Forest Products
Mo Money, Mo Problems – Assessing capital allocation opportunities
A year ago, we couldn't have imagined that the latest problem for the lumber industry would be that operations are making too much money, but here we seem to be. While it's clearly a good problem to have, we think investors are still discounting near-term results given the potential for capital misallocation towards value destructive investments. Just as the 2018 rally and crash has had lasting impacts on the supply chain, we think investors are also worried that too much cash will be deployed on expensive share repurchases and acquisitions at the peak of the cycle, putting balance sheets in a precarious situation at the wrong time.
So far, lumber producers have been relatively conservative with their growing cash piles with few acquisitions, major capital projects and share repurchases announced. Of those that have been announced (incl. Interfor's acquisition of a sawmill from WestRock, a Weyerhaeuser mill rebuild, and West Fraser's ~$57MM of share repurchases), we think all will create value for shareholders. In this report, we assess both the capacity and opportunities available to major North American lumber producers over the next 12-18 months. Below, we highlight our key takeaways for each company:
Canfor Corporation (TSX: CFP) – We expect Canfor's lumber business to generate significant FCF over the next year, with rapidly improving pulp markets "fixing" the only part of the story that wasn't working. While we think Canfor will have trouble repurchasing shares given an already concentrated shareholder base, acquiring the minority interests in Canfor Pulp or VIDA could simplify the operating structure. We think Canfor could also look to acquire more sawmills outside of the BC Interior.
Interfor Corporation (TSX: IFP) – After a few years of divestment, Interfor is looking to re-gain its title of the "growth" lumber company, which we expect will entail more sawmill acquisitions in the near- term. In our view, Interfor has displayed price discipline in its acquisitions and has a solid track record of implementing operational improvements.
PotlatchDeltic Corporation (NASDAQ: PCH) – While a clear beneficiary of higher lumber prices, we expect that Potlatch will continue to execute its usual strategy of acquiring attractive timberland properties at good prices. Lumber remains a secondary, but important part of enabling full value to be extracted from timberland operations. Share repurchases would likely be saved for a lower share price, based on management commentary.
West Fraser Timber Co. Ltd. (NYSE: WFG; TSX: WFG) – Having just completed the largest wood product acquisition in history, we think that West Fraser will take its time to integrate Norbord. In the near term, we expect more share repurchases (having already deployed ~$57MM YTD) with potential for smaller acquisitions (<$500MM), especially in lumber.
Western Forest Products Inc (TSX: WEF) – It's been quite a turnaround at Western over the past year, which was already in a tough spot going into COVID-19 due to an eight-month strike on the BC Coast. While share repurchases could make sense, we think that further geographic diversification would help to de-risk the business.
Weyerhaeuser Company (NYSE: WY) – Having recently changed its dividend policy, we think that most capital will be returned through the base + supplemental dividends with some opportunistic share repurchases. Weyerhaeuser has also shown a willingness to tackle large acquisitions in the past, purchasing Longview Timber in 2013 and Plum Creek in 2015. We think that a tie up with PotlatchDeltic could make strategic sense (click here for more details). Over the past year, Weyerhaeuser has also made some notable bolt-on acquisitions, which we think could also create shareholder value over time.