From its lows in 2011, shares of integrated forest products company Canfor Corporation (TSX: CFP) rose 300% by early 2015. Since then the company has lost roughly $2 billion in value with shares bottoming out at just $12.40 last month. While the stock has popped a bit since, it’s spent a majority of the past nine months below $20.
What’s going on?
Good times are changing
As with nearly every other commodity, the biggest driver to growth for lumber companies over the past decade has been China. With the country posting its slowest GDP growth rates in over 25 years, the industry was bound to face some pain. As early as 2011, Chinese imports of lumber started to slow significantly. By 2014, growth rates ground to a near halt.
As the industry’s biggest consumer stalls its spending, Canfor has seen its EBITDA margins collapse. In 2013 the company made about $80 in EBITDA per mfbm of lumber. Last year that fell below $40. Collapsing margins are having a rapid effect on profitability. In the last quarter net income dropped $1.5 million to just $29.7 million, despite sales growing over 10%. The company is still profitable, but investors are likely readjusting their valuations to reflect a less profitable business.
Is the selling overdone?
In 2016 Canfor is still expected to earn $1.22 a share. At the current price, shares trade at 14 times earnings.
If the company can reverse its falling profitability, the stock could have plenty of upside. While China has hindered industry growth rates, Canfor still sells a majority of its lumber to North American markets, specifically the U.S. In that market, the long-term fundamentals still look good. Housing starts are expected to grow 23% by 2018, and money spent on home improvement in the U.S. is coming off a multi-year low.
Also keep in mind that growth in China isn’t turning negative–it’s just slowing. The country is also shifting towards higher-grade lumber, which often comes with higher margins. For example, 93% of Chinese imports were low-grade lumber in 2007. By 2014, that fell to under 60%, with the rest being tier-two and prime grade. Canfor has capitalized on this by shifting its product offering, going from 30% specialty products in 2007 to 45% in 2014.
The shift in Chinese consumption combined with a strong outlook for the North American market has analysts expecting $1.83 in earnings per share in 2017. At that rate, the stock trades at just 10 times 2017 earnings. At its lows in February ($12.40), shares traded as low as 6.7 times forward earnings. While Chinese headwinds will likely present continued challenges, it would be hard to argue that shares weren’t undervalued if they drift back towards $12 a share.
