September 26, 2022
Interfor Corporation Georgia on my mind
Our view: Interfor’s tour of three mills (Eatonton, Georgetown, and Summerville) across the US South demonstrated its success in assembling a sizeable regional platform, while we think its ongoing strategic capital investment program provides a pathway to further high-return optimization and growth. Given the company’s relatively strong balance sheet and our view that it can comfortably keep generating FCF into 2023, we think there is good reason to look through the cycle trough.
Key points:
A runway to invest in the US South. Since first acquiring its way into the US South in 2013, the company has grown to be the third-largest lumber producer in the region (Exhibits 1, 7, 10), and it continues to see good opportunities to invest in its mills with ~US$450MM of planned strategic capex in the US South through 2025 (Exhibits 6, 8). Interfor’s predominantly US South-focused capital projects team prioritizes high-return projects (with a minimum hurdle rate of 12%, based on pre-tax cash flow) and can often find opportunities to grow production, improve product mix, and reduce conversion costs through pursuing projects that have already been implemented elsewhere in the company’s portfolio.
Growth-focused, but not to a fault. While Interfor’s current US South- focused capital program alone should significantly grow capacity by 2025, the company is targeting an 11% CAGR in production to 7.0 bbf by 2027 (Exhibit 2), which will be driven by a mix of M&A and incremental organic investment. In our view, the company is likely to build on both its US South and Eastern Canada platforms (we think GreenFirst is an obvious potential acquisition candidate and Interfor is likely to generate a portfolio of organic capital opportunities across the acquired EACOM assets). Despite the growth focus, the company noted that it also sees its own shares, which are trading below book value, as a bargain and recently repurchased $100MM through an SIB; we think further repurchases could remain high on the list of priorities if the shares continue to trade in the current range.
Labour issues in focus. Interfor’s turnover rate in the US South exceeds 30%, with management noting that hot operating conditions during summer often result in heavy turnover of new hires. The company has invested in several initiatives to develop and retain employees (Exhibit 13), and it emphasizes hiring from within. Labour issues for logging and hauling contractors (which are typically mom-and-pop operators) appear to be at least as challenging. Rising interest rates and looser labour market conditions could help ease the severity of the problems but are unlikely to eliminate them, in our view.
Tough part of the cycle, but valuation compelling in our view. While a slowing housing market and recession concerns have cast a shadow over the outlook for near-term lumber demand, IFP’s valuation is already below its historical average on an EV/Trend EBITDA basis (Exhibit 14).