Industry Reports

Deutsche Bank Reports Summaries

071001 Deutsche Bank Report - Rock-Tenn Meeting Notes

Deutsche Bank - Equity Research

Rock-Tenn {Ticker: RKT, Closing Price: USD 29.51, Target Price: USD 40.00, Recommendation: Buy}.

Management meetings with RKT were supportive of DB view

We recently attended meetings with RKT management in New York and the Mid-Atlantic.  We came away more confident in our bullish thesis.  We maintain our Buy rating based on favorable valuation, disciplined capital management and continued strength in key paperboard markets.

Management believes the stock is undervalued… …and company is actively repurchasing shares.

RKT looks noticeably undervalued relative to peers (13.7x ‘07E P/E, versus a group average of 17.1x; and 6.7x ‘07E EV/EBITDA, versus a group average of 8.5x). This is not lost on management. 1.6MM shares (4% of outstanding diluted shares) were repurchased in July & August. There are 2.4MM shares remaining under the current authorization.

RKT's balance sheet provides financial flexibility

Even with the large share repurchase program, we do not expect the net debt/EBITDA ratio to rise above 2.4x. Management suggested that it would be comfortable with a ratio “in the low 4's.” This suggests additional borrowing capacity of about $600MM, enough for a substantial acquisition. The issue is finding the right deal at the right price. In the absence of a significant deal, we think the company will continue returning cash to shareholders.

Valuation/risk

Our $40 target price is based on a modified DCF analysis. We estimate the normalized free cash flow to equity, and we apply a multiple which is the inverse of what we consider a fair cost of capital for the shares of RKT. The primary risks include a decline in the economy, capacity growth through imports, and a spike in the costs of key inputs.