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Fairfax alumnus thinks Resolute Forest Products is undervalued opportunity

Fairfax Financial Holdings Ltd. Chairman and Chief Executive Officer Prem Watsa speaks during the company's annual meeting in Toronto April 11, 2013.

Aaron Harris/REUTERS

A flock of value investors from across North America will land in Toronto this week to hear what Prem Watsa, the CEO of Fairfax Financial, has to say at his firm's annual meeting. But they should think about one of the company's investments on their way there.

Fairfax's annual meeting draws value investors from far and wide. It's more intimate than the big bash thrown by Warren Buffett at Berkshire Hathaway. But Fairfax's meeting is also surrounded by a constellation of conferences and other gatherings. Those with good constitutions can enjoy more than 40 hours of public and private events in Toronto this year that stretch over the course of four days.

The festivities begin on Monday April 11 with a two-day MicroCap conference for regular investors. It's organized by Fred Rockwell and Nate Tobik, who runs the Oddball Stocks investment letter. The meeting is devoted to small Canadian companies that don't happen to be in the commodity sector.

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Professional money managers gather on Wednesday for the Ben Graham Centre's value investing conference. The daylong event is organized by Dr. George Athanassakos and the Ivey Business School. Its many notable speakers include Charles Brandes, Peter Kauffman, Richard Rooney, Kim Shannon, Paul J. Lountzis, Irwin Rotenberg, and Chuck Akre.

That's all prelude to the main event on Thursday, which sees hundreds of shareholders crowd into Roy Thomson Hall to hear from Mr. Watsa. I doubt he'll be enthusiastic about most North American stocks. After all, he has hedged Fairfax's portfolio against both an equity downturn and deflation.

Fairfax has many investments but my attention was recently drawn to one of them by fund manager, and Fairfax alumnus, Francis Chou. He pointed to Resolute Forest Products as an undervalued opportunity in his recently published annual letter to investors, which is itself well worth reading.

Resolute makes its home in Montreal and produces wood products, market pulp, newsprint and specialty papers from facilities in North America and Asia. It generates most of its sales in the United States with lesser amounts in Canada and other countries across the globe.

Mr. Chou's funds own about 5 per cent of the company's stock and Fairfax controls roughly 32 per cent of the firm. But the investment has been less than inspiring for both parties in recent times.

Resolute's stock hit $21.70 (U.S.) in 2014 on the NYSE and subsequently fell back into the high teens. The shares took a real dive in 2015 and reached a 52-week low of $3.79 in February of this year, but bounced back above $5 more recently.

In his letter, Mr. Chou expressed astonishment that the stock fell to $4 per share. At that price, the firm had a market capitalization of about $360-million. (These days it's closer to $460-million.) He thinks that each of the firm's four main business segments could easily be sold for at least $400-million in a normal market.

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In addition, he figures that the firm's normalized annual earnings before interest, taxes, depreciation and amortization (EBITDA) is near $400-million. As a result, the firm trades at about one times its normalized EBITDA. Its net debt plus market capitalization is only about two times its normalized EBITDA. Both multiples are very low.

However, I hasten to add that Resolute isn't for the squeamish. After all, the company lost a sizable amount of money in each of the last three calendar years and its revenues fell 14 per cent in 2015 compared to the prior year.

But Mr. Chou is a believer and he snapped up more of the firm's shares for his flagship Chou Associates fund in recent months.

Bargain hunters would do well to take a copy of Resolute's annual report with them to read on the trip to Toronto. They might find a stock they'll want to put in their own portfolios.

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