Q2 confirms outlook is robust, but offset by full valuation in our view
Our view: SJ reported strong Q2 results and reaffirmed utility pole sales growth guidance. Important from the conference call, however, was commentary that management is seeing spot pole pricing hold up relatively well versus prior indication that extra capacity throughout the industry would negatively affect rates. However, 2024 margin guidance of 18% implies a step down in margin in H2 that is somewhat at odds with the comments surrounding pricing. Overall, the quarter confirmed that Stella is exposed to some very favourable long-term trends, although we believe this is fully reflected in the company’s premium valuation. We maintain our Sector Perform rating and $94 price target.
Key points:
Q2 above consensus. Q2 adj. EBITDA of $202MM exceeded consensus of $195MM (RBCe: $202MM) due to strong utility pole sales driven by higher pricing and volumes as well as higher railway tie volumes to non-Class 1 customers. Margins of 19.3% were below our estimate of 19.7% on higher SG&A. See Exhibit 1.
Pole pricing holding up better than previously expected. Overall, we view commentary on the pole pricing outlook as the most important takeaway from the quarter. Management noted that spot pricing is holding up better than prior expectations for weaker pricing in H2 as new capacity came online across the industry. We view this as a positive driver of gross margin in the back half of the year, and we raise our H2 estimates as a result. We increase our 2024 EBITDA margin to 18.6% (from 18.4%) vs. guidance of 18%, which we believe incorporates a degree of conservatism.
Guidance reaffirmed. Management today reaffirmed organic pole sales guidance of +15% CAGR 2023–25, as it now expects price and volume (versus mostly volume previously) to drive pole sales higher in 2024 and 2025. In addition, management flagged that it still expects tie sales to be up a low single digit and residential lumber to come in toward the low end of the previously guided range of $600–650MM. Overall, today’s update reaffirmed in our view the positive long-term outlook at Stella-Jones.
Adjusting estimates. We raise our 2024 estimates on the back of commentary surrounding the pricing outlook, partly offset by higher SG&A. Accordingly, our 2024 EBITDA estimate increases to $663MM (from $652MM). Our 2025 estimate of $668MM is unchanged.
Reiterating Sector Perform rating and $94 price target. Our unchanged price target reflects our largely unchanged estimates and a target multiple of 10x. We continue to see solid volume tailwinds as being offset by pole pricing risk into 2025 as well as valuation, and we view risk-reward as well- balanced at current share price levels