Clearwater Paper Corporation (New York: CLW) is a 2008 spin-off from Potlach Corporation. Clearwater is a producer of private label tissue and paperboard products. Their products are American-made and utilize primarily wood pulp. The Company is organized around three operating segments: Consumer Products; Pulp and Paperboard; and Wood Products. The private label tissue segment includes products such as facial and toilet tissue, paper towels and napkins. Paperboard products are sold to the packaging industry. The Company also participates in the lumber segment selling wood products including clear cedar and other dimensional lumber products.

Clearwater’s strategic plan is to grow the consumer products division by expanding capacity and product offerings and to become the low-cost producer of high-end pulp and paperboard products.

Part of Clearwater’s attraction, as an investment, is that it is a well run company in an out-of-favor industry. However, there are caveats. Sales are concentrated. In the Consumer Products segment, three customers represent 60% of net sales for the segment and 27% of total net sales. Additionally, the Company’s pension plan is underfunded. As of December 31, 2009, the pension plan was underfunded by $95.9 million. Clearwater has made additional payments to the pension plan. These company specific risks and problems are in addition to the normal and expected risks associated with a cyclical, commodity-based business.

The Company has a fiscal year ending December and recently reported its 2Q10 results. For the quarter, net earnings were $20.6 million, or $1.75 per diluted share, compared with net earnings of $75.4 million, or $6.43 per diluted share for 2Q09. The prior year results included special items totaling $4.60 per share for alternative fuel mixture tax credits, renewable energy tax credits and debt retirement costs. Excluding those items, 2Q09 diluted earnings were $1.83 per share.

For FY09, net income was $182.5 million, or $15.50 per diluted share. This compares with net income of $114.5 million, or $9.72 per diluted share for the twelve month period ending June 2010.

Net sales for 2Q10 were $343.86 million, 8.5% higher than 2Q09 sales of $316.91million.  Operating income was lower due to higher raw material costs. Net sales in FY09 totaled $1,250.1 million compared to $1,320.9 million for the trailing twelve months ending June 2010.

Free cash flow is considered by many a superior measure to earnings. For FY09, Clearwater reported free cash flow of $17.45 per share. For the trailing twelve months ending June 2010, free cash increased to $21.96 per share.

Clearwater has a very solid balance sheet. As of 2Q10, the Company reported cash and short term investments of $333.0 million and long term debt of $148.4 million. Cash and short term investments represent about 40% of the recent stock price. Clearwater does not report any goodwill or other intangibles on its balance sheet making the Price/TBV ratio 2.11.

The Company is both profitable and efficient. Return on Equity is 31.6% as compared to the industry median of 11.2%. similarly, return on assets, at 12.2% compares very favorably with the industry median of 2.6%.

Clearwater has long term debt of $148.4 million, as of June 2010. The long term debt to capital ration is 27.3% and long term debt to equity is 37.6% as compared to the industry medians of 35.8% and 60.8%, respectively.

In its short history, the Company has provided us with a number of earnings surprises.

Earnings Surprises              Last Qtr.   2Qtrs Ago     3Qtrs Ago  4Qtrs Ago
Estimate                                              1.32               0.14                    1.33              1.21
Actual                                                 1.75               0.41                    1.48              1.40     

Three analysts currently cover Clearwater and provide earnings estimates. The estimates range from $4.79 to $5.27 per share for FY10 providing an average estimate of $5.03 per share. In FY11, the analysts provide a range of $5.15 to $6.01 and an average of $5.48. The shares are trading now at a forward PE of 14.4X, a premium to the industry median TTM PE 10.9X. On the other hand, the industry median EV/EBITDA ratio is 8.02X and the industry median EV/FCF ratio is 5.47X whereas Clearwater has an EV/EBITDA ratio of 4.95X and EV/FCF ratio of 3.74X.

Our overall conclusion is that Clearwater is a well run company in an out-of-favor industry. We believe it is undervalued and offers an attractive return.

Disclosure: The author has a long position in Clearwater paper Corporation.