Domtar (UFS) Poised For Long-Term Growth Despite Risks

On May 12, we issued an updated research report on paper & paper products firm Domtar Corporation (TO:UFS) .

Domtar manufactures and distributes a wide array of fiber-based products including communication papers, specialty and packaging papers and adult incontinence products. It also owns and operates an extensive network of strategically located paper and printing supplies distribution facilities. The company is the largest integrated marketer of uncoated freesheet paper in North America with established brands such as Cougar, Lynx Opaque Ultra, Husky Opaque Offset, First Choice and Domtar EarthChoice.

Domtar is currently seeking growth through profitable investment opportunities with a commitment to pollution-free environment and sustainable practices. The company is also streamlining the cost structure, improving revenue quality and maintaining a healthy cash flow with a disciplined approach to cash utilization. Domtar shut down the largest paper machine in the U.S. at the Ashdown mill as it converted the Ashdown paper machine to fluff pulp production. With the Ashdown fluff pulp line and the streamlining of Plymouth, the company has approximately 2 million ton market pulp business that is well positioned for long-term growth. All these factors offer a solid investment opportunity for the company.

A steady dividend payment policy is also part of Domtar’s long-term strategy of providing attractive risk-adjusted returns to its stockholders. In addition, the company has historically repurchased shares as part of its balanced approach to deploy capital. The company’s investment strategy takes a holistic view of the rapidly evolving market and deploys a dynamic capital allocation approach to execute its growth strategy.

However, Domtar has grossly underperformed the Zacks categorized Paper & Paper Products industry in the last three months with an average loss of 6.8% compared with a 1.3% decline for the latter. The pulp and paper industry is highly cyclical. Fluctuations in the prices and the demand for the company’s pulp and paper products could result in lower sales volumes and smaller profit margins. The strengthening of U.S. dollar against pulp purchasing currencies is expected to hamper price realizations of Domtar's pulp products. In the paper segment, import challenges remain a headwind, although productivity and margin expansion are expected to be on track. However, long-term trends indicate some weakness in North American paper demand, which could hamper the company’s top line. Global demand for pulp is also likely to be volatile due to the strengthening U.S. dollar and consumer inventory swings, especially in China.

Given its international presence, the company often faces unfavorable foreign currency movements, impacting its top-line growth. Any future slowdown in the global economy or the manufacturing industry as a whole will have an adverse impact on its business and would hamper its long-term growth potential. A geopolitical impasse due to various conflicts and disruptions may further affect its international operations in key markets. The revamped market dynamics following Brexit are expected to affect firms like Domtar that has significant presence in the U.K. The company is likely to be stifled by the renegotiated deals and restrictions imposed on trade with other European Union members. Brexit could further result in higher tariff and non-tariff barriers to trade between the U.K. and the European Union, lowering productivity of the company.

Nevertheless, we remain impressed with the inherent growth potential of this Zacks Rank #3 (Hold) stock. Some better-ranked stocks in the industry include Mercer International Inc. (NASDAQ:MERC) , Sappi Limited (OTC:SPPJY) and Stora Enso Oyj (OTC:SEOAY) , each carrying a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Mercer is currently trading at a forward P/E of 7.28x.

Sappi has a long-term earnings growth expectation of 3.7%.

Stora Enso has a long-term earnings growth expectation of 3.0%.

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