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Prem Watsa Really Likes Resolute Forest Products

At the end of June, Prem Watsa’s Fairfax Financial Holdings reported 18.5 million shares of Resolute Forest Products Inc (NYSE:RFP) in its 13F portfolio. This new holding was also the third largest position that Fairfax reported in the filing (find more top stocks from Fairfax Financial Holdings). Resolute Forest Products sells paper products that are used in printed material, including newsprint and coated papers such as is found in magazines and catalogs. Watsa, a Canadian value investor, has been called “the Warren Buffett of Canada” for his value-oriented approach to investing (compare Berkshire Hathaway’s positions to Fairfax’s) and for Fairfax’s success since inception. Fairfax has continued to buy shares in the company despite warnings about the “death of print.” According to its most recent filing from October 12th, it owns 22.4 million shares of Resolute; this represents almost 22% of the shares outstanding.

Prem Watsa

The second quarter of 2012 saw a small (3%) decline in revenue compared to the same period in 2011. Some expenses came down but closure and impairment costs came in at $88 million, which was more than enough to give Resolute Forest Products Inc a net loss of $20 million versus $61 million in net income in the second quarter of last year. The company’s first quarter had also not gone well, and so in the first half of 2012 it only generated 3 cents per share in earnings; in the first half of 2011 it had delivered 94 cents per share. The closure and impairment costs, again, are responsible for much of this change and they are not likely to be recurring. When we strip them out, operating income is about flat.

Wall Street analysts believe that Resolute Forest Products Inc will earn about a dollar per share in earnings in 2013, which implies a forward P/E multiple of 13. That would be a reasonable multiple, and there should be some improvement once the company has finished restructuring, but it will need to be able to hold its operating income steady as the industry struggles. Michael Johnston’s Steelhead Partners also owned the stock at the end of the second quarter, reporting 12.9 million shares in its portfolio at that time. Resolute was also Steelhead’s top stock pick (see more stock picks from Steelhead Partners). However, a number of investors have taken the other side of the trade: 18% of the shares outstanding were held short according to the most recent data.

Domtar Corp. (NYSE:UFS), International Paper Company (NYSE:IP), Sonoco Products Company (NYSE:SON), and Weyerhaeuser Company (NYSE:WY) are four peers for Resolute. Weyerhaeuser is a real estate investment trust with a considerably larger market cap than Resolute (at $15.3 billion versus Resolute’s $1.3 billion). Its revenue and earnings were actually up in its most recent quarter versus a year earlier, and it pays a 2.4% dividend yield. It seems to be doing better than Resolute, though its valuation could be an issue. The other three peers carry forward P/E multiples less than or equal to Resolute’s (Sonoco at 13, Domtar at 10, and International Paper at 11) even though they have larger market caps than it as well. In addition, these three peers are profitable on a trailing basis with P/Es in the teens (or even a bit lower in the case of Domtar) on that basis. In the second quarter, earnings were down at International Paper, about flat at Sonoco, and actually up 9% at Domtar. This quick screen of the companies suggests that Domtar is doing better than these other comparable companies and is also a good value.

Watsa and Fairfax seem confident in Resolute. We’re a bit less sure, and there’s certainly quite a bit of short interest that agrees with us. Domtar, and possible Resolute’s other peers, seem to be better buys.

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