A Member of Pat McKeough’s Inner Circlerecently asked for his advice on a Canadian manufacturer with a distinct niche. The company makes the bulk of its revenue from railway ties and utility poles, while it also sells pressure-treated lumber to the construction industry.
Stella-Jones has several things going for it, says Pat, including clear leadership in its markets, and an opportunity to profit from infrastructure upgrades across North America. On the other hand, he notes, the company’s growth-by-acquisition strategy adds risk, which is increased by uncertainty about the future of North American free trade.
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Q: Pat: What is your advice on Stella-Jones? Thanks.
A: STELLA-JONES INC. (symbol SJ on Toronto ; www.stella-jones.com) is a manufacturer of pressure-treated wood products. They include railway ties (35% of sales); utility poles (33%); treated lumber products for the residential construction market (21%); general-purpose logs and lumber (6%); and lumber for industrial uses such as construction timbers and highway guardrails (5%).
The company gets most of its utility poles from the timberlands it leases in Quebec and B.C. It also buys wood for railway ties and other products from sawmills in the U.S. and Canada. The U.S. provides 69% of its sales, while Canada supplies the remaining 31%.
Revenue jumped 182.4%, from $651.6 million in 2011 to $1.84 billion in 2016.
Over that same period, Stella-Jones improved its earnings 176.3%, from $55.7 million in 2011 to $153.9 million in 2016. Due to more shares outstanding, earnings per share gained 155.2%, from $0.87 to $2.22 (all per-share amounts adjusted for a 4-for-1 stock split in October 2013).
Sales for the third quarter ended September 30, 2017, edged up 1.0%, to $517.6 million from $512.6 million a year earlier. Excluding currency effects, sales rose $12.9 million, or 2.5%.
Growth stocks: Demand strong in two of the company’s three markets
Stella-Jones purchased Bois KMS and Northern Pressure Treated Wood for a total of $19.2 million in December 2016. These acquisitions contributed $2.1 million in sales during the quarter.
Earnings fell 8.1% in that period, to $42.0 million, or $0.61 a share, from $45.7 million, or $0.66 a share. The decrease was largely due to lower prices for railway ties.
As of September 30, 2017, the company had reduced its long-term debt by 34.7%, to $449.0 million from $687.5 million at the start of 2017. Long-term debt now represents a low 13.2% of its market cap.
Stella-Jones continues to grow by acquisition. That strategy—along with currency fluctuations and uncertainty surrounding the future of NAFTA—adds risk. However, demand for utility poles and residential lumber remains strong, despite weaker demand for railway ties. The company also remains an established leader in all those niche markets. It stands to gain from infrastructure projects as North American power companies upgrade their transmission and distribution grids.
Stella-Jones shares trade at 20.5 times the company’s forecast 2018 earnings of $2.41 a share. The annual dividend rate of $0.44 yields 0.9%.
Inner Circle recommendation: Stella-Jones is okay to hold, but only for aggressive investors.
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