Boise Cascade: Better Prospects But Still Not Time To Buy
Summary
- Based on FYE 2020 results, BCC has an improved long-term ROE. Given its 0.96 correlation with Housing Starts, it has better prospects for the next few years.
- BCC has a higher valuation based on the updated ROE and latest valuation datasets. But there is still no margin of safety at the current price.
- But I caution any valuation based on datasets derived with last year’s inputs as the pandemic year is not a good reflection of the future.
- Wood product prices are cyclical and are expected to decline. With 0.73 correlation between product prices and BCC share price, there will be a buying opportunity when product prices come down.
Investment Thesis
Boise Cascade Company (NYSE:BCC or the Group) had fantastic FYE 2020 results due to improved Housing Starts and better product prices. This has resulted in the long-term ROE for BCC improving from 12.2% to 13.2%.
I believe that the updated long-term ROE is more representative of the future. This is because there is a 0.96 correlation between the US Housing Starts and BCC performance. The US Housing Starts is projected to be maintained if not do better than the 2020 levels over the next couple of years.
Using the updated ROE and an updated (Jan 2021) Damodaran valuation datasets, the value of BCC in terms of Book multiple has improved.
Scenarios | Value in terms of Book multiple | |
| Original (a) Based on 2013 to 2019 | Updated Based on 2013 to 2020 | |
Earning Power Value | 1.25 | 1.76 |
Earning with 4 % growth | 1.43 | 2.63 |
Note
a) As per my Jan 2021 Seeking Alpha article
However, I caution about relying on the updated computed numbers as I believe that the Jan 2021 datasets do not represent the long-term outlook for BCC. The datasets included the results of the pandemic year and are not representative of BCC's future, especially since the wood products sector and the US housing industry are not expected to see any long-term impact from Covid-19.
It is more realistic to view the Updated valuation numbers as the ceiling. BCC is currently trading at about 2.7 Price to Book multiple and even with these "ceiling" numbers, there is no margin of safety.
However, there is a 0.73 correlation between BCC share price and the Producer Price Index for Plywood and Engineered Wood Products. Product prices are not expected to rise further and given their cyclical nature, I expect the product prices to decline.
When this happens and assuming that the correlation still holds, I expect BCC's share price to come down. This will provide a buying opportunity as the fundamentals show that this is a good company.
1. Introduction
I first analyzed and valued BCC in my January 2021 Seeking Alpha article "Boise Cascade: Currently overpriced and a coming value trap."
It was based on BCC annual financials till 2019 using valuation parameters from Damodaran 2019 datasets.
Since then, BCC had released its 2020 financials and Damodaran has also published his 2020 datasets. The key impact from a valuation perspective is as follows:
Item | Notes | Original | Updated |
Average Long-term return (ROE) | a | 12.2 % | 13.2 % |
Cost of equity (r) | b | 9.7 % | 7.5 % |
Notes
a) Original was based on the average ROE from 2013 to 2019. Updated was based on the average ROE from 2013 to 2020. Note that BCC was listed in 2013.
b) r was derived based on different datasets. Refer to section 3.3
2. Better prospects ahead
The better Updated ROE was because for the year ended Dec 2020 the Group achieved USD 5.5 billion of revenue with USD 175 million net income. In comparison with the same period last year, the current period revenue is 18% higher while the net income is 116% higher.
The increase in sales was driven by both an increase in sales volume and selling prices.
- Construction activity was the key demand driver for the sales volume. For 2020, the US Housing Starts increased by 7% compared with the same period in 2019.
- For the year ended 2020, the average composite lumber and average composite panel prices were 57% and 54% higher compared with those in 2019.
For those interested, I have further analyses on the improved fundamentals in my blog post "Is Boise Cascade a reverse value trap?"
Would the Updated long-term ROE be a better reflection of what to expect in the future compared to the Original long-term ROE?
In my Jan 2021 article, I had mentioned that over the past 9 years there is a 0.96 correlation between BCC revenue and the US Housing Starts.
- Over the past 6 decades, the US Housing Starts have averaged about 1.5 million units annually.
- At this level of Housing Starts, BCC revenue is projected to be about USD 5.4 billion - i.e., about the 2020 revenue.
This augurs well for BCC as the Housing Starts for the next few years are projected to be better than the 2020 Housing Starts as shown in the chart below.
Source: Forisk Consulting. Founded in 2004, Forisk analyses forest supplies, wood demand, and timber pricing to develop forecasts and strategic guidance for clients.
3. Valuation
I had originally valued BCC using a single-stage dividend discount model that has been transformed into the following format.
I selected the model as BCC was trading at a high Price to Book multiple and the valuation model enables easy comparison.
3.1 Updated valuation
Given the latest information, would an Updated valuation of BCC be significantly different? The table shows a comparison.
Scenario | Growth rate | Valuation in terms of Price to Book multiple | |
Original (c) | Updated | ||
Earning Power Value | 0 % | 1.25 | 1.76 |
Earning Value - Conservative scenario | 4.0 % (a) | 1.43 | 2.63 |
Earning Value - Optimistic scenario | 6.2 % (b) | 1.69 | 5.36 |
Notes
a) Based on long-term nominal US GDP growth rate.
b) Based on BCC 2011 constant price. The constant price revenue for the respective years was derived by factoring in the annual revenue from Statista with the FRED plywood and engineered wood products producer price index. Refer to my Jan 2021 Seeking Alpha article.
c) As per the Jan 2021 Seeking Alpha article.
BCC share is currently trading at an equivalent Price to Book of 2.7. Looking at the valuation based on the Earning Value - Optimistic scenario, does it mean that there is a buying opportunity?
3.2 Valuation with growth
In the first place, I would be wary of any valuation based on a single-stage valuation model with a 6.2% growth in perpetuity.
- The long-term US GDP growth rate is expected to be 4%. At 6.2% growth in perpetuity, it would mean that eventually, BCC would be larger than the US economy.
- Secondly, the Updated valuation is based on an Updated cost of equity of 7.5 %. At this level, the value from the term (r - g) would be so small that it would skew the value. Note that in the Original valuation, this concern was not there as the cost of equity was much higher.
I would not consider the results for the 6.2% growth.
A more realistic growth assumption would be to assume that BCC can continue to grow in perpetuity at the long-term GDP growth rate of 4%. On such a basis, there is not a significant margin of safety.
3.3 Unrealistic parameters
Before jumping to any conclusion about the margin of safety under the Updated valuation, I would point out that the cost of equity was derived based on CAPM and the parameters as shown below.
Items | Value | |
| Original based on Jan 2020 datasets | Updated based on Jan 2021 datasets | |
Risk-free rate | 1.9 % | 1.9 % |
Risk premium | 5.2 % | 4.7 % |
Cash adjusted unlevered Beta | 1.25 | 0.96 |
Tax rate | 27 % | 27 % |
Cost of equity | 9.7 % | 7.5 % |
While computationally correct, we must question the "useability" of the Jan 2021 parameters as this included data from the pandemic year.
The cost of equity reflects both the risk of the cash flow and the time value of money. You would expect that given the pandemic year, the risk would be higher - i.e., we should expect a higher cost of equity.
However, the Updated cost of equity is lower compared to the one without the pandemic year. This is because of the lower Updated Risk premium and lower Updated Beta.
I do not think that the Updated parameters reflect the long-term outlook for BCC. The wood products industry is not like the airlines or hotel industry which are expected to experience some secular change in demand due to Covid-19.
My view is shared by many valuation professionals. For example:
… current capital market data shows serious irregularities. It's most of all the base interest rate, the implicit market return/the implicit market risk premium, the systematic risk (as measured by the beta factor), and the cost of debt that reflect these market irregularities..."
- BDO
Betas and estimates of the market risk premium (MRP) are long-term measures and our view is that these estimates do not need to be altered… the current market volatility will have little impact on calculated betas…we do not believe that there is sufficient evidence to justify any change to the estimated MRP."
A company's cost of capital is intended to reflect the level of risk related to an investment in the company. The current interest rate environment is reflective of a low-risk economy, due to inflationary policies. Due to the heightened uncertainty in the global economy, it is believed this is not a true representation of the current risks of future cash flows."
Given these views, a more realistic approach would be to use the 2019 valuation dataset with the Updated ROE. On such a basis, I valued BCC to be
- Earning Power Value = 1.36 Book multiple
- Earning with 4 % growth = 1.61 Book multiple
Unfortunately, there is still no margin of safety at the current price.
4. BCC share price
We know that BCC is a good company. But at the current price, it is not a good investment. Is there an opportunity for the share price to drop?
I found that there is a 0.73 correlation between BCC share price and the Producer Price Index for Plywood and Engineered Wood Products.
The chart below illustrates this.
Source: Author based on info from FRED Producer Price Index for Plywood and Engineered Wood Products.
Given this correlation, there are the prospects that when the current high product prices decline, the share price of BCC will drop accordingly.
4.1 Cyclical product prices
Wood products prices are cyclical as illustrated below. So the question is whether the current high product prices are sustainable.
Source: FRED Producer Price Index
I believe that the product prices will continue to be cyclical. As such I do not think that the current high price will last. I am not the only one with such a view as the following illustrates.
"Still, average lumber prices in 2021 should be below the extreme peaks recorded in August 2020 and December 2020."
"… a lumber correction will come… the only question is when. If the vaccine rollout is successful… some price relief should come later this year."
- Fortune.
The forecast from Trading Economics below shows prices peaking in the first half of 2021.
Source: Trading Economics.
The unknown is when will the product prices come down. However, if you are a patient retail investor, you should just sit and wait as:
- Long-term business performance is not going to be much better given the peak product prices. There is no point in buying BCC at the current price expecting higher valuations (as a result of even better long-term performance) as these have already been accounted for in my valuation.
- Product prices will come down given that they are at high levels. The corresponding BCC share price will decline as well if the correlation still holds.
5. Conclusion
- The long-term outlook for BCC has improved. This is due to the improved US Housing Starts and given the strong correlation between US Housing Starts and BCC performance.
- However, while the prospect for BCC is good, at the current price BCC is still not a good investment. This is despite questions about the valuation parameters being derived from datasets that included the pandemic year.
- Given the correlation between BCC share price and wood product prices, any decline in wood product prices will lead to lower BCC share prices.
- Wood product prices are cyclical. Many do not expect the current prices to remain high forever. When the product prices come down, BCC share price will follow suit if the correlation still holds. This would provide a better buying opportunity.
- By the way, my concerns about BCC capital allocation as per my Jan 2021 article still stand.
This article was written by
Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.
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Comments (6)
Good evaluation, author. A nice graphic might have been the share price of BCC overlaid with both housing starts and wood product prices.
Cheers
Sounds good. I am an amateur but when I learned stock analysis I was taught that revenue ("business fundamentals") ultimately drive share price ("pricing relationship")
It would seem to me that housing starts equals volume of revenue, and pricing of the product equals profitability (unless the pricing is driven by BCC's costs, in which case it's neutral) but both contribute to share price expansion.
Cheers