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080215 Deutsche Bank Report - Domtar's 4Q in 100 Words

Deutsche Bank - Equity Research

Domtar {Ticker: UFS, Closing Price: USD 7.12, Target Price: USD 14.00, Recommendation: Buy}.

* Disappointing.   Reporting GAAP EPS of $(0.05) and pointing to $0.06 net of special items.  DB @ $0.11 & consensus @ $0.09.  Input cost inflation ($21MM q/q) and the impact of seasonally weaker volumes/mix ($30MM q/q) were bigger than expected.

* Segments:

 * Paper.  EBIT = $106MM, 3Q = $133MM.  Shipment vol's -8.0% q/q (industry -3.3% q/q).    Higher costs for fiber, chemicals &

energy.  Stronger C$.

* Merchants.   EBIT = $1MM, 3Q = $6MM.  3Q was helped by a $2MM decline in allowance for doubtful accounts.  Temporary margin squeeze from rising paper prices.

* Wood.   EBIT = $(22MM), 3Q = $(13MM).  Lower prices, higher freight costs, stronger C$.  D&A also $2MM higher q/q.

* Other issues:    (1) Capex was just $116MM in '07.  Pointing to $240-270MM for '08 ($30-60MM lower than prior guidance and only about 50% of D&A).  (2) Merger synergies run-rate was $130MM at year- end (well ahead of $80MM target).  Rather than $200MM by March '09, new goal is more than $200MM by December '08.  (3) Expecting paper demand to fall 1-2%/yr in NA, but prepared to respond if demand declines faster.

* Change in view?   Not really.  Estimates need to be trimmed slightly, due to greater than expected cost inflation, but stock still looks very cheap.  Even on our reduced '08 numbers, FCFE = 15% of market cap.  Solid UFS markets over last year despite woeful NA demand suggests that consolidation, capacity rationalization, and a weak US$ are a powerful combination.  Maintain Buy and $14.00 price target.  Estimates: '08 goes from $0.50 to $0.45 (1Q = $0.08) and '09 goes from $0.60 to $0.50.