Boise Cascade: Great Company But Valuation Is Overextended

Investment Thesis

I am interested in reviewing the financials of Boise Cascade Company (NYSE:BCC) to determine whether it is a good time to initiate a position before its earnings report estimated next month on February 21st. Despite a 100% rally in the past year, the company’s financials have deteriorated. I believe there may be some profit-taking in the near future, especially if the company misses earnings. Therefore, I am giving it a hold rating until I observe improvements in the company’s performance.

Briefly on the Company

The company focuses on manufacturing and distributing building materials for residential and light commercial construction. The company manufactures building materials, such as engineered wood products of EWPs, which is their specialty. It comes in a variety of different high-performance beams, joists, and panels. The company also makes plywood, and oriented strand board, for flooring and walls.

It also distributes building materials. It provides wholesale distributions through its Boise Building Solutions distribution network. Materials such as metal roofing and siding, decking and outdoor living materials, and insulation and windows.

Financials

As of Q3´23, the company had around $1.3B in cash and equivalents, against around $440m in long-term debt. The company can easily pay back the debt if it wants to, but it chooses not to, and I don’t blame them. The cash can be used for other ventures. Ventures that could be used to further the growth of the company. The company’s cash position alone is worth $32 a share. But to just be sure that the company’s debt is not an issue, I would like to look at three solvency metrics below.

As you can see from the ratios above, the company is not in any solvency risk whatsoever. All returned green in the most recent years. For reference, I consider a debt-to-assets ratio under 0.6 to be acceptable. Debt-to-equity under 1.5, and interest coverage ratio over 5x for conservatism. It’s safe to say the company is not overindulging on debt. The massive pile of cash can be used for strategic acquisitions and slowly pay down the debt because interest expenses are quite low.

BCC’s current ratio is very robust also, to the point where I consider it to be a little too strong, and displays an inefficient use of capital, which is a good problem to have when the company has so much cash on hand. I would like to see the company’s current ratio come down to a more reasonable 2.0. That way it will show me that the company is not hoarding cash for no reason and is strategically making growth decisions that will help increase shareholder value. As I said, cash hoarding is a better problem to have than not having the ability to pay its short-term obligations. BCC certainly doesn’t have any liquidity issues.

Looking at the company’s margins, we can see a substantial improvement over the last decade, and a slight retracement close to the end of FY22. This undoubtedly was driven by a massive surge in lumber prices, which drove the demand for the company’s products. Since then, lumber prices have come considerably down over the last year and seem to have stabilized. I am certain margins will either continue to come down slightly more or stabilize at around where they are right now, which is not a bad level, however, we will need to see how it is developing over the next couple of quarters.

Continuing on efficiency and profitability, unsurprisingly, the company’s ROA and ROE have seen a massive surge over the last couple of years due to the substantial top-line acceleration. These metrics will see further deterioration in my opinion, before it settles down, and that will take a couple of quarters to develop.

According to the company’s 10-K, it has quite a lot of competition, however, of the ones mentioned, only two seem to be public companies, so I don’t think the below comparison is exhaustive, however, it looks like BCC is strong in the lead in terms of return on total capital. The company has a decent moat and is enjoying a competitive advantage compared to its peers. Even with the recent declines, BCC is still well above my minimum of 10%.

In terms of revenues, before the surge in lumber prices, the company saw a respectable 6% CAGR, but if we include the two spikes in prices, the company’s 10-year CAGR stands at around 11%, while only increasing in more recent years, which was not going to be sustainable as prices plummeted once again. Analysts estimate that the company will see around a 19% drop in revenues for FY23, which is understandable. Years after that it is hard to trust the numbers as no one can predict what the economy will experience, so I take those numbers with a grain of salt, however, the numbers are not positive.

Overall, the company benefited a lot from supply chain issues, which led to a massive surge in lumber prices and the demand for their products. The last few quarters are not giving me hope because every metric above is on a decline, and a rather steep one, which makes me a lot more cautious about where the company’s operations going to stabilize in the near future. That means everything may continue to decline further, and that would be bad for the stock, which grew 5x over the last 5 years. The balance sheet of the company is very strong and no issues there, with plenty of cash to weather any sort of downturn. If we do see a substantial downturn in the next while, the cash can be used to acquire some companies that would aid BCC’s growth further as many companies may get beaten down and present an opportunity to be acquired at a discount.

Valuation

I’m going to approach my revenue assumptions with a very conservative mindset, as I usually do with all my analyses. I am incorporating around a 19% decline in revenues for FY23, and then the company will see very small increases in revenue for the rest of the model, which ends up being around 2% CAGR over the next decade. That seems very conservative to me. On top of that, I modeled a more conservative and optimistic scenario, to give myself a range of possible outcomes. Below are those estimates, with their respective CAGRs.

In terms of margins and EPS, I went with much more conservative estimates than what the company managed to achieve at the end of FY22. This reflects the decrease in lumber prices and the company’s decline in efficiency and profitability because of it. Over time, I modeled that these would improve but only slightly. As you can see the company’s EPS will reach FY22’s levels only by FY32, which seems on the conservative side and will provide me with a decent margin of safety. Below are those estimates with FY22 as a comparison.

For the DCF analysis, I went with the company’s WACC of almost 11%, which is quite high, so I’m going to leave it at that. I am also going to use a 2.5% terminal growth rate. Furthermore, to be on the even safer side, I am going to add another 20% margin of safety to the intrinsic value calculation, just to really beat the company down and obtain as much margin of safety as I can get. With that said, BCC’s intrinsic value is around $158 a share, which means that even after such a rally, the company is still trading at a decent discount to its fair value.

Closing Comments

Although the company appears to have ample room to grow before reaching its fair value, I am still assigning it a hold rating due to recent declines in the above metrics. I believe that these metrics will continue to decrease for a while before stabilizing, which may cause the share price to drop even further. If this happens, it could result in a better entry point for investors.

In addition, as the company has experienced over 100% growth in the last year, some investors may choose to take profits, which could cause a drop in the share price. Due to this, I recommend waiting until the next earnings report is released before making any investment decisions. Given the rapid surge in share price, I do not believe that the risk/reward ratio is very favorable at this point.