Norbord NBD
October 16, 2011 - 11:00pm EST by
rosie918
2011 2012
Price: 8.24 EPS $0.00 $0.00
Shares Out. (in M): 44 P/E 0.0x 0.0x
Market Cap (in $M): 355 P/FCF 0.0x 0.0x
Net Debt (in $M): 433 EBIT 0 0
TEV ($): 788 TEV/EBIT 0.0x 0.0x

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Description

This write-up builds on cmn3d's detailed piece on US housing generally and on kevin155's piece on LPX.  For those interested in betting on a housing recovery, I believe Norbord (NBD CN) is a particularly attractive, albeit not terribly liquid, way to do so.

Norbord is based in Toronto and traded on the Toronto stock exchange in CAD.  However, its financials are reported in USD.  So all figures I give will be in USD, unless otherwise noted.

NBD is primarily a maker of OSB (Oriented Strand Board).  So this idea is very similar to kevin155's write-up on LPX.  Rather than rehash, I will simply note that housing starts in the US are at extremely depressed levels and that OSB volumes, and more importantly, prices should increase dramatically when starts do.  Every $10 per MSF change in the OSB price in North America drives an incremental $36mm of annualized EBITDA and $0.58 / share of fully taxed EPS.

Again, NBD is a very similar bet to LPX.  I will discuss certain differences, but would be the first to suggest the similarities are far more relevant than the differences.  I will summarize more of the numbers below, but in general, I think the upside to NBD is clearly higher than LPX in a true upside case, slight higher in a "normalized" case, and there is potentially a bit more downside in a bear case.  This is in large part due to the fact that LPX has a net cash position while NBD has net debt.  (Note that I listed NBD's net debt as $433mm for conservatism in the top table.  But in any normalized or upside scenario, net debt would be more like $248mm on a pro forma basis after taking into account the strike price proceeds on the warrants).

The most important other difference in my mind between NBD and LPX is liquidity.  NBD only trades ~$1.1mm per day at today's share price, while LPX trades ~15x that amount.  In addition, NBD is controlled by Brookfield Asset Management with a 52% stake.  NBD also has a minority of its business in Europe. 

On the other hand, there are a number of differences that I think swing in NBD's favor over LPX.  First, NBD has consistently delivered better EBITDA margins in North America OSB than LPX over the last 5+ years.  On a companywide basis, NBD has also averaged EBITDA margins ~580 bps higher than LPX over the period of 2002-2010.  NBD also had a slightly smaller pension funding gap at the end of 2010 ($25mm) compared to LPX ($61mm).  While NBD has a bit less operating leverage than LPX in a true upside case given that NBD is lower on the cost curve, NBD's net debt position should provide more upside to the equity in the event of a strong housing recovery. 

This is especially true when fully penalizing both LPX and NBD for their respective warrants outstanding.  This may very well be unfairly penalizing NBD over LPX.  LPX's remaining 9.9mm warrants outstanding will almost certainly be exercised given they are so massively in the money already ($1.39 / share strike price) and they don't expire till 2017.  On the other hand, there is some possibility that NBD's 13.6mm warrants expire worthless (particularly if a recovery is delayed) since NBD's have only a bit over 2 years till expiration (Dec 2013) and are struck 65% above the current share price.  Moreover, while assuming LPX's warrants are exercised only expands the share count by 7.5% on a gross basis, assuming that NBD's warrants are exercised (which I assume in all of my base and upside cases) expands the share count by 31% on a gross basis.  If NBD's warrants expire worthless, it will mean that this idea has not worked out well over the next 2 years (and being that early is basically the same as being wrong), but I suppose that for those with a very long time horizon, an eventual recovery on the smaller share base (without the warrant dilution) would ultimately provide significantly greater absolute upside than I suggest below.

I think the upside on "normalized" EBITDA is pretty similar to LPX, but slightly better.  The LPX write-up assumed a 5x multiple on $300-400mm of EBITDA and implies upside of ~80-135% on today's stock price after full warrant dilution.  Using the same 5x multiple on $250-300mm of EBITDA for NBD gets you to ~115-170% upside, after assuming full warrant dilution.  In fact, you can use a 0.5x multiple discount for NBD (i.e. 4.5x EBITDA) and still come to ~90-135% upside.  As a sanity check, EBITDA averaged $218mm over 2002-2010 for NBD, while LPX EBITDA averaged $255mm over that time frame.  So the "normalized" EBITDA assumption for NBD is ~15-38% higher than the 2002-2010 average, while the "normalized" assumption for LPX is actually ~17-57% above the 2002-2010 average.

Valuing NBD by applying a $/BSF of capacity based on recent private transactions also yields a bit more upside than at LPX.  The LPX write-up applies $270-280 / BSF of capacity.  Applying the same metric to NBD yields ~200% upside, again after full warrant dilution.  Moreover, considering NBD's higher EBITDA margins than LPX over the cycle, perhaps a case could be made to actually value NBD's capacity at a higher $ / BSF valuation.

In terms of downside, I would note that NBD is trading at only ~$131 / BSF of capacity today.  The stock is trading 7% above its 52 week closing price low 2 weeks ago and 65% above its all time closing low during the credit crisis.  (For comparison, LPX stock is trading 37% above its 52 week closing price low 2 weeks ago and 403% above its all time closing low during the credit crisis).  All that said, given NBD's more limited trading liquidity and positive net debt, its downside is potentially still greater than LPX.

While BAM's 52% stake in NBD is a potential risk and limits trading liquidity in the stock, one could argue that the presence of that "rich uncle" is actually beneficial to NBD, at least in certain circumstances.  In a downturn, BAM would have ample capacity to extend related party loans to NBD, which would be less onerous than third party financing.  (On the other hand, an excessively large rights offering in a downturn would be more dilutive than if BAM were not involved).  Generally speaking, BAM has proven itself to be a strong investor and capital allocator over time and across different businesses and industries.  Given the extreme cyclicality of the OSB business, this is important over time. 

While NBD's rights offering was highly dilutive, its other capital allocation decisions over the years (especially in the boom times) seem superior to LPX's.  Specifically, NBD paid a $10 / share special dividend in 2004 and another $10 / share special dividend in 2005.  I think that is the exact right move for a highly cyclical business in a boom time.  Moreover, NBD paid a $4 / share regular annual dividend, and bought back some of its stock in the boom years.  On the other hand, LPX basically spent its windfall earnings in the boom times on a vastly ramped up capex program.  To the extent that LPX and NBD both do the same thing again with their windfall earnings in the next boom times, I'd rather take the special dividends in cash than watch management ramp up capex again.

In summary, I found cmn3d's write-up on housing generally and kevin155's write-up on LPX to be very compelling.  In that vein, I am adding NBD CN to the mix.  While it is clearly less liquid than LPX and has positive net debt, I think its other positive attributes more than compensate especially in upside and "normalized" scenarios.

Risks:

Nearer term pressure out of Europe operations?

July 2012 bond maturity.  (Management has resisted refinancing them to date to avoid paying an excessive make-whole to call them).

 

Catalysts:

US housing starts recover.

Falling resin costs in an environment where global GDP slows, but US housing does not suffer from its already depressed levels.

Catalyst

US housing starts recover.

Falling resin costs in an environment where global GDP slows, but US housing does not suffer from its already depressed levels.

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