What are we looking for?
Undervalued stocks in the forest products sector.
We used StockCalc’s screener to select the 10 largest forest products companies on the Toronto Stock Exchange. We then use StockCalc’s valuation tools to calculate the fundamental (or intrinsic) valuation for each stock to determine whether it is undervalued or overvalued compared with its price. We calculated fundamental valuation for each stock using standard valuation techniques including discounted cash flow, comparables and adjusted book value.
Discounted cash flow (DCF) is a valuation technique in which cash flow projections are discounted back to the present to calculate value per share. A price comparables (price comps) technique values the company on the basis of ratios from selected comparable companies. An adjusted book value (ABV) is calculated by multiplying book value per share by its historical price to book ratio. If we have analyst coverage, we use the consensus target price.
More about StockCalc
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What we found
This sector is composed of two industries: companies that grow timber, mill lumber, and manufacture wood and wood products for construction; and companies that manufacture and market paper and paper-related products from wood pulp and other fibres.
In the sector we have seen a divergence in stock prices over the past 12 months – with lumber producers’ prices up 20 per cent to 55 per cent year over year; and pulp and paper companies down as much as 40 per cent over the same period. Underlying those stock price movements are movements in the prices of the commodities they produce. The price of lumber has been climbing at a rapid pace since the March lows because of the backlog demand and industry downtime created by COVID-19. It currently sits above US$800 per thousand board feet from a low of less than US$300 five months ago.
Prices for pulp and paper producers have been flat to lower with benchmark northern bleached softwood kraft (NBSK) down 10 per cent over the past 12 months and 30 per cent from two years ago. The much-publicized retail demand for tissue products such as toilet paper early in the pandemic has been offset by a plummet in orders for office paper supplies as well as a continuing decline in demand for newsprint.
It is also worth noting that companies in this sector generally have a lot of debt in their capital structure. They require the debt to construct and maintain their mills. With a levered structure, they are more prone to cash flow challenges during the lows of their respective commodity cycles and upward stock price leverage during rising commodity prices.
Let’s look at a couple of these companies.
Lumber represents 85 per cent of total revenue for West Fraser Timber Co. Ltd. The company, which has 75 mills located in Western Canada and the southern United States, is currently benefiting from the increase in lumber prices. Its stock has climbed to more than $70 from less than $25 five months ago. Our valuation models show the stock as fully valued with the expectation lumber prices are nearing their cyclical highs. We see that for most lumber producers on the list.
Resolute Forest Products Inc. owns or operates 40 pulp, paper, tissue and wood products facilities in the U.S. and Eastern Canada. Paper demand is expected to remain weak, with some recovery expected in the third quarter and toward year-end. Our models show Resolute as undervalued, with the note that we show a negative DCF value owing to the debt load of the company.
You can see in the accompanying table the percentage difference between each stock’s recent closing price and its intrinsic value. The StockCalc Valuation column is a weighted calculation derived from the models and analyst target data.
Investing involves risk, especially for volatile stocks like these. StockCalc accepts no liability whatsoever for any loss or damage arising from the use of this analysis.
Brian Donovan, CBV, is president of StockCalc, a Canadian fintech based in Miramichi, N.B.
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