Housing starts are down in the U.S., but the Chinese market for lumber has prices going up.DAVID PAUL MORRIS/Bloomberg
Lumber and timber stocks have surged in anticipation of a U.S. housing recovery, but some market observers suggest the forestry party isn't over.
A U.S. housing rebound is not yet in full swing, but other trends are helping to drive commodity prices and their stocks higher. Demand in China is growing briskly for North American lumber, but supply is getting tighter because of the destruction of trees by the B.C. mountain pine beetle, harvesting cutbacks in Quebec and the closing of sawmills in recent years.
The S&P/TSX Forest Products subindex, which comprises only Canfor Corp. and West Fraser Timber Co. Ltd., has gained nearly 108 per cent, including dividends, over the past 12 months.
"We are in a supercycle for lumber," suggests Raymond James Ltd. forestry analyst Daryl Swetlishoff, who has been expecting the impact of this confluence of events since publishing his "peak lumber" report in 2010. "We are in the third inning, and we see a lot of upside."
Average benchmark lumber prices soared to about $388 (U.S.) per thousand board feet in the first quarter of this year, the highest since the housing bubble in 2005. Yet the seasonally adjusted rate for U.S. housing starts in March was only about half of the peak of 2.07 million, eight years ago. "Because of China, we are seeing high lumber pricing with relatively low U.S. housing starts," Mr. Swetlishoff said.
"Five years ago, British Columbia sent 3 per cent of it lumber to China, and now it is 33 per cent," he said. The Chinese government plans to build 30 million housing units as part of last year's five-year plan so that will "soak up a lot of lumber," he noted. "If you look at exports from North America to China, they are running about the equivalent to 500,000 to 600,000 housing starts."
Forestry companies have not been able to crank up enough production to meet demand. The destructive pine beetle has killed 50 per cent of the pine trees in British Columbia, while the allowable timber harvest has fallen in Quebec because the province wants to promote the sustainability of forests. "Lumber prices have averaged over $500 [Canadian] per thousand board feet four times since 1997," Mr. Swetlishoff said. "We think we can get back to those levels in the next few years."
The analyst expects Canadian forestry companies to release stronger-than-expected first-quarter results when they start reporting this week. West Fraser posts results on Thursday. "A rising tide will lift all boats," he said. The analyst has "buy" ratings on West Fraser, Canfor, International Forest Products Ltd. (Interfor) and Conifex Timber Inc. "We've had a minor correction, and the stocks are off 20 per cent from their highs earlier this year," he said. There is a lot volatity in lumber prices, but we see those as buying opportunities."
Michael Underhill, chief investment officer at U.S.-based Capital Innovations LLC, is also upbeat, saying that the new supply-demand equation has created a three-phase bull market for forest products and timber investments. "It is going to go all the way to 2016 as supply shocks are felt, particularly in Canadian timber supply," he said.
The first phase, which has already taken place, is higher lumber prices triggered by the U.S. housing recovery and Chinese demand. In the second phase, which began in the first quarter, rising lumber prices will lead to higher log prices, while timberland values will skyrocket in the third phase, predicted Mr. Underhill, who also runs the Exemplar Timber Fund sold in Canada.
Mr. Underhill is a fan of three U.S. real estate investment trusts to play a housing recovery. They include Weyerhaeuser Co., which grows and harvest trees, builds homes and manufactures forest products. He also likes Plum Creek Timber Co. Inc., an owner of timberland and producer of lumber products and wood chips. And he sees upside in Rayonier Inc., which is involved in the sale and development of timberland and produces cellulose fibres. In Canada, he prefers West Fraser. "We like to own companies that own their own timber, and are not just lumber brokers," he said.
Morningstar analyst Daniel Rohr, who covers U.S.-listed timber securities, said he is a bull on the American housing market, timber demand and the potential for log prices to reach record highs, but is concerned about their lofty valuations. Plum Creek is actually trading at a "premium to where it was at the height of the housing boom in 2005," he said.
Investors might consider Weyerhaeuser, which has the most leverage to the housing recovery, on a pullback, but stocks like Plum Creek and Rayonier are "materially overvalued," Mr. Rohr suggested. "The price you have to pay to gain that exposure seems too high to me at the moment."