November 8, 2020
Interfor Corporation
Margin of safety; our top small cap idea
Our view: Interfor Corporation (“Interfor”) reported Q320 results that were above both our forecast and consensus expectations. With a significant amount of free cash flow set to be generated over the next 12 months and additional cash coming in from non-core (zero EBITDA) asset sales, we expect the company to move into a net cash position, which should result in a more aggressive return of capital to shareholders. Otherwise, we think that Interfor could become an attractive potential takeout candidate. We therefore reiterate our Outperform rating.
Key points:
Reiterating $24 price target and Outperform rating – Our price target is based on a 6.25x EV/EBITDA multiple on our trend EBITDA estimate of $275MM (85%) and our 2021E EBITDA of $346MM (15% weighting).
We expect the lumber business to generate significant free cash flow –
With essentially 100% of the business related to lumber, we expect that Interfor will be firing on all cylinders. While lumber prices have come down from record levels in September (as we would expect seasonally), they are still at an all-time high for November, and at $530/mfbm, the SYP Composite has only ever been higher for seven weeks in 2018 and the last four months of 2020. We currently expect that Interfor will generate ~$200MM of free cash flow over the next four quarters, which translates to a ~16% free cash flow yield.
There should also be some incoming proceeds from asset sales – In Q4, Interfor should receive some benefit from the sale of the Gilchrist sawmill (we expect under $10MM), and we expect that the company will be able to close on the sale of the Hammond sawmill site in Metro Vancouver in the first half of 2021 (we expect ~$40–55MM of gross proceeds). With both of these assets generating essentially zero EBITDA, we view the transactions positively. At current prices, the proceeds already represent ~4–5% of the enterprise value. For more details on the sale of the Gilchrist sawmill, please click here. Interfor also has ~C$162MM of duties on deposit with the US Government; historically there has been a ~80% recovery rate, although we don’t expect that for at least a few years.
Without some aggressive share repurchases, we think Interfor could become an attractive takeout candidate – With Interfor’s SYP-heavy lumber valuation lagging peers (at 4.5x EV/Trend EBITDA vs. Canfor’s BC- weighted lumber business at 4.5x, West Fraser at 5.7x, and Weyerhaeuser at 10.7x), we think that its unlevered balance sheet could catalyze a long- expected take-out by one of the larger lumber producers. We think that a company such as West Fraser (which is under-levered itself) could finance such a transaction with ~$700MM of debt (~40% of the purchase price) and still keep net debt to capital below its historical average of 20%. A barrier to such a transaction would be push-back from the BC Government and the less attractive US West assets, which would likely be sold.