Resolute Forest Products (RFP, Financial) looks to be a cheap company with an upcoming catalyst, which could lead to a re-rating of the stock.
The group operates in the forest products industry, which essentially means it produces lumber in the United States and Canada and owns facilities to turn this lumber into products such as pulp and paper.
One of the company's top shareholders is Prem Watsa (Trades, Portfolio). The investor's Fairfax Financial Holdings (TSE:FFH) owns 30.5 million shares, giving it a 12% portfolio weighting. Francis Chou (Trades, Portfolio)'s Chou Associates also owns a substantial position of 3.3 million shares, making it the third-largest position in the portfolio with a near 25% weighting.
These are not new positions for the value investors. The holdings go back to around 2012, so they are certainly long-term investors in this enterprise.
The value opportunity
For much of the past decade, the company's performance has been pretty underwhelming. It has lost money in four the past six years, and book value per share has declined from $21.60 in 2015 to $13.30 for 2020.
This trend is now reversing. Rising lumber prices have offered the company a windfall. Book value per share has jumped up to $18.80, and Wall Street analysts reckon the firm will earn net income of $497 million in its current financial year, producing earnings per share of $6.44.
Based on these metrics, the stock is trading at a forward price-earnings ratio of just 2.3 and a price-book ratio of 0.8.
In any cyclical industry, it is always challenging to analyze the outlook of the industry's businesses. If wood prices fall back to their long-term average, Resolute's earnings will fall back to their long-term average. This will take the company back to the loss-making position it was in for the majority of the past decade.
This is the biggest challenge of analyzing the enterprise. Still, it seems to me that management is not wasting the current environment. Over the summer, the company announced a $1 per share special dividend, returning $79 million to investors. The group generated $105 million in cash from operations in the third quarter.
The company has also been repurchasing shares. For the 12 months to the beginning of November, the company reduced its outstanding share count by 7%. It has also recently authorized another $100 million share repurchase facility, and net debt has fallen to a multi-year low of $184 million.
Cyclical industry
As I noted above, trying to predict the outlook for Resolute requires some level of speculation about the direction of lumber prices in the future. The price of U.S. lumber peaked in the second quarter before falling back and resuming its rally at the beginning of November. The performance of the commodity over the past couple of weeks suggests that Resolute will see yet another quarter of impressive profits for the three months to the end of December 2021.
What happens after this is a little difficult to understand. Much of the performance depends on the housing market in the U.S., which is currently experiencing a boom. Rising home prices have become a catalyst for builders and developers to initiate new developments, pushing housing starts to levels not seen since before the financial crisis.
Some analysts believe this trend is here to stay. They believe housing starts over the past decade have been nowhere near enough to meet the demand for new properties. It looks as if the industry is now trying to rectify this error. This could result in a multi-year growth spurt for the housing industry, which would almost certainly support lumber prices and Resolute's bottom line. This may be the catalyst that drives the stock higher over the next few years.
