IFP - Interfor

[Viking]

Every couple of years it appears i need to scratch my lumber itch. I initiated a position today in Interfor, a pure play lumber company. I was able to buy shares at CAN $32.25/share. They will be paying a CAN $2 special dividend (ex dividend May 28) so my effective cost will be $30.25 (i bought shares in my RRSP so there is no tax to be paid on dividend). 

I bought shares because i think there is a good chance that lumber prices will stay elevated longer than Mr Market currently thinks. If i am right shares of IFP (and all lumber producers) will move higher (and perhaps much higher) in the coming months (RBC has a target price of CAN $45). If i am wrong, and shares trade lower, IFP is sitting on $750 million in cash and they will buy hand over fist. Bottom line, I like the risk / reward set up. 

A company presentation from May 2021 is attached below; good overview of company and industry. 

Lumber markets are currently ‘as good as i have ever seen’ to quote IFP management from the Q1 call. Why? Demand is far outpacing supply. Why? US is short 4 million single family homes (underbuilt since 2010 housing bust).

- https://www.businessinsider.com/us-housing-shortage-nearly-4-million-homes-fannie-mac-data-2021-4

And people want houses right now (US and Canada are experiencing a housing boom). Covid has stoked demand for repair/remodelling. And supply is only steady (not able to ramp higher to satisfy higher demand as BC, the historic big swing producer, is reducing production due to mountain line beetle infestation). And sawmills (US south is becoming the new swing producer) typically take +2-3 years to commission.

- https://qz.com/1985276/america-is-running-short-of-wood/

So high prices are expected to last into 2022 (by high i mean over US $1,000 board ft). And anything over US $1,000 results in windfall earnings for all lumber producers (currently lumber July futures pricing is about US $1,450). 

Futures pricing: https://www.barchart.com/futures/quotes/LS*0/futures-prices

Currently RBC estimates IFP will generate CAN +$13/share in free cash flow in 2021. Of interest, the $2 special dividend the IFP just announced is also the amount its cash balance increased in the month of April (about $130 million). “Based on the current number of shares outstanding, the special dividend will result in an aggregate distribution of approximately $130 million. The dividend will be funded from cash on hand, which amounted to $750 million as at April 30, 2021, an increase of $137 million from March 31, 2021.”

What about softwood lumber duties? This impacts less than 15% of IFP’s business as most production is now in US and a chunk of the production in Canada is now sold in Canada (6% of sales). 

What about mountain pine beetle? All of IFP’s production in BC is in the southern part of the province which is minimally impacted by the beetle.

What about management and capital allocation? This looks promising for shareholders. The big problem IFP has is what to do with all the money it is earning right now. 

1.) invest in operations: will continue to be very disciplined

2.) acquisitions: focus is US south; just closed Summerville which will add 125 million board feet (with opportunity to expand to 200 million in next year or two); will be disciplined

3.) share buybacks: will be opportunistic (will not pay any price)

4.) special dividend: utilize if they are unable to use cash for 1, 2 or 3 above. They just announced a special dividend of $2. 

So if shares are cheap/fall in price management will buy back in volume (they have the cash). If shares go higher in price, management will issue special dividends. I wonder if we do not get another special dividend announcement in another 4 to 6 weeks. 

I wonder if IFP will not get bought out at some point. 

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So what could go wrong?

1.) lumber prices could tank. What would cause demand to slow? Will housing boom slow? Will reno demand reverse?

Will supply increase? Imports (currently 4% of supply) will be something to watch; likely not a near term concern (can’t ramp quick enough to impact total market). 

2.) management could do something stupid with growing cash hoard. Like for acquisition or overpay for shares in buyback. Listening to the Q1 call this seems unlikely (reinforced by decision to issue special dividend). 

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It is hard to pay $32.25 for a stock that has doubled in price the past 7 months. It is easy to think ‘missed that one’. Or ‘higher lumber prices have already been fully factored into current share price’. Psychology is a wickedly interesting thing...

Interfor-Investor-Presentation-May-2021.pdf

[Spekulatius]

Imports could come into play if the US lifts the Import duties, which currently don’t make sense. Then, lumber could flow from Canada again. another pot. large supplier is Russia as they have huge capacity, but are notoriously unreliable.

I also think that lumber prices are a bit seasonal and tend to peak in spring but I am not 100% sure about this.

My brother is in lumber trade and sells lumber for a large Belgian mill as a free Agent. The situation in Europe is similar and the mill he works with makes money by the wheelbarrow  (and he too) and he has never seen anything like it. He also mentioned to me that those things can flip in a month but probably not this time.

I have recently heard about Interfor in a Twitter spaces meeting where the Twitter lumber gang (Kyle Cerminara $BTN) were talking and the stock came up. They also mentioned the special $2 dividend. The way I look at it as an Investment - if I get most of my investment paid back (which means in terms of dividends) in a short time period, I would be interested. I wouldn’t care about buybacks and increasing capacity as my underlying assumption would be that this is going to be a crappy business again in 2 years and pays me nothing for a long time again.

If it turns out better than that, that would be great, but I wouldn’t make this my baseline assumption. So, this really depends on how much in total dividends they pay in the short period they are making hay.

So what I like to see and what would make me inclined to invest is a clear message from management that they are paying out most of their earnings in cash. Ideally I would like to see a monthly dividend payer that pays out 80% of net earnings or something along those lines.

No position.

[Viking]

My read is pretty simple: 1.) demand is going to stay stronger than expected by Mr Market 2.) supply is going to be constrained. So prices are going to stay higher than Mr Market expects. Not at US$1,400 levels; but anything north of $1,000 will allow lumber companies to print money. Anything north of $800 will be very profitable for lumber companies. At $1,400 price levels RBC estimates Interfor could be earning $55 million in free cash low per week ($0.80/share). Nuts if it last for any length of time.

On the supply side, Canada is not able to supply much more lumber. BC, the largest producing region, has been shrinking its allowable cut for the past few years and this will be continuing for at least the next decade (caused by mountain pine beetle infestation); many lumber mills have been permanently closed as there is no wood available to run them efficiently. Imports from the rest of the world are 4% of volume; even if they ramp 50% higher they will not add much volume. The US south is where all the future growth will come from but it will take years to add the needed capacity; in the near term lumber producers in the south are saying labour shortages are a problem. There was a mini spike in lumber prices in 2018 and many lumber companies mis read the situation (thought it would last longer than it did); lumber co management appear to be taking a much more cautious approach this time around (letting cash build on their balance sheet). 

i agree that the key is what management does with the free cash flow. I have only listened to the Q1 call and they seem to be quite aware of this issue/opportunity. (I need to listen to a few more conference calls to get a better read on management.) On the Q1 call they say they will be opportunistic with share buybacks (meaning only at the right price). And when that is not an option they will issue a special dividend. And that is what was just announced. So they appear to be walking the talk. If lumber stays at $1,400 perhaps they announce another special dividend of $2 in another month. 

in terms of holding period, i have no desire to hold commodity stocks through the cycle. I will be channelling my Peter Lynch with this opportunity  

it will be interesting to see what Biden does with the softwood lumber dispute. If the US settles with Canada the duties collected by the companies (expensed and held off balance sheet) will likely be returned to the companies. Interfor is not impacted as much by duties as other Canadian producers but there is something like $130 million (and growing) in this bucketfor them.

interfor also is selling an 11 acre piece of land in Maple Ridge (old Hammond Mill); prime industrial real estate located in greater Vancouver (on the Fraser River). This has to be worth a lot of $ ($75 million or more?). Timing on sale does not look imminent but the value of the asset is real. 

——————————-— 

Lumber executive expects volatility, elevated prices to last for ‘foreseeable future’

- https://www.cnbc.com/2021/05/20/elevated-lumber-prices-to-last-for-foreseeable-future-says-executive.html

• Our belief is that this cycle that we’re currently in ... is here for the foreseeable future,” Sherwood Lumber’s Kyle Little told CNBC on Thursday.
• While lumber prices may not necessarily set another record high, “the lows will tend to be much, much higher than they were in the past,” Little said.

Little said his view is informed by research his company conducted late last year, analyzing seven previous bullish cycles in lumber over the past 35 years. They’ve ranged from nine months to 41 months, he said, with the average falling between 18 and 24 months.

He said the current boom is in roughly its 11th month, sparked partly by a pandemic-related surge in home construction that caught both homebuilders and lumber producers off guard.

For Sherwood Lumber, Little said, “one of the key metrics that we look at specifically in measuring short-term demand and pace of sales is looking at our current shipments relative to our actual sales pace.”

In the past six months, as the lumber market heated up, sales compared with shipping rate accelerated to more than “double and triple the amount,” he said. But that’s changed recently.

“We’ve seen a decrease from the peak that we saw at the end of April of about 27% over the last two weeks,” he said. “It looks like we’ll see a similar kind of reduction this week, as well.”

 

Edited May 22, 2021 by Viking

[RichardGibbons]

1 hour ago, Spekulatius said:

Imports could come into play if the US lifts the Import duties, which currently don’t make sense. Then, lumber could flow from Canada again. another pot. large supplier is Russia as they have huge capacity, but are notoriously unreliable.

Right now, the lumber tariffs look more likely to increase than decrease. (And I suspect the tariffs are a net positive for Interfor because higher lumber prices are more important than a 9% tax on 15% of production.)

[StubbleJumper]

Viking,

Clearly prices for dimensional lumber are insane.  A 2x4 goes for like Cad$12 these days, which is nothing short of highway robbery.  I have half a mind to clean out my garage to see whether there is any hidden treasure that I could sell...

But, turning to more serious matters, as I understand it, the lumber companies buy the logs, saw them, and then market them.  So, how are you thinking about how the economic rents get distributed between the many little primary companies that cut the logs and the mills that saw them?  The mills will need to pony up cash to get the logs, so do the mills have enough market power or are do the mills effectively have a spatial monopsony that would allow them to extract a large portion of those rents for themselves rather than passing them on to the log suppliers (ie, does the milling margin increase, or is it mostly or completely competed away when the mills bid for logs?).  It strikes me that if a supply constraint exists, it is not milling capacity, but rather availability of logs....

 

SJ

Edited May 22, 2021 by StubbleJumper

[Ismael]

https://www.bloomberg.com/news/articles/2021-04-26/why-the-price-of-lumber-has-soared-day-after-day-after-day

[Viking]

Stubble, to answer your question as to who is the big winner in the lumber price spike it is unambiguously the lumber producers.  Not the tree suppliers. The presentation from Interfor that i linked to in my initial post above has a slide where they graph the price of logs over the past decade or so by region. There has been a spike in stumpage rates in BC the past couple of years (i need to better understand what the NDP government is doing) but this region is shrinking production and will continue to do so for the next decade or so. The US south is the key region and my understanding is trees are actually in an oversupply situation (can grow a tree in 40 years here versus 80 in BC) and as a result, prices paid have moved up very modestly the past 10 years. No surprise this is the region all BC producers (West Fraser, Canfor, Interfor) have been aggressively expanding into the past 10 years (buying up local producers); this is also the region where most of their investment is going (updating mills purchased). 

The other interesting dynamic is the amount of concentration with lumber producers. There are now a handful of very big players. And my guess is we will see more consolidation over the next 12-24 months as all the producers are swimming in cash. They will have to do something with the obscene amount of money that is coming in.

The crazy thing is it started in Q3 of last year. So lumber producers have been earning crazy amounts of money for close to 12 months. Interfor said they had $750 million of cash on hand (before special distribution); they have 65 million shares outstanding so even after the special distribution they will have over $10/share in cash (adding earnings from the 3 weeks in May we are through). And with lumber selling in the cash market for US $1,400 they are raining more money every week. 

it reminds me of the Stelco situation except the lumber companies have about a 4 or 5 month head start in terms of when lumber prices spiked higher and quarterly earnings jumping higher (and cash started to build on the balance sheet). 

Edited May 22, 2021 by Viking

[Viking]

3 hours ago, Ismael said:

https://www.bloomberg.com/news/articles/2021-04-26/why-the-price-of-lumber-has-soared-day-after-day-after-day

Interesting podcast... thanks for posting   Too bad they did not have time to get into the demand side of the equation (new US housing starts).

Edited May 22, 2021 by Viking

[RichardGibbons]

One thought on British Columbia volumes.  My brother used to manage the forest for Canfor in one of their northern regions (i.e. he bid on supply, planned the cut, negotiated with contractors and the Indigenous, etc.) About seven or eight years ago, they were drowning in trees.

Basically, after pine beetles attack a tree, the logging company only has a few years to harvest the wood before it becomes worthless. So, the government allowed more cutting than usual to harvest all the pine beetle trees while they still had value, essentially harvesting at a higher than sustainable rate.  (i.e. if it takes 80 years for a tree to grow, you can only harvest 1/80th if you want to be sustainable.)

But now that the pine beetle trees were harvested (or weren't, and became basically worthless), I imagine that they're returned to the sustainable harvest rate (or maybe even lower to make up for the beetle years.) I think this likely accounts for the rise in the BC Interior log costs on the chart, and also suggests that it's unlikely that BC will ramp up its harvest just because of higher prices.

[Viking]

Just listened to the West Fraser Q1 call. Great colour on what is causing current demand / supply issues in lumber. Basically, North American lumber industry today has capacity to supply wood to supply new housing starts of 1.4 million (US). Housing starts have jumped to about 1.6 million. Lumber imports from Europe, while up, are NOT (edit) going to solve the supply issue in the short term. (West Fraser Q1 presentation is attached below - see pages 10 and 11 for more into on softwood lumber demand and supply dynamics.) 

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<Q - Mark Wilde>: ...Ray can you give us any thoughts on what you think both the lumber and the panel markets are able to supply these days, just in terms of, you know, (US housing) start levels. I mean, is there enough capacity out there in OSB to, you know, support a, let's say, 1.8 million? And what would the number look like over in the lumber market right now? Any sense?
<A - Raymond Ferris>: Yeah. Well, good morning, Mark. I think we've provided some materials in our investor presentation that kind of gives a bit of a view on what we see as, you know, the current supply. And, you know, against kind of today's demand. So, I'm not going to peg a number because I really don't – can't speak for all the supply initiatives that are kind of going on in the industry today. And, you know, one thing about strong pricing is that it's going to encourage more supply to come on more rapidly and that's kind of hard to predict. But today, look, I think we've consistently said for a number of years that once we kind of get to 1.4 million housing starts based on how we saw supply coming on and not really knowing when demand would get to kind of 1.4 million housing starts that we saw, we would expect significant tension in the system. And of course, nobody expected housing starts to jump to 1.6 million or wherever they are today, and that's causing a lot of strain in the system. And I think it's the same issue on the OSB side. I don't think they're fundamentally different. I think that we're seeing the strain of the industry to supply, an industry that's – a market that's running at about 1.6 million today.

<Q - Mark Wilde>: Okay. All right. And then, Ray, is it possible – just give us a, kind of a brief thumbnail on what you're seeing on the trade side? Both what you think the potential is for lumber and OSB imports into North America. And then also what kind of activity levels you're seeing in terms of your exports pulled out on Western Canada and any exports out of the Southern U.S.
<A - Raymond Ferris>: ... I think we've been surprised that there hasn't been a stronger response from Europe on imports. I mean, obviously, European imports are up, they're up pretty significantly. And, I think, we've always recognized, there was probably a bit of a limit to those. And, I think, we're, kind of, seeing that. I think it's an indication of how strong other markets are around the world, that are, maybe, keeping those limited import opportunities even lower than what – maybe what we'd expect. And so, I think there's, obviously, less OSB imports than lumber, a lot more production in Europe in – on lumber than there is on OSB. I think it's pretty limited, about the opportunities to see OSB come into the U.S., but we're looking at that as well. Chris, do you want to add anything?
<A - Chris McIver>: Yeah. Mark, I would just add, potentially, we've definitely seen a reduction in exports on the lumber side and to a much lesser degree, on the OSB side being much smaller. The market really – so that's made up a bit of the shortfall for sure and I think that will continue. We are seeing Japan recover somewhat, but it appears that China is able to get enough fiber at what – at the pricing that they're at today and seem satisfied without getting towards the numbers where we are at in North America. So – but to Ray’s comments, the European lumber market is much stronger than it was previously in the last run up. So, it’s a big part of the reason we're not seeing the supply response from there.

Q1-21 West Fraser Earnings Presentation.pdf

Edited May 26, 2021 by Viking

[Spekulatius]

20 hours ago, RichardGibbons said:

One thought on British Columbia volumes.  My brother used to manage the forest for Canfor in one of their northern regions (i.e. he bid on supply, planned the cut, negotiated with contractors and the Indigenous, etc.) About seven or eight years ago, they were drowning in trees.

Basically, after pine beetles attack a tree, the logging company only has a few years to harvest the wood before it becomes worthless. So, the government allowed more cutting than usual to harvest all the pine beetle trees while they still had value, essentially harvesting at a higher than sustainable rate.  (i.e. if it takes 80 years for a tree to grow, you can only harvest 1/80th if you want to be sustainable.)

But now that the pine beetle trees were harvested (or weren't, and became basically worthless), I imagine that they're returned to the sustainable harvest rate (or maybe even lower to make up for the beetle years.) I think this likely accounts for the rise in the BC Interior log costs on the chart, and also suggests that it's unlikely that BC will ramp up its harvest just because of higher prices.

The pine beetle is an issue in Europe too and impacts the supply situation. Those usually occur after dry summers when the stressed trees get vulnerable to beetles which unfortunately happens more and more due to climate change.

 

One thing I do not quite understand is that we have been able to build north of 2M houses  without lumber prices going through the rough in the early 2000 during the boom then. What has changed?

One thing I do know is that capacity to existing mills can be added by debottlenecking and running more shifts. Building new mills takes a long time, but debottlencking to add capacity is much quicker and that’s what the mill my brother works with is doing in Europe.

 

Edited May 23, 2021 by Spekulatius

[Xerxes]

Viking, I promise we are going to be understanding if you want to buy Resolute or like-asset

The only people making money of lumber are folks that have strategic investors, like Jim Pattison. But i agree that prices will hold up and there is an housing inventory to replenish and it will take some years.

Edited May 23, 2021 by Xerxes

[Viking]

Spec, great question “One thing I do not quite understand is that we have been able to build north of 2M houses  without lumber prices going through the rough in the early 2000 during the boom then. What has changed?”

The simple answer to what has changed since early 2000 is 2 of the 4 large producing regions in North America (BC and rest of Canada) have dramatically shrunk the allowable cut (severely limited trees available for producers). As a result an enormous  number of sawmills have been permanently closed. And in BC the allowable cut will be falling another 25% over the next 5-6 years so volumes in this region will be falling further. As recently as 2018-19 BC reduced production/permanently closed something like 10 sawmills due to lack of wood. And in a third large producing region, the US northwest, production has been flat for 20 years (it has not been able to make up the shortfall from Canada). The one region in the US that has been growing is the US south; but it cannot grow fast enough to satisfy the current massive supply gap (hence wickedly high prices). And new mills take 3 years to get into full production so significant growth here will take time. Europe has been viewed as a potential source of supply but Canfor (significant operations in Europe) said supply to NA from Europe will be higher but not much (for a whole bunch of reasons). 

Another important point is not all softwood lumber is created equal. In the US south it takes 40 years to grow a tree. In Canada it takes 80 years. The 2x4 that comes from Canada is dry and dense wood (think straight) and is ideal for home construction; it is the preferred wood for building and commands a premium price. Southern yellow pine (SYP) 2x4 from the US south is more wet and can be twisted and can result in more waste (and time) during construction (adding to cost of build). 

The bottom line is we likely will see supply increase modestly during 2021 and 2022 as producers execute on low hanging fruit options. 

Therefore my view is the key to lumber prices will be what happens on the demand side:

1.) price elasticity of lumber: how much will demand fall given current nosebleed high prices?

2.) will US housing starts remain at 1.6 million or higher for 2021? This is THE key to lumber demand and therefore prices.

- check out the 25 year chart for housing starts in the US. Very bullish for housing starts going much HIGHER than 1.6 million in coming years as the US has been significantly under building for the past 10 years. https://tradingeconomics.com/united-states/housing-starts

- there appears to currently be an insatiable demand in Canada and US for single family homes, driven by Covid. As a result, resale prices for single family homes are through the roof. This should help home builders price their new homes higher to recoup significantly higher costs (not just lumber).

3.) will repair and remodel (R&R) demand stay high? Q1 commentary from forestry executives was they are just starting to see a small slowing in this area. This trend will be important to watch in the coming months. Home Depot sales were pretty strong in the most recent quarter. This bucket was really impacted by Covid and so it is hard to know how lumber demand will play out for this bucket in 2021 and 2022.

 

Edited May 24, 2021 by Viking

[Viking]

Here are a couple of links that provide more information / perspective:

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Wall Street Journal podcast: https://www.wsj.com/podcasts/the-journal/the-strange-economics-of-the-lumber-market/43b4d423-4754-4716-99b1-4cbb84a75366

The Strange Economics of the Lumber Market: There's a disconnect in the lumber market. The price of lumber is the highest it's ever been, but the price of the timber - the raw material - is at record lows. WSJ's Ryan Dezember on the paradox of the lumber market and tree farmer Joe Hopkins on how he's getting through this strange moment.

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- https://www.forbes.com/sites/billconerly/2021/05/22/why-lumber-and-plywood-prices-are-so-high-and-when-they-will-come-down/?ss=real-estate&sh=2d6e540b4b71

“Lumber and plywood prices typically rise in the spring  and drop by the end of fall, by about five percent. This year look for not a decline but a leveling off. Prices will remain high for another two or three years, then drop back to more normal levels. The key to the pace of decline will be mortgage rates. In the meantime, homebuilders will pass the costs along to their buyers. The do-it-yourselfers will have a good excuse to postpone new projects.”

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- https://financialpost.com/commodities/agriculture/millions-of-beetles-are-wiping-out-forests-all-across-the-world

”All told, the beetles felled 730 million cubic meters of pine between 2000 and 2015 in British Columbia, Canada’s largest exporter of timber to the U.S. housing market. That’s erased more than a decade of lumber supplies and and will reduce the allowable production in the B.C. Interior by a staggering 40 per cent, said David Elstone, owner of Vancouver-based Spar Tree Group. Provincial modelling indicates about 55 per cent of B.C.’s marketable pine trees will be dead by 2020.”

 

Edited May 25, 2021 by Viking

[Viking]

Below are a couple of interesting comments from Home Depot during Q1 call. Very high lumber prices do not appear to be impacting demand (in a major way)....   

1.) Chuck Grom - Gordon Haskett, Analyst: "...you spoke about the big increase in lumber prices. Curious what you're seeing on the demand side unit volume, if it's starting to compress a little bit as those prices rise."

Ted Decker - The Home Depot, Inc. - President & COO: "Well, the lumber environment is certainly unique. And the way, we're thinking about it right now, Chuck, it's really a storm environment. It's very tough to look at traditional elasticity, certainly prices are up as I referenced in the call. A sheet of OSB has quadrupled in price and it's up even more since the end of our fiscal quarter. But at the same time, demand has kept pace, and when we bring the product into the store, it sells, and the mills are at capacity. We have plenty of wood fiber in the supply chain. The relative bottleneck is in the sawmill cutting capacity. We don't see a lot of capacity coming online, so we're probably not going to see a lot of finished lumber product in distribution, so as soon as that product hits our stores, it sells. Certainly, price is up, and you would think there'd be a supply and demand traditional elasticity equation there, but it's hard to determine the impact given the storm nature of the demand.

2.) Regarding outlook for R&R (repair and remodel) segment moving forward

- Craig Menear - The Home Depot, Inc. - Chairman & CEO: "Well, again, Mike, when you think about we're at post-World War II housing availability, so you know, two months of supply versus historical average of six, that situation won't be resolved in near-term. It's going to take time for that to be resolved, so I think that supports home values and the continued growth in home values which we know as home values grow, people feel good about investing in their home overall. So that alone is, I think, a very positive outlook for home improvement as you move forward."

- https://ir.homedepot.com/~/media/Files/H/HomeDepot-IR/reports-and-presentations/quarterly-earnings/2021/Copy of HD 1Q21 Transcript_vF.pdf

Edited May 25, 2021 by Viking

[lnofeisone]

Viking - can you please stop posting as I'm not done buying.  I bought a starter position when my floor person charged me extra 20% for hardwood floor materials few months ago as "prices have risen between the time I signed the contract and now." That was February. Bought again few weeks ago around where we are now.

Anecdotally, we've had friends whose contractors upped plywood and hardwood prices and have to wait 2+ months for materials to arrive. We have other friends that are waiting for prices of lumber to go down to start construction work. 

[Viking]

It is useful to look at the last bull market in lumber. It ran from July 2017 (lumber prices bottomed at $350) to May 2018 (high $660). So it ran for about 11 months and the lumber price increased about 90%. And by Oct 2018 the price had fallen to $280. What a roller coaster ride.

Chart: https://futures.tradingcharts.com/historical/LU/2018/0/continuous.html

Lumber company profits and share prices soared. Interfor shares went from around $18 (June 2017) to a high of $27 (June of 2018). In the spring of 2018 lumber company executives must have thought the good times were going to last forever as most quickly spent the windfall profits on share buybacks, with most buying meaningful amounts of shares are peak prices. I was following West Fraser at the time and they were buying shares back then hand over fist at close to the price we see today. Needless to say, when lumber prices hit $280 in Oct 2018 (four months later) - and share prices spiralled downwards - management teams looked like idiots (and not good stewards of shareholder capital). 

The lesson is most management teams do NOT want to repeat the errors made in 2018 on the capital allocation front and look like fools a second time (not good for reputation or career). So far in the current bull market, management teams are being very cautious and largely letting the cash build on their balance sheet. Yes, at some point, if lumber prices stay high, this is not sustainable and something will need to be done with the excess cash. 

Interfor ended Q1 with a cash balance of over CAN $600 million and net debt of negative $200 million. My guess is they will likely earn close to $375 million in Q2 ($5.75/ share). Interfor’s market cap is only CAN $2.1 billion. The special dividend will cost 65 million shares x $2 = $130 million ; their cash balance was up $137 million in April  So even after paying a $2 dividend, Interfor will likely end Q2 with a cash balance of over $850 million ($13/share). 

In recently announcing the $2 special dividend, Interfor likely telegraphed/confirmed its preferred method of returning cash to shareholders (in the current environment). They did buy a sawmill in the US South that closed in Q1. And they have bought some shares back. However, management has said they will be opportunistic (meaning they will not overpay for either). That leaves special dividends as the easy, shareholder friendly method of returning excess cash to shareholders.

—————————-

How long will the bull market in lumber last? How much longer can lumber prices stay above $660 (the PEAK price in 2018)? We are already 17 months into the current bull run; prices began their relentless move higher after hitting US$350 in January 2020. There was a pull back in late Oct 2020 to $500. Prices peaked at $1,670 in early May. Today (May 26) we are at $1,334.

The good news for investors is lumber companies are ALREADY being priced for a big decline in lumber prices. Risk reward looks pretty compelling to me  my guess is this is not the last special dividends we will see from Interfor in 2021.

Edited May 26, 2021 by Viking

[jgsurita]

Numbers on the company:

	2008	2009	2010	2011	2012	2013	2014	2015	2016	2017	2018	2019	2020
Sales	437	390	626	758	849	1.105	1.447	1.687	1.793	1.990	2.187	1.876	2.184
EBITDA	14	17	53	47	60	134	169	92	66	97	292	63	550
Net income	-55	-24	-4	-14	-10	42	41	-30	200	288	111	-104	280
EPS	-1,18	-0,51	-0,08	-0,26	-0,17	0,73	0,62	-0,44	0,94	1,39	1,59	-1,54	4,18
Invested capital	578	506	519	502	496	656	839	1.178	1.076	974	1.033	1.056	1.005
Shareholder's equity	406	358	347	391	376	515	637	725	787	854	969	831	1.080
Net debt	172	148	172	111	120	141	203	452	290	119	64	225	-75
EBITDA margin average 5y					6,2%	8,3%	9,7%	8,6%	7,6%	7,0%	7,9%	6,4%	10,6%
profit margin average 5y					-3,5%	-0,2%	1,2%	0,5%	3,5%	6,7%	6,7%	4,9%	7,7%
ROE average 5y					-6%	0%	2%	1%	8%	15%	15%	11%	17%
ROIC average 5y					-4%	0%	2%	1%	6%	11%	12%	9%	15%

I don't like having to depend on lumber prices in order to make an investment, since it is impossible to predict. I would rather simply check historical profit margins on this kind of business to estimate an average return. Investing in the long term, short-term lumber prices shouldn't be a problem. I don't know how the business operates in detail and its moats, but initialy I will take into account only the numbers. Considering an average EBITDA margin of 10,6% in the past 5 years, it would mean 231k EBITDA - 125k D&A = 106k. Since it has no debt it means 106k profit before taxes. In other words, a price to earnings before taxes ratio of 20. Its sales have increased 4% CAGR in the last 5 years, but it would probably be a higher number if the company hadn't reduced its net debt with its earnings.

In short, by analyzing only the numbers, the company doesn't seem cheap, maybe around fair price: 20 pe ratio for a single digit growth, uncertainty about management capability of reinvesting cash flows at high returns. Since it's not clear to be a bargain, it has no margin of safety. Am I wrong in the analysis? What do you think?

 

Edited May 27, 2021 by jgsurita

[Viking]

Jgsurita, thanks for the excellent recap of the numbers for IFP for the past 10 years and 5 year averages. When looking at commodity type investments i think looking at the current and near future demand/supply picture is critical. 

I am not interested in holding a commodity name like IFP and holding for 5 or 10 years... too many unknowns, many of which are outside of managements control. If i was to buy a forestry company with the intention of holding for the long term i would go with West Fraser. They are diversified, a low cost producer and well managed = best in class (in my view). And i almost went with WFG when i started buying last week but decided on IFP because it is a pure play on lumber and it looked a little cheaper.

My interest in Interfor is driven by what is going on specifically in softwood lumber market today and the next year or two. Interfor is a pure play lumber company that looks to be reasonably well managed (not really sure here yet). I think Mr Market is not understanding the severe demand supply imbalance that exists today in lumber AND how long it may persist (demand could exceed supply for years). Covid has simply exposed the structural issue that have existed in the market since at least 2019 (when many large sawmills were permanently closed in BC due to reduction in allowable tree cut by provincial government). Lumber demand has spiked to a level far above what the industry can supply today. 

Lumber supply is a pretty well understood variable (it will grow modestly each of the next couple of years). Lumber demand is the wild card. And it looks to me like the US is in the early stages of a housing boom. Demand for single family homes is very, very strong (driven by low interest rates, household formation, desire for space etc). Supply of single family homes is low (4 million short by some accounts). Demand for lumber for repair and remodelling is also very robust (although it is expected to slow in 2H 2021). The home builders are saying (my interpretation) the constraint on new home construction is not higher prices for homes but availability of lumber (and other materials) and labour. This tells me that the modest amount in incremental lumber that can be produced will quickly be absorbed by home builders. This also suggests to me that and fall in lumber prices in the near term will be moderated by the demand picture. Not really sure; we will see (we have limited historical precedence).

So if the current housing boom in the US lasts into 2022 (my guess is that is likely) then it is also likely demand for lumber will continue to exceed supply. If this happens what will happen to lumber prices? My guess is lumber prices will remain higher than expected. Not US $1,300 high. But north of $660 seems reasonable to me. IFP will continue to print money and this will result in a much higher share price.

 

Edited May 27, 2021 by Viking

[Viking]

Update from Raymond James analyst Daryl Swetlishoff (May 24):

- https://www.theglobeandmail.com/investing/markets/inside-the-market/article-tuesdays-analyst-upgrades-and-downgrades-161/

“Building materials stocks have exhibited increased volatility during 2021 as commodities have soared to previously uncontemplated levels - offset by negative fund flows as investors (including strategic) have taken profits,” said Mr. Swetlishoff. “Building materials pricing has once again far outpaced our forecasts – resulting to the second US$200/mfbm lift to our 2021 WSPF benchmark lumber forecast (from US$750 to US$950). Looking ahead, investors currently have to weigh several variables, 1) Stocks discounting bargain-basement lumber pricing (sub US$500/mfbm) – less than a third of current spot. 2) Phenomenal current profitability with the 4th successive quarter of record quarterly earnings on tap. Our fresh estimates imply top picks Interfor and West Fraser will earn 20-25 per cent of their market cap during 2Q21 alone!”

“These tailwinds are balanced by, 3) A high probability that the next move in cash building materials commodity pricing is likely to the downside, which we expect could weigh on the stocks despite current bargain-basement valuations. In the very near term we view last week’s news of the U.S. Dept of Commerce preliminary 2nd Administrative Review effectively doubling lumber duties to 18.3 per cent from 9.0 per cent as a negative (esp. for Canfor whose preliminary rate goes to 21.0 per cent from 4.9 per cent). However, as an offset, similar to contract expirations over the past 12 months we expect July futures recently finding a level and trading higher to temper the sell-off in building materials share prices. We also forecast higher floor pricing as BC breakeven cost levels increase and are upping our 2022 lumber price forecast by US$50 to US$600.”

With increases to his price deck for commodity prices, Mr. Swetlishoff raised his 2021 financial estimates by an average of 35 per cent, leading to a series of target price changes for stocks in his coverage universe. They are:

• Canfor Corp. “strong buy”) to $53 from $46. The average on the Street is $41.83.
• Interfor Corp. (IFP-T, “strong buy”) to $60 from $47. Average: $47.67.
• West Fraser Timber Co. Ltd.  “strong buy”) to $170 from $145. Average: $137.

“We highlight target prices increase across the board, with our top picks West Fraser and Interfor up approximately 20 per cent; with our new targets implying 86-per-cent upside for each company,” he said. “With quarter-to-date lumber prices running 20 per cent ahead of 1Q21 levels, our new estimates imply Interfor is on track to earn more than 25 per cent of its current market cap in 2Q21 alone. West Fraser is highly levered to rallying OSBprices, up 38 per cent quarter-over-quarter, with our new forecast suggesting quarterly earnings close to US$2.0-billion which equates to over 20 per cent of market cap!”

[Redskin212]

Interfor Continues to Grow with Acquisition of Four US Sawmills from Georgia-Pacific

INTERFOR CORPORATION (“Interfor” or the “Company”) (TSX: IFP) announced today that it has reached an agreement with Georgia-Pacific Wood Products LLC and GP Wood Products LLC (collectively “Georgia-Pacific”) to acquire four of its sawmill operations located in Bay Springs, MS, Fayette, AL, DeQuincy, LA and Philomath, OR (collectively the “Sawmill Operations”). The total purchase price of US$375 MM, which includes working capital, will be funded entirely from cash on hand. The Sawmill Operations are highly complementary to Interfor’s existing platforms in the US South and the US Northwest, and the acquisition will support accelerated growth and enhance the Company’s position to benefit from robust market conditions. The acquisition will be immediately accretive to Interfor’s earnings and is expected to provide attractive returns in both the near-term and over the long-term. “This acquisition enhances Interfor’s growth-focused strategy as a pure-play lumber producer, and provides significant economies of scale given the complementary geographic fit with our existing US operations” said Ian Fillinger, President and Chief Executive Officer. “We’re excited to acquire these high-quality assets as part of our balanced approach to capital allocation to drive shareholder value.” The Sawmill Operations have a combined annual lumber production capacity of 720 million board feet. The Bay Springs, Fayette and Philomath sawmills are currently operating on a full-shifting basis. The DeQuincy sawmill, which was idled in May 2020 during the COVID-19 pandemic, has an annual capacity of 200 million board feet. Interfor is currently evaluating its strategy and options for the site, including re-start plans. On a pro-forma basis, Interfor’s total annual lumber production capacity will increase to 3.9 billion board feet, of which 3.0 billion board feet or 77% will be US-based and not subject to softwood lumber duties. Interfor’s US South production capacity will grow by 500 million board feet, or 29%, to 2.2 billion, while production capacity in the US Northwest will grow by 220 million, or 40%, to 770 million board feet. Following the transaction, 57% of Interfor’s production capacity will be in the US South, 20% will be in the US Northwest and the remaining 23% will be in British Columbia. The Sawmill Operations, excluding the DeQuincy sawmill, generated US$53 million of EBITDA1 in the first quarter of 2021, reflecting an EBITDA1 margin of US$508 or $643 per thousand board feet. This compares favorably with Interfor’s EBITDA margin of $589 per thousand board feet for the same period. Following the completion of this transaction Interfor will continue to have significant financial flexibility to consider additional value-creating capital deployment options. As of April 30, 2021 Interfor was in a net cash position of approximately $380 million. Proforma this acquisition and the special dividend announced on May 12, 2021, Interfor’s Net Debt to Invested Capital ratio as of April 30, 2021 would increase to 13%. Similarly, proforma liquidity as of April 30, 2021 would be approximately $500 million, before consideration of significant additional borrowing capacity available under existing credit limits and continued strong near-term operating cash flows. The completion of the acquisition is subject to customary conditions and regulatory approvals for a 2 transaction of this kind and is expected to close in the third quarter of 2021.

 

 

 

[Viking]

Redskin, thanks for posting the news release. Interfor has now made two lumber acquisitions so far in 2021 with a focus on US south. They must have a pretty high level of conviction that lumber prices are going to stay elevated well into 2022. Strategically they have made the decision to pay up to get capacity as opposed to building new (high cost, long timeline of +3 years, and difficulty in staffing). 

1.)  March 13 close: South Carolina: 125 million board feet; US $59 million (permitted for production of 200 million)

2.) announced May 7: Mississippi, Alabama, Louisiana (idled), Oregon: 720 mill bf; US $325 million

interfor has paid US $385 million (CAN $465) to grow production capacity 25% (from about 3.1 to 3.9 million board feet). They will likely earn something like CAN $370 million in Q2 which is a little less than they are paying for the 4 mills from GP. Hopefully the deal closes quickly in Q3 given the new mills are likely earning US $20-$25 million/month in EBITDA at current lumber prices.

Strategically, this gives IFP 13 mills in the US south. This also gives them their first mills in Mississippi, Alabama and Louisiana. They already have 8 mills in Georgia (largest lumber producer) and 2 in South Carolina. They are building out a very impressive footprint in the US south which is where all the growth in lumber production in NA is going to come from over the next decade. 

We will see tomorrow what Mr Market thinks of the acquisition. IFP was not getting much credit for all the cash sitting on its balance sheet (shares were cheap). If shares sell off i hope IFP is aggressive with a stock buyback as their balance sheet is still in great shape. 

Edited May 28, 2021 by Viking

[Spekulatius]

As an Interfor shareholder, those acquisitions are not what you want to see, imo. The thesis for me would be to get the vast majority of my capital returned via special dividends, in a short time period. It would not be  acquisitions as peak valuations.

[Viking]

Spec, if lumber prices take a tumble in Q4 and stay low into 2022 then this acquisition will look poorly timed. If lumber prices stay elevated into 2022 then this acquisition will look smart. My guess is IFP management believes the severe demand / supply imbalance that exists today is real and therefore prices will stay high. I did sell some shares today (as it was an outsized position) and i need more information. I do think the demand / supply imbalance in lumber is real. I may buy WFG if i want more exposure to get some diversification.

PS: i was kind on hoping IFP would get taken out (was a long shot) but that possibility is off the table now  

Edited May 28, 2021 by Viking

[Spekulatius]

Is it just me, or does it looks like lumber is going down: