With most market indicators seeming to point in a bullish direction right now, it probably seems a little counter-intuitive to focus on areas of the economy that don’t generate a lot of buzz or attention. As a value-oriented investor, however, I’ve gotten a lot of mileage over the years out of finding fundamentally solid companies that the market isn’t paying a lot of attention to at the moment. As the economy appears to be healthier than most had anticipated would be shown during this latest earnings season, there’s a good argument to make that the demand for goods from the Materials sector should also continue to be healthy.
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The Materials sector is one of the areas of the market I like to pay attention to, because it is one of the segments that feeds into so many other sectors and industries of the U.S. and global economy. It’s a sector that is full of companies you might not recognize by name immediately, because their products are used to build the finished products that you and I use. We’re more familiar with the companies that make those finished products; but Materials companies are among the businesses those industries rely on.
Domtar Corp. (UFS) is a company in the Paper & Related Products industry of the Materials sector. One of the other reasons you may not be familiar with this stock by name is because it isn’t one of the largest, more recognizable names in its industry; it is a small-cap stock, created in 2006 by the combination of Weyerhauser’s fine paper business and those of Domtar Inc. Despite their small-cap size, UFS is the largest integrated manufacturer of uncoated free sheet paper in North America; it is also a company that has some interesting fundamental strengths working in its favor right now. The stock has underperformed for most of the year, dropping from a high at around $54 in February 2019 and dropping to a trend low point in August at around $32. Since early October, however, the stock has started to pick up bullish momentum, forming an upward trend that has seen the stock increase to its current price a little below $39. That could be a sign the stock is poised to reverse the downward trend and possibly reclaim much of the value that was lost from March to August. Does that make the stock a good value right now? 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 $2.4 billion.
Earnings and Sales Growth: Over the last twelve months, earnings declined -39%, while revenues dropped by about -6%. In the last quarter, earnings improved by a little over 56%, while sales declined by about -2.6%. The company’s margin profile is narrow, with signs of weakening in the last quarter; Net Income as a percentage of Revenues was 3.82% over the last twelve months, and narrowed in the last quarter to 1.55%.
Free Cash Flow: UFS’s free cash flow is healthy, at $260 million over the last twelve months. This number translates to a healthy Free Cash Flow Yield of nearly 11%.
Debt to Equity: UFS’s debt/equity ratio is conservative, at .41. The company’s balance sheet shows that long-term debt is about $1 billion, with cash and liquid assets of only about $93 million in cash and liquid assets. This is a sign that liquidity could be a concern; if Net Income doesn’t begin to improve, the company could face problems servicing its debt.
Dividend: UFS’s annual dividend is $1.82 per share, which translates to a very impressive yield of 4.8% at the stock’s current price. That yield could be an interesting reason to think about taking a long-term position if you think the stock’s current price reflects a useful bargain.
Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value. UFS has a Book Value of $38.97. That translates to a Price/Book ratio of .98, while their historical Price/Book ratio is .92. That implies the stock is a bit overvalued; however the stock’s Price/Cash Flow ratio paints a very different picture, since UFS is trading almost 32% below its historical average. That puts a long-term target price at around $50.50.
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 downward trend from February of this year to the end of August; it also provides the baseline for the Fibonacci retracement calculations shown by the red horizontal lines on the far right side. After bottoming around $32, the stock consolidated between support at $32 and resistance at around $35 until early October; from that point the stock has picked up quite a bit of bullish momentum, and is currently about $1.50 below the 38.2% Fibonacci retracement line at around $40 per share. If the stock can break above that resistance point, it should be able to rally in the near-term to about $44, based on pivot highs last seen in June. Current support lies at the last pivot low, which is around $37. A drop below that point could see the stock drop to about $35, with its 52-week low around $32 not far from that point.
Near-term Keys: If you’re willing to be very aggressive, UFS’ current momentum could provide a signal to buy call options or the stock itself, with a near-term eye on the 38.2% retracement line at around $40, and $43 to $44 above that point if the upward momentum can continue. If that momentum slows, or even reverses and pushes the stock below $37, you could consider shorting the stock or working with put options with an eye on the $35 level as a quick-hit target, or $33 to $32 as a deeper exit target from there if bearish momentum continues. From a value perspective, the stock’s Price/Cash Flow ratio is interesting; but unfortunately I think there are enough concerns coming from the weakening Net Income and poor cash position that I can’t call the stock a good value right now. If the stock continues to hold in this price range, however, and begins to show improvement in these areas in the quarters ahead, the value proposition will likely become much more compelling.
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