Industry Reports

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080506 Deutsche Bank Report - Domtar's 1Q in 100 Words

Deutsche Bank - Equity Research

Domtar {Ticker: UFS, Closing Price: USD 5.90, Target Price: USD 10.00, Recommendation: Buy}.

* Maintaining Buy; reducing price target: Capacity rationalizations are likely to keep this market in good balance for the foreseeable future. We are cautious on the stock given increasing costs and weak industry volumes.  Improved prices should help off-set these headwinds in 2Q.  The stock looks inexpensive on a valuation basis. Maintain Buy, but we are reducing 12-month target from $14 to $10. 

* Disappointing qtr roughly in-line w/ recently reduced expectations. Reported GAAP EPS of $0.07, $0.05 net of special items.  DB @ $0.03 & consensus @ $0.04.  Input cost inflation of $40MM q/q ($0.05/share).  Price gains in UFS paper avg'd $14-15/ton q/q, vol's +3.9%.  Lumber rally should also help “bleeding” lumber business in 2Q.

* Other: (1) No dividend over next few qtrs.  Excess CF focused on debt reduction – want to trim by add'l $400-500MM.  Disappointing, but prudent, decision. (2) Q2 likely to see inflation pressure & incremental $17MM q/q in maintenance expense, but also better q/q price gains in paper.  (3) Sold 42K/acres in Quebec for $500/acre,(4) No evidence of further asset sales.  We'd like UFS to “explore”  options for Columbus, MS LWC mill. 

* Valuation/Risk: Our $10 price target is based on a 7.5X EV/EBITDA multiple using our '08 EBITDA estimate.  Our $10 price target is based on a 7.5X EV/EBITDA multiple using our '08 EBITDA estimate.  Historically, peer group averages have traded at a 7.5-9X EV/EBITDA multiple.  We've opted for the low-end of this range to reflect uncertainty around long-term trends in the uncoated free sheet market.  As a cross-check, we've run an updated discounted cashflow model, which also suggests a $10/share valuation.  We note that the lumber segment is apt to be $100MM EBITDA negative – suggesting a $1- $1.50 drag on valuation. Risks include further economic weakness, declining volumes, currency, and input cost pressure.