Temple Inland Isn’t Alone

06/07/2011 10:13 am EST

Focus: STOCKS

Igor Greenwald

Chief Investment Strategist, MLP Profits

Several mid-caps in the materials and industrials sectors are doing even better than Temple Inland was before International Paper pounced with its big bid, writes Senior Editor Igor Greenwald.

Those International Paper (IP) guys must be real saps.

Right after the market was subjected to another pasting Monday, they unwrapped their hostile takeover bid for corrugated-packaging and building-products maker Temple Inland (TIN).

Perhaps they haven’t heard that the economy is on the ropes again, and the housing market beyond repair. How else to explain IP valuing Temple Inland at a 45% premium to Monday’s market close?

Temple Inland has its own theory, of course—it alleges that its rival’s bid “grossly undervalues” its prospects, which reportedly includes:

  • the likelihood of further recovery in corrugated packaging “as the economy continues to improve” (what?!)
  • unrealized cost savings
  • and even the possibility that its building-materials business still has value...

International Paper retorts that the recovery in packaging will be slow, with the building-products business a drag for years—and anyway, its offer fully values any potential improvement.

In other words, the haggling has begun. And no matter how much criticism IP heaps on the object of its ambitions, its opening bid is far more eloquent.

Let’s split the difference and stipulate that, at 9.2 times the current year’s far-from-peaking cash flow, the offer is not crazy-rich, but not insultingly insufficient either.

For bystanders without a dog in this fight, the final outcome will be of modest import. The more interesting—and potentially far more lucrative—question is, who are the other Temple Inlands out there, in terms of potentially undervalued acquisition targets?

This can be a fun game to play, if only as a distraction from the clammy market action. And even if no greater fool shows up to bid over the top for these particular stocks, it’s always useful to poke around for hidden value, especially in sectors already seeing merger action.

NEXT: I Have 5 Suggestions

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I Have 5 Suggestions...First, Mercer (MERC)
For example, within the hour of IP’s Temple Inland bid, Briefing.com was highlighting high-end wood pulp supplier Mercer as a potential beneficiary from the increased merger speculation.

Like Temple Inland, Mercer saw its share price pulverized during the Great Recession, and like TIN it’s relatively cheap, selling for less than 7 times the current year’s earnings estimates (vs. 15 times before the IP bid for Temple Inland.)

The stock has been a much stronger performer than TIN year-to-date, gaining 52% despite dropping 20% over the last two months.

So I ran some screens for other mid-cap stocks in the materials and industrials sectors—all priced, like Temple Inland was, at less than 15 times earnings and less than ten times cash flow, and generating similarly solid returns on equity and investment.

Domtar (UFS)
This is how I found another paper play in Montreal-based Domtar, which turns wood pulp into a variety of high-end printing paper and paper stock for office stationery. Domtar sells for less than 9 times estimated 2011 earnings, and less than 4 times trailing cash flow.

Restructuring of assets previously shed by Weyerhauser (WY) is going so well that last month, Domtar hiked its quarterly dividend by 40%, and quadrupled its buyback allocation to roughly 15% of the current market cap. That quarterly report topped the consensus earnings estimate by 38%.

Investors have noticed: the stock is up 27% year-to-date, and 82% in a year.

Sauer-Danfoss (SHS)
Mobile-hydraulics specialist Sauer-Danfoss, a majority-owned subsidiary of Denmark’s Danfoss S/A, has rolled to a 65% gain for 2011 and a whopping 260% windfall in a year’s time.

When it reported quarterly results a month ago, the Iowa-based company raised its annual forecast, citing revenue growth of 46%, as Asian sales doubled. Revenue rose 36% in Europe and 37% in the Americas.

“Our markets continue strong,” noted the CEO, who nevertheless remained “somewhat concerned with the health of the macroeconomic environment globally.” But he was not concerned enough to delay new investments in Asia.

Despite its soaring share price, Sauer-Danfoss sells for less than 9 times trailing earnings and cash flow. The board is discussing what to do with that cash flow now that the company has paid down its debt.

TRW Automotive (TRW)
Like the paper and hydraulics industries, automotive suppliers are still recovering from the slump of 2008 and 2009. But TRW Automotive is already significantly cheaper than Temple Inland, at 7 times the current year’s earnings and just 4 times trailing cash flow.

Sales were up 15%, and earnings 38%, in the most recent quarter. The stock has gained 86% in the last year.

Texas Industries (TXI)
Finally, cement and concrete supplier Texas Industries remains in the red, though its business did improve earlier this year. But it seems to have caught the eye of two major investors who’ve been eagerly buying up shares on the open market.

One is an Egyptian construction tycoon who lifted his stake to 20% earlier this year, and promised the company he won’t increase that any further in 2011. And then there is the well-regarded money manager that spent some $25 million on TXI shares over the last two weeks.

None of these stocks are necessarily takeover candidates. But they’re all candidates to continue doing well.

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