Pat McKeough recently replied to an Inner Circle member looking for an opinion on Western Forest Products. The softwood lumber exporter saw profit jump in the latest quarter, says Pat. But it’s also facing lots of market uncertainty.

Q: Hi Pat: Can I have your insights on Western Forest Products? Thanks. 

A: WESTERN FOREST PRODUCTS (symbol WEF on Toronto; www.westernforest.com) is the largest woodland operator and lumber producer in coastal British Columbia. About 97% of its timber harvest (6.4 million cubic metres) comes from Crown lands. The company’s overall lumber capacity, at seven sawmills and two remanufacturing plants, is more than 1.1 billion board feet.

Western’s main activities are timber harvesting, reforestation, and milling logs to make lumber and by-products such as wood chips. It also remanufactures, or reproduces, original wood products. Most of the company’s employees, operations and corporate facilities are in the coastal region, although its products are sold in over 25 countries worldwide.

In the three months ended June 30, 2016, Western’s revenue rose 4.4%, to $301.8 million from $289.2 million a year earlier. Earnings per share rose 20.0%, to $0.06 from $0.05.

While lumber markets in Japan remain very competitive, prices in China have held steady. In the U.S., demand for softwood lumber has also stayed strong because of the improving home construction business. The U.S. repair and renovation market is also growing.

However, the 2006 softwood lumber agreement between Canada and the U.S. expired on October 12, 2015. So far, trade negotiations on a new deal have failed.

Penny Stocks: Allegations of an unfair cost advantage

U.S. lumber producers allege that Canadian firms have an unfair cost advantage that can only be offset by placing import duties on their products. They believe that Canadian provinces don’t charge producers enough for cutting on Crown land. As well, the low Canadian dollar now makes lumber imports from Canada significantly cheaper for U.S. buyers.

The U.S. won’t launch a formal investigation until later this year, but Canadian lumber companies expect it will start to impose punitive duties on their imports by the second quarter of 2017. It’s likely that such an outcome has already been factored into their share prices.

Western’s shares trade at 7.3 times this year’s forecast 2017 earnings of $0.29 a share. The company pays dividends at the rate of $0.02 per quarter. The stock yields a high 3.8%.

Western’s $58.3 million long-term debt is a low 7% of its $842.3 million market cap. That’s important for a firm in a cyclical business such as forestry.

Inner Circle recommendation: Western Forest Products is okay to hold for aggressive investors who want exposure to U.S. housing markets.

For our advice on avoiding the pitfalls of penny stocks, read Stock promotions can make an investment look deceptively appealing.

For our recent report on Canadian penny stock in the resource industry, read CanAlaska Uranium broadens its focus.