's revenue streams.

Local barriers to entry
There is no denying that tissue paper at its core is a commodity with little differentiation. However, Orchids Paper has managed to deliver positive earnings and operating cash flows in every single year of the past decade because of two key factors.

Firstly, tissue paper is a product with a high weight-to-value ratio, which suggests that local suppliers have huge freight cost advantages over their peers. As a result, Orchids Paper is shielded from foreign competition and any significant competition outside of its targeted area of operations.

Secondly, the not-in-my-backyard mentality means that new locations for manufacturing facilities are hard to come by. Orchids Paper is one of the few suppliers of tissue paper in the northeast Oklahoma region and the company sees only about four meaningful competitors in the area. Among them is Clearwater who only started to compete with Orchids Paper in the area in 2010, following its acquisition of supplier Cellu Tissue. True to the local nature of tissue paper supply, Clearwater is dominant in the Western U.S., where it has an estimated 22% market share.

Final thoughts
Orchids Paper is my top pick in the tissue-paper sector for its stable discount retail customer base and its local dominance in northeast Oklahoma. In contrast, Clearwater Paper has a significant non-tissue paper business, and Wausau Paper's business is much more economically sensitive given its exposure to the more cyclical away-from-home tissue market.

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The article Why This Tissue Paper Company Is a Safe Investment originally appeared on Fool.com.

Mark Lin has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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