While the market focuses on the soft lumber market and Western Forest Products' (WFSTF) struggle to return to profitability, a lurking giant threatens to disrupt their carefully constructed balance sheet: the continuous dry kilns. While seemingly a smart strategic move towards higher-value products, the sheer scale of their projected return on investment raises a red flag – a flag that might signal an impending accounting storm.

WFSTF has been very transparent about the financial expectations for their new kilns. The recently commissioned Saltair kiln, with a net cost of $12 million, is projected to deliver a staggering $9 million in incremental EBITDA annually. This translates to a 75% return on investment, a figure so high it seems almost fantastical.

Similarly, the two new kilns, with a total cost of $35 million, are anticipated to generate $27 million in annual incremental EBITDA, based on the stated 20% return threshold for strategic investments.

Unpacking the Numbers

Let's unpack these numbers. A 75% return on a $12 million investment implies a $9 million increase in annual EBITDA. This means WFSTF believes the Saltair kiln alone will catapult them from their current negative EBITDA to a positive $4.8 million, solely due to this single investment.

This projection seems exceptionally optimistic, especially given the soft lumber market. Consider their Q1 2024 results. Adjusted EBITDA was negative $4.2 million, and that's *with* the Saltair kiln already operational. If the kiln was truly generating the projected returns, Q1 EBITDA should have been significantly closer to positive territory.

"Discrepancy Alert: The significant difference between WFSTF's projected kiln returns and their actual Q1 2024 performance raises serious concerns about the viability of their kiln-driven transformation."

The discrepancy raises several questions. Are these projected returns achievable in the current market? Is there a potential miscalculation in the return projections? Or could this be a case of over-enthusiastic forecasting to justify capital expenditures?

Looking ahead, the potential impact of the two new kilns is even more dramatic. Based on the 20% return threshold, these kilns, with a combined cost of $35 million, should generate $27 million in incremental EBITDA. If their current EBITDA remains around the negative $4 million mark, these kilns would push them to a whopping $23 million in positive EBITDA. This would represent a nearly six-fold increase, a drastic transformation for a company struggling for profitability.

Such a dramatic turnaround fueled solely by kiln investments seems highly improbable.

The Impairment Charge Hypothesis

This raises a crucial hypothesis: Could WFSTF be setting themselves up for an impairment charge? If these kilns fail to deliver the astronomical returns projected, WFSTF might be forced to reevaluate their value, potentially leading to a significant write-down. Such a move would further damage their already fragile balance sheet and erode investor confidence.

Projected vs. Actual EBITDA Performance

To illustrate the potential risk, let's compare the projected EBITDA with the actual performance, assuming the two new kilns become operational in Q3 2024:

Conclusion

While WFSTF deserves credit for their strategic initiatives and commitment to First Nations partnerships, the financial viability of their kiln-driven transformation remains questionable. The discrepancy between projected returns and current performance necessitates further scrutiny. Investors should closely monitor the performance of these kilns and remain vigilant for any potential accounting adjustments. The lumber market might be soft, but a potential accounting storm might be brewing on WFSTF's horizon.

"Fun Fact: Western Forest Products is one of the oldest forestry companies in British Columbia, dating back to the 1950s. It was originally formed as a merger of several smaller logging and sawmill operations."