From the Reuters article: Single-family housing starts, which account for the biggest share of homebuilding, dropped 10.1% to a rate of 916,000 units, the lowest level since June 2020.
Residential fixed investment declined at its steepest pace in two years in the second quarter, contributing to the second straight quarterly drop in gross domestic product during that period. More pain is likely yet to come for the housing market.
A survey on Monday showed the National Association of Home Builders/Wells Fargo Housing Market sentiment index fell for an eighth straight month in August, dropping below the break-even level of 50 for the first time since May 2020. Rising construction costs and mortgage rates were largely blamed for the drop.
If it's so darn obvious that the US housing market is dead in the water, why oh why would I want to own West Fraser Timber (WFG)? Glad you asked.
West Fraser is a diversified wood products company with more than 60 facilities in Canada, the United States, the United Kingdom, and Europe. The Company produces lumber, engineered wood (OSB, LVL, MDF, plywood, particleboard), and other products including pulp, newsprint, wood chips, and renewable energy. West Fraser’s products are used in home construction, repair and remodeling, industrial applications, papers, tissue and box materials.
The paper and pulp business is a loss making unit. The company makes all its profits from lumber and engineered wood products. It is joined at the hip to the US housing market - everything else is a sideshow.
Some metrics:
Current market cap: $10.3 billion (share price: $90.81)
Trailing twelve months EPS: $25.17 (PE of 3.61x vs 15.22x for the Homebuilders ETF $XHB and 10.83x for Timber & Forestry ETF $WOOD)
Operating margin is still a robust 40%
First half 2022 operating cash flow of $1.6 billion
Working capital of $2.2 billion and long term debt of $500 million, which implies negative net debt of $1.7 billion
Book value of equity: $7.85 billion (Price to book of 0.76x vs 4.16x for XHB and 1.69x for WOOD)
Trailing twelve month sales: $10.4 billion (Price to Sales ratio of 0.75x vs 1.65x for XHB and 1.72x for WOOD)
To sum up, the stock is really, really cheap valuation-wise. Also, the company is shareholder-friendly, having spent $1.69 billion on share repurchases in H1 2022. That's on top of $1.3 billion spent on repurchases last year.
The lumber sector has already seen a couple of M&A deals this year (CTT and RFP) and there was a rumor on 7/19 that WFG was being acquired in a joint deal by Private-equity firm CVC Capital Partners and wood-panel manufacturer Kronospan Ltd. The share price soared from the previous day close of $83.24 to an intra-day high of $102.66 on this news. WFG squashed the rumor but noted that management had met with both companies. So perhaps something may still come of it. A cash-rich business with such stunning metrics is always going to be attractive to PE firms, since they can load the company with debt and easily generate a high IRR. If WFG falls to a takeover attempt, we get a small but quick win. If the company continues as an independent public-listed entity, even better.
I don't have a price target but a 10x earnings multiple implies a share price of $250, while the 15.22x multiple being accorded for XHB implies a price target of $383. The downside is minimal since the company has no net debt and continues to maintain robust operating margins. It's rare to find a cash flowing business trading cheap - I'm not going to get shaken out by alarmist news on housing starts.
Good Trading!
Kashyap