Making money is hard. It's so much easier to lose it or squander it or covet it. A hard way to make money is to buy stocks no one else wants. It's lonely, and you always worry about being wrong since few people agree with you. But if you can do it right, there is money to be made by being more patient than the herd.
With that in mind, consider the unloved shares of Norbord Inc. The company makes oriented strandboard, which is kind of like synthetic plywood. It's made of wood fibre glued together into panels and it's used, with Norbord's other related products, to build houses. Most of Norbord's sales (about 70 per cent) are in the United States. You may have heard by now about the dilapidated state of the housing market there.
And it will likely get worse. The U.S. central bank said yesterday that "the near-term prospects for the housing market remain uncertain," which is a sanitized way of saying housing is in deep trouble. The National Association of Home Builders says this will be a "year of transition" for housing starts, which it expects to bottom early in the year and slowly build from there. These associations tend to be more optimistic than they should be.
So it's not surprising that few investors would clamour for a piece of Norbord. That suggests it's not a bad time to look at it (and maybe other housing-related investments).
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Norbord is a very good, very well-managed company. It returned 47 per cent on equity in 2004, 46 per cent the next year and, despite lower prices and a fourth-quarter loss, 23 per cent last year. The company is also a cash machine, having paid dividends, bought back stock or repaid debt worth almost $800-million (U.S.) since 2001. Its plants are among the lowest-cost producers of OSB and it spends enough money to keep them in tip-top shape.
It is not, in other words, one of those marginal players that only makes money when times are good. Although the downturn in the economy and housing in 2002 was historically small, Norbord stayed in the black while many competitors lost money.
This cycle, of course, could be much more brutal. U.S. housing starts display an amazingly constant pattern going back 40 years: They tend to bottom out at about a million annually on a rolling average basis. They're at about 1.7 million right now, implying another 35-per-cent drop assuming the historical pattern holds and adjusting for a bigger population. You might argue that the era of easy money, which starts in the early nineties, has calmed the violent cycles of the past. The accompanying chart lends some credence to that argument. If you share this view, the drop in starts might be less dramatic, but drop the numbers probably will. So, you're wondering, why would I buy Norbord?
First of all, most of this information is already baked into the stock price. Norbord's market value actually peaked in the summer of 2004 at a little more than $14 (Canadian) a share, presaging the peak in the cycle. That's not to say it can't fall further: Changes in housing starts lead to bigger changes in material prices, which in turn lead to even bigger swings in the bottom line.
But it certainly suggests that a lot of the nosedive in housing is anticipated. Norbord, which closed yesterday at $8.17 on the Toronto Stock Exchange, bottomed at $6 a share after the mild 2002 housing trough, but today's company is in better shape. It pays a 40-cent dividend (an almost 5-per-cent yield), which looks sustainable still, and the cost to replace its assets is probably much higher than to buy the company.
This is not an investment without risk, besides the obvious drop in construction. There has been a lot of industry expansion in OSB plants over the past few years and more are planned (although some will be postponed). Stable pricing in the face of falling demand will require serious producer discipline. Norbord, for example, recently announced a 19-day shutdown at certain plants. OSB prices are, by some accounts, below the cash costs of lesser producers, which implies more capacity will be shuttered. That's crucial to Norbord's dividend. So far the signs are cautiously encouraging.
It's never easy to know when to buy shares in cyclical companies. It's often best to average your purchases out over time, relieving impatient investors of their stock at ridiculously low prices. You might get Norbord for less than today's price. But buying stock in top-quality firms at or near the cyclical trough, when no one wants them, generally proves rewarding in the long run.
Fabrice Taylor writes research for Pollitt & Co., a brokerage firm. The views expressed here are his own.
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