Norbord – A Dividend Built on Weak Foundation

The Company in a Nutshell

• Norbord is the largest oriented strand board (OSB) in North America.
• These panels are mostly used in the construction industry.
• OSB counts on the U.S. home construction industry to grow in the upcoming years.

Dividend investors often seek to put their money in a market leader that pays now. The idea of investing in a Canadian stock providing a strong payout is tempting. After all, you get rewarded right away. Norbord (OSB.TO) presents these characteristics. The company pays a yield over 6% and is a leader in its’ market. Unfortunately, this dividend isn’t built on strong foundations. Let’s dig deeper to see what OSB is made of!

Business Model

Norbord Inc is a producer of wood-based panels. It is engaged in manufacturing, sales, marketing and distribution of panelboards and related products. OSB is the largest manufacturer of oriented strand board (OSB) in North America with over 7.1 billion square feet of capacity. Norbord is a rare basic material company paying dividend.

OSB is a type of engineered wood similar to particle board, formed by adding adhesives and then compressing layers of wood strands (flakes) in specific orientations. The company has over 15 plant locations in the United States, Europe and Canada. About 25% of its’ production capacity is in Europe.

Source: Norbord Q2 2018 investors presentation

Growth Vectors

Source: Ycharts

Norbord made a major move in 2015 with the acquisition of Ainsworth. This added over 2 billion square feet capacity and made OSB the largest manufacturer in North America. This was an all-share transaction where Ainsworth shareholders received 0.1321 of a share of Norbord for each Ainsworth share. Ainsworth is now a wholly-owned subsidiary of Norbord.

Source: Norbord Q2 2018 investors presentation

Norbord is not only the largest OSB producer in North America, it is also an important player in Europe too. Wherever there is housing construction, Norbord will have its’ piece of the cake. Unfortunately, Europe GDP has been anemic for the past few years. On the other side, the wind is blowing toward the right direction in the U.S.:

Source: Norbord Q2 2018 investors presentation

If management’s projections become true, Norbord will have two-three years of strong demand for its’ products going forward. We are far from the 2 million housing starts of 2005, but a healthy housing market is around 1 million housing start in the U.S.

Potential Risks

OSB is pretty much a one trick pony company. When the housing construction business is healthy, Norbord uses its’ gigantic capacity (the second largest producer has about 5B square feet vs 7.1B for OSB) to surf on that tailwind. However, each time there is a recession, OSB will be left with nothing. The combination of rising interest rate and high household debt level may slow down the economy faster than we expect. This would hurt housing starts and bring back OSB to darker years.

Being the largest producer in an industry is not always a plus. Norbord can run full speed and generate lots of cash flow, but can also be stuck with overproduction and suffer from several fixed costs in its’ budget. This industry suffers from overcapacity since 2006. This limits OSB price growth potential in the upcoming years. Finally, keep in mind that the juicy 6% dividend was cut not too long ago. The company is showing zero dividend growth in the past 5 years.

Dividend Growth Perspective

As mentioned in the risk section, OSB dividend growth isn’t a real one. There have been two dividend cuts in the past 5 years. Management grew its dividend back to $0.60 (from $0.10) and rewarded shareholders for their patience with a special dividend in 2018.

Source: Ycharts

Going forward, don’t expect much dividend growth. Shareholders may get lucky and have 2-3 years of dividend growth. But when the next recession comes, OSB may as well cut its’ dividend again. Remember; high yield – high risk.

OSB doesn’t meet our  7 dividend growth investing principles.

Valuation

While management wants us to believe the future is bright, OSB has suffered on the stock market in 2018. Unfortunately, investors don’t see much value in OSB as it trades at a very low PE ratio:

Source: Ycharts

Remember that a low PE doesn’t always mean that there is a deal. This may be caused by a lack of growth (or higher risk potential).

We used a 2% dividend growth rate for OSB when we ran the dividend discount model calculation. This is more than what the company gave over the past 5 years considering the dividend cut, but we believe the company could increase its’ payment in the next few years.

Input Descriptions for 15-Cell Matrix				INPUTS
Enter Recent Annual Dividend Payment:				$2.40
Enter Expected Dividend Growth Rate Years 1-10:				2.00%
Enter Expected Terminal Dividend Growth Rate:				2.00%
Enter Discount Rate:				10.00%
	Discount Rate (Horizontal)
Margin of Safety	9.00%	10.00%	11.00%
20% Premium	$41.97	$36.72	$32.64
10% Premium	$38.47	$33.66	$29.92
Intrinsic Value	$34.97	$30.60	$27.20
10% Discount	$31.47	$27.54	$24.48
20% Discount	$27.98	$24.48	$21.76

Please read the Dividend Discount Model limitations to fully understand my calculations.

Unfortunately, we don’t see how we could use strong dividend growth figures. At this point, there is no deal on OSB.

Final Thoughts

We totally understand why investors would like to invest in Norbord. The company is a leader in its’ market. Demographic should help housing construction in North America in the upcoming years. The company is paying a 6%+ yield. Is there anything to not like about this company? Unfortunately; yes. As the economy is strong, OSB looks great. Keep in mind the dividend was cut not too long ago as OSB needed additional cash to survive a weaker period. More recessions will come and OSB will be dependant on the housing market.

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Disclaimer: We do not hold shares of OSB.TO in our Dividend Stocks Rock portfolios.

 

Featured Image Source: Pixabay