Is Boise Cascade a reverse value trap? (Part 1 of 2)

Value Investing Case Study 11-1:  I first covered Boise Cascade Company (BCC or the Group) in Jan 2021 for my Seeking Alpha article “Boise Cascade: Overpriced And A Potential Value Trap”.  Since then, BCC has released its 2020 results. This post is an updated analysis and is based on looking at BCC post-listing financials.

A value trap is a stock that appears cheap from a value investment perspective but is actually cheap for a reason. Instead of being a value stock, it is actually a dud. 

If you view the opposite of a value stock as a growth stock, a reverse value trap can then be thought of as a growth trap. This refers to a company that appears to be an investment opportunity from a growth perspective but is actually overpriced. 

BCC is a US NYSE listed company in the Lumber & Wood Production Industry. As of 1 Mac 2021, it is trading around a historical high of USD 49.94 per share equivalent to 2.3 Price to Book multiple.

This multiple is between the average Price to Book multiples of comparable sectors: (Source: Damodaran Jan 2021)

• 5.0 for the US building materials sector 

• 1.6 for the US paper/forest products sector. 

Damodaran classified BCC under the paper/forest products sector.  Based on this, BCC is expensive. However, BCC is cheap compared to the building materials sector.

How do you reconcile this? I would argue you cannot draw any conclusion about BCC valuation based on multiples.

Join me in a 2-parter as I showed the circumstances in which BCC can be a buying opportunity. An update was published on 22 May 2022.

Should you go and invest in BCC? Read my disclaimer.

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Contents

• Is there Anything Special about the Group’s Expertise?

• Is there Concern about how it Uses its Funds?

• Is the Current Performance Outstanding?

• Tracing the Group’s Rich and Unique History

• Is there a Great Future?

• Pulling it all together

Is there Anything Special about the Group’s Expertise?

BCC began operations in 2004 when it acquired the forest product and paper assets of OfficeMax.  It became a publicly held company of the NYSE in 2013. 

The Group manufactures engineered wood products, plywood, and lumber.  It also distributes a broad line of building materials, including wood products manufactured by the Group. It has 2 business segments:

• Wood Products. BCC is the second-largest producer of engineered wood products (EWP) and plywood in North America with 15 mills. EWP here refers to laminated veneer lumber, I-joists, and laminated beams. 

• Building Materials Distribution (BMD).  It is the only nationwide full-line wholesale distributor of building products for residential construction.  It has 38 branches nationwide and eight door shops.

All the BMD’s EWP is souced from the Wood Products segment with the other products sourced from over 1,000 third-party suppliers. 

BCC products are used for new housing construction and repair-and-remodeling of existing homes. The Group has a broad base of national and local customers.  These include retail lumberyards, home improvement centers, and leading wholesalers. 

BCC believes that its competitive edge is its vertically integrated business model.  It has enabled the Group to capture margins at both levels of the supply chain. However, BCC is not an integrated logging, saw-milling, and wood products manufacturer.

• The primary raw material in the Wood Products segment is wood fibre. 

• Timber accounted for about 80 % of the wood fibre costs. BCC sourced this through a mix of purchases under supply agreements, open market, and public timber auctions. 

Conceptually you can think of the wood-based industry as comprising:

• The upstream logging.

• The midstream primary processed wood products such as veneers, plywood, and panels.

• The downstream secondary processed wood products such as moulding and builders’ carpentry.

Based on this, the Wood Products segment operates in both the midstream and downstream sectors.

Is there Concern about how it Uses its Funds?

As of the end of Dec 2020, BCC had a Total Capital Employed (TCE) of USD 1.38 billion. 

Shareholder’s fund accounted for 62 % of the TCE with the balance from debt. Note that in this context, debt includes both operating and finance lease liabilities.

This is equivalent to a book debt to TCE ratio of 0.38 compared to the following US sector averages (Source: Damodaran Jan 2021):

• 0.56 for the US building materials sector.

• 0.37 for the US paper/forest products sector.

Items	Ref	USD million
Shareholders’ Equity	SHF	851
Minority Interests	MI	0
Total Debt and Lease	Debt	531
TCE		1,382

Items	Ref	USD million
Net Operating Assets	Net OA	977
Net Financial Assets	Net FA	405
Non-Operating Assets	Non-OA	0
Total		1,382
Table 1: Sources and Uses of Funds

About 71 % of the TCE has been deployed for the operations with the balance tied up mainly in cash.

Given that its debt to TCE ratio is about the industry level, the Group’s cash position looks high.  BCC has a cash-to-firm value of 29.3 % compared to the following US sector averages (Source: Damodaran Jan 2021):

• 5.9 % for the US building materials sector.

• 6.8 % for the US paper/forest products sector.

Chart 1: Sources and Uses of Funds

The Group does not provide any breakdown of how its funds have been deployed by segments. However, you can get a picture by looking at how the total assets have been deployed.

• The Wood Products segment accounted for 31 % of the total assets.

• The BMD segment accounted for about 49 % of the total assets.

• The balance which included cash is reported under Corporate. 

Chart 2: Assets deployed by segments

Is the Current Performance Outstanding?

For the year ended Dec 2020, the Group achieved USD 5.5 billion of revenue with USD 175 million net income. In comparison with the same period last year, the current period revenue is 18 % higher while the net income is 116 % higher.

The increase in sales was driven by both an increase in sales volume and selling prices

• Construction activity was the key demand driver for the sales volume. For 2020, the US Housing Starts increased by 7 % compared with the same period in 2019.

• For the year ended 2020, average composite lumber and average composite panel prices were 57 % and 54 % higher compared with those in 2019. 

The revenue growth is in line with the long-term improvement in revenue as can be seen from the Performance Index chart below.  Gross profitability has also improved since 2013.

Net income has been erratic as its financial performance is affected by the cyclical and commoditized nature of its products. 2013 was an exceptional year for net income.  This has resulted in the net income for the other years looking comparatively poor.

• There was more than double digits % increase in 2013 in panel and lumber prices compared to those in 2012. At the same time, the % increase in prices for wood fibre, its main raw materials, was lower. 

• There was an increase in sales volume in 2013 driven by 19 % growth in Housing Starts compared to that in 2012.

The relative decline in net income in 2018 was due to the one-off accelerated depreciation of a curtailed facility and impairment charges.

Chart 3: Performance Index

An analysis of the performance of the 2 segments from 2013 to 2020 showed

• The Wood Products segment average operating income is about 61% of that of the BMD segment.

• Both segments have about similar Return on Assets. 

Table 2: Segment Performance

The Total Assets employed by the Wood Products segment is about 63 % of that of the BMD segment. However, over the past 8 years, the capital expenditure of the Wood Products segment is 3.3 times that of the BMD segment. 

Tracing the Group’s Rich and Unique History

Over the past 8 years, the revenue of the Group has grown from USD 3.3 billion in 2013 to 5.5 billion in 2020 equivalent to a CAGR of 7.6 %.  Not all the segments were growing at the same rate

• The Wood Products segment accounted for about 21 % of the Group external revenue in 2013 but in 2020 it shrunk to 10 % of the Group external revenue. 

• The BMD segment revenue has grown from USD 2.6 billion in 2013 to USD 5.0 billion in 2020. It actually had a CAGR of 9.6 %

The chart below shows how the profile of the Group external revenue has changed over the 8 years period. 

Chart 4: Segment revenue

I had earlier pointed out the volatile nature of the Net Income.  As can be seen from the chart below, this is primarily due to the volatility of the Wood Products segment net margin.

The BMD segment margin has improved steadily since 2013.

Chart 5: PBT margin by segment

Wood Products

Although the external revenue of the Wood Products segment declined over the past 8 years, the segment operations have actually grown much bigger since 2013. This is because a bigger part of the segment sales has been to the BMD segment. 

• In 2020, the intersegment sales were USD 801 million compared to USD 460 million in 2013.

• On a total sales basis, the Wood Products segment revenue in 2019 is about 17 % higher than in 2013. 

At the same time, on a total sales basis, there is a significant change in the sales profile.  The EWP accounted for a bigger part in 2020 as can be seen below.

This reflects the Group strategy of diverting its production away from plywood to EWP.  

Chart 6: Wood Products segment revenue

To match its product sales profile, the Wood Products segment had acquired as well as divested and/or curtailed several of its facilities. For example

• In 2016, the Group acquired 2 engineered lumber facilities for USD 215.9 m.

• In 2018, the Group sold 2 lumber mills and particleboard plants in Northeast Oregon.

As can be seen from the table below, this has resulted in a significant increase in the EWP capacity by 2020 when compared to that in 2013,

Table 3: Wood Products segment capacity

I expect BCC to continue to focus on EWP.  Furthermore, M&A and divestment/closure will continue to be a feature of its business model. 

BMD

The BMD segment business strategy is to grow market share by

• Adding products and services. 

• Expanding to nearby geographies.

Compared to that in 2013, the 2020 BMD sales are about double with EWP showing the largest % increase. 

Chart 7: BMD segment revenue

Unlike the Wood Products segment, it would appear that the bulk of the growth is due to organic growth as over the past 8 years, BCC only spent about USD 41.2 million (or about 4 % of the total Group CAPEX) on acquisitions and/or expanding to new locations.

Is there a Great Future?

The Group’s performance is generally influenced by

• General economic conditions, especially Housing Starts.

• The commoditized and cyclical nature of the products and raw materials. 

Over the past 8 years, there is a 0.94 correlation between BCC revenue and the US Housing Starts. If this correlation continues to hold, it would augur well for BCC as the Housing Starts has been on an uptrend over the past decade.

• Over the past 6 decades, the US Housing Starts have averaged about 1.5 million units annually. 

• At this level of Housing Starts, BCC revenue is projected to be about USD 5.4 billion ie about the 2020 revenue.

• The US Housing Starts had a CAGR of 5.8 % from 2013 to 2020.  

Chart 8: US Housing Starts   Source: Trading Economics

Another positive indicator is industry growth. 

Statista projected that the revenue of veneer, plywood, and EWP manufacturers in the U.S. will amount to approximately 30 billion U.S. Dollars by 2024.  

• Based on Statista statistics, the US veneer, plywood, and EWP industry revenue had a CAGR of 1.8 % over the period from 2013 to 2020.

• Over the same period, BCC revenue grew at a CAGR of 7.6 %.  It showed that BCC has been able to grow its market share. 

Chart 9: US veneer, plywood, and EWP revenue   Source: Statista

Of course, revenue growth is impacted by the cyclical nature of the prices. 

Case Notes The challenge with fundamental analysis is that you are trying to assess the future performance of the business.  As an “outsider” your main source of information is the company's historical performance. However, when you have an extraordinary event such as the Covid-19 pandemic, the 2020 performance becomes suspect.  Should you ignore it? How would you incorporate it into your analysis? When you have a case like BCC that on top of the pandemic, you have cyclical products, this becomes messier. My first goal was to remove the impact of the cyclical price.   I did this by establishing a price index based on FRED Producer Price Index: Plywood and EWP using the 2011 price as the base.  I then scaled the revenue by this price index. All the subsequent revenue was then based on the 2011 price. Any revenue growth or decline is then due to volume rather than a combination of volume and price. (Source for industry revenue: Statista)  Secondly, the veneer, plywood, and EWP industry are not like those of the airlines or cruise industry. I do not see any long-term trend arising from the pandemic that would affect BCC's future outlook.  As such, I still assumed that the historical performance including that of 2020 is a good picture of what BCC can expect in the future.  As you can see, company analysis is more than merely reviewing the annual reports. So, if you are just starting out to analyze and value companies, it may be helpful to supplement it with third-party analyses.  There are several financial advisers who provide such analyses. Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis and valuation.

Case Notes

The challenge with fundamental analysis is that you are trying to assess the future performance of the business.  As an “outsider” your main source of information is the company's historical performance.

However, when you have an extraordinary event such as the Covid-19 pandemic, the 2020 performance becomes suspect.  Should you ignore it? How would you incorporate it into your analysis?

When you have a case like BCC that on top of the pandemic, you have cyclical products, this becomes messier.

My first goal was to remove the impact of the cyclical price.  

• I did this by establishing a price index based on FRED Producer Price Index: Plywood and EWP using the 2011 price as the base. 

• I then scaled the revenue by this price index. All the subsequent revenue was then based on the 2011 price. Any revenue growth or decline is then due to volume rather than a combination of volume and price. (Source for industry revenue: Statista) 

Secondly, the veneer, plywood, and EWP industry are not like those of the airlines or cruise industry. I do not see any long-term trend arising from the pandemic that would affect BCC's future outlook.  As such, I still assumed that the historical performance including that of 2020 is a good picture of what BCC can expect in the future. 

As you can see, company analysis is more than merely reviewing the annual reports. So, if you are just starting out to analyze and value companies, it may be helpful to supplement it with third-party analyses.  There are several financial advisers who provide such analyses. Those who do this well include people like Seeking Alpha.* Click the link for some free stock advice. If you subscribe to their services, you can tap into their business analysis and valuation.

On a constant price basis: 

• The US veneer, plywood, and EWP industry had a CAGR of - 4.7% over the period from 2011 to 2020 ie it shrunk. This is due to Statista projecting a reduced industry revenue in 2020.  

• Over the same period, BCC revenue at constant prices grew at 0.8 % CAGR

• BCC sales volume for laminated veneer, I-joists, and 3/8-inch plywood had a CAGR of 6.5 %, 4.3 %, and -2.3 % respectively

At the same time, FRED industrial production index showed the industry output growing at a CAGR of 3.0 % between Jan 2013 and the end of Dec 2020.

What the above statistics indicate is that this is not a sunset industry. However, the industry is unlikely to see double digits growth. 

Chart 10: Veneer, plywood, and EWP production.    Source: FRED

Pulling it all together

We have to differentiate between a good company and a good stock investment.

• A good investment is one that enables you to make money. From a value investor perspective, this requires that the stock be trading at a price that is below its intrinsic value.  Until we carry out a valuation of BCC, we cannot draw any conclusion on this.

• A good company is one with strong fundamentals and BCC seems to fit this.

BCC is a good company because:

• It is financially strong.  The Group has the industry average debt to capital ratio while having a higher than industry cash position.

• Revenue is trending up through a combination of organic growth and M&A exercises.

• The BMD segment gross margins are trending up.  However, the Wood Products segment's external sales margins are volatile although on average it has been about 10 % over the past 8 years. 

• The industry that BCC operates in is not a sunset industry.  There is still long-term growth although I doubt it would be double digits growth.  

Whether BCC would be a buying opportunity would depend on a detailed assessment of the intrinsic value.

If you want to know whether BCC is a good investment, join me in Part 2 of this series. 

End of Part 1 of 2

Part 2 of 2 was published on 29 Mac 2021

An Update was published on 22 May 2022

Reading guide

If you are a first-time visitor to this blog, you may not be familiar with some of the concepts that I have used in my analysis and valuation.  I suggest that you check up the Foundations series - Fundamentals 01,  Fundamentals 02, and Fundamentals 03.   I also have a Definitions page in case you are not familiar with the terms I have used. 

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Disclaimer & Disclosure

I am not an investment adviser, security analyst, or stockbroker.  The contents are meant for educational purposes and should not be taken as any recommendation to purchase or dispose of shares in the featured companies.   Investments or strategies mentioned on this website may not be suitable for you and you should have your own independent decision regarding them. 

The opinions expressed here are based on information I consider reliable but I do not warrant its completeness or accuracy and should not be relied on as such. 

I may have equity interests in some of the companies featured.

This blog is reader-supported. When you buy through links in the post, the blog will earn a small commission. The payment comes from the retailer and not from you.

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