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Morningstar | Canfor adjusted EBITDA Nearly Doubles on Strong Lumber, Pulp Pricing in 2Q

Canfor notched another quarter of strong results, thanks to both solid production and heady wood product prices. Excluding tariffs, adjusted EBITDA rose to CAD 401 million during the second quarter--up from CAD 228 million in the second quarter of last year. Lumber prices have risen more than 40% over the past 12 months through June, and NBSK pulp prices are up 36% over the same period. Despite an uptick in Canadian input costs, a large share of the price increase has padded Canfor's bottom line. Transportation bottlenecks and a harsh winter have kept pricing elevated longer than we originally expected, so we've raised our fair value estimate to CAD 31 from CAD 29 per share to account for higher near-term profitability. Our no-moat rating is unchanged.

However, there are signs that supply constraints associated with the trailing nine months are beginning to ease, as Canfor shipments have finally returned to normal levels. By our estimates, North America has wood product capacity available for production, and as transportation bottlenecks ease, pricing is set to fall in the near term. We've already begun to see signs of this, as weekly lumber prices have started to soften. We expect a nearly 10% decline in lumber and panel prices going into 2019 despite increasing product demand.

As we transition to 2020, we see room for a return to lumber prices of $500 per thousand board feet and above for a number of years as U.S. demographics support increased homebuilding activity, which makes up the bulk of lumber demand. Even the recent spate of new mill construction in the U.S. South won't be enough to keep demand from exhausting available capacity. As we approach 2025, we expect today's economic profits to subside, given a fairly flat production cost curve at midcycle levels of demand.

Looking beyond the substantial price increase over the prior year, Canfor operated well in the second quarter. Canadian lumber production rebounded to levels more consistent with last year, as inventory begins to destock and supply chain issues ease. Excluding tariffs, higher prices were more than enough to offset rising costs, as adjusted EBITDA margins for the lumber segment rose to 28.5%--up from 20.9% in the second quarter of last year. We've lifted our dimensional lumber price forecast to $500/mmbf for the year, with peak prices having reached higher-than-expected levels this summer.

Canfor's pulp and paper segment was no slouch, either, generating adjusted EBITDA margins of 27% in the second quarter versus 18% in 2017. Year-over-year improvement was primarily driven by higher prices, as export demand for pulp remains solid. With extremely stringent quality standards in place for Chinese OCC imports, which is a substitute for pulp, demand for imported pulp from Canada and the U.S. has strengthened. Over the long run, we see margins returning to the midteens as fiber-starved China eventually eases restrictions on OCC imports, easing demand for pulp and leading to lower pulp prices.

For more on our U.S. Housing thesis and its impact on lumber companies, see our December 2017 observer "Lumber Companies Poised to Profit as Millennials Form Households."