Canfor Corporation (“Canfor”) reported Q121 results that were above both our forecasts and consensus estimates. While the company's share price has performed well on an absolute basis, we'd highlight that the company is still trading below 2018 levels despite pricing being more than 2x higher. Even accounting for what we view as fairly conservative commodity price forecasts, we estimate that Canfor will generate ~$1.5 billion of FCF (before WC) over the next twelve months, or a ~33% FCF yield. This would leave CFP with over $1 billion of net cash, which we think will be hard to ignore.
Key points:
We are reiterating our Outperform rating and increasing our price target to $45 – Our price target is based on a blended multiple of ~6.25x on our Trend EBITDA of $815MM (85%) and our 2021E EBITDA of $2.6B (15%).
Big surprise to the upside in the European Lumber segment – Canfor's European Lumber business posted results well above our expectations, with revenue surprising to the upside by 65.5%. Management noted that the company is starting to see some accretion from the three mills in Sweden acquired by VIDA last year. While some volume has made its way to the North American market to take advantage of record pricing, pricing conditions in European markets have begun to strengthen as well. While we expect pricing to remain strong for the foreseeable future, the amount of usable beetle-damaged sawlogs in Sweden is finite, and we expect to see cost headwind eventually.
Our crystal ball foresees acquisitions in Canfor's future – As commodity prices continue to rally, the problem of where to deploy cash is becoming increasingly more evident. On the call, management indicated that they have a "50/50" split for preference between the US South and Europe. As we mentioned in our Top 10 Wood Products M&A Ideas note of December 10, 2020, acquiring Interfor would be a compelling way to grow their US South footprint, while using record free cash flow generation to help fund the purchase (we estimate Interfor's 2021E FCF Yield at ~30%). While a no-brainer on paper, potential hurdles include: 1) getting shareholders on board; and, 2) potential anti-trust in BC. We think that current market conditions would be attractive for finding potential buyers if asset sales were required.
The mid-term outlook looks good, but the short-term looks great – With current record-level prices, Q2 is shaping up to be an impressive quarter. Based on prevailing conditions, there is no indication of a reversal anytime soon. Demand remains robust, and supply conditions are likely to continue being tight in both lumber and pulp markets. In lumber, new residential construction is rolling at a rapid pace, while repair & remodel markets remain relatively stable. In pulp, prices continue to move upwards as economies reopen, benefiting end-markets in the printing & writing paper space. Transportation issues (trucks, rails and containers) have surfaced to create the right conditions for elevated pricing to persist.