Contrary to the consensus on Wall Street, I am bearish on West Fraser Timber Co. (WFG) shares.
The timber and wood products industry is one of the sectors that has cooled off recently as traders focus on how to benefit from higher energy prices, which have been blamed on oil & gas supply concerns over the war in Ukraine. The trend has weighed on shares of many lumber stocks, including West Fraser Timber, which is down more than 17% so far this year.
The company has a solid balance sheet and profitable operations, but I fear these two factors will not be enough to reverse the trend, as lumber prices and volumes could trend downward in the coming months.
The company has more than 60 facilities in North America and internationally. These facilities produce wood and various wood products, including pulp, newsprint, wood chips, and other residues. These products are supplied to the paper industry and various companies involved in house building, repair and remodeling, and industrial processes.
Q4 and FY-2021 Results
The unprecedented flooding of late 2021 impacted the company’s operations in British Columbia and the regular flow of finished products shipped from Western Canada to its various markets. However, the company has overcome the challenges.
For the fourth quarter of 2021, West Fraser Timber reported earnings per diluted share of $3.13, beating the consensus estimate by $0.10 on total revenue of approximately $2.04 billion. Revenue rose 20% year-over-year but missed analysts’ expectations by $20 million.
Adjusted EBITDA declined nearly 22% sequentially to $615 million for an Adjusted EBITDA margin of 30% of total revenue. The increase in the lumber segment was not enough to offset the sequential decline in the engineered wood products segments in North America and Europe and the loss in the pulp and paper segment.
For full year 2021, earnings per diluted share were $27.03 (up 216% year-on-year) while total revenue increased to $10.52 billion (up 140.52% year-on-year).
Adjusted EBITDA was $4.57 billion, up 338.1% year over year, for an Adjusted EBITDA margin of 43% of total revenue. Adjusted EBITDA improved year-over-year in all business segments.
Solid Balance Sheet
WFG’s balance sheet is solid, as evidenced by an interest coverage ratio of 94x, meaning the company has no trouble paying the cost of outstanding debt, and an Altman Z-Score of 13.3, indicating that it is in the “safe” zone. For those that don’t know, the Altman Z-Score predicts the probability that a company will go bankrupt within a couple of years. A score above 2.99 is considered safe.
Additionally, as of December 30, 2021, West Fraser Timber’s debt-to-EBITDA ratio was 0.21, while the industry median was 3.13. The company’s EBITDA pays off all outstanding debt in less than a year compared to over three years for many competitors.
Its current ratio of 2.7 indicates that the company generates sufficient cash from operations to pay off current liabilities on a timely basis.
Strong Operations
All major financial profitability indicators are improving.
As of December 30, 2021, the trailing 12-month gross profit margin was 55.86% versus the industry median of 30.6% and WFG’s five-year average of 38.9%.
In the same period, its trailing 12-month EBITDA margin was 43.2% versus the industry median of 21.3% and its five-year average of 20.2%.
As of December 30, 2021, the trailing 12-month net income margin was 28.02% (versus the industry median of 8.78%). WFG’s five-year net income margin is 11.1%, indicating increasing profitability.
The Company’s Outlook for 2022
In his commentary on the company’s fourth-quarter and full-year 2021 results, Ray Ferris, West Fraser’s President and Chief Executive Officer, said: “Fundamentals for housing are favorable entering 2022, and we continue to see signs of resilience in repair and remodeling demand in both our North American and European markets.”
Lumber 12-Month Price Target
Given the current circumstances, an early end to the war in Ukraine seems unlikely.
Russia continues its terrible aggression against Ukraine, and the G7 countries continue to tighten restrictions on the economy of the Russian Federation and its oligarchs.
Economists fear these sanctions will have boomerang effects that could hurt economic growth in multiple ways, but policymakers seem more concerned about inflation than a possible economic recession.
As a result, the U.S. Federal Reserve is expected to raise interest rates six times this year and twice next year to curb the current rapid rise in the price of goods and services.
It will take time for this tightening monetary policy to be reflected in higher interest rates on long-term borrowing, including home loans and home repairs and renovations, but it will happen.
Higher borrowing costs will affect the housing market and renovations and repairs to existing homes.
Therefore, it is expected that the demand for lumber will be lower in the future, which should be reflected in a lower price of the raw material. The fundamentals will certainly be less favorable for West Fraser Timber and other operators.
The impact of an expected fall in demand will be felt on lumber prices as early as this year, and analysts believe producers will be forced to sell at a much lower price of ~$742 per 1,000 board feet within a year, which will reflect a more than 20% drop from the current price of ~$970.
Wall Street’s Take
In the past three months, six Wall Street analysts have issued a 12-month price target for WFG. The company has a Strong Buy consensus rating based on six Buys, zero Holds, and zero Sell ratings.
The average West Fraser Timber Co. price target is $119.66, implying 53% upside potential.
Conclusion
The company has strong fundamentals, but this hasn’t been reflected in its stock price performance this year, as positive momentum in energy stocks has diverted traders’ attention away from timber stocks as well.
I expect this trend to continue with fresh headwinds likely caused by higher interest rates to combat elevated inflation. This will weaken demand for housing, home repairs, and remodeling, resulting in lower demand for wood products.
Download the TipRanks mobile app now
To find good ideas for stocks trading at attractive valuations, visit TipRanks’ Best Stocks to Buy, a newly launched tool that unites all of TipRanks’ equity insights.
Read full Disclaimer & Disclosure
