2023-11-17 17:21:36 ET
Summary
- Stella Jones continues to see margin expansion in its core infrastructure businesses.
- The stock is priced for continued growth in 2024 with a now fair valuation for its performance.
- The company pays a reasonable 1.1% dividend and continues to buy back shares with cash flow to support shares.
Stella Jones ( SJ:CA ) has been a consistent Canadian stock performer in 2023 with incredible margin expansion boosting the shares to all time highs. The stock has performed well since SJ as expected boosted the growth outlook for the 2023-2025 period in May. The company pays a solid dividend of 1.1% as of today with good potential to raise it over the coming few years. I wrote about SJ initially in April 2023 as the infrastructure sector continues to provide consistent revenue growth from government funding. It also provides a floor on the share price as weakness in the macroeconomic environment won't drastically impact sales volumes. Valuation is still reasonable, with institutions taking notice over the past year and pushing the stock multiple up considerably. While it will be harder to see multiple expansion from here, stable growth and some expansion is still possible with support from share repurchases. Year to date the stock is up 78% , far above the TSX return of 4.2% making it one of the strongest performers right now in Canada. Let's look at the continued solid fundamentals that make the company a solid choice for continued growth.
Q3 - Continued growth with margin expansion
Considering the company trades at just 15.5x trailing earnings, getting growth in both margins and revenues is impressive. Stella Jones had solid 13% revenue growth in Q3 albeit with most of that coming from pricing actions versus increased production. The $939 million CAD in revenue in Q3 was an all time record for Stella Jones. The pricing actions are a good sign as it shows they have solid pricing power with their core group of tier 1 customers. The ability to pass on cost increases and then some is an important one, which shows with the 22.7% gross margin up 6.2% from the 16.5% in Q3 2022. Continued margin expansion will be essential to beating the new investor day targets laid out since my last article on SJ. EBITDA margin was up 2.3% in just three months as a result of the strong gross margins in the utility pole business, with 20% being a milestone level. The major driver of the increase of both revenue and margin is the utility pole business, which continues to perform well due to a rip and replace cycle. Demand from rural solar projects continues to grow plus current grids need more consistent replacement. Wildfires could also be a longer term tailwind in Canada and the United States as increased activity there would necessitate additional poles. The railway tie business is seeing slow growth, but should also continue strong profitability with very stable earnings. This year the business is on pace for improved revenue with $195, $238 and $230 million in the past three quarters. This $850 million plus year is mostly due to pricing actions taken by SJ which customers are absorbing.
While the strength in the infrastructure side is apparent, so is the weakness on the lumber side due to poor pricing. Ignoring currency fluctuations sales were down 11%, which is a solid result considering the weakness seen by many of the other competitors in this space. Volumes were actually up year over year, but continued pressure on lumber prices after the recent bust has hurt them. This does mean increased profitability is possible here in the next business cycle when residential lumber demand improves once again. Longer term the residential lumber portion of the business isn't as big of a focus, with the infrastructure portion the majority of the 6% organic growth target through 2025. Debt is reasonable for SJ with the company having just 2.4x EBITDA, a reasonable level for a company with good scale and strong earnings visibility. At $1.04 Billion CAD of debt the company can continue to make tuck-in acquisitions to fuel growth plans of 9%+ growth of the railway tie and utility pole businesses.
Above you can see that the company traded from around 16x to as low as 9x earnings in the past three years. The current 15.5x earnings multiple is quite reasonable, with it averaging around 12x over the past 2.5 years with lower margins and growth. EPS growth is expected to be 8, 11 and 8% over the next three years after a 20%+ growth for 2023. This should be very supportive of the stock considering the stability of their end markets. This is demonstrated partially by a far below TSX beta of just 0.7 over the past year. The stability of the stock is likely helping its performance as companies with predictable earnings continue to have a premium multiple in this market. EBITDA margins are increasing past 20% as the high margin utility pole business is outgrowing the lower margin processed wood products division. Whether the margins can stay at this level is unclear, as it is above the guidance range they gave earlier in the year. However, the market sees this as sustainable as the share price is reflecting a strong 2024 environment for the utility and tie business.
Stable but catalyst light
In the current macroeconomic climate a company like SJ is essential to have in your portfolio due to its stability of earnings. Other companies in the area have struggled or only tracked the market, but they may rebound if a difficult 2024 emerges. Countries, states and cities have really ramped up investment in recent years in infrastructure as it begins to show its age. This is a strong tailwind for SJ in the coming years in all of its main businesses. The company continues to buy its own float back as well, although that may decrease with the stock having done so well throughout 2023. Dividend increases are likely in 2024, with possible small acquisitions through both the utility pole business or railway tie business. Adjacencies are possible such as composite poles or other wood products if the price is in SJ's targeted range. However, overall the company is a stable and solid grower without any big positive or negative catalyst. In this current environment I consider that a good thing and continue to rate Stella Jones a buy for long term appreciation.
For further details see:
Stella-Jones: Value In The Storm