Stella Jones has a long track record of steady and profitable growth. This was achieved organically and through selective acquisitions. The Covid-19 pandemic boosted demand for its residential lumber products, which pushed the company to record profits. However, will Stella do well to sustain the record profits in 2022? - this concern is already fully reflected in an undemanding valuation.<\/p>\n
Utility poles, railway ties, and home improvement products<\/strong><\/p>\n The company is headquartered in Montreal, Canada, has three main operating divisions, utility poles, railway ties, and residential lumber. Sales are mostly generated in the U.S. (68%), with 32% coming from Canada.<\/p>\n The largest division (35% of sales in 2020) provides utility poles to North American electrical utilities and telecommunication companies. Treated wood poles offer durability (lasting from 40 to 50 years), and a relatively low cost of purchase, installation, and maintenance.<\/p>\n The second-largest division (29% of sales) provides railway ties to railway operators in Canada and the United States. Demand for railway ties comes mainly from replacement requirements with occasional activity in new track construction. A relatively stable volume of new ties is required for maintenance purposes\u2014management estimates that approximately 1.5% to 3.0% of all ties on active railway lines need to be replaced every year. I<\/p>\n The third-largest division (26% of sales) manufactures pressure-treated residential lumber for use in patios, decks, fences, and other outdoor applications.<\/p>\n Stella Jones operates 40 wood-treating facilities in the United States and Canada, as well as 12 pole-peeling facilities. Wood supply for utility poles is sourced from its timber harvesting licenses (forest licenses and\/or timber quotas), state and provincial and timber sales, private woodland owners, and purchases of timber on the open market. Wood supply for railway ties and timbers as well as residential lumber is purchased from sawmills throughout Canada and the United States.<\/p>\n A stable and profitable business<\/strong><\/p>\n The company generated strong revenue and profit growth over the past 10 years. Revenues amounted to $2.7 billion over the 12 months to the end of September 2021. That was 3 times higher than the revenues generated 10 years prior. Net income was also 3 times higher and earnings per share jumped by the same margin. Growth was achieved through internal expansion as well as selective acquisitions.<\/p>\n Profit margins remained relatively stable over the past decade\u2014EBITDA margins averaged 14.6% while fluctuating between 11.5% and 17.3%. The return on equity averaged 16.2% and fluctuated between 11.5% and 18.3%.<\/p>\n Growth potential: Selective acquisitions and organic growth<\/strong><\/p>\n The company makes regular acquisitions, although these are mostly small to mid-size and complementary to the company\u2019s operations. Since 2010 there were 16 acquisitions for a total cost of about $750 million.<\/p>\n Relatively larger acquisitions were concluded in 2010 (Tangent Rail Corporation for US$170 million - railway ties), 2012 (McFarland Cascade for US$172 million - utility poles), 2015 (RAM Forest Group & Ramfor Lumber for US$45 million \u2013 residential lumber), and 2021 (Cahaba Pressure Treated Forest Products and Cahaba Timber for US$103 million).<\/p>\n The company intends to continue with its selective acquisition program in the utility pole and railway tie segments. Organic growth should come from replacing aging utility poles, as well as new utility poles in rural areas for 5G networks and fiber-to-home lines.<\/p>\n Balance sheet in good order and positive cash flow<\/strong><\/p>\n The company had shareholders equity of $1.5 billion by the end of September 2021, and total debt of $679 million. Net debt to EBITDA totalled 1.6 times and the total debt-to-capital ratio was 0.32. EBITDA covered the interest expense 15.9 times. This is a healthy balance sheet although there will be some additional debt added for the late 2021 acquisition of Cahaba, mentioned above.<\/p>\n Cash flow from operations amounted to $234 million in the 12 months ended September 2021 while capital expenditures were $68 million, leaving a sound free cash flow balance of $166 million.<\/p>\n Capital expenditure for organic growth, asset maintenance, and productivity enhancement is estimated at $50-$60 million per year. Given historical average operating cash flows well above this level, it should leave ample room for dividend growth and share buybacks.<\/p>\n Risks on the horizon<\/strong><\/p>\n The residential lumber business is cyclical and follows the ups and downs of the general economy. However, this is the smallest of the three main business units and is balanced by the more stable and larger utility pole and railway ties divisions.<\/p>\n The cost and availability of lumber are further risk factors to the business. Volatile and runaway lumber prices (as experienced over the past 24 months) increase the input costs for the company, which cannot always be passed on immediately to clients. This is partly mitigated by the fact that the company provides lumber to its utility pole division from its facilities.<\/p>\n Stella engages in regular acquisition activity, which can be accretive. However, it adds risk to the company profile in case the intended synergies do not materialize.<\/p>\n A strong performance in 2020-21 but momentum slowing<\/strong><\/p>\n The residential lumber division experienced exceptional demand in 2020 and the first half of 2021. This helped the company to achieve record results in 2020 and estimates indicate another record year in 2021.<\/p>\n However, Covid-fuelled demand for residential lumber now seems to have run its course\u2014this was on full display in the third quarter results when residential lumber sales dropped by 23% compared to the same period a year earlier. Perhaps more concerning was the drop in the overall EBITDA margin, which declined by a whopping 672 basis points from a year earlier. Management commented that the lower profit margin was the result of weaker residential demand as well as elevated fiber costs for residential lumber and railway ties.<\/p>\n For the full 2021 year, management lowered estimates for revenue and EBITDA at the time of the third-quarter results announcement. EBITDA is now expected to be close to $400 million, which will be slightly higher than 2020. The results announcement is expected on March 9.<\/p>\n For 2022 management expects to maintain its EBITDA at the 2021 level. Residential lumber sales are expected to drop back to pre-Covid levels while utility poles should show some organic growth aided by the acquisitions that closed at the end of 2021.<\/p>\n Longer-term, it is reasonable to expect that revenues and profit growth should continue to grow at a moderate rate of 5%-10% per year as a result of a mix of organic and acquisitive growth.<\/p>","protected":false},"excerpt":{"rendered":" Stella Jones has a long track record of steady and profitable growth. This was achieved organically and through selective acquisitions. The Covid-19 pandemic boosted demand for its residential lumber products, which pushed the company to record profits. However, will Stella … Continue reading