Norbord Inc. (NYSE:OSB ) is the largest North American producer of OSB (oriented strand board, which is a fabricated plywood) with 8 billion ft2 of capacity produced by 13 mills, six in Canada and seven in the United States. The company is diversified into the UK with three plants producing MDF (medium density fibreboard) and particleboard as well as an OSB plant in Genk, Belgium. Please note the symbol for Norbord has changed to "OSB" on both the TSX and the NYSE.

Norbord reported excellent Q1 2016 results on April 29, with $61 million in EBITDA generated versus $122 million for all of 2015 (all dollars US). According to the company, "The momentum of the strong second half of 2015 continued into the first quarter of 2016, with North American benchmark OSB prices 17% higher than the same period last year".

This was most impressive as benchmark OSB prices fell in Q1 versus Q4, from $242 per thousand square feet to $226 or down 6.6%, whereas adjusted EBITDA rose from $57 million to $61 million. European OSB prices rose marginally from 226 euros to 230 euros. Even though Norbord's revenues fell from $415 million in Q4 2015 to $384 million Q1 2016, adjusted EPS rose from 19 cents to 23 cents.

Most importantly, OSB prices have continued to strengthen in Q2 and last week. On Friday, Random Lengths reported that benchmark North Central 7/16 OSB hit $268, up 7.2% on the week. This is $42 higher than the Q1 average price of $22

According to Norbord's commodity and currency sensitivity table, a fully employed North American plant fleet would generate $232 million in additional adjusted EBITDA if this OSB price held for the whole year. An additional $12 million would be generated in the European price held. Therefore, Norbord could be generating adjusted EBITDA at an annualized rate of $488 million or eight times the Q1 2016 rate and four times the entire 2015 EBITDA reported.

Norbord has exposure to currency fluctuations from the USD/CAD, USD/EUR and Pound/EUR rates. But the company has currency hedges to offset this volatility.

Note two Norbord mills, one in Quebec, and one in Georgia, are curtailed, and therefore the assumption is these would be put on line. Nevertheless, we calculate the potential EBITDA generation of $488 million should drive Norbord's stock higher after a three and a half year consolidation.

There is no doubt OSB prices rise during the seasonally strong spring and summer building season in North America. But I believe OSB prices could go even higher. OSB trades at a discount to traditional plywood, but the discount has been narrowing. OSB prices hit $400/1000 ft2 in 2003, and I believe now that the industry has restarted many of the mills idled during the housing crisis, the trade is tighter than commonly believed with no new mills being built.

US housing starts were up 14% year over year in March, with single family dwelling construction up 23%. New residential construction is key to the Norbord story, but OSB is also used for industrial buildings and uses.

Consolidation in the structural panels industry, low interest rates, and 14% year over year higher US residential housing starts are part of the reason. The other reason for Norbord's better than market results is the merger of Norbord with Ainsworth, which closed on March 31, 2015. Ainsworth was the owner of four of the Canadian plants, and the merger is bringing with it $45 million in annualized cost synergies, equal to 53 cents per share. Norbord has large tax losses in the USA and Canada so this is going directly to the bottom line.

Other publicly traded OSB producers are Weyerhauser (WY) and Lousiana-Pacific Corp. (LPX). Weyerhauser reported a bullish view on both lumber and OSB on Friday. OSB EBITDA rose from $25 million to $31 million and Weyerhauser said OSB prices were $7 higher in May than in April.

Louisiana-Pacific reported Q1 results with an equally bullish tone on OSB reporting net sales of $217 million up $27 million and adjusted EBITDA swung positive by $43 million. LP will hold its conference call at 11am EST today.

Weyerhauser sold 759 million square feet in the quarter and LP sold 1,052 million versus Norbord's 1,337 million square feet of shipments in North America.

Net Debt is Reasonable and Debt/EBITDA coming down

Norbord's $749 million in net debt as of Q1 represents a debt/capital ratio of 32% on a market basis and 50% on a book basis. Rising EBITDA levels are expected to reduce Net debt/Adj. EBITDA levels to manageable levels. Norbord had excess liquidity of $$321 million comprised by $14 million in cash and $237 million in unused bank lines and undrawn A/R securitization as of Q1 2016. Note that typically working capital needs rise at the beginning of the year so working capital consumed $53 million of the $55 million in cash flow before working capital items, but this should be reversed as the year progresses and cash balances should improve.

The company has $200 million in 7.7% senior notes maturing in February of 2017 and therefore this debt is current. However, I expect this will be easily refinanced with the backing of Norbord's majority shareholder (see below), and at a better rate, which could boost the bottom line next year even further.

Norbord has an incredible amount of leverage to OSB pricing. If OSB prices are maintained at the current $268 USD and 230 euro level, at level FX rates, the company could generate $42/1000 ft2 or approximately $244 million more in annualized EBITDA. Norbord ran at a 92% operating rate at the 11 active plants in North America but shipped 7% more OSB on 12 fewer fiscal days due to their reporting cycle (ends on Saturdays). Strong seasonal demand for OSB has been compounded by two fires - one massive at Fort McMurray, Alberta a town of 88,000 people which were evacuated last week. At least 1,600 homes and buildings have been destroyed.

Coincidentally, there was a fire at the wood lot of the Norbord High Level, Alberta plant which has a rated annual capacity of 860 million ft2. The fire has been contained according to the CBC on May 5. This plant, if damaged, would be fully insured for loss and business interruption, but could squeeze panel pricing in Western Canada.

Two ways to value Norbord are via EV/EBITDA and via Price/Cash Flow. Please note Norbord's reporting currency is the USD but the stock trades most actively on the TSX in Canadian dollars.

If we annualized the first quarter EBITDA CFPS number of 65 cents, the $2.60 USD cash flow translates to $3.32 CAD at a 1.28 CAD/USD forex rate. The P/CFPS 2016 estimated multiple is only 8.2X assuming results are flat with Q1. But I expect Q2 will be better than Q1 unless the High Level plant is more severely damaged than known. I have not performed a historical multiple analysis for Norbord but this multiple seems attractive in an environment conducive to further growth in new housing starts and rising panel prices.

A second way to value Norbord is EV/EBITDA (adjusted). An 8 times multiple assuming $488 million in annualized adjusted EBITDA results in a market valuation of $3.91 billion USD. Deducting $750 million in net debt as of Q1 2016 results in a target market capitalization of $3.26 billion USD or $4.173 billion CAD indicating a potential stock price of $48.80 CAD.

Norbord did pay an extraordinary dividend of $2.40 per share a couple of years ago. The company has switched to a variable dividend rate which is currently 10 cents per quarter or 40 cents per annum, for a yield of 1.5% at the closing TSX price of $27.25 CAD. Given the dividend was covered by 6.5 times in Q1, I would expect a dividend increase for Q2.

Even without a dividend increase, the total return I expect from Norbord is extremely positive and could reach 80% within a year if our target price is realized, assuming flat currency rates. A stronger Canadian dollar would hurt Norbord's results as costs in Canadian dollars are exceeded by exports to the United States.

I do not expect a renegotiated NAFTA free trade agreement from a potential Trump US presidency due to gridlock in Congress and push back from Canada. Nor would a non-renewal of the expired Softwood Lumber US/Canadian trade agreement affect OSB as it is a manufactured product and Norbord has assets in both Canada and the United States.

Please note Brookfield Asset Management (BAM) owned 53.1% or 45.4 million of Norbord's 85.4 million outstanding common shares and therefore controls Norbord. This reduces liquidity in the stock trading which was 133,000 average shares per day on the TSX and 8,000 shares per day on the NYSE over the past 50 trading days (source: Marketwatch). Therefore this stock can be volatile and is for risk tolerant investors only.

This article was written by

Disclosure: I am/we are long OSB. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This report was disseminated to readers of The BCMI Report 24 hours in advance of this article.