Description
LPX – Louisiana Pacific – Current Price $8.10 – Price Target $14.50
LPX is the largest OSB (oriented strand board) company in the world (40% of sales). Additionally LPX sells lumber and engineered wood products (32%), composite wood products (20%) and plastic building products (8%) (including vinyl siding and composite decking). LPX is the only company focused exclusively on these areas and is spending real money in R&D for production improvements and product improvements to distance itself from competition. As the home builders consolidate they will increase purchases of products that are easier to install, can be supplied in large quantities and have decorative variety – LPX is one of the few suppliers capable of meeting these needs.
Cash - $137mm
Debt - $709mm
Shares - 105.0mm
Market Cap $850mm
EV - $1,417 – unadjusted for remaining asset sales
THE EVENT: Last year LPX announced that it would focus only on assets where it felt it had a sustainable competitive advantage. In conjunction with that announcement, LPX began a massive asset disposal program with the stated objective of receiving $600-700mm of after tax proceeds. Upon completion of these asset sales LPX will be a much more focused company and actually more of a building material company, compared to its history as a forest products company.
LPX ended 2002 with $137mm in cash and $709mm of debt (limited recourse note of 396.5mm is offset by a $403mm notes receivable from asset sale – setup this way for tax deferral purposes). Since year-end LPX has announced just over $200mm of additional asset sales, after approximately $200mm of asset sales last year. Major asset still remaining to be sold is 500,000 acres, will be sold in tranches. Recent acreage has garnered approximately $700 per acre. If proceeds from remaining acreage is $300mm (600 per acre, hopefully higher) and the company spends an incremental $50mm on settlement of contingencies (see below for more info), new balance sheet would consist of $150mm of net debt.
OSB is used in housing construction (75% to new build and 25% remodel etc.) and is a commodity product. It is a cheaper and better product than structural panels, which it has been taking share from since its introduction 25 years ago. OSB is now approximately 55% of the market. OSB capacity has been consolidating over the last few years, current markets shares are: LPX 27%, Weyerhauser 17%, Nexfor 14%, GP 9%, Huber 6%. Potlatch 5% and others 16%. Additional consolidation would be great, but the market seems relatively healthy with current shares (UBS has some good industry data). Very little new capacity has been built in the last 12 months and no new capacity is scheduled to be completed in 2003 with two new facilities expected in 2004. While capacity creep in inevitable, supply/demand is better than it has been in recent years. LPX has shown great discipline with 3 of its mills currently off-line. OSB vs. structural panel shift should create demand for incremental 1B square feet a year all other factors held constant. Capacity utilization should be over 90% this year and next year, past year where capacity utilization was over 90% yielded prices over $200 per thousand square feet.
LPX feels it has some of the lowest cost capacity and plans on further reduce costs $10-12 per thousand square feet with some incremental CapEx spend over the next 3-5 years. OSB prices have averaged $195 per thousand square feet over the last 5 years, but it has averaged only $160 in the last 2 years as 2000 and 2001 capacity additions had to be absorbed. The company feels that $190 is a reasonable estimate for the next few years. Company will not disclose it average cash cost, but based on my conversations with the company, I would estimate it is around $140. LPX has 6B square feet of capacity. If we assume prices average $180 that yields $240mm of EBITDA from OSB (company’s estimates would be closer to $350, EBITDA should grow if additional cost reductions from CapEx materialize and additional capacity from debottlenecking kick in).
LPX’s other businesses are much less commodity like. They are sold based on product features and variety. LPX has the number strong position in exterior siding with the broadest product line. LPX is #1 in most of the other composite wood markets it serves. LPX has just begun ramping up capacity and sales in composite decking (key competitor is TREX) and is already sold out for 2003 (company raised prices 30% January 1st). These businesses should generate at least $145mm of EBITDA annually.
Maintenance CapEx is $40mm, LPX will spend $75mm in 2003, $100mm in 2004 and $105 in 2005 to reduce OSB cost – D&A is $125mm. This CapEx will also allow for 1B square feet of OSB to be created through debottlenecks and reduce the use of natural gas and other energy based inputs in the production process (reducing leverage to energy disruption, which nicked the 1st quarter numbers by $10mm) – total reduction in cost per thousand square feet of $10-12. Incremental CapEx of $250 should yield 60mm of additional EBITDA on existing capacity, plus increase capacity by 16%.
Corporate expenses are $80mm. Cash pension costs for 2003 will be $21mm above the amount recognized in the income statement company uses 8.5% return assumption. Total pension costs for the year will be $37mm with total benefits paid of $20mm.
Company has indicated that they are not planning any new builds in the next 2 years, except maybe a few extruders for the composite decking/lumber business. Additionally, company does not need any more capacity or geographic diversification, but would consider buying other mills, if and only if they are not only priced right, but also upgradeable to the company’s standards.
There are 2 class action product liability cases outstanding. LPX has set up settlements for both of these cases and thinks they are under control. LPX has proposed a plan to completely settle one of these cases and estimates it will be resolved for under $50mm by the end of 2003. The second case is long-tailed but has an estimated total liability of $40mm.
Company will be considering stock buybacks or a dividend after the completion of the asset sales and a new bank agreement is established (needed primarily for L/Cs). Appropriate debt level would be closer to $400mm, implying over 20mm shares could and should be repurchased.
Adding all of this together:
2004E
OSB EBITDA – 240 – 350 - conservative estimate– company’s estimate
Other EBITDA - 145
Corp Expense - (80) – (90)
Net Interest Exp - (35) – much of this is b/c some junk debt can’t be repaid easily
CapEx - (100) – substantially above maintenance levels
Cash Pension - (20)
Cash Taxes - (70) – (95)
EBITDA - 305 - 405
FCF - 80 - 155
Net Debt - 150 – adjusted for asset sales
Market Cap - 850
Adjusted EV - 1,000
EV/EBITDA - 3.3X – 2.5X – adjusted for asset sales
FCF to equity - 9.4% - 15.5% - may improve substantially if the company buys back stock.
Most paper and forest product companies trade at least 4.5X EBITDA and building material companies trade at even higher multiples. Few if any companies will be as underlevered as LPX.
Target EBITDA Multiple – using $350 EBITDA (midpoint of conservative and company’s estimate)
4.5X - $13.60 stock price a 67% gain
5.0X - $15.25 stock price a 87% gain
Somewhere in the middle is our price target of 14.50.
Risks:
· New housing turns negative. If this is your concern you can hedge with many of the other building product companies or Weyerhauser – which depends on housing for approximately 50% of its business.
· Competitors want market share and build lots of new capacity. Always possible, but most of the other big competitors have other things to worry about (WY – integrating a merger, Nexfor – just bought Intl Paper’s OSB facilities, GP – swimming in debt,)
· Some other product liability class action happens. Company has spent a lot of time and money changing their selling materials and products to reduce such risks, but you can never eliminate such risks.
Catalyst
Restructuring; selling timber acreage. Pro forma for asset sales, LPX will have little debt and trade below 3x EBITDA.