As U.S. housing market improves, consider this pure-play lumber stock

Share

Investors should have one stock within their diversified portfolios with exposure to the strengthening U.S. housing market. Vancouver-based Interfor Corp., a lumber pure-play and the fourth-largest North American lumber producer, has significant U.S. exposure. This is one stock investors should consider owning.

Here's a rundown of the company's key drivers.

Favourable industry conditions: An improving housing market equates to rising lumber demand. U.S. new home sales in May increased to a 546,000 annualized pace, the highest level since February, 2008. An improving labour market, combined with a low interest-rate environment, should provide further support for a U.S. housing recovery to continue.

Lennar Corp., one of the U.S. largest home builders, beat expectations when it reported second-quarter earnings last week. The company's average price for homes delivered climbed to a record high, and the outlook looks promising. Stuart Miller, the chief executive officer, said, "The home-building market continued its steady improvement throughout our second quarter. Driven by higher wages and employment, reasonable affordability levels, supply shortages and favourable monthly payment comparisons to rentals, the home-building market is well positioned for multiyear growth ahead."

Leveraged to the United States: Some 76 per cent of Interfor's pro forma 2014 volumes were sold into the U.S. market. Approximately two-thirds of Interfor's production capacity is south of the border – 40 per cent and rising from the attractive U.S. southeast region, and 28 per cent from the U.S. northwest.

Location: Interfor has been expanding through acquisitions focused in the U.S. southeast region – a prime, low-cost location. Prior to 2013, the company had no exposure to this area; now, as mentioned, 40 per cent of its production capacity is there. Log supply is abundant, resulting in lower production costs for the company. On the first-quarter conference call, Duncan Davies, president and CEO, said: "I think it's fair to say it's the most profitable region in North America."

Steady production growth: Management has been successful in identifying, acquiring and integrating acquisitions, giving the company an impressive lumber-production growth profile. In 2014, sales increased 30.9 per cent from 2013 due to higher volumes and prices. The company has the financial flexibility to continue to grow both organically and through acquisitions.

Capital investment: Management has invested more than $350-million in projects over the past several years as the company expands and optimizes its operations.

Valuation

The stock trades at a forward EV/EBITDA of 6.7 times the 2016 consensus estimate. (EV/EBITDA, a key valuation metric, stands for enterprise value divided by earnings before interest, taxes, depreciation and amortization.) This above its three-year historical average of 5.1 times and one-year average of 5.5 times.

Chart watch

The stock has been in a multiyear uptrend, but its stock price can be volatile. On June 26, when the stock market was down over Greek debt concerns, this stock was up 2.3 per cent. Year-to-date the stock price is down 4.5 per cent; however, since May 6, the stock price is up more than 25 per cent. The recent rally can be attributed to firming lumber futures prices driven by a strengthening U.S. housing outlook.

Last week, the share price experienced a "golden cross" – a technical positive – where the 50-day moving average crossed above the 200-day moving average. There is resistance at $22, $23.50, and technical support between $19.60 and $20, then at $19 and $18.

The recent rally has caused the share price to approach an overbought level. The relative strength index is at 67; generally a reading of 70 or higher indicates an overbought condition.

Analysts' recommendations

There are eight analysts with "buy" recommendations, one with a "market perform" recommendation and one with a "sell" recommendation. One-year price targets range from $21 to $27.50, the average being $24.28, implying a 15.8-per-cent potential return. Analysts have been lowering their upcoming second-quarter and 2015 earnings forecasts. The consensus earnings estimate for the second quarter is a loss of 13 cents. The consensus earnings forecasts for 2015 and 2016 are 41 cents and $1.70, respectively.

The bottom line

With its attractive U.S. exposure and a favourable industry backdrop, Interfor is a stock to own. I would be accumulating shares on a pullback in the stock price as the valuation is high and the stock appears overbought in the near term.

Jennifer Dowty, CFA, Globe Investor's in-house equities analyst, writes exclusively for our subscribers at Inside the Market.