West Fraser Timber: It’s bingo for $100/share (NYSE: WFG)
Stocks with high multiples and no earnings but with big dreams stacked on top of big stories are repricing at lower multiples. Meanwhile, a whole range of industries are beginning to receive some likely overdue attention: cyclicals/industrials, energy, banks, and more. Take for example West Fraser Timber (WFG). West Fraser Timber is a company I wrote about last year from May 2020 – shortly after the big spike in timber prices which you can see here:
West Fraser: Let the Good Times Roll
West Fraser Timber Stock: The Path to $100
West Fraser Timber and the Valuable Alligator Jaws
West Fraser Lumber Stock: Bullish Backdrop Ahead of Q3 Earnings Report
A central tenet of my thesis throughout my writings on WFG was that, in my view, the market was, has been, and continues to price WFG as if the company would return to mid-cycle earnings ( or lower) starting tomorrow when in my view earnings will undoubtedly moderate/normalize, but this process of normalization will likely take much longer than the market expects. Given the extremely supportive housing market backdrop and the unending impact of COVID on logistics/supply chains etc, it could very well be that the lumber market will take MUCH longer to normalize than most people think and eventually arrives at a new normal level of mid-cycle activity that is significantly higher than the long-term historic mid-cycle.
Look at what has happened to lumber prices over the past year:
Supply and demand were clearly out of whack during the April/May/June 2021 time frame, sending prices skyrocketing to an unsustainable high and subsequent decline until finding a floor/support around $500 at $600 per mbf, which is well above the historical normalized average price around $350 per mbf. And after rebounding to nearly double the long-term historical average price during the third quarter, lumber saw a modest supply followed by a higher massive supply in the fourth quarter, over above $1,000 per mbf, where we currently find ourselves today. In each of these surges, there seemed to be a variety of unique factors ranging from weather, to logistical bottlenecks, to one-off circumstances that always seem to arise in a commodity market. Never quite the same from instance to instance, but there always seems to be something about these types of companies.
Now if you are planning to build something or do a project, yes of course that too will pass, if you can wait, that always happens at some point, doesn’t it? But when it comes to estimating the value of a company like West Fraser Timber, a competitor in a mature, commoditized industry, in which the good times invariably return to normal mid-cycle levels at some point (much like pessimistic times, possibly btw) you need to realize that WFG is likely to generate MUCH more than mid-cycle cash flow levels throughout the return to normalized mid-cycle levels. Remember that historical mid-cycle earnings are trending around a long-term average lumber price of around $350 per mbf and the current futures price is 4x that level! And on top of that, WFG is reinvesting excess cash back into its own business and balance sheet through optimization projects, acquiring capacity new to them, reducing debt and reducing outstanding stock, which which is to say that over time they get better and better. company (i.e. mid-cycle earnings power, in my view, is likely up).
Looking to the near term, I suspect analysts are predicting that this recent lumber price spike is rare, which means WFG is likely to generate MUCH more cash flow than they were expecting when they estimated 12-month price targets. The WFG and the price targets are likely going to be raised quite quickly.
In fact, Scotia recently raised its price target on WFG from C$137 to C$143 and CIBC raised its price target from C$120 to C$150 and rated the company as an “outperformer”. So in USD that works out to around $115-$120 USD per share, given that the stock is trading at just under $100/share at the time of writing, which is around 15-20% of up from current levels, not so bad .
The bottom line for me is that at 2.2x EV/EBIT, WFG shares are still trading at a ridiculously cheap multiple.
Trading for a cheap multiple is not always a good thing, but in this case the management team seems to have taken tremendous action and remains disciplined from a capital allocation perspective by buying up debt and buying back stock, increasing dividends and adding/diversifying production capacity via acquisitions of existing capacity in the US (versus building a bunch of new capacity). There are likely some one-time adjustments to come due to the adverse conditions in Canada that impacted West Fraser’s operations in Q3/Q4, but in general, reasonable people have to agree that the business continues to grow from the bottom. left up right and as such I plan to hang on for the ride. In one of my articles on WFG, I applied an analogy I pulled from a nerdy podcast talking about the alligator jaws of value and price and how WFG was increasing in value, but the price was basically flat…it’s an alligator jaw situation, the alligator looked up! Let’s hope it continues.
Thanks for reading.