On today’s TSX Breakouts report, there are 36 stocks on the positive breakouts list (stocks with positive price momentum), and seven stocks are on the negative breakouts list (stocks with negative price momentum).
On Friday, lumber prices climbed to a two-year high. Consequently, a number of forest products stocks have positive price momentum and are listed on the positive breakouts list.
Discussed today is a stock that appears on the positive breakouts list - Hardwoods Distribution Inc. (HDI-T), a distributor of hardwood lumber and building products. This stock is a way for investors to play the U.S. housing market. U.S. building permits data is promising and mortgage applications are strong. For the past five consecutive quarters, the share price has rallied sharply the day after the company has released its quarterly earnings results. From a technical analysis perspective, the stock recently exhibited a bullish “golden cross” pattern. In addition, the stock also offers investors income, currently yielding 1.9 per cent.
A brief outline is provided below that may serve as a springboard for further fundamental research when conducting your own due diligence.
The company
Langley, B.C.-based HDI is a distributor of hardwood lumber and building products used in the residential, repair and remodel, and commercial construction markets. Management estimates that approximately 50 per cent of its products serves the residential construction market (new construction as well as repair and renovation). The other major market that HDI supplies is the commercial construction sector. The company is a market leader with over 60 distribution centres located across North America, making it North America’s largest distributor of architectural building products. The company has a diversified customer base with approximately 40,000 customers. The largest customer accounts for less than 2 per cent of its sales. There is seasonality in the company’s business with the second and third quarters typically the strongest.
In terms of product mix, in 2019, approximately 32 per cent of the company’s sales came from hardwood plywood, 27 per cent of sales consisted of high-grade hardwood lumber, 22 per cent of sales were decorative surfaces and composites including laminates and fibreboard, 10 per cent of sales were doors, and the balance consisted of other architectural building products. Given that the company’s products are used in the final construction stages, there is a six to nine month delay between strong housing starts data and economic benefits realized by HDI.
In terms of geographical revenue breakdown, in 2019, 88 per cent of the company’s total sales came from the U.S., with the balance, 12 per cent, from Canada. As such, U.S. housing starts data is a key statistic to monitor and the company benefits from a rising U.S. dollar.
The company operates in a highly fragmented market allowing for acquisition growth opportunities. Management estimates that the company’s market share in North America is approximately 10 per cent. Since 2011, the company has completed 10 acquisitions, one this year. In March, the company announced the US$3-million acquisition of Diamond Hardwoods, a distributor with operations in northern California and estimated annual sales of US$6-million. Management continues to actively seek out acquisition opportunities.
On June 10, management provided an operational update. In May, average daily organic sales increased 16 per cent month-over-month. The president and chief executive officer Rob Brown said, “In May, we saw increased activity across our distribution network as the pace of construction in many regions increased.”
Hardwood Distribution will be reporting its quarterly earnings results in August. The Street is currently expecting sales to be $280-million, EBITDA to be $15.9-million, and earnings per share to come in at 21 cents. For the past five consecutive quarters, the share price has rallied the day after the company has released its earnings results, rising between 2 per cent and 8 per cent.
After the market closed on May 5, the company reported better-than-expected first-quarter financial results that lifted the share price by 4.6 per cent the following day. Sales came in at $325-million, ahead of the consensus estimate of $313-million. Gross profit margin was a record 19.3 per cent, ahead of its historical range of between 18 per cent and 19 per cent. Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization) was $22.8-million, above the consensus estimate of $19.8-million. Adjusted earnings per share came was 44 cents, surpassing the Street’s forecast of 35 cents. The company has a strong balance sheet. At quarter-end, the company had $59.8-million of cash and borrowing capacity of $42.1-million. While the net debt-to-adjusted EBITDA ratio stood at 2.1 times.
Housing outlook and repair and remodel activity
Industry conditions point to rising future housing demand with mortgage applications climbing. With a low interest rate environment (low mortgage rates) and more individuals working remotely, having a multi-purpose, beautiful home with home office potential has become a priority for people. U.S. building permits in May climbed 14.4 per cent month-over-month. In a report issued on July 8 from the Mortgage Bankers Association, home buying intentions were strong, “Mortgage rates declined to another record low as renewed fears of a coronavirus resurgence offset the impacts from a week of mostly positive economic data, such as June factory orders and payroll employment. The 30-year fixed rate slipped to 3.26 per cent - down 53 basis points since late March. Borrowers acted in response to these lower rates.”
Last week, lumber prices jumped to a two-year high, boosted by strong demand and limited supply arising from mill closures. A report issued by the National Association of Home Builders on July 10 remarked on the 50-per-cent spike in lumber prices since April, saying, “Producers did not anticipate the massive uptick in demand from do-it-yourselfers and big box retailers during the pandemic.”
Dividend policy
The company pays its shareholders a quarterly dividend of 8.5 cents per share or 34 cents per share on a yearly basis. This equates to a current annualized dividend yield of 1.9 per cent.
Management is committed to returning capital to investors. The company has announced a dividend increase each calendar year since 2012.
Analysts’ recommendations
There are five firms actively covering this small-cap industrials stock with a market capitalization of $372-million, of which four analysts have buy recommendations and one analyst (Yuri Lynk, the analyst at Canaccord Genuity) has a ‘hold’ recommendation.
The five firms providing recent research coverage on the company are as follows in alphabetical order: Acumen Capital, Canaccord Genuity, CIBC Capital Markets, Cormark Securities, and National Bank Financial.
Revised recommendations
Month-to-date, three analysts have revised their target prices – all higher.
- Hamir Patel, the analyst at CIBC Capital Markets, increased his target price to $20 from $18.
- Jeff Fenwick, the analyst at Cormark Securities, upgraded his recommendation to a ‘buy’ from a ‘market perform’ and raised his target price to $19 from $15.
- Canaccord Genuity’s analyst Yuri Lynk hiked his target price to $17 (the low on the Street) from $11.
Financial forecasts
The Street is forecasting EBITDA of $74-million in 2020, rising to $81-million in 2021. The consensus earnings per share estimates are $1.16 for 2020, climbing to $1.47 in 2021.
Earnings forecasts are recovering. To illustrate, three months ago, the consensus EBITDA estimates were $67-million for 2020 and $79-million for 2021. The Street was forecasting earnings per share of $1.01 in 2020 and $1.45 the following year.
Valuation
According to Bloomberg, the stock is trading at an enterprise value-to-EBITDA multiple of 7.6 times the 2021 consensus estimate, slightly ahead of its three-year historical average of 7 times. During this time period, the stock has traded at a forward EV/EBITDA multiple range of below five times to as high as 9 times.
The average one-year target price is $19.00, suggesting there is 8-per-cent upside in the share price over the next 12 months (a total return of 10 per cent including the 1.9-per-cent dividend yield). Individual target prices are as follows in numerical order: $17 (the low on the Street is from Yuri Lynk, the analyst at Canaccord Genuity), $18, $19, $20 and $21 (the high on the Street is from Zachary Evershed, the analyst at National Bank Financial).
Insider transactions
Year-to-date, only one insider has reported trading activity in the public market. On March 23, David Hughes, senior vice-president – acquisitions, purchased 10,000 shares at a price per share of $8.0594, increasing this account’s holdings to 298,881 shares.
Chart watch
On Friday, the share price rallied over 3 per cent on high volume with over 143,000 shares traded. Liquidity for this small-cap stock can be low, which can increase price volatility. The three-month historical daily average trading volume is approximately 60,000 shares.
The share price has recovered to pre-COVID levels. Year-to-date, the share price is back in positive territory, up 8 per cent.
Recently, the stock exhibited a bullish technical signal – a “golden cross” – which occurs when the 50-day moving average (at $14.33) crosses above the 200-day moving average (at $13.97).
In terms of key resistance and support levels, the share price has overhead resistance around $20. After that, there is a major ceiling of resistance around $22, which is near is record closing high of $21.95 reached in Oct. 2017. Looking at the downside, there is strong technical support around $15.
The Breakouts file is a technical analysis screen intended to identify companies that are technically breaking out. In addition, this report highlights a company’s dividend policy, analysts’ recommendations, financial forecasts, and provides a brief technical analysis for a security to provide readers with more information.
If a stock appears on the positive breakouts list, this indicates positive price momentum, and that a company may be worthwhile for investors to look at the fundamentals in order to determine if the recent price strength is warranted and will continue. If a security appears on the negative breakouts list, this indicates negative price momentum, and may be indicative of either deteriorating fundamentals or perhaps indicates a buying opportunity.
Securities screened are from the S&P/TSX composite index, the S&P/TSX Small Cap index, as well as Canadian small cap stocks outside of these indices that have a minimum market capitalization of $200-million.
A technical analysis screen does not replace fundamental analysis, but can help identify companies worth having a closer look at.
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