Enterprise Value = $3.014 billion
Operating Income = $454 million
EV/Operating Income = 6.63x
Earnings Yield = 13%
Price/Revenue = .4x
Debt/Equity = 37%
Domtar is a paper company. They sell paper products, like copy paper. They also sell personal care paper-based products, like diapers and toilet paper. They are the largest manufacturer of freesheet paper in North America, operating 10 paper mills that produce 3 million tons of uncoated freesheet paper per year. 77% of their production is in the US and the rest occurs in Canada. They also produce 1.8 million tons of pulp per year, with production also divided between the US and Canada. Pulp is derived from separating fiber from wood, which is a raw material used to make a variety of paper products.
The 52-week high for Domtar is $53.89 and a return to these levels would represent a 54% increase in the stock price. The stock is under pressure for the typical small cap value reason this year: trade jitters. Domtar has most of their production operation in the United States and they sell overseas. 58% of their pulp revenue, for instance, is derived from foreign markets. This makes them sensitive to the worries about trade, tariffs, and Trump tweets. The strong US dollar has not helped the stock, either.
At current levels, it is cheap by every measure. EV/EBIT is 6.63x, price/sales is .4x, it is below book value, it is only at 108% of tangible book value, and it is trading at 3.8x cash flow.
I like boring stocks, and it doesn’t get much more boring than copy paper, tissues, and toilet paper.
This is a stable, mature, company that is not growing significantly, which is why the stock boasts a high dividend yield. For the last 10 years, revenue has floated around $5 billion to $5.8 billion. It has consistently made money for each of the last 10 years, with the exception of 2017, a year in which they lost $4.11 per share. Even though they lost money that year, it was not tied to the actual performance of the business. This loss was related to the change in the tax law that year and was a one time expense. This year, the trade war hasn’t significantly impacted the actual revenues, earnings, and cash flows of the company. The movement in the stock looks to me like an overreaction to the scary headlines.
At some point, this trade war is going to be resolved. My expectation is that once that happens, regardless of the actual outcome, stocks like Domtar will rally just because it’s over with. The market just needs a resolution. It doesn’t even have to be a good resolution. This might seem endless, but at some point, this will go away one way or another.
Domtar’s core, boring, business is not going anywhere or changing any time soon. Diaper use isn’t going to decline because of a trade war tweet. Diapers can’t be disrupted by some money losing startup backed by venture capital cash. In fact, adult diapers are likely a growth industry considering the fact that the senior population globally will continue to expand as life expectancy increases. Copy paper isn’t going anywhere, either. People have been talking about paperless offices (Captain Picard only used his iPad with the LCARS O/S) since I was a kid and paper doesn’t seem to go away. The persistence of the paper market is reflected in Domtar’s stability in earnings and cash flow.
Meanwhile, while I wait for the stock to snap back to a normal multiples, I will be paid a nice 5.22% dividend yield. Domtar’s strong free cash flow also suggests that this dividend can be sustained.
Like everyone else, I am worried about the probability of recession, so I considered Domtar’s performance during the last crisis before I purchased the stock. Domtar continued to earn money during the last recession, making a profit of $3.59 per share in 2009. The stock reacted more violently than the actual business to the recession, falling from $100 per share to $30. I don’t think this will happen again if we face another recession because Domtar is much cheaper today than it was back in 2007. Going into the last recession, Domtar traded at a much higher valuation. In 2007, it traded at 1.5x book value and today it trades at .84x book. Going into that crisis, Domtar was also much more leveraged with a debt/equity ratio that was over 100%. Today, debt/equity is only 37%.
Domtar has a high degree of financial quality. The Altman Z-Score of 2.34 implies that the company is not in distress. The Piotroski F-Score of 7 also exhibits a high degree of financial strength. The debt/equity ratio of 37% is also at a low and safe level. The Beneish M-Score of -2.68 implies that the company is not an earnings manipulator.
Domtar trades at a discount to its competitors and its history. The current P/E of 7.74 compares to a 5-year average of of 14 for the stock, which seems right for a mature company that isn’t expected to change much and pays a high dividend yield. An increase to this level would be an increase of 80% in the stock price. The average P/E for the industry is 16.45. The current EV/EBIT multiple of 6.63 compares to a 5-year average of 14.16 for the stock. On a price/sales basis, the current .40x level compares to an industry average of .63x and a 5-year average for Domtar of .50x.
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