A Sky-High Yield That's Not Pulp Fiction

11/03/2010 3:48 pm EST


Roger Conrad

Chief Analyst/Managing Partner, Capitalist Times

The paper-making subsidiary of a leading Canadian timber producer is stacking up huge shareholder returns thanks to an uncommonly generous yield, writes Roger S. Conrad in Canadian Edge.

The Canfor Pulp Income Fund (TSX: CFX-U, OTC: CFPUF) is the highest-yielding trust I’ve ever recommended, weighing in with a truly extraordinary 20.8% yield at last count.

The trust’s sole asset is a 49.8% interest in Canfor Pulp Limited Partnership, a leading global supplier of pulp and paper products operating three mills in Prince George, BC. The partnership is the largest North American and third-largest global producer of NBSK pulp—northern bleached softwood kraft. It’s also one of the world’s lowest-cost operators and the leading producer of fully bleached, high-performance kraft paper.

Canfor’s competitive advantage lies in the proximity of its facilities to British Columbia forests that are rich in high-strength, fine Northern Fibers. These assets are run by the majority (50.2%) partner Canfor (TSX: CFP, OTC: CFPZF), a resource giant with more than C$2.5 billion in annual revenue.

At the depths of the 2008-09 recession, the company was squeezed by weak pricing for its products and the shutdown of much of the Canadian timber industry, which reduced the availability of cheap sawmill residual chips.

That crunch has lessened considerably over the past year, as global demand for softwood pulp has ratcheted up and the timber industry has at least partly revived, both thanks in large part to growing Asian demand that’s offset continued weakness in North America.

[Nonetheless,] the strength in the Canadian dollar reduces the value of export revenue. Also, fiber costs have risen 4% over the past year. The company, however, continues to spend heavily on improvements. As a result, production capacity has risen even as operating costs have fallen and capital costs have remained modest.

The most important question, of course, is how Canfor can possibly pay out a yield of 20%-plus indefinitely. The answer is, it can’t—but management will continue to dish out a yield comfortably in the double digits while providing a way for yield-seekers to play the rebound in Canada’s asset-rich forestry industry.

Management’s policy is essentially to pay out 90% or better of cash flow after debt service and maintenance capital costs.

More encouraging, Canfor has just survived a very difficult time for its market, and it’s now enjoying some of the fruits of recovery. Product prices have risen sharply and remain firm, even as the British Columbia timber industry has remained healthy enough to keep a supply of affordable chips available.

Reflecting that profitability, the current distribution was raised another 13.6% last month, the sixth increase in the past ten months.

[The fund should] continue to both yield double digits and hit new highs long after its conversion date, even if the pulp and paper market does weaken. That’s more than enough to justify buying Canfor Pulp Income Fund up to my long-standing target of US$15, as well as my expectation for annual total returns of 15% to 20%.

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