Stella Jones Thesis (SJ)
A boring, inflation proof, and stable business
Stella Jones Analysis
Summary
Management
Long term oriented
Diligent capital allocators
Shareholder friendly
Competitive advantage
Duopoly with Koppers
North American Leader in Market for Poles and Rail Ties
Margin of Safety price point
Ten Cap entry $40.50
DCF entry $26.02
Current stock price - $35.64
The Company
Stella Jones is North Americas leading producer of utility poles and railway ties. The company also manufactures and distributes residential lumber to the Canadian and US market. They operate 42 wood treatment plants, 12 pole peeling facilities and a coal tar distillery.
The Story
Stella Jones operates in a sector supporting critical infrastructure. Specifically, power grids, Class 1 and Commercial Rail, marine, and bridges. The majority of the sales to these companies is driven via scheduled maintenance or replacement due to natural disasters which have become more frequent. The critical infrastructure portion of the business makes up around 70% of the revenue this business has. We believe that the railway business is stable with little or no growth annually. Where we think there may be a large opportunity is in the utility poles business.
In addition to a changing global climate, the emergence of 5g, new broadband initiatives, electric vehicle adoption, and IoT attachments on utility poles is putting a strain on existing electrical distribution systems. These initiatives will lead Utilities to retire poles earlier that their useful life. This will occur primarily for two reasons.
It is cheaper to construct and operate above ground distribution networks. Similarly it is more cost effective to build out or upgrade a broadband network using the distribution infrastructure when it is built above ground. If it one or the other already existed in an area, safe digging practices (hydrovac) or directional drilling would need to be utilized. When communications cables are attached to utility poles, a certain distance of separation is required between the communication cables and the utilities power cables . This is stipulated by local building standards or the codes of the day when facilities are installed but is generally done for safety, and operational reasons. Almost any installation of new broadband will require the replacement of a certain number of poles by the utility for uplift, bending moment/structural, clearance, code, or for end of life reasons (its easier to lean and entire line that is close to end of life than to sporadically replace every third or 4th pole).
The distribution network is currently not built to support the load that will be required of it by adding electric vehicles to the network. In 2020 there were 276 million vehicles registered in the united states. Assuming that the average car today is 150hp and is operating at 30% capacity. That means that each vehicle on the road is using 45kW/hr of drive time. With an average drive time of 8.5 hr's /week, the annual drive time is 442 hr. Each electric vehicle on the road will use 19890kWh of power in a given year. When that figure is compared to the average annual consumption of an entire household in North America of 10,715kWh/year, you can quickly see the problem. The Utility Grid in North America is built to service existing infrastructure and we would need to double the capacity of the system if we hit full adoption. Infrastructure will need to be upgraded to larger and heavier duty cables. This replacement process will lead to the installation of larger and more heavy duty poles for example from a 1 phase #4Al cable to a 3 phase 3/0 system for some mainline infrastructure.
To quantify this further lets assume that we hit a 10% adoption rate of electric vehicles in the United States over the next 5-10 years. That would mean that there are 27.6million electric vehicles on the roads. Each vehicle consumes 19,890kWh of power per year. That would equate to a total of 548,964,000 MWh of power per year. Divided by the average home consumption of 10.715 MWh per year would mean the addition of 51.2 million homes equivalent on the distribution system. That is approximately 1/3 of the current residential load on the distribution system in north America today and could not be supported by the existing grid or generation capacity. This shift will lead to the entire distribution network being rebuilt over the next 30 years regardless of the remaining useful life of the assets.
In North America there are currently an estimated 130 million poles in service. These poles will be replace roughly every 40 - 60 years. In California for example, PG&E announced in 2021 that over 500,000.00 poles were at risk of critical failure and needed to be replaced. In the future with more frequent damaging weather patterns, it would be safe to assume that more poles will need to be replaced more frequently leading to additional revenue for stella Jones.
On the rail side of the business, Stela-Jones provides Railway ties for replacement purposes. These are also part of maintenance program replacements and are based on use. As long as trains keep running rail ties will be required. The more they run the more replacements they will have. Although we cannon predict the future, a safe a assumption is that this part of the business remains flat and consistent overtime with no or low single digit earnings growth.
Stella jones has a plan to continue to grow through Strategic acquisitions, as well as through organic growth. That plan has not changed in close to a decade. The management team at Stella Jones has so far, done exactly what they say they were planning on doing and their forecasts have generally been very close for the companies growth. We expect management to continue to expand and improve on the business for many years to come.
The Evaluation
10 Cap Evaluation
At Black Opal we value businesses as if we were going to buy the entire thing. Our Ten Cap analysis is very simple and is a similar method that the Oracle of Omaha would use to value a wonderful business. It ensures that if we purchased the whole business, we would get a return of our entire initial investment over a ten year period. This analysis does not include any growth metrics and assumes that the business will be steady and constant throughout time.
In 2021, Stella Jones had cashflow from operations of $251 million in. They had capital expenditures of 64 million. Some of the capital expenditures may have improved operations and profitability but because its difficult to distinguish we will assume the entire amount was for ordinary maintenance of the business. Stella Jones paid a total of $76 million in taxes in 2021 so we will adjust to show pre tax earnings.
251m - 64m + 76m = 263m in owner earnings
Shares outstanding 65m
263m/65m = 4.05/ share
Over ten years we want our entire investment back so that means my purchase price per share today is around $40.50/share.
DCF Evaluation
In order to ensure that we have multiple different ways to look at the value of a business, we also complete a DCF evaluation. We utilize 15% annual returns and are always looking to enter every position with a margin of safety so that even when we are wrong, we don’t lose money.
Stella Jones had 2021 EPS of $3.37. We expect the 10 year earnings growth rate to be around 11%. This factors in additional revenue from the utility pole business, Inflationary increases in the Railway ties business, and a flat Retail Lumber segment. We expect management to make several accreditive acquisitions of approximately 100m a year. Based on these numbers we believe the future price of the company discounted to today is worth 52.04. For Black Opal, we would consider an entry price 50% below what we feel the company is worth. Our buy price based on growth would be $26.02.
Current Event
We typically look for event driven investment opportunities with predictable outcomes. We believe that Stella Jones like many other companies right now are going through a macro economic event due to a pending recession and rising interest rates. We also believe that investors are predicting a slowdown in lumber sales which could negatively affect ~25% of Stella Jones revenue in the short term. Management however has already factored in this slowdown. Additionally the tremendous increase in lumber prices throughout the pandemic may have lead some investors to believe there was more growth possibility for the business than what actually occurred. We can see that the slowdown in the growth of their lumber business correlated to the selloff of the stock price.
At the time of writing Stella jones is trading around 32.35 and we have already purchased our first block of shares. We will also be selling puts at or below our fair and on sale prices in an attempt to pick up more shares with a better premium or adjust our cost basis downward.
Stay tuned for our next letter which we are in the process of writing. We may also put out a newsletter on options in the next few weeks explaining the basics and how value oriented investors use these tools.
Black Opal
Great analysis!