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Hardwoods Distribution is a new Key stock

The Investment Reporter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846

We’ve added Hardwoods Distribution to our Key stocks. This ‘Higher Risk’ stock is a buy for long-term gains and rising dividends. The company’s earnings are growing quickly and its excess cash flow gives it the means to continue to grow and reward you.


Key stock Stella-Jones graduated from ‘Higher Risk’ to ‘Average’ (in our August 30 issue). Partly to include a ‘Higher Risk’ Key stock, we’ve added B.C.-based Hardwoods Distribution, or HWD to our Keys. It’s a buy for long-term gains and rising dividends.

HWD describes itself as “one of North America’s largest distributors of premium hardwood lumber, sheet goods and panel products to the cabinet, moulding, millwork, furniture and specialty wood products industries.” Its subsidiaries operate 32 distribution centers in Canada and the U.S.

In the six months to June 30, HWD earned $7.6 million, or 46 cents a share. This was more than double the $3.6 million, or 22 cents a share, it earned a year earlier. Sales growth exceeded costs growth.

HWD’s first-half profit more than doubled

In the first half, HWD earned another $2.7 million of ‘comprehensive’ income. This was due to the rise of the U.S. dollar. Sales and profits south of the border turned into more loonies. The company generates nearly three-quarters of its sales in the U.S. (sales of $136 million out of total sales of $183 million in the first half). In last year’s first half, comprehensive income was just $59,000.

HWD’s first-half comprehensive income stood at $10.3 million, compared to only $3.7 million, a year earlier. The low loonie should keep raising its comprehensive income. But since the company has no control over exchange rates, we exclude this from our examination of its income statement.

In the first half, HWD’s sales jumped by over a fifth, to $183 million. It generates half its sales from new residential construction. In the second quarter, U.S. housing starts of 872,000 had increased by 17.7 per cent, from 741,000 a year earlier. Even better, average prices for hardwood lumber products were up by 14 per cent from a year earlier. Higher prices more than offset a 12.5 per cent decline in Canadian housing starts in the second quarter of 2013.

Each one of HWD’s costs increased less than its sales. As a group, its costs rose by 17 per cent. Since this was much less than the company’s sales growth of over a fifth, its first-half pre-tax income nearly doubled, to $11.5 million. In addition, its tax rate fell by four percentage points, to 34 per cent. But tax rates are largely beyond HWD’s control and it’s no basis for sustainable earnings growth.

Higher prices reflected trade duties on imported plywood from China, which took effect in March. This raised prices for both North American and imported panel products right away. In the first half, HWD’s gross profit margin jumped by 0.8 percentage points, to 18.6 per cent. It expects to earn a more normal gross profit margin of 18 per cent in the second half of this year. One problem is that 14 per cent of HWD’s sales are of hardwood plywood manufactured in China and subject to the trade duties. But it’s diversifying its supplier base geographically. In the first half, the company moved to import more from Indonesia, Malaysia and Russia. A recent acquisition will raise its sales of tropical woods from Africa and South America.

In the first half, HWD generated cash flow of $9.7 million. This was up by nearly a half from $6.5 million, a year earlier. This confirms the company’s higher earnings in the first half. Even better, the cash flow greatly exceeded net capital spending of less than $0.3 million and dividend payments of under $1.1 million. This gave it the means to pay $3 million for the acquisition in North Carolina.

HWD’s excess cash flow should also enable it to repay debt. On June 30, its net debt and finance lease obligations of $47.2 million were nearly 3.3 times its cash flow of $14.4 million over the latest four quarters. While hardwood prices are more stable than ordinary lumber prices, this is still a little high for our comfort. It’s above our usual comfort level of two time or less. But with excess cash flow of over $8 million, the company should manage to repay debt.

HWD generates growing excess cash flow

HWD’s rising and excess cash flow also lets it increase its dividends. After paying nothing in 2010, it paid two cents a share in 2011. The company raised its dividend to a dozen cents a share in 2012. It now pays 14 cents a share, for a yield of 1.7 per cent. We expect HWD to continue to raise its dividend in the years ahead. Still, it will take a long-time to reach the peak cash distribution of $1.08 a unit it made in 2005, when it was an income fund.

In fact, those cash distributions explain why HWD still has a deficit instead of retained earnings. On the positive side, this deficit is shrinking. It should continue to shrink as the company earns more than it pays in dividends.

The rising dividends are one way HWD rewards you. That’s no surprise, since management and insiders own 6,478,900 shares, or 39.5 per cent, of the 16,394,490 shares. Management’s ownership makes its interest similar to yours. Despite management’s large stake, HWD’s shares trade. This can let individual investors build a stake in the company.

President and chief executive officer Lance Blanco is positive about HWD’s outlook. He says “we remain optimistic about the balance of 2013 and beyond. While we expect margins will trend down to more typical levels in the second half of the year, demand from the U.S. residential construction market is expected to remain strong and drive continued sales growth for Hardwoods.” In fact, forecasters see stronger U.S. house starts for several years. Growth in the Canadian renovation and commercial construction markets will help offset lower housing starts in Canada. Indeed, HWD wants more presence in commercial and institutional construction markets. It also wants to introduce new products and expand its production capabilities.

In 2013, we expect HWD to earn 80 cents a share. This is more than double the 38 cents a share it earned last year. Next year, we expect the company to earn 85 cents a share. Its acquisition on the U.S. East Coast is generating yearly sales of $4 million.

New Key stock HARDWOODS DISTRIBUTION $8.30 (Quality rating: Higher Risk; Sector: Consumer; TSX-HWD; T: 604-881-1990; www.hardwoods-inc.com) is a buy for long-term share price gains and rising dividends.




The Investment Reporter, MPL Communications Inc.
133 Richmond St.W., Toronto, ON, M5H 3M8. 1-800-804-8846