We are keeping our Hold recommendation on Brazil-based pulp-producer Aracruz Celulose S.A. (ARA) with a price target of $80. The company's multiple expansion plans are solid and we believe that it is going to enhance the value of the stock over the long term.
Moreover, the international pulp and paper markets remain tight, and the short-term outlook for pulp prices is positive. The recent upgrade of Brazil to 'investment grade' by Standard & Poor's and by Fitch is also encouraging for Brazilian stocks.
However, the continued strength of the Brazilian real [monetary unit] undermines Aracruz's exports and increases its real-denominated production costs. Additionally, the higher inflation and interest rates throughout the world and particularly in Brazil are the sources of great concern.
According to the Pulp and Paper Product Council (PPPC), global pulp demand increased by 7.3% year-over-year in the first two months of 2008. We expect this to grow above average in the following years. Aracruz has drawn up expansion plans that will make it the supplier of 25% of world's hardwood pulp demand in 2015.
In addition, the company has a solid dividend distribution policy. For 2008, we expect dividends of at least US$2.8 per ADR. The company has already declared interests on equity of US$0.41 per ADR in March.
Currently, Aracruz's ADR is trading at 16.4x our 2008 EPS estimate, higher than the industry median of 13.5x, but in-line with the industry median of 16.4x. The current valuation is not particularly attractive. Additionally, if we consider the price/sales ratio, the stock does not seem to be undervalued at all.
