Our view: We had the pleasure of hosting West Fraser's veteran CFO, Chris Virostek, with European clients last week. Most meetings had a distinctive ESG flavour (characteristic of European accounts) with the company able to meet almost all account thresholds.
Key points:
US housing market looks difficult in 2023, but WFG is well positioned - With higher interest rates, home affordability challenges and a slowing NA economy, we anticipate that 2023 will be a difficult year for all building material names in our coverage. That said, after record profitability over the last two years, we believe the industry is very well positioned to weather almost any difficulty. In the case of West Fraser, the company had $1.323B in cash and $772MM in softwood lumber deposits at the end of Q322, representing 31% of its market capitalization.
Housing market changes should limit the downside - Over the last 15 years, repair & renovation (R&R) spending has grown, and now accounts for 40% of lumber demand (from 25%) and 33% of OSB (from 25%) in NA. We expect these end markets to be somewhat stable going forward based on an old housing stock (average age is 40 years in NA) and financing challenges that will tend to keep families in their current homes, leading to higher R&R levels. In addition, we anticipate the growth of Mass Timber will add an incremental NA lumber demand of ~7-8% over the next 10 years.
WFG has a low cost platform - Historically, West Fraser was considered the lumber benchmark, the company peers would measure themselves against. The 2021 acquisition of Norbord added low cost OSB production to the company, diversifying its product mix and geographical footprint. A key advantage is the company's rigorous monthly benchmarking which ranks every one of its 34 sawmill and 12 OSB facilities in NA on a host of cost, recovery and value metrics. In addition, WFG also benchmarks itself to industry peers on a quarterly basis.
Balanced capital allocation with low risk capex - Since February 2021, West Fraser has retired almost 75% of the shares issued to acquire Norbord, reduced its debt by over $700MM and has raised its dividend three times. Despite that, the company's current valuation is lower than it was at the start of 2021. West Fraser has embarked on a lower risk strategy for major sawmill upgrades by building a new sawmill beside an existing mill, minimizing risks for labour and residual offtake agreements.
Valuation remains very inexpensive, but we need a catalyst - West Fraser is trading at 5.3x our 2023 EBITDA forecast, 4.1x 2024E and 4.2x trend. On a lumber capacity basis, it's trading at less than half of current replacement.