Our view: Management outlined a growth plan that demonstrated to us a very convincing opportunity set that should enable SJ to drive attractive growth out to 2025. Importantly, we believe the 2025 targets provided at the Investor Day incorporate conservatism, especially as it relates to US infrastructure related spending. We also point to what we view as upside to margin targets on the back of increasing pole mix, tie pricing, and economies of scale. We see solid opportunity in the shares. Reiterate OP.
Key points:
Investor Day 2023: We attended SJ’s 2023 Investor Day in Toronto. We had a chance to catch up with members of the operating and sales teams across each of SJ's segments at the Investor Day.
Roll out of new pole capacity is a big deal. In general, exiting the pandemic SJ was categorized as a COVID winner that benefited from a meaningful increase in residential lumber demand. Focus at the time therefore was on the negative impact of a "normalizing" residential lumber demand environment. However, what was missed during this time was the meaningful opportunity emerging in utility poles, which we expect to drive the next leg of organic growth at Stella-Jones and is key to our investment thesis. SJ today guided to +15% pole revenue CAGR 2022 to 2025 (and consolidated revenue of >$3.6B (cons. $3.5B)). Management highlighted various long-term growth drivers in the pole business including a large percentage of poles approaching the end of useful life, growth of 5G networks, and newer and stronger lines to support heavier loads. Key is that this guidance does not fully reflect a meaningful expected uptick in US infrastructure spending, and we therefore see risk to the upside.
We also see upside to margin guidance. Management today guided to EBITDA margin of 16%. Key is that we see this as conservative as EBITDA margins came in at 16.9% in Q1 – and we highlight that higher margin pole revenue should make up a larger percentage of top line going forward (in addition to increasing economies of scale and pricing adjustments in the tie business). Taken together, we see risk to the upside to SJ’s 16% margin target and estimate a 1% improvement in margin would represent +6% upside versus our 2025 EBITDA estimate.
Raising estimates. We have adjusted our estimates to align with SJ’s guidance and our 2025 EBITDA estimate increases to $577MM (from $563MM), above prior consensus of $563MM.
PT increases to $69 (from $67); Reiterate OP. Our PT increases due to our higher estimates; however, we continue to see upside to long-term infrastructure related revenue and margin. Applying our higher estimate to our target multiple (unchanged) results in our revised $69 PT. Reiterate Outperform rating with lead coverage transferred to James McGarragle.