TD comments on Stella Jones MY COMMENTS..GDL GOODFELLOW INC IS VERY UNDERVALUED
Housing/Lumber We are removing our position in Hardwoods Distribution Inc. (HDI-T, portfolio weight 4.5%) and modestly raising Stella-Jones Inc. (SJ-T) to 3.5% from 2.2%. As discussed last week (LINK), we believe that momentum in lumber and housing-related equities is beginning to slow. With lumber prices now down 24.1% from their March 2022 peak and OSB price momentum slowing (prices were flat last week after 11 consecutive weekly increases), we believe that both commodities are at risk of further declines, given their elevated price levels. We witnessed this last year, when prices peaked in early-summer (Exhibit 1). A further risk to housing-related equities, in our view, is the swift rise in mortgage rates and the high negative correlation of U.S. housing equities to mortgage rates (Exhibit 2). Following the sharp rise in mortgage rates through 2022 (4.52% from 3.27%), we are again beginning to see housing equities underperform. We previously saw this through 2013-2014 and 2018 (a period similar to today, in our view). Along with the above-mentioned risks, we are also witnessing a slowdown in bottom-up earnings momentum for Hardwoods. As we show in Exhibit 3, consensus earnings moved slightly lower after Q4/F21 results last week. Also, when compared with portfolio holding Doman Building Materials Group Ltd. (DBM-T, portfolio weight 2.0%), relative price strength and now relative earnings momentum favour Doman over Hardwoods (Exhibit 4). As a result, we are removing Hardwoods after a 167% gain from our early-2020 portfolio addition. With the removal of Hardwoods, we are modestly increasing our position in Stella-Jones. Following Q4/F21 results earlier this month, earnings estimates were again raised, with the 2022 and 2023 consensus now 4.9% and 10.5% above their October 2021 lows, respectively. This has further continued the positive reversal in the 12-month forward consensus estimate. Stella-Jones is presently trading 26.9% below its all-time high (April 2021); however, forward earnings are only 11.0% below their peak. As a result, SJ is presently trading at a 12-month forward P/E of 11.2x, which is well below its 10-year average of 15.8x. Stella-Jones is also trading at what we view to be technical price support (Exhibit 6). As a result of its positive earnings momentum, relatively lower valuation, and recent pullback to technical price support, we are raising Stella-Jones to 3.5% in our small-cap portfolio