Key points:
2023 has been tough so far, but several factors make us more optimistic about the set-up for 2024. Lumber prices fell well short of our estimates in Q123 (please click here), with W. SPF prices in particular trading at an unusually large discount (~$185/mfbm versus a normalized discount in the $70/mfbm range), driven by weaker new housing demand vs. more robust R&R activity. However, we think the impact of recent capacity removals (e.g., Canfor's Houston and Chetwynd mills, which closed early in Q2) will only be felt at the end of Q2/start of Q3. With lean channel inventories, materially higher lumber prices are likely with only a modest pick-up in demand. Housing affordability is undoubtedly challenged, but housing starts have tracked ahead of our expectations through 2023 to-date, and we think potential rate relief in H223/2024 would be a tailwind for demand.
Capital allocation remains on the front burner. Interfor is prioritizing (1) managing debt levels, with net debt of $720MM at YE22 following the Chaleur acquisition pushing Interfor slightly above its target range of 5-25% net debt to invested capital (please see Exhibit 5); (2) annual maintenance capital of ~$80MM; (3) its strategic capital program in the US South, which it expects to conclude in 2025. Management believes the capital requirements/opportunities for the mills recently acquired from EACOM and Chaleur are much more modest, and as such, we think investors' focus is increasingly on the implied step-up in free cash flow beyond 2025. Interfor seems open to instituting a modest regular dividend, but we think it will aim to preserve flexibility given its growth focus, history of opportunistically repurchasing shares, and the cyclicality of the lumber business.
Valuation is highly attractive. Interfor is trading at an EV/EBITDA multiple of ~3.6x on our Trend EBITDA estimate of $525MM, which is significantly below its historical average of ~4.6x (please see Exhibit 7), despite duties on deposit now amounting to US$512MM, or ~C$10/share on an after-tax basis. On a capacity basis, valuation is ~C$330/mfbm or ~US$250/mfbm (please see Exhibit 8), which compares to replacement cost of ~US$900/ mfbm. However, Interfor is in the process of selling its Coastal tenures (~1.6MM m3, and we estimate @ $100-130/m3, or $150-$200MM in value); if you net that off the EV, capacity value falls to ~C$300/mfbm or ~US$225/mfbm.