Temple-Inland, Inc. (TIN), which makes paper, packaging and building products, was put on credit rating watch with a positive outlook by Standard & Poor’s. The stock is up nearly 10% on the news Wednesday and it is also giving a boost to some of Temple-Inland’s competitors’ stocks. S&P credits the company will reducing its debt load by $440 million over the last year, and said that if it can continue with its debt reduction plans it would be eligible for a credit upgrade to “BBB”. While their efforts to reduce debt should be commended, it is a bit surprising that this announcement would be met with such enthusiasm by the market.
Temple-Inland was able to shave its debt in an environment that was certainly not hospitable to an important business segment, building products such as lumber and particle board. Clearly, this segment is heavily correlated to the strength of US housing starts, which have been at extremely low levels over the past two years. The company was able to utilize $175 million in alternative-fuels tax credits as well as $335 million in free cash flow in fiscal 2009, and rolled the majority of that into cutting down its debt. What makes this especially impressive is that the company devoted these resources even though they did not have any significant amount of debt maturing until 2012. It is clear that there were not a lot of great opportunities for TIN to invest in growth over the last year, so they were content to bide their time and strengthen their balance sheet. This may not be the sexiest strategy for investors, but it should give them greater flexibility to pursue growth as better opportunities present themselves in the years ahead.
The company’s strong and disciplined execution over the last year as well as stabilization in economic conditions has allowed the stock to return over 400% over the last 52-weeks. However, even after its impressive run, we are not yet concerned over its current valuation. Aggressive cost cutting should make a quick rebound in profitability possible once housing starts do begin to pick up. Its corrugated packaging business segment is somewhat more stable, but it is still subject to commodity (lumber) price fluctuations which weigh heavily on margins. An improvement in economic activity would increase the demand for Temple-Inland’s packaging products and would prove to benefit the bottom-line.
Both price-to-cash earnings and price-to-sales are currently well within their historically normal ranges, so as of yet, no red flags there. Based on the current fundamentals, we see a price range of $18 to $26 as a reasonable to expect over the coming year, barring considerable further weakening housing environment or a double-dip hampering the US economy. Temple-Inland has done a good job managing costs and lowering debt in a difficult environment, but after today’s appreciation the stock remains Fairly Valued. There are certainly more attractive stocks available for value investors, but it is good to see a company getting credit for strong, conservative management in a tough market environment.