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Is Domtar Corp. a Good Stock to Buy?

Paper company Domtar Corp. (NYSE:UFS) is down about 13% so far in 2012 and up very slightly over the past year, underperforming a rising S&P 500. The underperformance this year has been driven by quarterly reports which showed earnings growth compared to the same quarters in 2011 but failed to meet analyst expectations. Domtar’s three verticals in papermaking are pulp and paper (which offers a variety of paper sheet products), distribution (which provides these and other products to paper customers), and personal care.

Steven Cohen

Hedge fund ownership at Domtar Corp. (NYSE:UFS) was not very deep at the end of the first quarter, but it was broad as five different funds reported a position of between $20 and $30 million on their 13F filings. Blue Mountain Capital, co-managed by Andrew Feldstein and Stephen Siderow, and Jeffrey Gates’s Gates Capital Management each owned slightly more than 300,000 shares of the company at the end of March. Billionaire Steven Cohen’s SAC Capital Advisors, Wayne Cooperman’s Cobalt Capital Management, and Kingdon Capital (managed by Mark Kingdon) each more than doubled its previous position in Domtar. There was some significant insider selling at Domtar earlier this year which was not related to cashing in of stock options, but these generally took place at prices well above the current stock price.

Domtar’s 10-Q for the second quarter of 2012 showed a 2% decrease in revenue compared to the second quarter of 2011, but the cessation of certain impairment charges meant that the company’s earnings rose slightly- and, since share count decreased, earnings per share rose by 24% compared to a year ago. Over the first half of the year, however, earnings per share have fallen based on the weakness of the first quarter compared to the first quarter of 2011. Some concerns about the company’s performance are also warranted given that the core pulp and paper business is struggling, with declines in revenue and a small increase in operating income being obscured by good performance in the personal care segment. The company attributed weakness in the pulp and paper business to both pulp pricing and volume of paper shipments.

Domtar Corp. (NYSE:UFS) now trades at 10 times trailing earnings and 9 times forward estimates of its earnings by sell-side analysts. Given the current market capitalization of $2.6 billion, the implied EV/EBITDA multiple on a trailing basis is 3.5x. These are fairly low multiples for a company even if it is falling short of earnings targets, and the company additionally pays a dividend yield of 2.5%. In that sense it looks like a value stock unless the trends in pricing that have held back the pulp and paper business continue. However, a beta of 2.1 indicates that on a statistical basis the stock is exposed to declines in the broader market.

The closest peer in the paper industry is International Paper Company (NYSE:IP), which suffered a fall in its earnings in its last quarter compared to the same period in the previous year and trades at slightly higher earnings multiples than Domtar. International Paper Company (NYSE:IP)’s trailing price-to-earnings ratio is 13 and the forward P/E is 10, though investors should note the slightly higher dividend yield of 3.2%. In this case we don’t see too much of a difference between the two companies- both appear to be struggling when we look deeper into Domtar’s financials, and both are priced at a similar fairly low valuation with similarly moderate dividend yields. Sonoco Products (NYSE:SON) is focused on paper-based packaging products and has also taken a hit to its earnings recently; Sonoco Products (NYSE:SON) is also on the value-dividends spectrum with a trailing P/E of 15 but a 3.9% dividend yield. Resolute Forest Products (NYSE:RFP) focuses on newsprint and commercial printing paper- on its face a terrible business to be in- and trades at 13 times forward earnings estimates with no dividend.

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