Domtar Dives Further Into the Diaper Biz

$272 million acquisition means big things for UFS shareholders

   
Domtar Dives Further Into the Diaper Biz

Paper company Domtar (UFS) announced July 1 that it had acquired Associated Hygienic Products for $272 million, doubling the revenue of its personal care segment. While still tiny in comparison to its paper division, the move signals its commitment to the diaper business.

This is good news for shareholders. Here’s why:

Associated Hygienic Products makes store-brand baby diapers from plants in Ohio and Texas. Its $320 million in revenue nicely complements Domtar’s Attends brand of adult incontinence products. Domtar acquired Attends’ U.S. and Canadian business for $315 million in August 2011 and Attends’ European business for $232 million in March 2012.

Add in the $61 million acquisition of EAM in May 2012, and Domtar’s personal care segment went from zero revenue less than two years ago to $399 million at the end of 2012. With the store-brand addition, its 2013 revenue should be at least $760 million. It’s well on its way to building a billion-dollar business.

Analysts are very positive about the latest acquisition because it continues to diversify Domtar’s non-paper business. With the two businesses joining forces, it provides the personal care segment with operating synergies both in terms of cost savings and a greater exposure to the $5-billion North American diaper market.

While Kimberly-Clark (KMB) and Procter & Gamble (PG) control about 70% of the diaper market in North America, the private-label business is the fastest growing in terms of market share — currently around 20%. Associated Hygienic Products makes Domtar a major player in this area. It also gives UFS a position in both the infant and adult markets, making it much more attractive to retailers.

From a profit perspective, the personal care segment provides the company with a stable stream of income. In 2012, its operating income of $45 million was 11.3% of revenue, compared to 7.6% for its pulp and paper segment and an operating loss of $16 million on revenue of $685 million for its distribution business. It would take one very large acquisition for the personal care segment to overtake its pulp and paper business, but it’s not out of the realm of possibility.

Domtar generated free cash flow of $315 million in 2012, and should generate at least $400 million in 2013. Its net-debt-to-total capitalization ratio is just 18%, providing it with lots of leverage should it need to swing a much bigger deal than the type it’s made over the past two years. Having said that, finding acquisitions is easier said than done, given the market share domination of Pampers and Huggies.

Domtar’s core business of uncoated free sheet paper is losing sales on an annual basis. While its biggest segment still generates a healthy EBITDA margin, Domtar realized several years ago that it needed to diversify into specialty paper, the pulp market and personal care in order to solidify its overall business. This diversification was meant to deliver a more stable and predictable cash flow, and all evidence suggests this is happening.

With a current dividend yield of 3.3%, a free cash flow yield of 17% based on 2013 free cash flow of $400 million (expected to grow over the next few years), you have to wonder why income investors aren’t lighting it up.

CEO John Williams has done a good job making the tough calls. In the first quarter, its profit was hit by some productivity glitches related to the conversion of its mill in Marlboro, S.C. Previously a commodity mill, it’s spending $30 million to convert into a specialty paper mill so that it can supply Appleton Papers in Wisconsin with $3 billion in uncoated base paper during the next 15 years. With the paper business being as tough as it is, this deal makes a lot of sense for Domtar: short-term pain for long-term gain.

Since Domtar announced its first-quarter earnings April 25, its stock has lost about 7% of its value and currently trades around $68 as of July 3. Most analysts have a 12-month price target of $86, suggesting the potential upside is above 30%. Raymond James analyst Daryl Swetlishoff upped his target to $95 from $90 on Domtar’s most recent acquisition, providing investors with potentially larger gains.

If you’re looking for big-time capital gains from Domtar, you’re likely barking up the wrong tree. However, if you want solid returns and good income, Domtar’s a great bet. With the baby diaper acquisition, it became an even better bet.

Shareholders should be pleased.

As of this writing, Will Ashworth did not own a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/07/domtar-dives-further-into-the-diaper-biz/.

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