Editor’s note: This column is part of our Best Stocks for 2016 contest. Hilary Kramer’s pick for the contest is Domtar Corp (USA) (UFS).
Like many other stocks during the stormy start to the year, Domtar (UFS) had a rough couple of weeks leading up to February. But it didn’t take long for investor sentiment to swing in the opposite direction, hoisting UFS off its lows to close March 22 over 12% higher than its deepest trough just a month ago.
I’ve never lost confidence in this pick because UFS’ business continues to execute well in a difficult market, posting a strong bottom-line beat in its fourth-quarter report early last month. While earnings of $0.91 a share came in below last year’s $1.11 a share, the results were still an impressive $0.26 ahead of analyst estimates. The company compensated lower paper prices with continued efficiencies in operations in order to keep operating income relatively flat in the quarter ($86 million versus last year’s $88 million) and the Personal Care segment growing (operating income came in at $16 million, up from $11 million last year).
A lot of the upside was driven by a 2.3% increase in volumes in the fourth quarter, and while the growth may not be sustainable longer term, management indicated on the conference call that the company is benefiting from strong shipments of fluff pulp, which is used in absorbency products.
In fact, UFS has plans to convert its paper machines to fluff pulp in its Ashdown, Arkansas mill to help meet some of the demand. The costs will lead to an increase in maintenance expenses in the first half of the year that will likely pressure earnings, but overall I expect maintenance costs to be flat for the full year.
While the stock has traded nicely in recent weeks, share prices are still below last year’s as macro fears continue to plague investors. However, firmer commodity prices coupled with growing optimism on the global economy should help push the industry higher as a whole, and while we likely haven’t seen the last of the volatility, the stock still offers a solid dividend yield and an attractive valuation. And with the company producing a minimum of $150 million to $200 million in free cash flow versus its $2 billion market capitalization, additional downside is limited from here.
Considering all of the above, the decline in paper prices since the first quarter of 2015 should drive the company’s full-year earnings down to about $3 a share from the $3.33 earned last year. But given a more reasonable economic environment and keeping in mind current fears that paper dumping in China has weighed on the stock, earnings results appear to be bottoming out. I believe we’ll see share prices reflect this in time, allowing them to outperform significantly from current depressed levels.
Hilary Kramer is the editor of GameChangers, Breakout Stocks Under $10, High Octane Trader,Absolute Capital Return and Value Authority. She is an accomplished investment specialist and market strategist with more than 25 years of experience in portfolio management, equity research, trading, and risk management. She has extensive expertise in global financial management, asset allocation, investment banking and private equity ventures, and is regularly sought after to provide her analysis on Bloomberg, CNBC, Fox Business Network and other media.
