The phrase “adult diapers” typically doesn’t whip investors into a buying frenzy. But with 10,000 American baby boomers turning 65 on a daily basis and a current population of 44.7 million people age 65+ in the United States, there is a big need that has to be filled. Everyone is focused on selling Boomers healthcare, retirement communities and wealth management; personal hygiene products are often overlooked. Domtar Corp. (NYSE: UFS) to the rescue.

As the largest producer of uncoated freesheet paper in North America, Domtar is also major pulp producer. But the demand for uncoated, freesheet paper has been on the decline due to the continuing proliferation of digital technology, forcing the company to reinvent itself through acquisition in the personal care product space.

#-ad_banner-#The company was formed in 2006, merging the fine paper assets of Weyerhaeuser (NYSE: WY) and Domtar, Inc. Right now, 83% of revenue is generated from pulp and paper. Annually, the company produces about 1.6 million metric tons of pulp and paper with a total manufacturing capacity of 3.4 million metric tons. Personal care only represents 17% of annual sales which topped $5.2 billion last year. But that’s where the growth lies.

The company’s top two objectives are to grow sales while becoming less vulnerable to the steady decline of communication paper demand, and to reduce its earnings volatility by increasing predictable cash flow. This campaign began five years ago and it looks like they took a page out of the Kimberly Clark (NYSE: KMB) playbook.

In the early 1990’s KMB began a major transition to transform itself into a global consumer brands manufacturer by concentrating on personal care products like tissue and disposable diapers. Eventually, KMB succeeded in spinning off its pulp and traditional paper business and evolved into the global, personal care powerhouse it aspired to.

I see a similar path for Domtar. But, with a twist.

Attends, Domtar’s flagship personal care brand, created the disposable adult diaper category in 1980. In 2013, Domtar acquired Associated Hygienic Products for $272 million adding the number one supplier of store brand infant diapers in the United States. The ultimate goal of the purchase was to help drive the personal care division towards $200 million plus in annualized EBITDA. 

In addition to private label diapers, Domtar also manufactures branded diapers under the Fitti, SleepWell, and Comfee brand names. These products are primarily sold through regional grocery chains using a value pricing strategy. The branded Attends adult incontinence products are distributed through retailers as well as being sold directly to institutions and healthcare professionals.

I see Domtar’s ascension in the personal care space offering both defensive and growth benefits to investors and at the same time. In North America, personal care products are often immune to tough economic times. Pinched American consumers may not go out to eat as often but they definitely won’t forgo diapers. Add Domtar’s value pricing strategy to the mix and the defensive investment thesis is even more attractive.

Now, a look at the emerging world: As the global middle class rises, personal care product consumption increases. According to a 2010 study by McKinsey and Company, baby care hygiene products are among the first products that emerging middle class consumers gravitate to. Domtar’s personal care products are sold in over 50 countries around the world with the same value pricing strategy used in North America. 

The company’s goal of a $200 million EBITDA contribution would translate into the personal care segment contributing over 25% to the annual sales effort. This would be a nearly 50% increase.

From a balance sheet standpoint, Domtar is in good shape to execute this growth strategy while continuing to return value to shareholders.  Historically, the paper business is incredibly capital intensive. However, over the last five years, the company has held its long term debt to capitalization to around 30% which is very respectable when compared to the likes of larger peers such as Kimberly Clark and International Paper (NYSE: IP) who’s long term debt to cap rate comes in at twice that for the same period.

Management has also kept the dividend payout ratio at a respectable 54% (my rule of thumb is usually no higher than 60%) indicating that retained earnings are being reinvested in the business at a healthy rate. The aforementioned peers have payout ratios north of 70%. Domtar is using its capital wisely. The dividend has also doubled over the last five years resulting in an annualized growth rate of 20%.

Risks To Consider: While it seems that Domtar has teed up its vision to grow the personal care business, it faces significant headwinds. Bigger competitors have much larger marketing budgets and higher brand equity in global markets. Also, the growth of the emerging middle class may be threatened by a weakening global economy. Domtar’s value pricing product strategy is a good defense on both of these fronts. And while input costs are lower thanks to weaker commodity prices and a stronger U.S. dollar, the specter of higher prices and a softer dollar always looms, threatening margins and profits. However, it appears as if management has a firm grip on the balance sheet and is prudent when it comes to allocating capital.

Action To Take: Domtar shares currently trade around $35 with a forward PE of 11.7, a 4.4% dividend yield and just at their tangible book value. The 2016 earnings per share consensus estimates are right at $2.99. 2017 EPS are expected to grow by 12% to $3.36. Based on the company’s solid dividend growth rate, disciplined management and articulated growth plan, a 12-month price target of $45 is achievable with forward PE expansion to 15. The result, including dividends, would be a total return of 33%. 

P.S. Be sure you take the time to read our latest report of the 10 Most Shockingly Profitable Predictions for 2016. Our previous predictions have given investors annual returns as high as 310%. And this year’s group might still be our biggest money-makers yet. To hear the full list of predictions, including how to profit from Google’s crazy new business venture, go here.