Stock Analysis

West Fraser Timber Co. Ltd.'s (TSE:WFG) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

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TSX:WFG
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Most readers would already be aware that West Fraser Timber's (TSE:WFG) stock increased significantly by 24% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study West Fraser Timber's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for West Fraser Timber

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for West Fraser Timber is:

13% = CA$368m ÷ CA$2.8b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.13 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

West Fraser Timber's Earnings Growth And 13% ROE

To begin with, West Fraser Timber seems to have a respectable ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. As you might expect, the 3.5% net income decline reported by West Fraser Timber is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

From the 4.4% decline reported by the industry in the same period, we infer that West Fraser Timber and its industry are both shrinking at a similar rate.

past-earnings-growth
TSX:WFG Past Earnings Growth February 4th 2021

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is WFG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is West Fraser Timber Making Efficient Use Of Its Profits?

West Fraser Timber's low three-year median payout ratio of 4.7% (or a retention ratio of 95%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Moreover, West Fraser Timber has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 11% over the next three years.

Conclusion

Overall, we feel that West Fraser Timber certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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