Domtar's strategy to diversify out of uncoated fine paper, pulp and into diapers, adult incontinent products gets thumbs up from investors; company's shares up 12% year-to-date, due to 37% jump in past three months, following IP mill closure announcement
DON MILLS, Ontario
December 17, 2013
– Domtar Inc.'s big move into the market for adult incontinence over the past couple of years is getting good reviews from investors who believe it will temper ongoing concerns regarding the company's core pulp-and-paper business and provide a positive long-term catalyst for the stock.
"It's almost become a demographic play now," said Peter Jackson, vice-CIO and lead manager of Canadian equities at Cumberland Private Wealth Management in Toronto. "It is trying to change its stripes a bit, and we like the strategy and continue to own the stock."
After falling steadily in the first part of the year, Domtar shares have climbed 12% year to date due to a 37% bump in the past three months on the TSX (it also trades in New York). The stock has soared for a few reasons, most notably the early September announcement of a mill closure by rival International Paper Co.
The company's foray into the incontinence market has also boosted the share price and looks to be a key factor for the future.
Domtar has continued to build out this segment - which it first entered in 2011 by acquiring Attends Healthcare Inc. - through acquisitions of U.S.-based Associated Hygienic Products this summer and Laboratorios Indas, one of Europe's biggest adult diaper makers, earlier this month.
Mr. Jackson said the shift into diapers and personal care products is necessary to offset Domtar's core business, which, he estimated, continues to decline at a rate of roughly 4% annually.
"The company does all the right things with its ample free cash flow, including buying back its own shares, but they needed to diversify into something with more sustainable growth," he said Mark Wilde, analyst at Deutsche Bank, agrees, noting the Indas deal is an important step in diversifying away from pulp and uncoated white paper. "Of all Domtar's personal care acquisitions, this deal strikes us as the most transformational," he said in a note to clients.
Mr. Wilde said conditions are also improving in Domtar's legacy paper operations, because of International
Paper's mill closure announcement, and raised his price target to US$90 but left his hold rating unchanged.
"While Domtar doesn't look expensive from a valuation standpoint, our concerns are pressure on pulp prices in 2014, and forecasting rate of secular decline in the company," he said
Mr. Wilde's caution isn't unique. Five of the other 15 analysts who cover the stock have hold ratings as well. But the majority of analysts are bullish on Domtar's upside potential in 2014.
Paul Quinn at RBC Capital Markets upgraded his rating following the Indas deal earlier this month to "top pick" in his coverage universe, while increasing his price target to US$115 from US$100.
"While Domtar continues to successfully reposition its business into growth markets (personal care), recent industry capacity reductions should support strong near-to medium-term profitability in white papers," he said. "At the same time, Domtar's net-long pulp position could lead to a near-term earnings surprise to the upside if current momentum continues." The Indas acquisition also continues Domtar's progress toward a goal of US$300-million-plus of EBITDA from its consumer product businesses by 2017, he said, while returning the majority of free cash flow to shareholders.