Stella-Jones Inc.

Stella-Jones Inc. is a Canada-based company, which is also a leading producer and marketer of pressure-treated wood products. The business supplies North America’s railroad operators with timbers and railway ties, and the continent’s electrical utilities and telecommunication businesses with utility poles.

Guidance: The Company expects its FY20 EBITDA of CAD 300 million to CAD 325 million with a margin contraction over FY19 and expects a sustained demand from utility pole, railway tie and industrial product categories.

Q1FY20 Financial Highlights: SJ came up with a decent quarterly number with top-line growth of 14% on y-o-y basis to CAD 503 million. The quarter witnessed strong momentum in its utility poles and residential lumber segment due to improved demand and higher pricing. The railway’s ties segment has shown a decent growth due to increase in prices and higher shipments to Class 1 customers, while lower volume to non-Class 1 customers remained a drag. The performance of the industrial products segment was impressive, depicting a double-digit growth aided by stronger railway bridge sales. Gross profit improved 19% over Q1FY19 to CAD 83 million, thanks to higher revenue. Operating income declined to CAD 45 million, as compared to CAD 46 million in pcp. EBITDA margin shrank 200 bps to 12.5% due to higher cost of sales and selling and administrative expenses. Net income contracted slightly to CAD 28 million, as compared to CAD 29 million in pcp. The Group declared a quarterly dividend of CAD 0.15 per common share, payable on June 26, 2020.

Q1FY20 Income Statement Highlights (Source: Company Reports)

Valuation Methodology: Price to Earnings Based Relative Valuation (Illustrative)

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

Stock Recommendation: The stock of SJ reported a ~6% gain in the last one month, due to improved demand for its front-line products. The group expects a sustained demand for its utility pole, railway tie and industrial product categories while a slowdown is expected in residential lumber segment. The group’s offerings are considered critical to the integrity of the supply chains for North American utilities, railroads and the construction industry. The Company has ample liquidity and additional borrowings capacity of CAD 108 million under its credit facilities seems sufficient to support its near-term working capital requirements. We believes that the resiliency of the Company’s utility pole, railway tie and residential lumber product categories as well as its solid balance sheet and liquidity, places it in a favorable position to navigate through the current challenging environment.  We have valued the stock using P/E based relative valuation method and have arrived at a target upside of double-digit (in percentage terms). For the said purposes, we have considered peers like Stantec Inc (TSX: STN), WSP Global Inc (TSX: WSP), Interfor Corp (TSX: IFP) and so on. Hence, we recommend a ‘Buy’ rating on the stock at the closing price of CAD 33.07 on May 22, 2020. 

SJ Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

Interfor Corporation

Interfor Corporation (TSX: IFP) sells lumber, timber, and other wood products. The Company operates sawmills to convert timber into lumber, logs, wood chips, and other wood products for sale.

Due to the ongoing COVID 19, the Company has taken prompt measures and reduced its working capital through balancing inventory levels with demand and reducing discretionary spending and commitments. Further to provide support to the near-term operations, the Company issued two different Senior Secured Notes amounting USD 50,000,000 each, bearing interest of 3.34% and 3.25% respectively.

Q1FY20 Income Statement Highlights: IFP impresses with its first-quarter results, wherein the Company reported a top line growth along with a bottom-line improvement, in comparison to the previous corresponding period. Sales during the first three months of FY20 stood at CAD 479.64 million, higher than CAD 451.16 million in the previous corresponding quarter. The growth was driven by an increase in the overall lumber prices, followed by significant demand from logs, residual products and other products. Operating earnings stood at CAD 14.94 million, as compared to a loss of CAD 16.81 million in pcp, supported by higher sales, lower selling and administration expense and recovery on long term incentive compensation, while higher production cost remained as a drag. Net earnings stood at CAD 6,309 million, as compared to a net loss of CAD 15,302 million in Q1FY20, primarily attributable by an improve operating earnings and lower finance cost and other expense, offset by a loss in foreign exchange loss. The Company exited the quarter with a cash and cash equivalent of CAD 103.57 million and a total asset of CAD 1,569.51 million.

Q1FY20 Income Statement Highlights (Source: Company Reports)

Valuation Methodology: EV to Sales Based Relative Valuation (Illustrative)

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

Stock Recommendation: The stock of IFP has revived in the recent past, delivering a robust return of ~52% in the last one month, outperforming the index by ~46%. Near-term lumber demand is expected to be negatively impacted by uncertainties related to COVID-19. However, industrywide lumber production curtailments should help balance supply with demand. The benchmark lumber prices weakened significantly through early April and have since found a level of support from industrywide production curtailments that began in the second half of March. The group expects demand for lumber to normalize over the mid- to long-term, particularly in the North American repair and renovation, residential and industrial segments. The company has reduced its production and continue to adjust its production according to the demand. The group is focusing on reducing the non-essential expenditure to conserve the cash. The company also reduced its capital expenditure by ~CAD 140 million. The company is also actively reviewing the evolving Canadian and U.S. government stimulus programs to access any available support for its business operations and employees. The company is well-capitalized to meet its necessary working capital-requirement in the near term. We expect an improvement in the macro scenario of the industry, as soon as the economy recovers from the current lock-down phase. We have valued the stock using EV/Sales based relative valuation method and have arrived at a target upside of lower double-digit (in percentage terms). For the said purposes, we have considered Canfor Corp (TSX: CFP), Canfor Pulp Products Inc (TSX: CFX) and Western Forest Products Inc (TSX: WEF) etc. as a peer group. Hence, we recommend a ‘Speculative Buy’ rating on the stock at the current market price of CAD 9.90 on May 22, 2020. 

IFP Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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