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forest products

A pulp machine at a Domtar mill in Hawesville, Ky.Pierre Charbonneau

Domtar Corp. and its investors have caught a big break, courtesy of the company's chief rival.

International Paper Co. said on Wednesday it will close a major paper mill in Alabama, lopping 8 per cent from North American supply capacity and helping to rebalance a market in structural decline.

Someone had to do it.

"It's nice to be able to free-ride on a competitor," said Daryl Swetlishoff, a forestry analyst at Raymond James. "It's not cheap to shut down these assets."

To be fair, Mr. Swetlishoff said, Domtar has done its share of downsizing over the past decade, closing mills in Cornwall, Ont., Ottawa and other North American sites.

This time it was International Paper's turn.

"We knew one of them would have to do something relatively shortly. It wasn't clear which one it would be," said Scotia Capital analyst Benoît Laprade. "Both Domtar and IP over the last several years have been very disciplined in taking capacity out when needed. One could argue that this year it took a little longer than it should. There was some worry they wouldn't do it and prices would continue to slip."

Shares of Domtar, the largest copy paper producer in North America, rose almost 16 per cent on Wednesday, adding $350-million in market capitalization, one week after hitting a two-year low.

The past two earnings reports have been rough ones for investors of the Montreal-based company.

"We didn't operate up to our usual standards," Domtar's chief executive officer John Williams said in July after posting a $46-million (U.S.) net loss in the second quarter.

He blamed higher costs and lower productivity – uncharacteristic for a company known for its discipline, which is required in the paper business.

The use of copy paper, or uncoated freesheet, is steadily decreasing. These days, information wants to be digital.

"The demand for uncoated freesheet in North America has been in decline since 1999 and has recently accelerated as consumers continue to switch to electronic alternatives such as online publications and electronic billing and filing," International Paper said in announcing the closing of its mill, which has 1,100 employees and annual production capacity of almost one million tons.

The closing "significantly improves the outlook for the North American copy paper market," said Stephen Atkinson, an analyst at BMO Nesbitt Burns. "What everyone was looking for was a more stable market for next year."

Although paper is unfashionable, the two market leaders have been careful to try to avoid price distortion and excess supply through regularly curtailing capacity. And beyond the sector's obvious challenges, Domtar still generates substantial free cash flow and has increased shareholder dividends for the past three years.

"The market's been a little bit complacent on the sector and on Domtar," Mr. Swetlishoff said. Even after an impressive one-day spike, Domtar's stock is still well within its year-to-date trading range. And its valuation is still low, Mr. Swetlishoff said, maintaining his $95 target price.

Still, there is not much future potential in servicing a dwindling market exclusively. Domtar has tried to diversify its product mix by expanding into personal care through a series of acquisitions of baby diaper and adult incontinence product manufacturers. But those new lines of business are still on Domtar's margins, representing just 7 per cent of last year's revenue.

"Until Domtar demonstrates that they can replace the earnings associated with the uncoated freesheet business with others, until that becomes evident, the multiple discount will continue," Mr. Swetlishoff said.

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