Conifex Timber Inc (TSX: CFF) is a Canada-based company that is operating in the forest and wood products sector. Its primary business includes timber harvesting, reforestation, forest management, as well as lumber finishing and distribution. Its lumber products are sold in the United States, Chinese, Canadian and Japanese markets. Furthermore, the Company is engaged in bioenergy production through its power generation facility at Mackenzie, British Columbia, Canada. It operates under two business segments: Lumber and Bioenergy.

Investment Rationale

• Positive outlook: Following the restart and ramp-up of Mackenzie sawmill operations in the third quarter, the group expect that it will achieve annualized operating rates of approximately 90% in the fourth quarter of 2020. The group expects lumber markets to remain strong, despite recent volatility, supported by robust demand from the US housing starts and continued strength in the repair and remodeling sector. Mackenzie power plant is forecasted to operate at full capacity in the fourth quarter and continue to generate a steady and diversified source of cash flow in the upcoming seasonal high period of revenue under the Electricity Purchase Agreement.
• Stock hovering in a bullish zone: At the last closing price, share of CFF traded well above the crucial long-term, short-term as well as immediate support levels of 200-day, 100-day, 50-day, 30-day, 20-day, 10-day and 5-day SMAs, which implies a bullish price trend in the stock. Further, the moving average convergence divergence (MACD) is rising and hovering above its 9-day SMA, with the difference between 12-day and 26-day EMAs is positive, which is another bullish indicator.

Technical Chart (as on November 10, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

• Strong Relative Outperformance: Shares of CFF have registered strong relative outperformance against the benchmark TSX Composite index. In a year over period, CFF relative outperformance stood at 230%, 91% in YTD, 23% in 3-Month, 12% in a month over period and 8% in the past five trading sessions. Also, the stock has significantly outperformed its peers in the same time period.
• Hedge Funds holding a significant stake in the company: Hedge Funds stake in CFF stood at 18.44%, and institutional ownership stood at approximately 40%, which provides solid confidence in CFF shares from the retail investor’s standpoint. Presence of institutional ownership in penny-cap stocks brings a lot of confidence for the shareholders and provide confidence in the business and management. Further, the presence of hedge funds is icing on the cake, as it indicates a short-term potential in the stock because hedge funds usually invest for short-term gains.
• Insiders remained net buyer throughout 2020: Throughout 2020, insiders have increased their stake three times, which implies that insiders are bullish on the future performance of the company. Also, all these insider activities took place in May 2020, when CFF shares were mostly tilted towards its 52W low price level. This indicates that insiders have used discounted price as an opportunity to increase stake in the company. Also, insider buying brings confidence among the retail shareholders in the stock’s future performance.

Insiders Activity Over the Past 1-Year. Source: Refinitiv (Thomson Reuters)

• Reduced Balance Sheet Risk: The group’s financial performance has improved drastically due to the completion of the sale of the US Sawmill business and repayment of the Lumber Credit Facility. With Net Debt to Capitalization ratio improved drastically from 67% at the end of Q4FY19 to 32% at the end of Q3FY20, and net debt to capitalization excluding Power Term Loan ratio stood at -3% in Q3FY20 vs 61% in Q4FY19. Liquidity position improved from CAD 5.2 million in Q4FY19 to CAD 6.4million in Q3FY20. More importantly, total debt reduced to CAD 64.8 million against 257.2 million reported at the end of Q4FY19.
• Risk Associated to Investment: The company is exposed to commodity price risk related to the sale of lumber and residual products and purchase of certain manufacturing inputs which are purchased primarily on the open market. Further, the company is exposed to currency risk primary with respect of the US dollar.

Q3FY20 Financial Highlights

Source: Refinitiv (Thomson Reuters)

• The group’s total revenue totaled to CAD 37.6 million in the third quarter of 2020, an increase of 248% from the previous quarter and an increase of 64% from the third quarter of 2019. The higher revenues were attributable to the restart and ramp-up of operations at its Mackenzie sawmill during the third quarter of 2020, following a 13-week curtailment in the prior quarter and significantly higher lumber prices.
• In the quarter under consideration, the group recorded an operating income of CAD 7.0 million against a d operating loss of CAD 1.4 million in the previous quarter and operating losses of CAD 8.6 million in the third quarter of 2019. Operating results included countervailing ("CV") and anti-dumping ("AD") duties expense of CAD 3.7 million in the third quarter of 2020, CAD 0.2 million in the second quarter of 2020 and CAD 1.3 million in the third quarter of 2019.
• Selling, general and administrative ("SG&A") costs of CAD 1.8 million in the third quarter of 2020 reflected a decrease of 4% from the prior quarter and a decrease of 39% from the third quarter of the last year.
• Finance costs were CAD 1.2 million in the third quarter of 2020 compared to CAD 1.2 million in the previous quarter and CAD 7.0 million in the third quarter of 2019. Interest and finance costs were lower than the third quarter of 2019 due to the repayment of the Lumber Credit Facility on February 1, 2020. Finance and interest costs subsequent to February 1, 2020 relates primarily to the Power Term Loan.
• Adjusted EBITDA was CAD 7.6 million in the third quarter of 2020, as compared to negative CAD 1.1 million in the previous quarter and negative CAD 7.0 million in the third quarter of 2019. Adjusted EBITDA in the third quarter of 2020 benefited from the restart and ramp-up of Mackenzie sawmill operations, significantly higher lumber prices, continued positive results from bioenergy operations, which was offset partially by derivative losses of CAD 2.6 million.
• Total debt was CAD 64.8 million on September 30, 2020 compared to CAD 257.2 million at December 31, 2019. The net reduction of CAD 192.4 million in debt comprised repayment of the previous Lumber Credit Facility of CAD 189.4 million, lease repayments of CAD 1.1 million and Power Term Loan payments of CAD 1.9 million. The company’s Power Term Loan, which is largely non-recourse to its operations, represents substantially all of the outstanding long-term debt. At September 30, 2020, the company had CAD 61.4 million outstanding on its Power Term Loan, while the company’s remaining long-term debt, consisting of leases, was CAD 3.4 million.
• At September 30, 2020, the group had total liquidity of CAD 6.4 million, compared to CAD 5.2 million at December 31, 2019 and CAD 8.0 million at September 30, 2019. Liquidity at September 30, 2020 was comprised of unrestricted cash of CAD 6.4 million.

Stock Performance

CFF shares are featuring a price return of 225% on a YoY basis, 86% on YTD basis, 23% over the last 3-Months, and 12% in a month over period.

1-year Price Chart (as on November 10, 2020, after the market close). Source: Refinitiv (Thomson Reuters)

In a year over period, its shares have registered a 52W high of CAD 1.80 (on August 20, 2020), and a 52W low of 0.25 (on November 28, 2019). At the last closing, its shares traded approximately 430% higher from its 52W low price and 28% lower from its 52W high, implies that stocks are strongly tilted towards its year’s peak level.

Top-10 Shareholders

The top 10 shareholders have been highlighted in the table, which together forms around 44.02% of the total shareholding. Polar Asset Management Partners Inc. and Blue Wolf Capital Partners LLC. holds the maximum interests in the company at 18.44% and 17.43%, respectively. The institutional ownership in the CFF stood at 39.96%, and ownership of the strategic entities stood at 4.23%.

Source: Refinitiv (Thomson Reuters)

Valuation Methodology (Illustrative): EV to EBITDA based Valuation Metrics

Note: All the forecasted figures are taken from Thomson Reuters, NTM: Next Twelve Months

Peer Comparison

Source: Refinitiv (Thomson Reuters)

Stock Recommendation: The company reported robust performance in the third quarter of 2020, with revenue recorded an increase of 248% from the prior quarter and an increase of 64% from the third quarter of 2019. The group recorded operating income of CAD 7.0 million in the third quarter of 2020 compared to an operating loss of CAD 1.4 million in the previous quarter and an operating loss of CAD 8.6 million in the third quarter of 2019. Further, revenues from lumber products were CAD 31.2 million in the third quarter of 2020 and represented an increase of 429% from the previous quarter and an increase of 90% from the third quarter of 2019.

The group’s financial performance has improved drastically over the last one year due to the completion of the sale of the US Sawmill business and repayment of the Lumber Credit Facility. More importantly, total debt reduced to CAD 66.3 million against 257.2 million reported at the end of Q4FY19. Going forward, the group expects lumber markets to remain strong, despite recent volatility, supported by robust demand from the US housing starts and continued strength in the repair and remodeling sector.

From the technical standpoint, the share of CFF traded well above the crucial long-term, short-term as well as immediate support levels of 200-day, 100-day, 50-day, 30-day, 20-day, 10-day and 5-day SMAs. This implies a bullish price trend in the stock.

However, the company is exposed to commodity price risk related to the sale of lumber and residual products and purchase of certain manufacturing inputs which are purchased primarily on the open market. Further, the company is exposed to currency risk primary with respect to the US dollar.

Therefore, based on the above rationale and valuation done using the above methodology, we have given a “Speculative Buy” recommendation at the closing price of CAD 1.30 on November 10, 2020.

Disclaimer

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