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It's remarkable how many companies contribute to the housing market. The players range from raw material providers and manufacturers to retailers and homebuilders, and this massive supply chain is ripe with investment opportunities. The first of these many firms I want to analyze is Louisiana-Pacific Corporation (NYSE:LPX). Louisiana-Pacific is a leading provider of building solutions that are utilized by builders, remodelers, and homeowners. The three primary business units are Siding, Oriented Strand Board (OSB), and Engineered Wood Products (EWP). In 2021, these segments accounted for 26%, 52%, and 14% of revenue, respectively. The remaining revenue is gathered from the South America and Other business units.
My method of analysis rests in looking at the past two earnings calls of companies and seeing what changed and what stayed the same. I'll then talk a bit about what those similarities and differences mean for the stock going forward as well as how that plays into my valuation of the company through a DCF/3-Statement Model. First, some quick earnings numbers:
One of the biggest topics of discussion from both calls was about capacity. Both the company's Siding and OSB business are selling to production, which means everything they make is part of an order file from a customer. With both of the primary businesses running at full steam, the only way to materially increase volume, and to some extent revenue, is to add capacity. That's why each call gave status updates on such expansion projects. With their Holton mill now set to start Siding production this month, the company sees the ability for Siding revenue to grow 15% in total for 2022 compared to 2021 levels. 8-9% of this growth will be due to pricing power and the remaining can be attributed to the additional capacity this project will provide. Equal importance was placed on the firm's Sagola transition to Siding production, but production from this plant won't come online until ~Q1 of '23- the combination of the two projects creating a roadmap where increased revenues can stem not just from price but more product sold. This is nothing but great news for the company and investors alike - management just needs to make sure capital is allocated effectively and proper IRR hurdles are met.
Are we surprised? Like nearly all other earnings calls over the last two years, a huge point of discussion surrounded these twin terrors. We'll start out with resins, which are a large portion of Louisiana-Pacific's raw material costs and are used frequently in the Siding and OSB product portfolio. There was a time in Q3 and prior months when the OSB segment had to be nimble and ship certain resins to the more-picky Sidings business as availability became tight. They've since stopped this practice as there's been some easing on the availability front, but that doesn't solve their resin problem entirely. In Q4, management stressed how pricing of the resins have increased greatly in the last year and that they continue to see a risk of further price inflation for these materials - ultimately hurting Cost of Goods Sold in the near term as the company sees as high as 20% YoY resin inflation for 2022.
Unfortunately, that's not the only issue related to shortages. In Q3, there was some mentioning of availability problems with flatbed trucks that were driving freight prices higher, but the company stated they had some leeway due to the ability to convert some shipments from truck to rail and also utilize their own trucking fleet (albeit small). This didn't play out as they had hoped. In the Q4 call it was revealed that due to a railcar shortage, the company decided to manage its finished goods inventory by forcing downtime at the Peace Valley location (OSB production). Obviously losing volume is never a good thing, and although the impact can seem small in the near term, if the situation doesn't subside it can add up to hurt the OSB business quite a bit. This is especially true for the OSB business segment that has relied so much on pricing for its outstanding performance. When the segment's already dismal volume growth takes a hit, revenue and profit become even more sensitive to price swings. For example, 2021 OSB revenue increased by $1.2 billion. An astounding $1.1 billion of this incremental revenue was solely due to pricing. That's an awful lot of volatility associated with the company's largest business unit that could just as easily see a $1 billion dollar decrease sequentially for 2022. Analysts' EPS expectations for 2022 can be seen reflecting this possibility, with the average consensus estimated EPS for the company dropping over the next two years compared to 2021 results. Certainly, something to be aware of as an investor, but in my view, there is a greater chance of a large downside for OSB in the future than any upside (although Q1 2022 should be a favorable comp to Q1 2021), so this needs to be factored into any valuation of the company.
My last note on this topic will be giving a little bit of credit for their OSB strategy. In both calls, one could get the sense that management realizes the volatility seen in the OSB market and their revenue reliance on this price isn't healthy long-term. They have stressed the importance of transitioning away from commodity-based sales of OSB while emphasizing their focus on value-added OSB products, such as Tec Shield, Flame Block, and Weather Logic. This won't solve the probable near-term up and down swings in revenue due to OSB pricing, but it's the right mindset to have.
Now on to some things that changed from Q3 to Q4.
Back to some good news. In a testament to their strengthening balance sheet and a record year in terms of revenue, Louisiana-Pacific announced an increase in their quarterly dividend from $0.18/share to $0.22/share, representing a 22% bump. The dividend yield of ~1.3% isn't going to blow anyone away, but a 22% increase is nothing to scoff at. I believe they'll have plenty of room in the future for similar increases, especially due to how much the company focuses on capital allocation. Sure, according to each earnings call the firm only spent about $16 million in both Q3 and Q4 on dividend payments. However, $399 million and $313 million were spent on share buybacks in Q3 and Q4, respectively. We could talk circles around if that's an effective way to return capital to shareholders, but regardless, it signals management has a lot of focus on capital allocation, particularly to owners of the stock. With such a low payout ratio and strong balance sheet, count on sizeable dividend increases in the future.
In Q3, the guidance we were given on LPX's 2022 CapEx was to expect a spend greater than $250 million. That's about the amount spent in 2021 as the company invested a lot of resources in its Holton expansion project, and as already touched upon, is a great sign for a company that needs to increase its capacity. In the Q4 call, that number took a noticeable jump upward with the expected CapEx spend in 2022 being quoted at up to $430 million. That's a huge number, so what is that change being driven by? Well, in the Q4 call, the company announced plans for their 4th and largest to-date ExpertFinish (Siding) facility that will be located in Bath, NY. Also, the company's Sagola, MI plant will transition from OSB production to Siding - which will warrant additional CapEx dollars. Finally, the company stated that they were beginning to search for additional opportunities for capacity expansion after the Sagola conversion. It's a little early in the ballgame to know what that looks like, with possibilities ranging from adding capacity to a current plant or building a new facility altogether.
I love this news. I don't think an inflationary environment is here for the long run (at least in terms of OSB pricing), so the company is shifting focus to its bread and butter Siding segment. This size of investment will cause its cash position to deteriorate slightly, but overall it's not something I'm worried about for 2 reasons. The first is that the company maintains an undrawn from credit revolver of ~$550 million. In the past, the company has managed to fund its investments solely through cash flow from operations and reserves, but even if the company starts drawing from this resource, the balance sheet is in good enough shape where it won't hurt them financially and only will be a blip on the radar. The second reason I'm not worried has to do with trade-offs. Free cash flow may take a hit in the short term, but looking much more long term, added capacity creates the opportunity for more free cash flow in later years. In summation, spending a lot of money now will put the company in a better situation later. Especially as a lot of their CapEx goals are productivity related and not general maintenance to prolong the life of existing assets.
As mentioned in the intro of my article, I derive my share price targets from a discounted cash flow model that is driven by a full three-statement model for each company I analyze. At a high level, here are some assumptions for 2022 and beyond I gained from each earnings call that is inputted into my models.
1. The company's long-term EBITDA margin goal is 25%. Assuming this goal is realistic, it serves as a great way to check my other assumptions to make sure the margin that returns is not unrealistically straying from this number. After all, the finance team at Louisiana-Pacific will have better insight into future profit than anyone else.
2. Revenue growth will stagnate and decrease YOY starting in Q2. This coincides to when OSB prices increased so much at the same time last year. These tough comps will make some numbers look worse on paper, but I believe the company is making the right choice as it continues to invest more in its Siding segment rather than OSB.
3. The company cut a lot of its SG&A spend once the pandemic hit. I expect this number as a % of sales to a minimum return to 2019 levels.
4. High CapEx in the near term, with it hurting free cash flow as this investment is added to a large capital allocation budget. But long-term growth rate will benefit as the capacity expansion mindset leaves revenue upside.
For those familiar with these types of models, there are obviously a lot more assumptions that go into it. In future articles, I plan on digging into my assumptions and what went wrong versus what went right. But to oversimplify everything and provide some numbers, here is a snippet of a valuation sensitivity table with a range of WACC (Weighted Average Cost of Capital) and Long-term growth rate assumptions (both very important for the terminal value of a DCF).
A few notes about the inner-workings of my model and DCFs in general. A DCF sums the present value of all future years' cash flows. There are two periods we project unlevered free cash flow for. The first stage is your forecast period, which for this model is 5 years. The stage one cash flows are ultimately determined by various assumptions such as revenue growth rate and profit margins, among other things. These 5 years of free cash flows are then discounted by some factor to get the present value of each and then summed together. For Louisiana-Pacific, the sum of its present valued cash flows for the next 5 years is $2.9 billion.
This completes the first half of the enterprise value calculation. The remaining step is to find a way to quantify the present value of all future cash flows after the initial 5 year forecast period. There are a few methods of doing this, but I use the Perpetuity Growth Model. At a high level, this model assumes an infinite long-term growth rate of free cash flows and utilizes this growth rate and Weighted Average Cost of Capital to arrive at the terminal value. This terminal value is then discounted to find the present value, and for Louisiana-Pacific this number is $4.3 billion. Adding this $4.3 billion terminal value of cash flows to the $2.9 billion of stage 1 cash flows brings us to the Enterprise Value of $7.2 billion.
We then need to get to Equity Value, which is obtained by subtracting long-term debt from cash & equivalents to get Net Debt. For LPX, Net Debt is equal to -$12 million (since cash exceeds debt). This number is subtracted from Enterprise Value and leaves us with an Equity Value of $7.2 billion. To get our final share price estimate, take this equity value and divide it by our diluted common shares outstanding (86.613 million) to get an average share price of $83.24.
As mentioned earlier, I will be reviewing particular assumptions and their accuracy (or lack thereof) in future articles when more company actuals are available.
There are certainly some risks that could affect this valuation. The first one is the company's current proportion of revenue that comes from OSB sales, which sat at 52% by the end of 2021. Although a negative impact from lower OSB commodity pricing is taken into account in the valuation, the downside could be even lower given the historical volatility associated with OSB. Lower revenues, even if short term, can hurt free cash flow generation and thus the value of Louisiana-Pacific's stock.
Another risk for the stock is its correlation to the North American residential housing market. As new construction grows, so, in theory, does demand for Siding, OSB, and EWP. The opposite holds true for when the market goes down. However, there is still a sizeable shortage of homes in the United States. Bidding wars are taking place on properties, often pushing prices significantly over asking. Strength in future outlook is further supported by homebuilders having such long backlogs of new homes to construct. Even if prices of these new or old homes cool, Louisiana-Pacific's products will still be in demand by builders as they purchase materials to satisfy their long list of waiting customers. Attached below is a figure from the company's most recent earnings presentation showing how their Siding business has even managed to outperform the growth of new housing starts in the past 12 months when comparing Q4 '21 to Q4 '20:
For reference sake, here are some comparable companies and how Louisiana-Pacific stacks up in regards to some key ratios. Apples to apple comps are impossible to find in any industry, but both Boise Cascade (BCC) and Builders FirstSource (BLDR) are close as we're going to get to the company's operations. Obviously, this industry comes with low valuation multiples, but I don't think the market is fully pricing in the extreme focus management has in adding capacity over the years. As the stock shifts its focus to Siding and less so on commodity-based OSB, I see no reason why the price/earnings ratio shouldn't drift more towards that of Builders FirstSource. With that being said, both BCC and BLDR are part of the group of stocks I will analyze in future articles, so that's really where I'll be able to establish whether these multiples are justified or not. But from the outside looking in, I see no red flags for the stock with these comps.
|Louisiana-Pacific||Boise Cascade||Builders FirstSource|
Source: Seeking Alpha Financials
There are certainly shortcomings to primarily analyzing earnings calls, but I believe it can be a very useful tool in a holistic analysis of a stock - especially as wording from executives across these calls can be so strategic and have a deeper meaning than face-value. Financial models also rely on forecasts and inputted assumptions, but just like earnings calls, if they are utilized correctly they can provide valuable insights into the valuation and financial health of a company.
My Discounted Cash Flow valuation model suggests the intrinsic value of Louisiana-Pacific's stock is $83.24, representing a ~22% upside from the most recent closing price of $68.43.
The stock has reached as high as $77.64 in the last year, so this valuation isn't in unchartered waters. Even as interest rates are set to rise, I think the housing market is strong enough to buck inflationary headwinds as homebuilders boast near-record backlogs and the DIY market still rides its pandemic-era high. Louisiana-Pacific is a company that will benefit from this continued strength as it invests heavily in future expansion projects and shows an impressive ability to bring in cash - often giving a large portion of that back to shareholders. Especially with the recent developments with Ukraine/Russia having led the overall market lower in the past few weeks, I think current pricing levels present a profitable opportunity to jump in and invest in a solid all-around company.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.