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Financial Analysis – Western Forest Products
J. Jay Nichol BUS639 Oct 17, 2015
Executive Summary
This analysis utilizes the financial statements of Western Forest Products (“Western” or “The
Company”) covering the years ending Dec. 31, 2012-14. These statements have been prepared in
compliance with International Financial Reporting Standards.i KPMG LLP audited the financial
statements, finding them to fairly present Western’s position. As we’ll see over the course of this
examination, not only has Western undergone volatile market shifts in its sector, it’s also
experienced significant internally derived financial fluctuations. Though there has been growth
in revenue over the last three years, Western has been unable to capitalize on this and increase
profit margins. In spite of lowering an equity deficit that was present before the span of this
paper, there are still long-term debt issues that raise concern. A final note: in 2014 there was a
major share transaction (approximately 40 million shares at $2.50/share) when one shareholder,
BSSML, reduced its stake (previously held 29%; dropped to 17%).ii Interesting as this
transaction is, it remains outside the scope of this paper.
Background Information
Located in coastal B.C., Canada, and headquartered in Vancouver, Western’s timberland
operations spread across most of Vancouver Island, Powell River and the Sunshine Coast. “The
Company is an integrated Canadian forest products company operating in one business segment
comprised of timber harvesting, log sales and lumber manufacturing and sales in worldwide
markets.”iii Western operates on a combination of privately owned lands and Crown tenures,
with an annual available harvest of almost 7.5 million m3 of wood. A staple of coastal B.C.
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logging, The Company has few competitors of similar size and interests. TimberWest, Island
Timberlands and Interfor may compete with Western in certain areas, but none could be
described as an analogous company. While direct comparisons will prove difficult, analysis can
be completed against the industry as a whole.
Accounting Numbers and Policies
Before discussing some of the more significant line items from Western’s financial report, there
are some significant accounting policies to clarify. First is a change in accounting policy that
became effective Dec. 31, 2014, and was then applied retrospectively through another two years’
reports to Dec. 31, 2012.iv This change impacts the way The Company measures land assets.
Previously, the policy was to recognize land at fair value minus impairment costs; the new policy
carries the value at cost minus impairments. Management feels this represents a more relevant
figure and increases its comparability with industry peers. “Balances as at Jan. 1, 2013, and Dec.
31, 2013, have been adjusted to reflect a $22.3 million reduction to the revaluation reserve and a
corresponding decrease to deficit.”v
Another significant accounting policy that bears discussion: the evaluation of biological
assets. Standing timber, a biological asset,vi is recognized at fair-market value minus costs to sell.
Carrying value at Dec. 31, 2014: $56.9 million. The forestry sector is volatile, and these
biological assets must be treated very conservatively. It’s easy to overestimate the value of a
given stand should the market be in an upturn, and similarly easy to underestimate the
probability of damage. Infestations, fire, shifting market conditions and legislative changes are a
few factors that could negatively influence the value of a stand. There’s no evidence to lead us to
the conclusion that Western has overestimated the value of its biological assets, but one must
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keep in mind the values presented are subjective estimations created using the best available
information at the time, and may change.
Finally, intangible assets – another significant accounting policy that has a profound
effect on forestry. Carrying value at Dec. 31, 2014: $129.3 million. The majority of the area The
Company operates on is a tenure granted on Crown land that allows Western to harvest a certain
amount of timber annually. “Accordingly, these are valued at their acquired cost less
accumulated amortization and any accumulated impairment losses. Amortization is recognized
on a straight-line basis over 40 years.”vii There’s no guarantee the annual allowable cut granted
by the Crown to Western will remain constant year-to-year. Legislation and environmental
concerns play a profound role in the estimation of these figures. Again, there’s no evidence to
suggest Western has overestimated the value of these assets, but their vulnerability to changes in
value due to forces outside The Company’s control must be considered when executing an
appraisal of Western’s current and future value.
The rest of Western’s timber supply comes from privately held lands. “At Dec. 31, 2014,
Western owned approximately 23,293 hectares of private land and harvested approximately
357,720 m3 off that land, which had a fair market value, less costs to sell, of $79 per m3 (2013:
265,500 and $89 m3 per, respectively).”viii Now that we have outlined the policies unique to this
sector, let’s begin an examination of the significant accounting numbers.
The first line item to discuss: inventory. As apparent in Exhibit A, there was a substantial
increase of the inventory Western carried Jan. 1-Dec. 31, 2013 ($15.9 million), but there’s only
been a marginal increase since then to Dec. 31, 2014 ($6.9 million). Western is still making its
way back from a deficit induced by the market slump of 2008-09, and the ability to increase
inventory on hand may simply be a result of having an increased cash flow and reduced debt.
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Log markets are volatile; the more diverse an inventory The Company has on hand, the nimbler
it can be in its response to variable market conditions. These figures are relatively consistent
against larger competitor Interfor who, as of Dec. 31, 2014, and 2013, held inventory of $149
million and $150 million, respectively.ix
Property, plant and equipment is the next figure for discussion.x There’s been a steady
increase in PP&E over the last three years. From Jan. 1-Dec. 31, 2013, $23.3 million; from Dec.
31, 2013, to Dec. 31, 2014, $31.8 million. The driving force of this increase: buildings and
equipment; the other contributing factors to PP&E, logging roads and land, have remained
reasonably consistent. There’s been a significant increase in long-term debt accompanying the
increase in PP&E. Much like increased inventory, the new purchases are seemingly giving
Western a competitive edge. Also reasonable to assume: some purchasing opportunities may
have risen, as The Company’s competitors have not been able to rebound adequately to the 200809 market slump.
A final number on the balance sheet worth discussion: the decreasing deficit visible under
shareholder equity. Though not discussed in the 2013-14 financial statement, it’s reasonable to
assume this deficit rose from the 2008-09 market crash. Western decreased this deficit by $122.7
million in 2013 and another $20.5 million in 2014. One factor that may have played a role in the
decreased focus on deficit reduction is the reduced net income noted on the income sheet
attached as Exhibit B. Though Western had $59.4 million more in revenue in 2014, the cost of
goods sold was $76.2 million higher. Another contributing factor to reduced net income in 2014
is the additional $23.1 million deferred income tax recovery Western was able to take advantage
of in 2013.
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Analysis
One important note about the following analysis is the presence of a deficit in shareholder equity.
This was taken into account while calculating certain ratios. Let’s with an examination of the
quick ratio. Helpful in capital-intensive resource sectors, it compares current short-term financial
obligations against a company’s liquidity. The minimum accepted value that a creditor or analyst
likes to see is 1.xi Quick ratio is calculated by dividing the total of current assets minus inventory
by a firm's total short-term obligations. For Western, we can note a steady decline from 2012-14
as the ratio moves from 1.04 to 0.91 to 0.81, respectively, implying an inability to respond to
current liabilities with liquid assets. One issue to mind: the increase in static inventory The
Company has on hand is increasing as the ratio decreases. We can now turn to the inventory
turnover ratio to give us a more integral view.
Assessing Western’s inventory-turnover ratio will help evaluate management’s efficiency
at generating sales from inventory on hand. This figure is calculated by dividing revenue by
inventory. For the sake of this calculation, we’ll exclude biological assets. Not only are these
reflected to some degree in revenue, not having the same holding costs as inventory means they
could skew the calculation. From 2012-14 this ratio is 7.94, 7.38 and 7.44, respectively. Though
somewhat lower than industry standard, Western is able to achieve a remarkably stable
inventory-turnover ratio.xii Maintaining this ratio may be one of the guiding principles of The
Company’s management strategy.
Next, the operating profit margin – similar to the straight profit margin ratio but more
rigorous as it takes into account more operating factors. Annual averages for the forestry sector
vary between 10% and 14%.xiii There is substantial fluctuation of this ratio over the selected
years: 2012, 3.9%; 2013, 10.8%; 2014, 6.8%. Forestry is a volatile sector, naturally, so the
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fluctuations would not be as concerning if the values themselves were higher. This third ratio has
negative implications for Western’s future. The Company seems to be unable to increase
profitability even with an increase in revenue.
Investigating Western’s debt-to-equity ratio will give a clear indication whether The
Company’s carrying too much debt. This is one ratio where the equity deficit will need to be
taken into account directly. For the purposes of this ratio, we’ll examine only long-term debt.
This number progresses from 9.45% in 2012 to 23.14% in 2013 and then to 17.89% in 2014. The
lower this percentage, the lower the debt load carried by a company. There’s no industry-wide
acceptable figure to compare against; each firm has a different debt structure. More important are
variabilities in this figure, such as those present for Western. While not dire, these numbers do
require attention when evaluating overall performance.
Western’s return-on-assets ratio, which will let us assess how well the asset base was
utilized, is calculated by dividing assets by net income. Due to the complex nature of the forestry
sector and the way it reports intangible and biological assets, we’ll include all current and noncurrent assets for the sake of this ratio. From 2012-14 we see this figure move from 4.65% to
18.70% and 9.85%, respectively. Though the final two years exceed the industry standard, again,
it’s the fluctuations that raise red flags.xiv Western seems unable to smooth out its financial
position from year-to-year.
In sum, the ratios used to analyze the financial performance of Western have shown
potential areas where management could improve. However, it’s difficult to draw solid
conclusions about a firm in a sector with so many variables without further research and a more
detailed report. Overall, The Company shows promise, but does not appear to be currently
operating at peak efficiency.
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i
Western Forest Products Annual Report 2013/2014 Note 2
Note 13
iii
Note 3(d)
iv
Note 3(b)
v
Note 3(b)
vi
Note 3(g)
vii
Note 3(h)
viii
Note 6(a)
ix
Interfor Annual Financial Statement 2014
x
Note 5
xi
http://www.investopedia.com/articles/active-trading/082615/key-financial-ratios-analyze-mining-industry.asp
xii
http://csimarket.com/Industry/industry_Efficiency.php?ind=105
xiii
http://csimarket.com/Industry/industry_Profitability_Ratios.php?ind=105
xiv
http://csimarket.com/Industry/industry_ManagementEffectiveness.php?ind=105
ii
Exhibit A
Balance Sheet
(Expressed in millions of Canadian Dollars)
Decem ber 31, 2014
Assets
Current assets :
Cash and cash equivalents
Trade and other receivables
Inventory (Note 4)
Prepaid expenses and other assets
Non-current assets :
Property, plant and equipment (Note 5)
Intangible assets (Note 5)
Biological assets (Note 6)
Other assets (Note 7)
Deferred income tax asets (Note 10)
Liabilities and Shareholders ’ Equity
Current liabilities :
Accounts payable and accrued liabilities
Revolving credit facility (Note 8)
Silviculture provision (Note 12)
Discontinued operations (Note 22)
Non-current liabilities:
Long-term debt (Note 9)
Silviculture provision (Note 12)
Other liabilities (Note 11)
Deferred revenue
Discontinued operations (Note 22)
Shareholders’ equity
Share capital - voting shares (Note 13)
Share capital - non-voting shares (Note 13)
Contributed surplus
Deficit
Decem ber 31, 2013
[Restated - Note 3(b)]
January 1, 2013
[Restated - Note 3(b)]
$1.8
65.6
139.4
8.8
215.6
$5.6
69
132.5
10.1
217.2
$18.8
69.5
116.6
7.6
212.5
249.3
129.3
56.9
13.2
29.9
$694.2
226
130.5
58.4
11.9
26.5
$670.5
194.2
126.1
60.8
12.7
$606.3
$76.6
6.7
10.7
0.3
94.3
$79.8
12.3
0.6
92.7
$74.0
13.4
5.1
92.5
$73.0
19
32.9
62.4
4.5
286.1
$88.5
17.7
20.3
64.4
4.5
288.1
$33.8
17.6
35.6
66.4
2.7
248.6
504.4
7
(103.3)
408.1
$694.2
486.6
13.1
6.5
(123.8)
382.4
$670.5
479.7
120.3
4.2
(246.5)
357.7
$606.3
Exhibit B
Income Statement (combined from 2 annual reports to display 3 years data)
Year ended Dec 31,
(Expressed in millions of Canadian Dollars except for share price and per share amounts)
2014
Revenue
Cost and Expenses
Cost of goods sold
Export tax
Freight
Selling and adminis tration
Reversal of impairments (Note 5)
Operating income prior to restructuring items and other income
Operating restructuring items (Note 19)
Other income (Note 21)
Operating income
Finance costs (Note 20)
Income before income taxes
Current income tax expense (Note 10)
Deferred income tax recovery (Note 10)
Net income from continuing operations
Net loss from discontinued operations (Note 22)
Net income
Other comprehensive income
Items that will not be reclassified to profit or loss:
Change in revaluation reserve
Defined benefit plan actuarial gain (loss)
Total comprehensive income
Net income per share (in dollars ):
Basic earnings per share
Diluted earnings per share
Basic earnings per share - continuing operations
Diluted earnings per share - continuing operations
Weighted average number of common shares outstanding (thousands
Basic
Diluted
$1,036.9
2013
$977.5
2012
$925.4
86.8
32.2
(2.9)
956.6
80.3
(10.8)
1.4
70.9
(5.7)
65.2
(0.2)
3.4
68.4
68.4
764.3
0.9
82.0
33.0
(8.2)
872.0
105.5
(0.7)
0.3
105.1
(5.4)
99.7
(0.3)
26.5
125.9
(0.5)
125.4
777.8
6.0
88.2
28.6
(12.9)
887.7
37.7
(4.8)
2.8
35.7
(6.3)
29.4
(0.1)
29.3
(1.1)
28.2
(16.5)
$51.9
12.9
$138.3
(1.6)
(7.0)
$19.6
$0.17
$0.17
$0.17
$0.17
$0.29
$0.28
$0.29
$0.28
$0.06
$0.06
$0.06
$0.06
392,267.0
396,892.0
438,547.0
443,254.0
467,945.0
470,459.0
840.5
-
Exhibit C
Cash Flow (combined from 2 annual reports to display 3 years data)
(Expressed in millions of Canadian Dollars except for share price and per share amounts)
Cash Provided By (used in)
Operating Activities:
Net income from continuous operations
Items not involving cash
Amortization of property, plant and equipment (Note 5)
Amortization of intangible assets (Note 5)
Gain on dispos al of assets
Change in fair value of biological assets (Note 6)
Net finance costs (Note 20)
Reversal of impairments on intangible assets (Note 5)
Deferred income tax recovery
Other
Changes in non-cash working capital items :
Trade and other receivables
Inventory
Prepaid expenses and other assets
Silviculture provision
Accounts payable and accrued liabilities
Investing Activities
Additions to property, plant and equipment (Note 5)
Proceeds on disposals of assets
Financing Activites
Drawings under revolving credit facility
Interest paid
Repayment of long-term debt
Draw down of long-term debt
Refinancing fees
Repurchase of shares (Note 13)
Dividends
Proceeds from exercise of stock options
Cash used in continuing operations
Cash used in di continued operations (Note 22)
Decrease in cash and cash equivalents
Cash and cash equivalents, beginning of year
Cash and cash equivalents, end of year
Year Ended Dec 31,
2014
2013
$68.4
$125.9
2012
$29.3
25.7
3.9
(0.2)
1.5
5.7
(2.9)
(3.4)
(4.3)
94.4
25.5
3.7
(1.5)
2.3
5.4
(8.2)
(26.5)
(2.7)
123.9
22.4
3.4
(1.7)
1.6
6.3
(12.9)
(6.4)
42.0
3.4
(6.9)
1.3
(1.6)
(3.2)
(7.0)
87.4
0.5
(15.9)
(2.5)
(1.1)
5.8
(13.2)
110.7
(6.6)
16.0
(1.1)
0.1
7.3
15.7
57.7
(49.9)
0.4
(49.5)
(59.0)
3.3
(55.7)
32.0
16.9
(15.1)
6.7
(4.0)
(15.8)
(31.4)
3.1
(41.4)
(3.5)
(0.3)
(3.8)
5.6
$1.8
(3.5)
(45.0)
100.0
(0.6)
(100.3)
(15.6)
(65.0)
(10.0)
(3.2)
(13.2)
18.8
$5.6
(8.9)
(4.0)
(28.0)
3.7
(1.0)
0.2
(38.0)
4.6
(1.1)
3.5
15.3
$18.8