Francis Chou is one of the most renowned value investors of our time. The manager of Chou Associates Management was named Morningstar’s Fund Manager of the Decade in 2004, an award who’s alumnus include Bill Gross and Bruce Berkowitz. Chou currently managers a modestly sized 13F portfolio of close to $375 million in US equities, and has a penchant for financials, technology, and services companies, choosing to allocate nearly 75% of his total capital to these three sectors. Today, we’re going to take a look at one of Chou Associates’s top stock picks, a paper company with a $1.2 billion market cap that has returned close to 30% over the past three months. We’re talking about Resolute Forest Products Inc (NYSE:RFP).
Resolute Forest Products, formerly known as AbitibiBowater, is a forest products company with operations spanning the US, Canada, the UK, and South Korea. Resolute’s headquarters are in Montreal, where executives manage close to $5 billion in annual revenues and over 10,000 employees across the company’s operational zones. The company is the world’s largest producer of uncoated mechanical paper, in addition to the newsprint. Resolute also makes market pulp, coated papers, and assorted wood products in over twenty mills throughout the world.
Since the end of the recession, Resolute Forest Products has actually seen its top line decline quite significantly each year, averaging an annual decrease 11.1% over the past three years. In comparison to industry peers like International Paper Company (NYSE:IP), Fibria Celulose S.A. (NYSE:FBR), Sonoco Products Company (NYSE:SON), and Domtar Corp. (NYSE:UFS), these declines are unimpressive to say the least. International Paper and Sonoco have averaged 2-3% revenue growth post-recession, while Fibria Celulose (22.5%) and Domtar (-4.3%) are at each end of the spectrum, so to speak.
Below average efficiency – operating and net margins of 2.4% and -1.0% specifically – have hurt Resolute over the past few years, as the company has also experienced middling earnings. Interestingly, the paper producer has beaten the Street’s estimates in each of the past two quarters, most recently in August, the end of its fiscal second quarter, when EPS was a whopping 30 cents a share, 380% above consensus estimates.
The company took majority control of Fibrek, a small-sized Canadian pulp producer and recycler, in May, and announced in June that it would purchase all of the company’s remaining shares outstanding. Upon completion of the acquisition, Fibrek traded at a relatively small market cap near $100 million, and had generated over $500 million in revenues each of the past two years. Resolute CEO Richard Garneau said that he was “delighted to mark […] integration of Fibrek within the Resolute family,” and stated that:
“We’ve [Resolute Forest Products] consistently said that we would remain true to the three themes that underlie Resolute’s strategy: cost-effective operational excellence, disciplined use of capital and strategic development. Increasing our capacity in the growing global pulp market by adding these assets is consistent with our strategy. Resolute is uniquely positioned to generate additional value from these assets by completing their integration.”
By the end of 2013, the Street expects Resolute to make around $1.00 in earnings per share, and predicts the company to grow its EPS by 5.0% a year over the next half-decade. This forecast is below those set for International Paper (5.63%) and Sonoco (6.5%), but more bullish than those of Domtar (1.5%) and Fibria Celulose, which is expected to experienced negative EPS growth over this period.
Operating in a paper products sub-industry for which the S&P gives a “neutral” forecast over the next 12 months, Resolute Forest Products’s prospects are modest, but there are obvious inhibitors to long-term demand, most notably regarding companies that make products consumed by newspaper, magazine, and other print publishing clients. Interestingly, it is possible that production cutbacks will keep paper prices high – coated sheet prices are currently near $2 per cwt. – which can provide some intermediate-term tailwinds to companies like Resolute.
From a valuation standpoint, shares of the company currently trade at sales (0.4X) and book (0.3X) multiples more than 50% below industry averages, and cheaper than the likes of International Paper (0.6X, 2.3X), Sonoco (0.7X, 2.0X), Domtar (0.5X, 1.0X) and Fibria Celulose (1.8X, 0.6X). A similar story can be told in terms of earnings multiples, both from forward and backward looking perspectives.
In short, Resolute Forest Products looks to be undervalued at the moment, and even though its shares have generated a healthy return since news of its Fibrek acquisition first broke, there is still moderate upside to be had. Whether its the production gains that are likely to be had from the move, or analysts’ bullish EPS forecasts, we can see why Francis Chou was named Morningstar’s Fund Manager of the Decade. This is a company that is overlooked by most armchair analysts, but if our analysis, and Chou’s pedigree are any indication, now is a perfect time to consider adding Resolute to your portfolio. But don’t take our word for it, check out Chou’s 13F portfolio for yourself.
