Canada's Warren Buffett Loves This Stock

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Resolute Forest Products (NYSE: RFP) is a global forest products company.  The stock trades around $14.00 and emerged from bankruptcy at the end of 2010.  High levels of debt in a period of weak demand in paper and forest products pushed RFP into bankruptcy protection.  Since emerging, housing and print media demand in North America has stabilized, but at lower levels.  RFP has caught the attention of Prem Watsa, often called the “Canadian Warren Buffett,” who now holds 18.4 million shares as of the latest 13D filing which accounts for over 24.8% of his fund’s holdings.  A position this size by an investor of his stature warrants further investigation by investors.

Resolute Forest Products Description

RFP is a player in the paper & forest products industry.  Peers include Weyerhaeuser (NYSE: WY), International Paper (NYSE: IP), Plum Creek Timber (PCL) and private players like Georgia-Pacific.  RFP is one of the smaller publicly traded firms but has one of the cleanest balance sheets as a result.  Weyerhaeuser has revenue of a $7 billion annually and has a $16.5 billion market value while RFP has about $4.5 billion in sales.  International Paper has sales of $27 billion and a market value of $18.3 billion.  Resolute’s debt to equity ratio is only 18 which is small compared to Weyerhaeuser and International Paper with D/E ratios of 104 and 170.  Resolute does have a pension liability that seems significant but the discount rate used in Canada is significant below that in US, inflating the size of the liability.   

Demand Trends Turning the Corner?

Two trends pushed RFP to bankruptcy.  The number of housing starts plummeted, which negatively impacted the lumber business.  Second, newsprint and print media were impacted by the recession and a secular trend towards digital media the US and Canada.  Wood products currently account for around 10% of sales.  The number of housing starts is rebounding (see on this chart) but remains below normalized levels, likely in the 1.2 – 1.4 million range.

The bigger question facing RFP is when and if their paper products market starts to recover, newsprint in particular which account for around a third of annual sales.  Prem Watsa among others, likely believe newsprint has bottomed out and demand will flatten out and may even start to grow based on export demand.  Recent data says otherwise and is concerning.  December North American newsprint stats show an increase of 5.9% in inventory levels month over month.  Shipments decline by 7% y/y but commercial print was up 20% y/y which offset softness elsewhere in the market.  Exports also declined in the December data by 15%y/y and accounted for 27% of volume.  The price of newsprint also appears to have declined in January by 15%.

The shares have had an upward trend since mid-November, but still remains below $15 where it traded in 1H12 and the 2011 high of close to $30.  The valuation looks attractive with an EV/EBITDA multiple of around 3.2x FY13 estimates.  A normal range for the industry is 4.5x-5.5x NTM EBITDA.  The firm repurchased shares in 2012, another positive indication of expectations on future cash flows and that management feels the shares are undervalued.

Conclusion

The case for RFP is that newsprint is stable and demand is not eroding further.  Management is working to increase profitability at certain plants, the coated paper facility in Catawba, has restricted its operations and is committed to only selling profitability tons.  In addition, management expects energy projects at its plants will positively contribute $65 million in EBITDA annually.  The problem is that demand is still uncertain and recent data resulted in estimates were revised downward over the past month 30 days, with consensus falling to $0.74 from $0.93.


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