A Domtar pulp machine is seen in this file photo.Pierre Charbonneau
John Williams, CEO of Montreal-based paper maker Domtar Corp., was in New York City last week for an investment conference when he did an interview with Bloomberg about the company's plans to make further acquisitions for its diaper business.
"The dialogue on Domtar will be about the growth businesses, and, by the way, we own a paper business that generates lots of cash," Mr. Williams said, per Bloomberg. "Not the other way around."
Not to be terribly impertinent, but: From your lips to the investing gods' ears.
I understand why Mr. Williams wants so badly for this story to come true. It's because the existing Domtar thesis hasn't worked out so well. Way back in January, 2012, I asked if Domtar was the cheapest stock in Canada, based on "its combination of low price multiples, long-term earnings growth and healthy cash flow that's being shovelled back to shareholders in the form of dividends and share repurchases."
Alas, the low multiples correctly forecast the company's subsequent earnings decline from the problems in the market for "uncoated free sheet," or simple copy paper, Domtar's main line of business. While Domtar's TSX-listed shares are up about 32 per cent, including dividends, from that January, 2012, column, that's in large part because of the loonie's freefall. The company's New York Stock Exchange-listed shares are essentially flat over that time, dividends included.
Mr. Williams has a fine plan for Domtar, to be fair. Rather than live and die in a commoditized market, the company will build its "personal care" business, which encompasses diapers for babies and adult incontinence products, with demand for the latter expected to grow as the global population ages. Rather than try to build a brand name to go against well-known products like Pampers or Depend (owned by giants Procter & Gamble Co. and Kimberly-Clark Corp.), Domtar is focusing on quality, store-brand or generic products, a less-risky move.
Analysts trying to value the company are typically putting a multiple of around four or five on its EBITDA, or earnings before interest, taxes, depreciation and amortization, produced by the pulp and paper business. Personal care, by contrast, is getting a multiple of around eight on its EBITDA, illustrating the appeal of growing that segment's profits.
The problem, if you can call it that, is that Domtar has been an exceptionally disciplined acquirer of the makers of these types of products. So much so, that the pace of the company's transformation is more evolutionary than revolutionary. And some are running out of patience.
Analyst Steven Chercover of D.A. Davidson cut his rating to "neutral" earlier this year. In May, he said he'd been "getting concerned about the lack of traction in personal care" a year prior. "A year later, sales and EBITDA are lower and our concern is on the rise. Given the well-known secular challenges faced by Domtar's core paper business, traction in the new business is crucial. As we've said, for Domtar to thrive, personal care has to grow faster than paper contracts," he wrote in a note.
In the second quarter, Domtar reported $1.1-billion (U.S.) in its pulp and paper segment, down 4 per cent from the year prior. The personal care business recorded $216-million in sales, down 8 per cent from the year earlier.
Mr. Chercover's target price of $40, just above Domtar's Wednesday closing price on the NYSE of $38.91, is one of the lowest on the Street.
There are believers, however, chief among them is Stephen Atkinson of Dundee Securities, who has a "buy" rating and $55 target price. Mr. Atkinson, who worked for Domtar many years ago, before Mr. Williams arrived, thinks the CEO can take the personal care segment's EBITDA to $150-million in 2016 and $300-million in the medium term. At $300-million, he says, the personal care business alone is worth $40 per share, giving you the pulp and paper business for free, he argues. "In the meantime, Domtar is paying investors to wait by offering an attractive dividend," he says. (The yield is 4 per cent.)
Being paid to wait, of course, works better when the stock price doesn't actually decline. If Mr. Williams can execute this growth plan, Domtar may reverse its recent trajectory. If not, expect more paper losses.