Canfor: A Constructive Timber Stock

Oct. 6.10 | About: Canfor Pulp (CFPUF)

One stock in particular that I would like to highlight is Canfor (OTC:CFPUF). Wood stocks should be swept up in the gathering commodity rally, even if forest product prices are not immediately enjoying strong demand in the USA.

Canfor has 142 million shares outstanding for a market capitalization of about $1.2 billion Cdn. The public float is approximately 75 million shares. Canfor has just closed the sale of a problematic operation (selling its 50% interest in Howe Sound Pulp and Paper to Paper Excellence BV). Canfor enjoys a healthy cash flow from its 50% interest in Canfor Pulp Income Fund (CFX.UN). CME lumber prices have been creeping up again, with spring futures trading at $254.50 US/1000 board feet.

If you subtract the value of CFP’s interest in CFX.UN, worth $3.58/share from CFP’s stock price, you are left with C$4.60 for all the other operations, or $655 million. Canfor Pulp Income Fund is in itself a decent play on Northern Bleached Softwood Pulp (NBSK), the biggest producer in North America with annual capacity of 1 million mt.

CFX.UN units currently pay a 25 cent monthly distribution, which will rise and fall with distributable cash flow, which must be paid out. The most recent distribution increase from 22 cents was partly due to undistributed cash and not a sign that the company expects higher cash flow. At current prices ($14.55) the units are trading at 4.85 times the annualized annual distribution rate, a fair price.

Note the Fund will convert to a corporation as of the end of the year, and although shareholder payouts should continue to be paid out as a quarterly dividend, the level is still uncertain, and will depend on NBSK prices.

Canfor's main business is Western SPF Spruce-Pine-Fir) lumber and SYP (Southern Yellow Pine) and produced 1.6 billion board feet of product in the 1st half of 2010 in the Lumber division, generating $629 million in revenue and $52.7 million in EBITDA.

The value ex-Canfor Pulp includes all the timber tenures and licenses, the sawmills and wood product mills in British Columbia, Alberta and North Carolina), the three OSB plants, as well as tree nurseries and a legacy of good forestry stewardship).

I know you are going to mention the MPB and the B.C. fires. The Mountain Pine Beetle does threaten part of the Company's wood tenures but is hurt by a cold winter and that was the case last year. The B.C. fires in the Interior of B.C. did force the closure of a couple of mills this Summer, a temporary problem but always a danger for forestry companies. Fire damage devalues a tenure but the expectation is the provincial Ministry would make it up to the Company with other lands.

The Pulp and Paper division (including the 50% interest in the Fund) generated $112.6 million in EBITDA on $550 million in revenues, from production of 623,000 tons of pulp and 67,300 tons of paper. The paper is unbleached kraft sack paper and higher value electrical grades.

Recently, the Company reopened its Quesnel sawmill dedicated to serving Chinese markets with metric-sized lumber and sales are probably improving with the turnaround in Chinese economic growth.

Canfor has conservative financial leverage and good liquidity. Working Capital was positive with a current ratio of 2.2 as of the end of Q2. Cash on hand was on a consolidated basis, $226.9 million. Consolidated long term debt was only $89.2 million at the end of the quarter with $444.3 million in operating loan facilities of which nil were drawn down. Including $116 million in pension obligations, $58.5 million for reforestry and other long-term liabilities, there are another $215.2 million of future debts.

But the equity in the Company of $1.7 billion on a book basis which far exceeds these liabilities. What are the assets worth on a market value basis?

You and I both know, the valuations in forest products rise and fall faster than a Brazilian genetically-engineered eucalyptus tree. But I think now is the time to buy these assets, before the U.S. consumer finally pulls it together and starts buying (new) houses again. In the meantime, Canadian and Chinese markets should be supportive.

We know The Jim Pattison Group the largest shareholder with 48 million or 33.6%, likes to buy more CFP (through affiliate Great Pacific Capital Corp and others). In early July GPCC bought 3.17 million shares of Canfor at about $8/share. The second largest Canfor shareholder, money manager Mackenzie Financial, sold 3.4 million of the 23.1 million shares held in client accounts and funds leaving 19.7 million (13.9%). The sale was most likely to GPCC. They have not sold more since that time. Canfor's stock is moderately liquid at other times.

Enjoy this market – Luck favors the Brave.

Disclosure: Long Canfor