Upside/downside, a perpetually bad industry, valuationThe upside is far greater than the downside I'm reading things like this:
“Yes, thanks everyone, I was able to dump 1/3 of my holding, brining cost to zero.”
“Well this may be a good learning opportunity, about the methods you use to determine what is likely or unlikely for any given stock price. How do you determine what a stock could get to?”
This is reasonable play, but I think it’s snatching defeat from the jaws of victory., These opportunities are incredibly rare. Despite that, it’s a good follow-on point and you can't go too far wrong playing with only with the house's money of course... but I'd never considered giving up my upside and selling. My primary framework is let winners run, cut losses, but all in the context of the fundamentals.
Conviction, upside, and downside. At present I have clear conviction in the transformational nature of this boom, even if it's short-lived – it’s gone on long enough to remove all debt already. It's a game-changer as futures point to it running for at least a year… maybe more. Each year it runs adds $2.50 per share in cash to the balance sheet as it stands, but we know that share count is going down soon. This type of extreme arbitrage opportunity is literally like the first few who piled in on the GameStop trade. The upside is 500%+….
The downside, when the debt is gone, is really the current price. Even if the mill was out of the equation, a debt free worst case for the is maybe 8x the power earnings and Ken squandering those on dumb things ang ignoring shareholders. So that’s 8 * $14M over 46M shares (no more buybacks assumed) is $2.43/share. I don’t see a shopping spree happen as you rarely get struck by lightning twice.
My upside? This is the 2
nd cheapest forestry stock, in an industry that’s performed so poorly for so long it’s a joke. But the punchline of underinvestment and disruption overlaid by the inevitable rise in demand due to demographics sets the stage for a staggeringly large correction. This is the Homer Simpson of forestry names, in an industry that’s the Barney Gamble of the equity world. They’ve been on an all-you-can drink bender for decades but we’re all out of beer now and change is coming.
A brutal track record makes this unnaturally good boom possible. Take the housing mega boom leading to the crash 15 years ago. Here’s PWC on 2004 and 2005:
Global forest, paper and paper-based packaging companies face another challenging year following a difficult 2005 for most businesses in the industry, according to PricewaterhouseCoopers ninth annual Global Forest, Paper and Packaging Industry Survey, released July 27. Return on capital employed (ROCE), a key measure of performance in this capital-intensive industry, fell to an average of 4.5 percent in 2005 from 5.3 percent in 2004 - far from the target of 10 to 12 percent.
Housing sales and new builds in the US increased due to a favourable economy and interest rates. The strong housing market drove North American demand for lumber and structural panel products in 2005. The growth in manufacturing capacity, especially for lumber, coupled with improvements in rail transportation pushed product prices down in 2005 compared to 2004. Profits were diminished by higher raw materials and labour prices, energy prices and increased transportation costs.
Robert Barnden, global forest, paper & packaging leader, PricewaterhouseCoopers said: “2005 showed why it can be so difficult to make a decent return in the sector. The companies that succeed are ones who are innovative and develop methods to do more with less. Projections for 2006 remain challenging and innovation will again be the key to profitability.”
It's easier to do some homework and deal with facts than just guess. However, I'm mindful of that GameStop analogy as often you have other uses for the investment money or just don't have the line of sight into the fundamentals and how strong they truly are. Or, you get tired of “being early” and having to wait. Conviction and depth play a role. What are the scenarios? If I woke up with a 200% gain in GameStop I'd run screaming for the exits as I have zero faith in the staying power. Less extreme, I've sold great names Brookfield and Amazon with great upside to buy names like this in the past on the hunch it was a better risk/reward profile in the names I knew better.
I view the upside as extreme and a generational opportunity, mostly because I had environed a $700 peak for a few weeks/months following by long-run $500 lumber as the best near term case. Just because it’s safest to anchor in the past. This shock happens at a time when real assets are important so housing is a must-have and moreover it can be built anywhere. Biden’s 2 Trillion Infrastructure plan is coming. Housing is underbuilt by 4 million units. Consolidation is on the way so the inmates won't run the asylum for much longer.
What is this worth? I might be wrong of course, but I don't think $4 or $5 a share is possible unless reddit mob will bid it up.
I was bullish under $1 and was still even buying uner $1.50.
RBC's $3 target seems more plausible to me, if everything is fine.
Anyway, if it goes to $4+ we all will be even richer, right? :D
This take? Stocks are not valued magically. They reflect the prevailing conditions, and they’ve been awful for forestry barring a few brief blips to date. You bought a despised stock with sneeringly arrogant management who made excuse after excuse, offered no vision, and destroyed value with impunity. There were no consequences for the catastrophic failure in 2018 as you recall. It was priced for a de-do of the Great Recession at the time. Context matters – that was a great buying opportunity at $1.
My points:
- <$1/share makes sense as fallout from the faceplant and makes sense at the 2019 price, averaging $372, or head into Covid. Conifex breaks even at $400, so -7% margins mean downtime (nobody runs at cash losses).
- This tells me zero value for the mill due to no earnings, and a limited fraction of replacement cost for the powerplant less a larger debt. That’s how you get $1 a share.
- It’s also based on a much greater sense of ill-ease about mgmt.
- What $2.35/share at $1000 lumber?
- It’s 3x the lumber price... but the impacts is deeper.. It goes from -7% (so not running) to +150% cash lumber margins.
- In other words, you go from earning $10M to maybe $120M or so.
- Share prices lag earnings. Cagy investors get ahead of this. You can look forward or look behind, but making your anchor point that you should be able to buy ~$380M in assets for ~$46M makes zero sense outside of a doomsday case fear-driven environmnet.
- Reddit mobs are speculative bubbles that unless your in early sit out as there is no long-run basis for that price. There is no margin of safety.
- You don’t need a speculative bubble to pick up another 200-400% on this thing, but it's unsuitable to hold for most people.
- Ken's irrational and opaque behavior worsened the crisis considerably, but the risk has diminished.
- RBC adjusts to hit modest targets. Should this continue this will move on up like clockwork. Quinn is largely hitting his next Q forecast. It is not a long run.
- These guys are low-risk. So the bigger safe names are priorities.
- Why stick your neck out for this? Nobody cares about it. Paul will just put the same old 30%+ target on it. If it takes a year no worries. If it gets there in a week? Time for another 30% target. Rise and repeat.
- There are lots of ways to value a stock. Sum of parts, cashflow multiple, or old school dividend discount model. This can easily pay out $6 to $8M a year on power cash.
- That tells me the current price is fairly valued for the power plant along ($8M/46M shares = 17 cents a share = 7.4% yield). That’s what I woulkd expect to hold this.
- It ignores the value of the mill of course, so it’s conservative. As a cash cow the mill should be able to pay an easy $8M a year too (it’s going to make as much as $80M this year, so 10x that) long run, meaning the div yield easily possible is more like 15% per year. How many of those are out there? None, as they get bid up to the point of equilibrium.
- The sum of parts value than at $1/share was likely $150M, so you got it for a 75% discount. The sum of parts value now is likely between $300 and $380M, so $6.50 to $8.20 per share. I don’t see the discount as being that much less in fact, and that assumes the same 46 million shares forever.
- This matters, as do the facts. The facts changred. Whatever any one individual's fixed anchor point may be doesn't matter.
- This has two levers from share price appreciation. Closing the gap to peers is one. This will always have a discount to larger and better run names, but should that discount be 70%? Or is 20% a more fair discount? I think so.
- Benefiting from great industry acceptance pushes up sector-wide valuation too, so there’s going to be that force as well.
It’ll take a while to undo the awful past results. Nobody believes it's different until it is. In any case, even people I know who work in the industry, who I speak at length to about finance and valuation, still tell me they need to buy Tesla for "diversification" as "sure it'll go up but it'll just end up at $0.31 again someday when 2x4s are $2 again." No. Get back in your clown car. There is unlikely to be another race to the bottom, and if there was a small one the robust balance sheets and lack of debt make it a ho-hum event and not a disaster like last time.
I worry about this take as anyone this financially and analytically input shouldn’t be stock picking anything, let alone a fringe forestry small-cap run by an unaccountable despot. But all I care about is the capital structure will fundamentally and permanently change, The industry will consolidate and grow up. You will see a return of capital to shareholders. New supply will be tough to add, and demand is robust. To have a gutter valuation you need an overwhelming excess of lumber chasing paltry demand. We saw a flash of that in 2019 in the dying days of the pine beetle glut, where demand froze given interest rate threats. That was a flash in the pan, however. The main risk is a 2008 type wideout. Tell me where you're going to find an extra 20 million M3 of logs a year, make them free, and cut the US housing demand by 1/4 to get there. That's the low point where you are zero cash earnings and basically trading at 1/3 or 1/4 your liquidation value. But the jokes on the market, as Conifex is already that low.
This is a slam dunk, but the role of Ken still is a huge risk to me. This and Resolute were my two April/May 2020 deep value plays. I had to sell some of my CFF to pivot more into RFP as their emergence has been marked by calm and capable leadership, shareholder-friendly actions, and clarity on their strategic goals. Ken keeps you in the dark which I can't stand. Anyway, my Resolute is up 300% and my CFF is up… well not 300%. I’d expected them to have a similar trajectory but it’s unfortunate to not have any articulated vision whatsoever and that has an economic cost. I wasn’t planning on the role of self-sabotage here, but oh well.
But what's old is new again – cash and greed will carry the day. This 2007 take from PWC seems apt today. At some juncture you make so much money you turn some heads. I am going to start a blog on the topic and have an idea for how to frame how transformation this may indeed be. here's the quote, talking about private equity, like the Koch brothers who bought GP:
"At first glance, the forest industry is not an obvious target for buy-out funds, with its commodity cycles and potentially high capital intensity. So what have these new investors been looking for? Perceiving the glass half full, rather than half empty, private equity has seen the opportunities hidden behind poor returns from public companies, the potential value creation opportunities through a sharper focus on the business and, in some situations, better management. The low cost of debt over the past few years has helped to make deals attractive financially also.