Domtar (NYSE:UFS) jumped the most it has in four years on news International Paper (NYSE:IP) is closing a mill in Alabama reducing North American capacity by at least 7%. Despite the big jump September 11, Domtar's stock is still in negative territory year-to-date. Is Domtar suddenly a buy?

Slow Progress

Three years ago I discussed the reasons why I thought Boston based Baupost Group's $225 million investment in Domtar would pan out for Baupost's billionaire founder, Seth Klarman. I reasoned that Klarman's second-quarter holdings report would shine a light on the direction of Domtar's stock: If he was still holding the 2.68 million shares it would demonstrate confidence in the company. Unfortunately, Baupost's Q2 holdings report showed the sale of 850,000 shares; another one million shares in the third quarter and the remaining 800,000 shares in the final three months of 2010. 

You can't blame Klarman for selling. By the end of 2010, Domtar stock was trading at $75.92, 25% above Baupost's break-even price of $60.82. Klarman had held Domtar stock for most of four years by the time he unloaded the remaining shares. Sure, it broke through the $100 mark five months later in 2011, but hindsight's 20/20.

Round Two

Put yourself in Klarman's shoes today. Would you buy at this point? For starters, the 7% reduction in the North American capacity for white paper, commonly used for copiers and printers, reduces the downward pressure on pricing at a time when demand continues to dwindle. This gives this part of Domtar's business a little breathing room.

Where the company has changed considerably is in its personal care segment, which didn't exist when Klarman exited at the end of 2010. In 2011, Domtar acquired Attends Healthcare, a manufacturer of adult incontinence products, for $315 million. It followed that up with two smaller acquisitions and then paid $272 million in May to buy Associated Hygienic Products, the largest supplier of store brand infant diapers in the U.S. Suddenly, its personal care segment was a real and growing part of its overall business. By 2017, it anticipates personal care will contribute $200 million in annualized EBITDA, representing one-third of its current EBITDA. By 2017, it wants to be generating between $300 million and $500 million annualized EBITDA from businesses that are growing like its personal care segment. While it might not generate nearly as much revenue as its paper business, it makes up for it by bringing the profits. And that's what's been lacking in recent years.  


Domtar's current enterprise value is $2.8 billion, 4.8 times EBITDA. Its three peers: International Paper, MeadWestvaco (NYSE:MWV) and Weyerhaeuser (NYSE:WY) have an average multiple of 11.5, more than double Domtar. In terms of return on assets none of its peers are more profitable than Domtar and yet it's pulling up the rear. Another important metric is net debt as a multiple of EBITDA. Domtar's net debt position is $668 million or a multiple of one compared to an average of 2.7 times for its three peers. Procter & Gamble (NYSE:PG), the maker of Pampers, has an enterprise value of 12.7 times EBITDA. If Domtar's personal care segment hits its $200 million goal for annualized EBITDA by 2017, it will have an enterprise value equal to the entire company in 2013. Can you say spin-off? 

Bottom Line

While its last two quarterly reports are a very real reminder that Domtar's not out of the woods just yet, its free cash flow generation is so strong it's likely to continue growing its annual dividend payout, which currently sits at $2.20 yielding 3.1%—and that's after its 10% surge.

I see an undervalued stock that seems to be slowly getting itself ready to grow once more. Investors will eventually get on board; perhaps even Seth Klarman. Regardless of what he does, I think the 10% pop September 11 is just the beginning of a leg up to $90 and beyond. 

Should you buy? Definitely. 

Disclosure - At the time of writing, the author did not own shares of any company mentioned in this article.

Related Articles
  1. Stock Analysis

    Allstate: How Being Boring Earns it Billions (ALL)

    A summary of what Allstate Insurance sells and whom it sells it to including recent mergers and acquisitions that have helped boost its bottom line.
  2. Options & Futures

    Cyclical Versus Non-Cyclical Stocks

    Investing during an economic downturn simply means changing your focus. Discover the benefits of defensive stocks.
  3. Investing Basics

    How to Deduct Your Stock Losses

    Held onto a stock for too long? Selling at a loss is never ideal, but it is possible to minimize the damage. Here's how.
  4. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  5. Stock Analysis

    When Will Dick's Sporting Goods Bounce Back? (DKS)

    Is DKS a bargain here?
  6. Investing News

    How AT&T Evolved into a Mobile Phone Giant

    A third of Americans use an AT&T mobile phone. How did it evolve from a state-sponsored monopoly, though antitrust and a technological revolution?
  7. Stock Analysis

    Home Depot: Can its Shares Continue Climbing?

    Home Depot has outperformed the market by a wide margin in the last 12 months. Is this sustainable?
  8. Stock Analysis

    Yelp: Can it Regain its Losses in 2016? (YELP)

    Yelp investors have had reason to be happy recently. Will the good spirits last?
  9. Stock Analysis

    Is Walmart's Rally Sustainable? (WMT)

    Walmart is enjoying a short-term rally. Is it sustainable? Is Amazon still a better bet?
  10. Stock Analysis

    GoPro's Stock: Can it Fall Much Further? (GPRO)

    As a company that primarily sells discretionary products, GoPro and its potential falls right in line with consumer trends. Is that good or bad?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center