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- By Robert Abbott
One economic forecaster predicts housing starts in the United States will grow by 9% this year. If that occurs, this could be another banner year for the Boise Cascade Company (NYSE:BCC), but perhaps not as good as 2020, when its share price roughly doubled:
About Boise Cascade
As the name suggests, Boise Cascade is based in Boise, Idaho. It began operations in its current configuration when Boise Cascade, L.L.C. acquired the forest products and paper assets of Office Max in 2004.
It is a building products company, or as it explains in its 10-K for 2020, "a vertically integrated building materials distributor and wood products manufacturer with widespread operations throughout the United States and Canada."
It cites information from Resource Information Systems Inc.'s Capacity Report in claiming to be "one of the largest" wholesale distributors of building products in the U.S., and the second-largest manufacturer of laminated veneer lumber, I-joists and plywood in North America.
The products it manufactures and sells go mainly to new residential construction, repair-and-renovation projects, light commercial and industrial applications.
Its base of more than 4,500 customers includes retail lumberyards, home improvement centers, wholesalers and industrial converters. The biggest of those customers are The Home Depot (NYSE:HD) and Builders FirstSource (NASDAQ:BLDR).
It operates through two segments:
Wood Products manufactures engineered wood products, EWP and plywood;
Building Materials Distribution (BMD), wholesales building materials.
One of the biggest customers for the Wood Products division is the Building Materials division, as shown in this illustration from the 10-K:
In its 10-K, the company explained its environment this way:
"General economic conditions, including but not limited to housing starts, repair-and-remodeling activity, light commercial construction, inventory levels of new and existing homes for sale, foreclosure rates, interest rates, unemployment rates, household formation rates, prospective home buyers' access to and cost of financing, and housing affordability, that ultimately affect demand for our products."
When demand gets too far ahead of supply, prices increase. That was the case for panelling prices in 2020, but not for 2019:
For the Wood Products segment, the biggest competitors are Weyerhaeuser Company (NYSE:WY), Louisiana-Pacific Corporation (NYSE:LPX), Georgia Pacific and Roseburg Forest Products. In addition, it competes with dimension lumber producers in cases where plain lumber may be substituted for an engineered product.
In the Building Materials segment, the primary competitors are BlueLinx Holdings Inc. (NYSE:BXC), Weyerhaeuser Company, Dixie Plywood and Lumber, OrePac, U.S. Lumber Group, Huttig Building Products (NASDAQ:HBP) and Capital Lumber.
Boise Cascade argues that it has competitive advantages: "We believe our large, vertically-integrated operations provide us with significant advantages over less integrated competitors and position us to optimally serve our customers." Its return on equity (ROE) of 23.16% backs up that claim.
Investors should be aware of several factors that affect the well-being of the industry and Boise Cascade:
The industry is cyclical, with prices reflecting several macro-economic developments. Buy-and-hold investors should expect troughs as well as peaks.
One of those macro elements is interest (and mortgage) rates. Some investors are selling or shying away from the company and its peers because they believe inflation and interest rates will rise this year.
Many of the products it buys and sells are commodities, making Boise Cascade a price-taker rather than a price-setter. It has a limited ability to set the kinds of prices it needs to operate with adequate margins.
On Feb. 22, the company released its fourth-quarter and 2020 full-year results:
On the top line, it reported sales of $5.474 billion, a year-over-year increase of 18%. Wood Products was up 4% while Building Materials increased by 20%.
Adjusted Ebitda grew 97% to $423.098 million.
Net income rose 116% to $174.979 million; that worked out to $4.44 per common share (diluted) compared to $2.06 in 2019.
It noted in the earnings release, "As both a manufacturer and a distributor, our 2020 financial results were favorably impacted by higher commodity wood products pricing compared to pricing in 2019."
Still, 2020 was a severe up-and-down year, with a sharp downturn in the second half of the first quarter and the first half of the second quarter. Construction activity and Boise Cascade recovered in the second half. In fact, product demand in the third quarter picked up so much that it was greater than supply, causing significant increases in wood and other commodity prices.
The company did not offer any numbers for 2021, but it did point to continued strength in the housing market. It cited a consensus forecast from the Blue Chip Economic Indicators that single- and multi-family housing starts would increase to 151 million units, compared to 138 million in 2020 and 1.29 million in 2019. That would represent a 9.42% year over year increase.
That demand is being driven by low mortgage rates, continuing work-from-home practices and demographics. However, not everyone expects interest rates to remain low; Bank of America (NYSE:BAC) downgraded its rating on Boise Cascade from Neutral to Underperform on March 12 because of the possibility that higher interest rates might depress stocks related to the housing industry. It also expressed concern about plywood imports gaining traction and about the expansion of supply by mills as they attempt to cash in on higher wood prices.
As the metrics on the top half of this table above suggest, the company is well-capitalized and debt is not a problem. The Piotroski F-Score and Altman Z-Score are both strong, and its return on invested capital (ROIC) is significantly higher than its weighted average cost of capital (WACC).
Boise Cascade's margins are in line with those of other companies in the Forest Products Industry, and stronger than its own historical median. Return on equity is robust at 23%.
Given that its two business segments involve the ownership of manufacturing plants, warehousing facilities and large product inventories, we might also argue that it has an above-average return on assets.
The three growth lines at the bottom of the table reinforce the idea that Boise Cascade is doing well. Revenue has grown by an average of more than 9% per year over the past 10 years, a figure in line with the Blue Chip forecast for 2021:
The growth of Ebitda has been faster than of revenue, suggesting the company has become increasingly productive:
Earnings per share (diluted) have also increased significantly:
And, to internally generate new funds for expansion, it has been growing its free cash flow:
Dividends and share repurchases
Boise Cascade offers a small dividend yield small because the share price has risen so far:
However, if we look at just the dividend payments, we see they, too, have risen quickly, an average of 78.8% per year over the past three years. In fact, they've grown since the company began paying them:
With a dividend payout ratio of just 9%, there is adequate room for higher payments.
Turning to the share count, that has trended down over the past decade:
If we look only at the share price, we would consider Boise Cascade sharply overvalued:
The price-earnings ratio offers a less overvalued snapshot. It is currently 14.95, which is below the industry median of 18.34 and below its own 10-year median of 17.56.
But if we turn to the PEG ratio (the price-earnings ratio divided by the five-year Ebitda growth rate), the stock is undervalued. The PEG ratio sits at 0.86, below the fair value threshold of 1.00.
The discounted cash flow (DCF) calculator, based on a 3-out-of-5 rating, arrives at nearly a fair valuation:
Guru ownership has been up and down in the past two years:
Six of the gurus followed by GuruFocus held positions in Boise Cascade at the end of Q4 2020, including:
Chuck Royce (Trades, Portfolio) of Royce Investment Partners owned 142,401 shares, an increase of 5.85% since the end of the third quarter. His stake represented 0.36% of Boise Cascade's equity and 0.06% of his firm's assets.
HOTCHKIS & WILEY opened a new position in the fourth quarter with the purchase of 108,490 shares.
Institutional investors owned 86.08% of the company's shares at the end of 2020, while insiders owned 3.06%.
Boise Cascade has successfully ridden the latest surge in housing starts, and a year into the recovery it is in a strong financial position. It also has been profitable and has become increasingly productive. Its dividend yield is modest, thanks to the ballooning share price, while growing rapidly.
The question for investors is whether the forecast of a 9% increase in housing starts this year will occur, or whether rising inflation/interest rates or some other economic hurdle blocks it. Will the cycle continue to be strong, or will it falter?
I expect many value investors will want a margin of safety before putting Boise Cascade on their shortlists; the balance sheet is strong but that's not enough by itself considering that it is either at or near the top of its cycle as a cyclical company. Growth investors who are optimistic about the economy and housing starts may see potential here.
Disclaimer: I do not own shares in any of the companies named in this article and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.