CA - Interfor: Counting On A Rate Pivot That Isn't Quite Ready

2023-11-16 08:54:30 ET

Summary

• Interfor is facing challenges from higher interest rates, high inventory levels, and forest fires, impacting their earnings.
• The company is focused on reducing debt and does not plan to engage in buybacks. At least their debt is fixed rate.
• While there are positive medium-term dynamics, such as a housing shortage, a rate pivot is needed for significant and rapid earnings improvement.
• While the multiple isn't totally unreasonable, it's a volatile business and there are cheaper and safer picks out there.

Interfor (IFSPF) is beginning to see the hit from higher rates and the fact that inventory levels in the industry were high last quarter. Forest fires didn't help either. The company is focusing on deleveraging, and buybacks are not on the table. However, inventory levels are falling, but while that may help preserve the situation, management acknowledges the trouble of rate hikes now hitting lumber markets. Better medium-term dynamics including the housing shortage are a positive, but it's unlikely to be a secular factor to restore earnings massively and rapidly. We need a rate pivot for that, and the data evolution since our last coverage shows that the market shouldn't keep jumping the gun on the issue, and therefore caution is needed for Interfor.

Considering Earnings

European imports are causing higher inventories and sudden drop offs in new construction demand have been an issue for the company. Lumber prices have continued to fall, and then forest fires in their northern geographies also added double digit declines of around 10% on a sequential basis to their troubles. EBITDA came down substantially .

R&R markets still look strong on a volume basis. There hasn't been any real change in these markets. The issue is that we are now beginning to see issues with housing starts .

While housing starts have rebounded somewhat in the latest month, they are coming down quarter to quarter. The upside is that there is at least some declines in inventory, going down to the lower third of industry inventory levels. Moreover, we should see some recovery in volumes extraordinarily lost on account of the forest fires.

On balance, expectations for prices aren't really suggesting a recovery, and in all likelihood there won't be too much quarterly improvement. Indeed, management acknowledges that interest rate-related hits are only coming in now.

Bottom Line

While inventories were too high last quarter, and they are coming down for the end of the year, lumber markets can be very sensitive to these S/D dynamics. As inventories fall, things should continue to improve hopefully starting next year as the realities of the housing shortage kick in.

Another thing to note is that the debt is fixed, limiting the direct effects of higher rates.

Unfortunately, with operating leverage and a lot of commodity sensitivity, it's hard to know how profits will evolve. Importantly, historical averages of EBITDA aren't very useful as they don't share the higher rate environment that we will see incrementally. Deglobalisation and other inflationary factors are a concern, and limit how far rates can fall. We think that it's conceivable EBITDA will recover in 2024 to a level where implied multiples might be around 12x EV/EBITDA, where we assume higher rates persist beyond current rosy expectations of a pivot. At current run-rates, the multiple is around 15x.

Ultimately, it's structural concerns around underlying wage growth and the factors that will allow inflation to persist that give us pause. A cold winter may introduce new issues in the energy picture as well in Europe, which has follow on effects for global markets. All of this could endanger Fed plans to pivot rates and make the newbuild environment more appealing.

At these multiples, there are companies whose economics we can trust more at a lower multiple.

For further details see: