It’s hard to imagine a better backdrop for Canadian lumber stocks: U.S. home-building activity is strong, lumber prices are rising and duties on lumber exports to the United States are set to decline – underscoring why forestry stocks should continue to recover.
“We have definitely entered a positive environment in the wood products industry. Supply has dropped as demand has picked up,” John Duncanson, vice-president at Corton Capital (an alternative fund manager) and timber analyst on the Corton Global Timber Fund, said in an e-mail.
Just last year, the sector was weighed down by lacklustre U.S. home-building activity and the escalating trade war between the U.S. and China, which hurt lumber prices.
By the time some Canadian lumber producers announced plans to shutter mills last fall to slash supply – a move known as curtailment – prices for lumber and oriented strand board (wood panels used in home construction) had plummeted.
Some forestry share prices fell more than 50 per cent during this period between mid-2018 to mid-2019 as profitability tanked. West Fraser Timber Co. reported a loss of 85 cents a share in the second quarter of 2019, down from a profit of $4.52 a year earlier.
In retrospect, these bleak months offered an excellent buying opportunity. West Fraser shares have risen 35 per cent from their recent lows, as the backdrop improved. Shares in Norbord Inc., an OSB producer, have rallied 57 per cent.
But given that forestry stocks are still well off their highs, they appear to have more room to run if lumber prices rise.
Mr. Duncanson raised his 2020 price target on lumber to US$500 per thousand board feet, up from US$450 previously, and he expects that North American consumption this year will rise to a 14-year high.
According to a report from Citigroup this week, lumber prices have risen for eight consecutive weeks. Lumber now trades at about US$400 per thousand board feet, amid solid demand.
The U.S. housing market, which has a strong correlation with forestry commodity prices, is underpinning much of this demand. In December, single family housing starts surged 11.2 per cent from the previous month, in seasonally adjusted terms, hitting their highest level since 2006.
“December’s housing starts report was simply stunning,” Jocelyn Paquet and Kyle Dahms, economists at National Bank Financial, said in a report last month.
It’s likely not a fluke. U.S. home-building companies in the S&P 500, whose share prices on Tuesday surpassed record highs set in 2006, are noting that buyer traffic increased in January amid low inventories of unsold homes.
What’s more, the upswing in demand for lumber comes as duties are set to fall. The U.S. Commerce Department ruled this month that tariffs imposed on Canadian lumber sold in the U.S. – set at more than 20 per cent, on average, two years ago – could fall to about 8 per cent this year.
Analysts are reluctant to revise their profit estimates for Canadian producers, given that the revised rates are preliminary and producers won’t get a refund on their overpayments until the trade dispute is resolved. Nonetheless, Hamir Patel, an analyst at CIBC World Markets, said in a note that reduced duties offer “a meaningful reduction in the cost curve for B.C. producers.”
What Canadian forestry stocks should investors consider buying?
Among the top Canadian holdings in Mr. Duncanson’s global timber fund: Canfor Corp., Interfor Corp., Norbord and West Fraser.
Ron Meisels, president of Phases & Cycles, a Montreal-based technical analysis firm, is also enthusiastic about Norbord. He expects that rising interest in the stock, reflected in higher trading volumes, will drive the share price toward his near-term price target of $44. After that, he can see the stock rising to $49.
Daryl Swetlishoff, an analyst at Raymond James, last week highlighted the case for buying Interfor: It’s a pure lumber play, with a relatively high exposure to the U.S. market and a strong balance sheet. His 12-month price target of $18.50 implies gains of more than 20 per cent, driven by sound fundamentals.
“Coupled with the [more than] two billion board feet of permanently curtailed lumber capacity, with the spring building season right around the corner, we expect tight near-term lumber markets,” Mr. Swetlishoff said in a note.