August 19, 2021
Forest Products
Thinking through lumber valuations
Our view: Although lumber stocks are likely to remain under pressure until pricing starts to increase, we think that the worst of the declines are over and that it is a good time to start getting up to speed on the sector. Canfor, Conifex, and Western remain deep value picks, while West Fraser and Interfor receive a modest premium for their US South focused asset bases. While we think lumber producers should trade at a discount to replacement, we feel that the current 50-80% discount is too punitive given our positive outlook on housing and healthy balance sheets. To close the valuation gap, we are looking for: 1) increased consolidation; 2) production discipline; and 3) shareholder friendly capital allocation.
Lumber producers are trading at a meaningful discount to both precedent transactions and replacement cost – After adjusting for non-lumber assets, we found that North American sawmills are trading at a meaningful discount on almost any metric. Over the past five years, transaction multiples have averaged $500/mfbm in the US South and $250/mfbm in all other North American regions. Greenfield costs have increased from ~$500/mfbm a few years ago to ~$600-650/mfbm today.
Canfor is trading at the largest discount of the major producers – Even after adjusting for their higher exposure to British Columbia, both Canfor's lumber assets are trading at a >50% discount relative to recent precedent transactions (mix adjusted). After backing out Canfor's other assets, the company's lumber assets are being valued by the market at ~C$950 million, or $143/mfbm. Even if you assume Canfor's BC Interior lumber and tenure assets are worth nothing, Canfor's US South lumber assets are trading at $371/mfbm, which is still a ~25% discount to US South precedent transactions. That's also before providing value for 3 pellet plants in BC, 2 glulam plants, a finger joint plant, and a trucking fleet.
West Fraser and Interfor lumber assets are trading at a >25% discount to precedent transactions and at a ~50% discount to replacement – Despite continued strong free cash flow generation in the US South (the latest SYP 2x4 price of $487/mfbm is 33% above the pre-pandemic 30-year average of $365/mfbm), the two US South oriented producers are still trading at a meaningful discount. In our view, this discount provides a reasonable margin of safety and could make Interfor an attractive acquisition target.