The strategy team at Merrill Lynch has rebalanced its portfolio with upgrades Owens-Illinois Inc. (NYSE: OI), Louisiana-Pacific Corp. (NYSE: LPX) and Domtar Corp. (NYSE: UFS) to Buy from Neutral. Tuesday’s rotation report noted that these changes were prompted by an improving global growth outlook expected by the firm’s strategists
They also followed a recent downgrade of containerboard stocks, which required the team to rebalance its ratings. Merrill specified that these are 12-month outlook calls rather than how it expects first-quarter earnings reactions to go. Also supporting the rotational call was that the BofAML China Activity Coincident Tracker improved for the fourth consecutive month in March and appears to be confirming that the worst in the cycle is likely now over.
Among these three upgrades, the analysts are calling for an average of over 20% upside, even before adding in dividends. That is handily higher than the current climate of analyst calls in Dow Jones industrials and S&P 500 stocks, with an implied upside of 8% to 10% in total return at this stage of the bull market.
So far in 2019, shares of Owens-Illinois have risen 16%, while the S&P 500 has seen a gain of about 17%. What is interesting about this call is that it came after a downgrade back in February from Buy to Neutral. Merrill raised its expected multiples because the firm now expects a rebound in relative performance and sees Owens-Illinois benefiting from an improving macro story, emerging markets and the energy backdrop that positively helped the company previously. The firm also sees that its pricing signs are ultimately constructive in Brazil and Mexico, and it even anticipates the same for Europe.
The $21 Owens-Illinois price objective was raised to $24 and compares to a $19.45 prior close. That represents implied upside of over 23%, plus it comes with a 1% yield that can be factored in for a total return expectation. Merrill’s old target already was above the $20.79 prior consensus target price from Refinitiv. The report said this:
Its connection to oil and other commodity pricing might seem unintuitive. However, while glassmaking is energy-intensive (so higher oil prices could reflect potential cost increases in natural gas and oil), such costs are passed through over time. More importantly, such inflection is often coincident with a pickup in emerging markets, places where glass still grows. Additionally, higher input costs could also spur peer companies to increase pricing for glass as well.
Louisiana-Pacific stock is down 6% so far in 2019, again compared with a 17% gain for the S&P 500. Merrill raised it to Buy after a period in which its primary commodity product (oriented strand board) was on a steady decline. The firm believes that the bad pricing news in the oriented strand board segment is now basically priced in to the shares. It also expects that this building season is likely to improve with better weather, even as some oriented strand board mills have been temporarily idled, a move that should help to firm up segment pricing. The Louisiana-Pacific call noted this:
While the company is doing what it can to become more value-added, the stock still trades in sympathy with commodity OSB. Our supply/demand model puts OSB at an 84% operating rate for 2019, not a terrific place to be. However, distribution inventories seem low and the recent trade press has suggested buying activity improved in recent weeks. Lastly, trade contacts and the trade press report recent OSB mill curtailments that could amount to about 1% annual capacity – not huge, but a start.
Merrill raised the Louisiana-Pacific price objective to $30 from $29, but that is still less than the prior consensus analyst target of $31.00. The new target indicates implied upside of over 21% from the $24.75 prior close, and there is a 2.2% dividend yield to consider.
The 22% year-to-date gain in Domtar shares exceeds the performance of the S&P 500. News that Georgia-Pacific would be shutting its uncoated free sheet capacity gets credit for the outperformance, but there has been a pullback in recent weeks based on reductions to first-quarter estimates and around news that uncoated free sheet capacity pricing has been slower to be implemented than expected.
On Domtar, Merrill does expect an improving pulp outlook to provide a catalyst for the shares, and the latest info from the Pulp & Paper Products Council reported a solid 2.7% increase in shipments in March from a year ago — plus a 4.3% gain in shipments to China. The call noted that inventory levels remain elevated, but those inventories also decreased by three days from the prior month.
Merrill’s lifted its price objective on Domtar to $58 from $56, which represents an implied 12-month upside projection of about 20% from the current $48.35 share price. Domtar also has a 3.5% dividend to add in for expected or implied total return calculations. The prior consensus target price was $52.75.
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