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Resolute Forest Products (TSX: RFP) is in the business of producing newsprint, specialty papers, wood products and market pulp. As commodity prices fell, Resolute Forest Products was significantly impacted as all four of the company’s business areas lost money over multi-year periods.
Executives focused on reducing the fixed costs of each business segment, but weakness in each underlying market threatened to drown Resolute Forest Products due to fall in prices.
During this period, the market price of Resolute Forest Products reduced from over $20 per share to $4.25 per share with a market capitalization of approximately $384 million. The company continues to have consolidated sales of close to $3.6 billion; in each of its major businesses, Resolute Forest Products is the highest producer worldwide.
Resolute Forest Products continues to be the largest mass producer of wood products in North America, the fourth largest in North America for market pulp, the number two producer of newsprint in the world and the largest producer in North America of uncoated mechanical paper and an emerging tissue producer.
The company has suffered from a drastic decline in the consumption of newsprint as the world moves to the digital age. In order to mitigate this impact, the company has diversified operations and branched out into higher margin businesses.
The wood products business of the company has recurring revenues of approximately $600 million, while the other three businesses have consolidated revenues of approximately $1 billion each. Thus, it appears that each of the four business segments could be worth $500 million if commodity prices normalize. On this basis, Resolute Forest Products looks ridiculously underpriced.
The company’s EBITDA (earnings before interest, taxes, depreciation and amortization) is approximately $450 million. Hence, with Resolute Forest Products trading at $4.25 per share at writing, the total value of the company is being valued by the market at approximately 1 times earnings.
Although the company is highly leveraged and carries about $365 million in liabilities, investors appear to be valuing the entire company at 2 times earnings. The company had cash of approximately $350 million a year ago but used approximately $160 million to buy Atlas Paper and plans to spend $280 million to renovate a few pulp mills to diversify operations.
A few years ago, the company bought Fibrek Inc. for approximately $125 million. Hence, the value of Fibrek ($125 million), Atlas Paper ($160 million) and the renovation of paper mills ($280 million) comes out to be $565 million.
In addition, the company has significant tax loss carry forwards of nearly $2 billion that can be used to offset pro-forma net income. Although the forest products industry is highly capital intensive and characterized by undesirable investment characteristics such as low return on invested capital, low return on equity, high leverage and slim margins, Resolute Forest Products appears to be selling at a rock bottom price.
The liquidation value of the company is several multiples the company’s stock price; the company could therefore initiate buybacks or pay a special dividend to reward long-term shareholders.
All these factors demonstrate that at its current prices, Resolute is extremely undervalued. Prem Watsa of reputed Canadian investment firm Fairfax Financial Holdings recognizes the incredible opportunity in the company and Resolute is one of Fairfax’s larger portfolio holdings.
