TD Stella!
XED Q4/14 EBITDA of $39.7 million was below consensus of $43.0 million and our $45.7 million estimate. Although earnings were below expectations, the miss, which was a result of lower-than-expected margins, appears to have been driven primarily by mix issues. More specifically, Stella-Jones generated a higher proportion of sales from its railway tie segment (Note: We remind that management continues to adjust railway tie contract pricing higher). Looking forward, we continue to believe that Stella-Jones is facing a strong outlook. We forecast healthy growth within the utility poles segment, driven by our expectation that demand will grow as utilities seek to replace the increasing number of installed poles that are approaching the end of their useful lives. Meanwhile, we expect sales growth in railway tie to remain strong over the near-term as a result of Stella-Jones’ recent contract repricing initiatives. Furthermore, we continue to expect margins to improve, driven by both the aforementioned re-pricing efforts and an ongoing focus by management on pursuing efficiency gains across the company’s network. We have increased our EPS estimate for 2015 to $2.23 (from $2.06), though we note that nearly all of the increase is driven by updated f/x rate assumptions owing to the decline in the Canadian dollar. We have also introduced an EPS estimate of $2.47 for 2016, with the y/y growth driven by most of the same factors discussed above. Our target price increases to $46.00 (from $43.00). TD Investment Conclusion We continue to view Stella-Jones’ high level of U.S. exposure (~80% of revenues) and its lack of exposure to the oil & gas end-markets as attractive investment attributes at this time. Given its positioning and favourable growth outlook, we believe that Stella-Jones continues to warrant what we see as healthy valuation multiple. That said, at current levels, we see the stock’s upside potential — which remains attractive, in our view — as likely to be driven more through the realization of growth expectations and less through further expansion of the stock’s valuation. Given the healthy return realized by SJ since we added the stock to the Action List in November 2014 (up ~22%) and the current 18.6% return to our target price, we have lowered our recommendation to BUY (from Action List Buy).