West Fraser Timber Co. Ltd.
Revenues per share have increased relatively steadily. There was a decline in 2019 due to lower lumber prices. And there is another decline currently underway again due to low lumber prices. Earnings per share have grown in a highly cyclic fashion and were negative in 2019 due to low lumber prices and due to export duties paid. There had been a huge recovery in earnings since in the past couple of years. A sharp earnings decline is nmow underway. This seems sure to be the case for Q2 when it is reported and likely for Q3 as well.
| West Fraser Timber Co. Ltd. (WFG, Toronto and U.S.) | |
| RESEARCH SUMMARY | |
| Report Author(s): | InvestorsFriend Inc. Analyst(s) |
| Author(s)’ disclosure of share ownership: | The Author(s) hold no shares |
| Based on financials from: | 2022 Y.E. +Q1 ’23 |
| Last updated: | July 6, 2023 |
| Share Price At Date of Last Update: | $ 83.28 |
| Currency: | $ U.S. |
| Generic Rating (This rating does not consider the circumstances of any individual investor and is therefore not specific advice for any individual): | Sell at U.S. $83 and CAN $110 |
| Qualifies as a stock that could be bought with confidence to hold for 20 years? | Maybe, but this is a tough and cyclical business |
| Has Wonderful Economics? | Poor to great depending on lumber prices |
| Has Excellent and Trustworthy Management? | Yes |
| Likely to grow earnings per share at an attractive rate over the next decade? | Yes, in the long term |
| Positive near-term earnings outlook? | No |
| Valuation? | Fair |
| SUMMARY AND RATING: The graph of revenues per share (red line) shows strong and relatively steady growth since 2012. Growth was assisted by share buy backs. Earnings per share have trended upward sharply but in a highly volatile fashion with some years showing a loss and with earnings currently having declined sharply from record highs. The Value ratios based on trailing earnings would support a rating of Buy but the forward P/E level would suggest a rating of Sell. Management quality appears strong. The insider trading signal is weak but positive. Executive compensation is reasonable. The near term outlook is for a sharp year-over-year decline in earnings in Q2 and probably in Q3 as well unless lumber prices recover as U.S. home building remains relatively strong. The economics of the business are good most of the time. Its competitive advantage is through being a low cost producer. This company can be expected to be highly cyclical. Overall we would rate this as a Sell at this time due to the weak near-term outlook and the general unpredictability of the company. Thos with a particular interest and faith in the lumber business may wish to hold a modest stake. | |
| The macro outlook is negative due to higher interest rates reducing the demand for new houses and due to predictions that the North American economy may enter a recession. | |
| LONG TERM VALUE CREATION: The shares were relatively stagnant for many years prior to 2009. Since then they have risen quite substantially but have had two very major pull-backs | |
| DESCRIPTION OF BUSINESS: (updated in 2022) West Fraser Timer is primarily a diversified lumber producer. Its main products are dimensional lumber and Oriented Strand Board (OSB) panels. It also produces plywood and other engineered wood products. Its plants include 34 lumber mills, 14 OSB mills, 11 other engineered wood products mills, 5 pulp and newsprint mills and 6 renewable energy plants. It’s a Canadian company but now reports in US dollars. Its plants are primarily located in Alberta, B.C. and the south eastern United States. It has 11,000 employees. In 2021 its revenues were US $10.5 billion. In 2021 the United States accounted for 69% of its sales, Canada was 16% and the remaining 15% was sold in Asia and Europe. 53% of its plant assets are located in Canada, 39% in the US and the remaining 8% are in Europe. | |
| ECONOMICS OF THE BUSINESS: Producing lumber is a tough business. The company rightly strives to be the low cost producer because that is the only way to be consistently profitable in this commodity business. The past economics have been volatile but good. | |
| RISKS: See annual report for a full discussion of risks. Low commodity prices caused by over-capacity and competition is major risk. Other risks environmental protests and regulations. | |
| INSIDER TRADING / INSIDER HOLDING: Checking from September 1, 2022 to July 5, 2023 there was very little insider trading in the public market. One senior officer bought 256 shares in an RRSP at U.S. $98. An entity called Banasino Investments has become an insider with a whopping 8.4 million shares but it was not clear at what price those were purchased but presumable some were purchased relatively recently. This is perhaps a mysterious entity since locations indicated are Luxemburg and Cypress. Overall, this suggests a positive insider trading signal although not based on many individuals owners buying. The company itself had been buying back shares fairly aggressively at prices up to U.S. $95 but they ceased doing so at the end of December. On July 27, 2022 the Great Pacific Capital Corporation (Jimmy Pattison) reported an initial position of 5.9 million shares. | |
| WARREN BUFFETT’s CRITERIA: Buffett indicates that all investments must pass four key tests: the business is simple to understand and predict (marginal pass – the products are simple to understand but the commodity pricing swings are not), has favourable long-term economics due to cost advantages or superior brand power (pass as a low cost producer), apparently able and trustworthy management (pass), a sensible price – below its intrinsic value (probable pass), Other criteria that have been attributed to Buffett include: a low debt ratio (pass), good recent profit history (pass) little chance of permanent loss of the investors capital (pass) a low level of maintenance type capital spending required to maintain existing operations excluding growth (probable pass) | |
| MOST RECENT EARNINGS AND SALES TREND: Earnings growth has recently been very volatile. There was a very sharp increase in profits in 2020 and 2021, then a decline in 2022 and with negative earnings in Q4 2022 and Q1 of 2023. The volatility is driven mostly by lumber prices. | |
| COMPARABLE STORE SALES OR INDUSTRY SPECIFIC STATISTICS: Not applicable | |
| Earnings Growth Scenario and Justifiable P/E: This highly cyclic company does not lend itself to analysis based on the P/E ratio. | |
| VALUE RATIOS: Analysed at U.S. 83. The dividend yield is relatively minimal at 1.4% but represented a pay-out of just 12% of trailing earnings. The price to book value ratios seems quite reasonable to attractive at 0.9 and at 1.3 after deducting goodwill and intangible assets.. The earnings ratios are not particularly reliable given the highly cyclic nature of its earnings. The P/E based on trailing year earnings is ostensibly attractive at 8.8. The P/E based on analyst forecast earnings is very unattractive at some 435 as analysts apparently expect earnings to plunge to near zero. The ROE based on trailing year earnings is good at 10% but this is unreliable given that the average over the past ten years is about 21% but with a range from minus 6% to 58%. Overall, the trailing value ratios would support a rating of Buy but we note that the forward P/E would suggest a rating of Sell. | |
| TAXATION: Nothing unusual | |
| SUPPORTING RESEARCH AND ANALYSIS | |
| Symbol and Exchange: | WFG, Toronto and U.S. |
| Currency: | $ U.S. |
| Contact: | 0 |
| Web-site: | 0 |
| INCOME AND PRICE / EARNINGS RATIO ANALYSIS | |
| Latest four quarters annual sales $ millions: | $8,217.0 |
| Latest four quarters annual earnings $ millions: | $842.0 |
| P/E ratio based on latest four quarters earnings: | 8.8 |
| Latest four quarters annual earnings, adjusted, $ millions: | $842.0 |
| BASIS OR SOURCE OF ADJUSTED EARNINGS: There has definitely been unusual gains and losses over the year. However, given the inherent volatility of earnings and given uncertainty about what to adjust for, we have made no adjustments. The company adds back restructuring charges in adjusted EBITDA but does not add back retroactive adjustments to duties | |
| Quality of Earnings Measurement and Persistence: The earnings are measured in a conservative manner but persistence is not high at all due to the cyclic nature and dependence on commodity prices. | |
| P/E ratio based on latest four quarters earnings, adjusted | 8.8 |
| Latest fiscal year annual earnings: | $1,975.0 |
| P/E ratio based on latest fiscal year earnings: | 3.7 |
| Fiscal earnings adjusted: | $1,975.0 |
| P/E ratio for fiscal earnings adjusted: | 3.7 |
| Latest four quarters profit as percent of sales | 10.2% |
| Dividend Yield: | 1.4% |
| Price / Sales Ratio | 0.90 |
| BALANCE SHEET ITEMS | |
| Price to (diluted) book value ratio: | 0.92 |
| Balance Sheet: The balance sheet is strong. Debt is relatively minimal with just 7 cents of debt for each dollar of common equity. Purchased goodwill represents a relatively modest 22% of the assets The debt rating is investment grade but relatively low at BBB minus probably because the debt rating agencies note the highly cyclical nature of the business and its dependence on commodity prices. | |
| Quality of Net Assets (Book Equity Value) Measurement: High quality, see comments on balance sheet. | |
| Number of Diluted common shares in millions: | 83.6 |
| Controlling Shareholder: As of April 2022 the founding Ketcham family controls approximately (or at least) 7.5% of the votes. It appears the Jimmy Pattison as well an investment fund also have stakes of relatively similar size to this 7.5 level. | |
| Market Equity Capitalization (Value) $ millions: | $6,958.5 |
| Percentage of assets supported by common equity: (remainder is debt or other liabilities) | 76.7% |
| Interest-bearing debt as a percentage of common equity | 7% |
| Current assets / current liabilities: | 3.7 |
| Liquidity and capital structure: The Balance sheet is strong with good liquidity and modest debt. | |
| RETURN ON EQUITY AND ON MARKET VALUE | |
| Latest four quarters adjusted (if applicable) net income return on average equity: | 10.4% |
| Latest fiscal year adjusted (if applicable) net income return on average equity: | 25.9% |
| Adjusted (if applicable) latest four quarters return on market capitalization: | 12.1% |
| GROWTH RATIOS, OUTLOOK and CALCULATED INTRINSIC VALUE PER SHARE | |
| 5 years compounded growth in sales/share | 16.2% |
| Volatility of sales growth per share: | Moderately volatile |
| 5 Years compounded growth in earnings/share | 30.0% |
| 5 years compounded growth in adjusted earnings per share | 30.0% |
| Volatility of earnings growth: | Volatile |
| Projected current year earnings $millions: | not available |
| Management projected price to earnings ratio: | not available |
| Over the last ten years, has this been a truly excellent company exhibiting strong and steady growth in revenues per share and in (adjusted) earnings per share? | No, quite cyclical |
| Expected growth in EPS based on adjusted fiscal Return on equity times percent of earnings retained: | 22.8% |
| More conservative estimate of compounded growth in earnings per share over the forecast period: | 0.0% |
| More optimistic estimate of compounded growth in earnings per share over the forecast period: | 10.0% |
| OUTLOOK AND AMBITIONS FOR BUSINESS: The near-term outlook is for lower year-over-year earnings in Q2 and Q3 of 2023 due to lower commodity prices even as U.S. home construction remains reasonably strong. The lower Canadian dollar is a benefit as costs are primarily in Canadian dollars and revenues primarily in US dollars. | |
| LONG TERM PREDICTABILITY: The company has done well in a tough industry for many years and this seems likely to continue but with great volatility. | |
| Estimated present value per share: This company is highly cyclical and therefore does not lend itself to a calculation of intrinsic value based on earnings. | |
| ADDITIONAL COMMENTS | |
| INDUSTRY ATTRACTIVENESS: (These comments reflect the industry and the company’s particular incumbent position within that industry segment.) Michael Porter of Harvard argues that an attractive industry is one where firms are somewhat protected from competition based on the following four tests. Barriers to entry (Pass given the capital intensive nature of the business). No issues with powerful suppliers (marginal pass at best as governments control much of the timber). No issues with dependence on powerful customers (pass), No potential for substitute products (pass) No tendency to compete ruinously on price (fail due to commodity nature). Overall this industry appears to be a tough industry and not that attractive even for an established large incumbent. | |
| COMPETITIVE ADVANTAGE: The company focuses on being a low-cost producer. | |
| COMPETITIVE POSITION: We do not have information on this but clearly it has a major market share. | |
| RECENT EVENTS: In response to slower home building levels and declining lumber prices they have curtailed production at some mills and shut down others. In August 2022 they announced that they will permanently reduce capacity at three B.C. sawmills by eliminating one shift. In Q1, 2022 the company permanently reduced operations at its Hinton pulp mill. West Fraser in early 2021 made a massive all-stock acquisition of Norbord – the world’s largest Oriented Strand Board (panel) producer. Lumber futures on Nasdaq (LSB) have been extremely volatile peaked at an extraordinary record of $1670 in May 2021 and then declined to under $500 in August 2021 and then recovered to about $1250 in early 2022 but then slumped to $476 as of early September 2022 and as of early July 2023 is at $540 . The company had been buying back its own shares very aggressively but ceased doing so at the end of 2022. | |
| ACCOUNTING AND DISCLOSURE ISSUES: The company focuses on adjusted EBITDA and does not adjust for all of the unusual items. They could focus more on bottom line net earnings. | |
| COMMON SHARE STRUCTURE USED: Normal, one vote per share. But the founding family as well as now Jimmy Pattison own class B shares that represent only 3.3% of the total shares but which apparently would have a veto over certain corporate transactions. These class B shares do not trade on the exchange. | |
| MANAGEMENT QUALITY: Appears to be high quality. We like their focus on being the low cost producer and on promoting from within the company. | |
| Capital Allocation Skills: West Fraser has shown good skills in capital allocation probably including its decision to repurchase a very substantial percentage of its shares in recent years. They have kept debt down at reasonable levels. | |
| EXECUTIVE COMPENSATION: Appears to be reasonable | |
| BOARD OF DIRECTORS: Warren Buffett has suggested that ideal Board members be owner-oriented, business-savvy, interested and financially independent. This appears to be a good Board. It has ten members. Two are from the founding family. Several are from the investment world with expertise in forestry. The others all have related industry experience. Most, although not all, own a reasonable number of shares. | |
| Basis and Limitations of Analysis: The following applies to all the companies rated. Conclusions are based largely on achieved earnings, balance sheet strength, achieved earnings per share growth trend and industry attractiveness. We undertake a relatively detailed analysis of the published financial statements including growth per share trends and our general view of the industry attractiveness and the company’s growth prospects. Despite this diligence our analysis is subject to limitations including the following examples. We have not met with management or discussed the long term earnings growth prospects with management. We have not reviewed all press releases. We typically have no special expertise or knowledge of the industry. | |
| DISCLAIMER: All stock ratings presented are “generic” in nature and do not take into account the unique circumstances and risk tolerance and risk capacity of any individual. The information presented is not a recommendation for any individual to buy or sell any security. The authors are not registered investment advisors and the information presented is not to be considered investment advice to any individual. The reader should consult a registered investment advisor or registered dealer prior to making any investment decision. For ease of writing style the newsletter and articles are often written in the first person. But, legally speaking, all information and opinions are provided by InvestorsFriend Inc. and not by the authors as individuals. The author(s) of this report may have a position, as disclosed in each report. The authors’ positions may subsequently change without notice. | |
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