CANFOR CORPORATION
On March 25, shareholders of Slocan Forest Products
voted in favour of the plan of arrangement providing for the Company’s
acquisition by Canfor Corporation. The combination became effective April
1, 2004 and the financial results will be consolidated in the second
quarter report. We believe that despite the recent run in the stock, the
market has yet to fully appreciate the potential of this combined entity.
Capacity should increase to over 5.2 billion board feet of lumber, 1.2
million tonnes of pulp, 950 million square feet of plywood and OSB and
150,000 tonnes of kraft paper. Besides the usual economies of scale and
rising commodity prices, the $60 million in projected synergies appears to
be quite conservative.
On April 23, Canfor reported results for the first
quarter of fiscal 2004 that were above most analysts’ expectations. The
Company generated $92.4 million of EBITDA, almost triple the $33.5 million
of EBITDA last year. Operating income improved to $62.4 million in the
quarter compared to only $3.1 million in the first quarter of 2003. On an
earnings per share basis, Canfor earned $0.34 compared to $0.43 the
previous year, which doesn’t really tell the full story. In the current
quarter Canfor had a $6.0 million unrealized foreign exchange loss on
long-term debt compared to a $36.2 million gain a year ago. Looking past
this non-operating item, we saw a real turn in the profitability in the
quarter.
What drove this improvement? US dollar denominated
lumber prices were 51% higher than in the same period in 2003 due to
strong housing demand. Pulp prices were 23% higher as a recovering economy
powered demand. Canfor’s CRMI program (cost reduction/margin improvement)
is now targeting annual savings of $230 million compared to $150 million
at inception. As an example, productivity at the wood products division
was 20% higher and conversion costs were 23% lower than the fourth quarter
of 2003. Given the magnitude of improvement, we are optimistic that the
forecast of $60 million in synergies from Slocan will be revised upward.
Looking forward to the second quarter results,
Canfor should be “firing on all cylinders”. Lumber prices (Western SPF
2x4) have increased to $462 per thousand board feet compared to $233 last
year and pulp prices have increased to $640 per tonne from $558 a year
ago. Combine better commodity prices, with continued cost cutting and the
Slocan synergies, and Canfor’s earnings for the second quarter could
surprise many people. How good could they be? Earnings of $1.00 per share
would not be an unrealistic estimate. Finally, as the softwood lumber
dispute swings in favour of Canada, the refund of duties paid will
eventually become reflected in Canfor’s share price.
LAURENTIAN BANK
Laurentian Bank had a difficult year in fiscal 2003,
as a result of lower net interest margins, loan loss provisions and cost
increases. Although the Bank reported $3.32 per fully diluted common
share, the headline number included several unusual items. A restructuring
charge and loan losses were more than offset by a large gain on the sale
of 57 bank branches. Excluding the unusual items, Laurentian Bank earned
$1.80 per fully diluted common share, implying a return on equity of only
4%. Although the earnings were disappointing, the Bank remains well
capitalized and is committed to paying its annual dividend of $1.16.
As we await the return to more normalized levels of
profitability, Raymond McManus, CEO, has begun to define the future
direction of the Bank. As he stated in a recent news release, "given the
uncertain economic and interest rate environment, the Bank has adopted
more conservative growth and profitability objectives". In keeping with
this strategy, Laurentian Bank divested 57 branches in Ontario and Western
Canada for a pre-tax gain of $69.9 million, which was included in the
results as discussed above. Laurentian received almost twice book value
for these branches, which was an excellent price for these assets. Clearly
the buyer, the TD Bank, was a motivated purchaser.
Results for the first six months indicate that the
Bank is on track to meet its goals for fiscal 2004. Return on equity for
the six-month period was 6% compared to the 5% objective. Diluted earnings
per share for the first months were $0.85, which implies that the full
year EPS objective of $1.44 is achievable. Year to date, total revenue of
$244 million is 49% of the annual target of $503 million. The efficiency
ratio came in at 76.6%, ahead of the 77.0% objective for the year. Capital
ratios, both Tier 1 and total, were more conservative than mandated.
Finally, the loan loss ratio of 0.25% was only slightly higher than the
2004 objective of 0.22%. The Board of Directors considered the results to
be “satisfactory”, the financial condition of the Bank to be “sound” and
declared the quarterly dividend of $0.29 per share.
Although the strategic repositioning will not occur
overnight, we support management's efforts to "get back to business" in
order to improve profitability over the long run.
Ray McManus seems to have a clear vision for the Bank and has shown a
willingness to make things happen. We would point to the sale of the 57
branches in Ontario and Western Canada to TD Bank and the privatization of
B2B Trust as examples of his decisiveness. As we wait patiently for the
turnaround to play out, the healthy dividend should provide downside
protection.
SHOPKO STORES
ShopKo Stores is a discount specialty retailer,
which manages 361 stores in 23 states. Of these stores, 141 are operated
under the ShopKo name while the remaining 220 stores operate under the
Pamida banner. The ShopKo retail segment consists of a multi-department
retailer located primarily in mid-size and larger communities with an
average store size of 90,000 square feet. The Pamida retail segment is a
general merchandise retailer serving smaller and more rural communities,
offering a convenient, one-stop shopping format with an average store size
of 27,500 square feet.
Shares of ShopKo reached an all time high of $40.75
in July 1999. Earnings had grown from $1 per share in 1993 to $2.60 a
share in 1999, an average annual growth rate over 17% per year. The
following year, a softening U.S. economy turned same store sales
comparisons negative while competition from Wal-Mart and other larger
department stores eroded profit margins. As a result, ShopKo’s earnings
fell to $1.14 per share. With that, many investors who purchased ShopKo
for its earnings growth exited the stock. As ShopKo’s share price fell and
interest in the stock dissipated, most of the brokerage firms on Wall
Street either issued sell recommendations or dropped coverage entirely. By
the end of the year, ShopKo shares had fallen below $5.
Today ShopKo appears to be making strides to improve
its operations and increase sales. First of all, the company has made
significant management changes in the last year and a half including the
addition of Sam Duncan as CEO. Duncan previously served as President of
Fred Meyer, a general merchandise and food retailer. Second, ShopKo has
added pharmacies and optical centers to its Pamida stores. In addition to
generating store traffic, these services have contributed significantly to
the company’s overall sales and profitability in its ShopKo division.
Finally, the company is busy remodeling and re-modernizing its Pamida
stores. The remodeled stores will feature a new “easy-to-shop” appearance,
including improved sight lines, reduced aisle congestion and attractive,
easy-to-read signing.
ShopKo trades at a 30% discount to its book value of
$20.15 per share and roughly 10 times management’s earnings guidance of
between $1.33 and $1.48 per share. ShopKo also owns nearly half of its
store locations as well as its corporate headquarters and distribution
centres. Insiders hold less than 3% of the outstanding shares and
therefore the company could theoretically be a takeover candidate. Same
store sales rose 3.2% in May and if this trend continues, we feel ShopKo
could command a higher price to book and or price to earnings multiple
going forward.
TODHUNTER INTERNATIONAL
Todhunter International is engaged in a number of
different businesses, all of which are related to the production of
alcoholic beverages. First of all, the company is the largest supplier of
bulk rum, citrus brandy and fortified citrus wine in the United States.
The company sells its bulk alcohol products to over 40 producers of
beverage alcohol in the U.S. and exports products to approximately 10
foreign countries. Second, to complement its distilling operations, the
company also produces vinegar, vinegar stock and cooking wine. Finally,
Todhunter carries its own line of premium branded estate and flavoured
rums under the brand name “Cruzan”. Cruzan is sold to retailers in the
U.S., Europe and Canada, including Liquor Stores in Ontario, which carry
Cruzan’s Coconut and Vanilla flavoured rums.
Todhunter is 68% owned by Angostura Limited, a
Trinidad based distiller. Due to the high percentage of stock that
Angostura owns, Todhunter’s public float is small and trading in the stock
is thin. As a result, very few people on Wall Street bother to follow it
and therefore, not surprisingly, many investors do not know the company.
Shares of Todhunter sell at a slight premium to its book value of $12.77
per share: a figure that likely understates the company’s 138 acres of
land that it owns in Florida and the Virgin Islands. The shares also trade
for less than 15 times earnings of approximately $1 per share. However, if
you exclude the operating loss of the Cruzan line, the multiple on the
remaining bulk and cooking wine/vinegar divisions would actually be closer
to 10 times earnings. This multiple is low considering the high margin
high cash flow nature of these businesses.
As for Cruzan Rum, we feel this asset could be the
company’s hidden jewel. Comparable valuations such as Seagram’s sale of
Captain Morgan and Diageo’s sale of Malibu suggest that Cruzan alone could
be worth as much as $8 to $10 per share. Furthermore, Barcardi, the
world’s number one selling brand of rum in the world, is rumoured to be
considering a public stock offering. An IPO of this magnitude could
revitalize interest in the sector and set a new precedent for valuations
in the industry given that Barcardi would likely fetch a premium multiple.
On a final note, it seems that Todhunter is close to being taken private
by its parent Angostura Limited. On June 9th 2004, Angostura purchased $10
million worth of Todhunter stock in a private placement at $14.00 per
share. Given the lack of interest in the stock, the added costs of being a
public company, and the potential hidden value in the Cruzan brand, we
would not be surprised if Angostura made a premium offer for the remaining
Todhunter shares.
Irwin A. Michael, CFA
