Moving deeper into 2021, more and more investors and analysts continue to attempt to look past the pandemic-driven pressures that have weighed on public activities and on the economy for the past year. One-year anniversaries are being marked, with the apparent assumption that with vaccines being administered on an accelerated basis and being made available to larger segments of the U.S. population, the worst is behind us and it’s time to start “getting back to normal.”
In a broad sense, the market has been moving for most of the past year on the same basis – anticipating the end of the pandemic on the assumption that once the health crisis has passed, the economy can get back to churning along. The last week, however has raised concerns about inflation risks, which I think makes sense. Federal stimulus has kept pumping money into the economy, and the Fed has maintained its public stance that since it is willing to accept somewhat higher inflation levels on a relatively short-term basis, holding the line on its accommodative monetary policy is also appropriate. That has kept the S&P 500 and the Down Jones Industrial Average hovering a little below their last highs for the last couple of weeks, while the NASDAQ has actually started to form a patten of lower highs for the last six weeks.
The necessary shift of big portions corporate America into extended, work-at-home arrangements for the past year has had a big impact on the industries built on keeping offices running. These are companies that supply everything from computers to printers, to office equipment, paper products and so on. With the biggest portion of corporate populations working from home, the demand for the services these companies provide has remained low. Even as some companies are starting to bring workers back on a gradual basis, the truth is that a significant increase in business service demand is going to rebound quickly; many analysts are predicting business activity for these businesses won’t return to pre-pandemic levels until 2023.
Consider the case of Domtar Corp (UFS). This is a stock I’ve followed for a few years because of their leadership position as the largest producer of uncoated free sheet paper in North America. This is a small-cap stock that is a perfect example of the current disconnect between broad market performance that might make you think the worst is over and the reality that significant portions of working America continue to struggle with. The shutdowns imposed all over the world at the early stages of COVID-19 immediately shut off demand for this company’s products and prompted analysts to forecast sales declines of 12%-15% for all of 2020, with any recovery to previous levels of demand described merely as “eventual” – a roundabout way, in my opinion of saying, “we have no idea.”
The drawdown on UFS’ business prompted the company to take drastic measures last year, suspending its dividend and share buyback programs, reducing inventories and cutting its budget for capital expenditures through the rest of the year to preserve liquidity. Those are defensive moves that are understandable. from a low point at around $16.50 in July of last year, though, the stock has moved into a strong upward trend, following the momentum of the broad market. As of early March, the stock had more than doubled in value, and as of this writing is just a little below a high at around $39.50. What does that mean for the stock’s value proposition? Let’s find out.
Fundamental and Value Profile
Domtar Corporation designs, manufactures, markets and distributes a range of fiber-based products, including communication papers, specialty and packaging papers and absorbent hygiene products. The Company segments include Pulp and Paper and Personal Care. The Pulp and Paper segment consists of the design, manufacturing, marketing and distribution of communication, specialty and packaging papers, as well as softwood, fluff and hardwood market pulp. The Personal Care segment consists of the design, manufacturing, marketing and distribution of absorbent hygiene products. The Company is a marketer of uncoated freesheet paper in North America serving a range of customers, including merchants, retail outlets, stationers, printers, publishers, converters and end users. It is also a marketer and producer of a line of incontinence care products, as well as infant diapers. It has a network of wood fiber converting assets that produce paper grade, fluff and specialty pulp. UFS has a current market cap of about $1.9 billion.
Earnings and Sales Growth: Over the last twelve months, earnings increased more than 1000% (not a typo), while revenues dropped by about -26%. That kind of divergence is only possible if the company is drastically cutting costs. In the last quarter, earnings improved by 3%, while sales declined -18%. The company’s margin profile is negative, with signs that the past year has continued to erode these levels; Net Income as a percentage of Revenues was -2.93% over the last twelve months, and dropped in the last quarter to -6.41%.
Free Cash Flow: UFS’s free cash flow has managed to remain healthy, at $239 million over the last twelve months, but it should be noted this metric was around $260 million at the end of 2019. The current number translates to a healthy Free Cash Flow Yield of nearly 12%.
Debt to Equity: UFS’s debt/equity ratio is conservative, at .48. The company’s balance sheet shows that long-term debt is about $1.06 billion, with cash and liquid assets of about $309 million in cash and liquid assets. The company has actually managed to increase its liquidity significantly over the past year; at the end of 2019, cash was about $93 million. I attribute this increase to the suspension of dividend payments, stock buybacks, and cost-cutting. For now, the company should be able to continue servicing its debt; however if Net Income remains negative, UFS could burn through its cash very quickly.
Dividend: UFS suspended their dividend payout in 2020. Earlier this month, they announced a new share repurchase program, but have provided no new details about resuming the dividend.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target around $38.60 per share. That implies that UFS is pretty fairly valued, with about 5% upside from its current price.
Technical Profile
Here’s a look at the stock’s latest technical chart.
Current Price Action/Trends and Pivots: The red line on the chart traces the stock’s upward trend from its July 2020 low at around $16.60 to its recent high at around $39.50. It also informs the Fibonacci retracement lines shown on the right side of the chart. After dropping into the end of last week off of that high point, the stock found support at around $35 and has bounced off of that level, with current momentum pushing the stock just a little below the recent high. Immediate resistance, then is around $39 with support at around $35. A drop below support should find next support at around the 38.2% retracement line, in the $31.50 price range. The stock would need to push above $39.50 to mark any kind of new, significant upside, with next expected resistance somewhere between $43 and $44.
Near-term Keys: UFS’s current price suggests there is very little in the way of near-term upside for this stock. If anything, I think the company’s high valuation, paired with concerns about deteriorating Net Income are enough to offset attractive liquidity and Free Cash Flow levels and should keep fundamentally-driven, value-focused investors looking elsewhere. If you prefer to work with short-term trading strategies, wait for a push above $39.50 before looking for an opportunity to buy the stock or work with call options. A drop below $35, however could offer an interesting signal to consider shorting the stock or buying put options, with an eye on $31.50 as an attractive price target on a bearish trade.