Resolute Forest Products: Higher Prices Look On The Cards

About: Resolute Forest Products Inc. (RFP)
by: Individual Trader

The company has a very attractive valuation.

Technicals match up.

Key financials are all trading in the right direction.

Unearthing potential cheap stocks for the portfolio is something we enjoy. However finding the "perfect" candidate can be difficult in itself. We look first for companies which have a solid financial footing and which are also reporting a profit. If possible, a growing dividend is also desirable. Getting all of the above though on top of an attractive valuation can be difficult to find to say the least.

One stock though that interests us at present is Resolute Forest Products, Inc. (NYSE:RFP). Its valuation at present is its calling card as the company seems to be heavily discounted against the industry in general. Resolute Forest Products at present trades with an earnings multiple of 3.1 and a cash flow multiple of 1.7. These attractive numbers are backed up by a book multiple of 0.5 and a sales multiple of 0.2. The firm's debt-to-equity ratio of 0.28 demonstrates that the company is working off a solid financial footing.

However, RFP does not pay a dividend which is a pity. Cheap stocks can remain cheap for months if not years on end before bouncing back to something near their intrinsic values. In these situations, collecting a growing dividend is highly favorable as the investor can continue to get paid while waiting. Furthermore, the cost basis of the shares can be reduced if one reinvests the dividends back into the investment.

To get over the dividend problem, since we are dealing with a stock price of under $10, one could sell covered calls for example on a percentage of the total position which would bring in income on a monthly basis. This strategy only really works when you can sell those calls at or above the share price of the stock. It is very risky to sell covered calls aggressively when one's position is showing a large unrealized loss.

Therefore, because of this point, we would be opting for more of a shorter-term trade/investment here. Let's have a look at the technicals to see if we can pin down any clues as to where the share price of this stock is headed over the next few months.

As we can see from the long-term chart below, Resolute Forest Products printed a multi-year inverse head-and-shoulders reversal pattern back in 2016 and 2017. The successful reversal led to a strong trending move which resulted in a top in September 2018. Since then, shares have been undergoing a flag or rectangle formation. These formations usually are continuation patterns as they usually end up being pauses in the underlying trend. What also is encouraging for a potential long play is that divergences are appearing between the RSI indicator and price. This means momentum to the downside is losing its luster. This usually means a resumption of the previous trend (from July 2017 to September 2018) may be on the cards in the short-term.

On the daily chart, we can see that volume has been declining since the start of the flag. This is perfectly normal. At this stage, price would have to penetrate the upper trend line of the flag before volume would increase significantly.

Earnings growth is what will ultimately drive shares forward. While this key metric can be very difficult to predict, we can look at some key trends which will give us some clues as to what level of profit this firm will be earning over the next year for example.

As mentioned, the firm's debt-to-equity ratio is a very respectable 0.28 and is trending lower. The interest coverage ratio is 9.23 and trending higher. Gross margins of 32.1% have never been higher over the past decade. Furthermore, 2020 earnings projections continue to rise with analysts now predicting $1.72 in earnings per share.

Therefore, the firm's valuation and how its key financial metrics are trending are strong calling cards at present for this stock. Its technicals also point to a strong move higher once it breaks out of its parallelogram. We will decide shortly how we want to move forward with this idea.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in RFP over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.