February 13, 2021
West Fraser Timber Co. Ltd.
The Year of the Ox has us feeling Bullish
Our view: West Fraser Timber Co. Ltd. (“West Fraser”) reported Q420 results that were above our expectations, largely driven by better-than- expected Lumber and North American OSB results. Both lumber and OSB prices continue to push past record levels, setting up a continuation of record free cash flow generation. Just when we thought things couldn't get any better, pulp markets have also started to rally based on increased demand from China. Rather than being a drag on results, we think pulp will be a contributor in 2021.
Key points:
Increasing our price target +$15 to $100 and reiterating our Outperform rating – Our price target is based on a blended ~8.0x multiple on our trend EBITDA of $1,375MM (85% weighting) and our 2021E EBITDA of $2,416MM (15%). Our forecasts and Trend EBITDA estimate have been updated to reflect the acquisition of Norbord.
There's still a runway for organic growth in the US South – Management highlighted the success of the new manufacturing complex at Opelika which was completed in 2020, with a significant uplift in productivity and cost reduction. The more modern facility also addresses the challenge of finding labor in the US South. With fewer, but higher value jobs at the mill, turnover has been reduced and recruiting efforts have been more successful. The construction of the new complex at Dudley, Georgia is on track and the planer is set to be started up by the end of the month, with the rest of the facility coming online later in Q2. Dudley is expected to have similar benefits to Opelika, and management noted that there is still a runway to complete similar projects. Beyond organic growth, we think West Fraser could also look for bolt-on acquisition opportunities.
Lumber and OSB prices continue to reach new, unbelievable heights – While we don't expect prices to stay at these lofty levels, not much stands in the way over the next few months. Lumber and OSB prices are currently trading at ~2.5-3.0x their historical averages, resulting in extremely high FCF generation for both commodities. Despite this, West Fraser continues to trade at a reasonable valuation of ~7.0x EV/Trend EBITDA as compared to its historical average of ~6.0x (but keeping in mind that we expect West Fraser to generate ~$1.2 billion of FCF in 2021, or ~$10/share).
Rapidly rising pulp prices solidify a small, but the shakiest part of the story – A combination of factors have contributed to the rally, including: 1) the rapid rise in Chinese demand; 2) supply disruptions from a heavy winter maintenance schedule, and; 3) a global container shortage which has significantly lengthened global supply chains. For additional details, please click here. We expect that West Fraser will benefit more quickly than peers due to its high % of sales to Asia, where pricing is more responsive. Higher prices will also help to mask some of the recent operational issues at the Hinton pulp mill in particular.