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Pulp Fiction

Richard Croft
April 2, 2012
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Moody’s Investor Services recently released an analysis of the global paper and forest products industry, and doesn’t like what it sees. It believes overall operating income for most players in the industry will decrease in the next year and a half as demand fades and prices weaken.

If Moody’s outlook pans out, that could spell trouble for some of Canada’s biggest paper producers, such as Domtar Corp. (TSX: UFS, Friday’s close: $95.27). Shares are trading just off their 52-week high of $102, after a powerful, uninterrupted rally since last August. Positive analyst sentiment is running exceptionally high, with consensus recommendations generally at the “strong buy” level. However, given that the company posted an 80% drop in quarterly earnings in the fourth quarter of 2011, as pulp prices fell and shipments dwindled, and given that the outlook for paper products is not good, the consensus estimates might just be a case of pulp fiction.

Going contrary to analyst expectations, Moody’s does not expect the situation to improve, suggesting further downside risk for companies in the forest products and paper sector. If you are an aggressive trader who buys into this argument consider establishing long put positions in Domtar to lever the potential of further downside. Specifically look at buying the UFS June 94 puts at $3.50.

Richard Croft
Richard Croft http://www.croftgroup.com/

President, CIO & Portfolio Manager

Croft Financial Group

Richard Croft has been in the securities business since 1975. Since February 1993, Mr. Croft has been licensed as an investment counselor/portfolio manager, operating under the corporate name R. N. Croft Financial Group Inc. Richard has written extensively on utilizing individual stocks, mutual funds and exchangetraded funds within a portfolio model. His work includes nine books and thousands of articles and commentaries for Canada’s largest media channels. In 1998, Richard co‐developed three FPX Indexes geared to average Canadian investors for the National Post. In 2004, he extended that concept to include three RealWorld portfolio indexes, which demonstrate the performance of the FPX portfolio indexes adjusted for real-world costs. He also developed two option writing indexes for the Montreal Exchange, and developed the FundLine methodology, which is a graphic interpretation of portfolio diversification. Richard has also developed a Manager Value Added Index for rating the performance of fund managers on a risk adjusted basis relative to a benchmark. And In 1999, he co-developed a portfolio management system for Charles Schwab Canada. As global portfolio manager who focuses on risk-adjusted performance. Richard believes that performance is not just about return, it is about how that return was achieved.

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