Wednesday, June 23, 2010

Domtar Corp. (NYSE:UFS): Credit Suisse raises target to $125 - new Street high

Domtar Corp. (NYSE:UFS) is getting some very interesting commentary this morning:

- Credit Suisse is raising their target to $125 (prev. $105) noting that since they initiated coverage of the paper and packaging industry at Credit Suisse back on May 5th, 2009, they had assumed a relatively gradual cyclical recovery with 2013 as the likely peak pricing year for most pulp, paper and paperboard grades. As the firm wrote on June 17th, they now see a more vigorous upcycle than they envisioned back in the spring of 2009.

As they stated in their June 17th note, they now see the peak of the current pulp, paper and paperboard pricing cycle as 2012, versus 2013 previously.

$100-$200/Tonne Pulp Correction Seen: As they have written, Credit Suisse sees a second half 2010 pulp-price correction followed by rising prices for most of 2011 and 2012. They even build in some impact on uncoated prices. Yet, their 2010 and 2011 EPS estimates are the highest on the Street.

Domtar Estimates Rise: As a result of their current view of the cycle, Credit Suisse is raising their EPS estimates, with 2010 moving up by $1.90, to $9.35, with 2011 rising by $2.10, to $10.00, and with 2012 (now the expected peak) jumping by $2.90, to $12.50.

Running Out of Net Debt Next Year?

Exhibit below shows the recent history and our expectations for Domtar’s net debt “destruction.” Specifically, Credit Suisse sees the company running out of its net debt position by the end of 2011, even though we assume that the company repurchases about $140 million of stock over this period. They note the board recently authorized a $150 million share repurchase.

Free Cash Flow Exceeds Stock Price
For the four years 2009 through 2012, they estimate that Domtar will generate free cash flow per share (before dividends) totaling $68.85. Looked at differently, the company’s free cash flow per share for this year and the next two years will equal 97.3% of the stock price seen at tonight’s $54.36 close. Firm believes the market is seriously underestimating the company’s free cash flow generation, particularly given that Domtar has between $3-$6 per share in “excess” deprecation each and every year based on the purchase accounting applied to the Weyerhaeuser assets acquired in 2007. Credit Suisse also point out that they build in a substantial, $100-$200 per metric ton (tonne), correction in market pulp prices during the second half of 2010, with prices resuming their uptrend for most of 2011 and 2012.

Target Up to $125: Credit Suisse's one-year target price now reflects their cyclical peak target of $125, as they now see the stock reflecting the 2012 peak by mid- 2011, or about one year from now. In 2007, Domtar traded near $140 despite having $2.5 billion in net debt and generating much lower earnings and cash flow than currently.

- Goldman Sachs is removing Domtar (UFS) from the Americas Conviction Buy list (maintain Buy) as: 1) they expect a pause in the pulp price cycle as news flow softens thru the seasonally weak summer, when demand slows and inventories rise and 2) they under appreciated the multiple compression as pulp and paper prices rose to historic highs. However, the firm maintains their Buy rating as they expect uncoated freesheet prices to be sustainable and for Domtar to generate nearly $14/share in free cash flow in 2010. Since being added to the Conv. List on 3/16/2010, Domtar is -18.9% vs. paper/forest peers -7.2%, S&P500 -5.5%; over the past 12-months, Domtar is +244.5% vs. S&P500 +22.6%.

Goldman maintains their Buy rating on Domtar shares and make no changes to their 2010-2012 EPS forecasts or 12-month price target. Although there is likely to be headline risk for pulp through the seasonally weaker summer, they maintain their Buy rating on Domtar stock given: 1) strong earnings leverage to robust uncoated freesheet (UCFS) and pulp prices; 2) upside to their 2Q2010 EPS estimate on stronger-than-expected UCFS and pulp prices; 3) improving balance sheet and massive free cash generation; and 4) valuation is compelling trading at a +25% free cash flow yield and only at 3.6X 2010 EBITDA. On mid-cycle cash EPS and EBITDA, Domtar is trading at 4.7X and 6.7X, respectively, levels they believe to be inexpensive.

The firm sees 56% upside to their 12-month $85 price target (PT), which is based on their 2011 cash EPS and EBITDA estimates of $13.90/share and $1.1 bn and 6.1X and 4.5X multiples, respectively. Goldman estimates Domtar will generate nearly $14/share of free cash flow in 2010 and 2011. With a balance sheet expected to be near 1.0X levered in early 3Q2010, they expect Domtar will step up its return of cash to shareholders through increased dividends and share repurchase.

Notablecalls: Credit Suisse's call with a Street high target of $125 trumps Goldman's cosmetic change to their Conviction Buy list.

Credit Suisse's Paper Products team has been around for several cycles, so they tend to know what they are talking about.

Remember the huge Louisiana-Pacific (NYSE:LPX) call back in March 2010?

UFS is a mover and CSFB's call offers way over 100% upside.

I think UFS can move nicely today, possibly to the tune of 5-7%, putting $57-58 levels in play.

I also think UFS stands to benefit from this call over the next several days, putting higher levels in play.

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