Canfor Pulp CFX-U CN
February 07, 2008 - 3:32pm EST by
2008 2009
Price: 10.05 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 350 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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This stock is the best yielding security with improving fundamentals that we have found in a while.  Canfor Pulp is a Canadian income trust that was formed to own 50% of three pulp mills that were spun-off by Canfor Corporation in 2006.  Its business consists almost entirely of manufacturing and selling softwood pulp, and as such, is fairly easy to analyze.  Pulp prices have been at record levels recently, as a weak dollar and strong international demand have outweighed domestic weakness.  New pricing increases are announced regularly.


We believe that the pricing environment for softwood pulp will remain strong, due to the lack of new pulp supply coming online (it costs approximately $1 billion to construct a pulp plant) and growing paper demand from fiber-poor countries.  Additionally, even with pulp prices at record levels, a number of pulp producers are in distressed conditions due to US dollar weakness and surging fiber prices.  For example, Pope and Talbot, which accounts for more than 5% of global softwood pulp capacity, is currently going through bankruptcy proceedings and it is unclear whether their pulp mills will continue to operate.  Any shuttering of pulp capacity will significantly tighten supplies and support the current price levels.


More importantly, we think that Canfor has a few characteristics that make it a very interesting investment.  Namely:


1)     A low-cost manufacturing position due to large, efficient mills, with most of its capacity in the bottom quartile of the global cost curve

2)     Preferred access to fiber, with mills situated in northern interior British Columbia, where the pine beetle infestation has created a surfeit of dead, pulpable logs (versus competitors who have to rely on chips from currently-shuttered sawmills)

3)     A tax-efficient income trust structure that currently yields 14%, with a distribution that should increase from recent levels due to recent gains in pulp pricing and a weakening Canadian dollar

4)     A valuation that is below 5x normalized EBITDA less Capital Expenditures, and less than 60 % of replacement cost, even ignoring the tax-efficient structure

5)     The consensus EBITDA estimate for 2008 appears low and provides Canfor with the opportunity to beat analyst estimates by a reasonable margin


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