Forestry companies are set to report huge profits. Will their stock prices get spruced up?

Canadian forestry companies are set to report explosive first-quarter profit growth this week. Perhaps investors should take notice.

The sector has been on a volatile ride over much of the past six months as the stock market weighs lofty commodity prices and a busy housing market against rising interest rates and fears of a recession.

West Fraser Timber Co. Ltd. is typical of the wild swings.

From recent highs in early March, the stock price slid 26 per cent by early April. It has rebounded about 20 per cent over the past three weeks, leaving the stock down more than 8 per cent in 2022.

Some observers expect that the company’s quarterly financial results, which will be released after markets close on Thursday, could help clear the confusion and renew investor enthusiasm.

“The market seems not interested, but the earnings from the tree stocks is real. And look at their balance sheets: no debt and lots of cash,” John Duncanson, timber analyst at Corton Capital’s Global Timber Fund, said in an e-mail.

Here’s one way of looking at what’s coming from a sector that includes West Fraser Timber Co. Ltd., Canfor Corp. and Interfor Corp.: Companies could generate a full year’s worth of earnings in just one quarter, according to Daryl Swetlishoff, an analyst at Raymond James Ltd.

He believes that profits will surge from the previous quarter, as lumber prices in the first three months of 2022 approached record highs amid rising demand from U.S. homebuilders.

Mr. Swetlishoff expects West Fraser will report earnings of US$10.02 a share, up from US$3.13 in the fourth quarter, suggesting an increase of 220 per cent.

In the case of Interfor, which will report its financial results on May 11, he expects earnings will rise 540 per cent from the previous quarter, boosted in part by a recent acquisition.

Yet, he is astonished that stock prices aren’t reflecting this level of profit growth.

The analyst noted that the sector is trading at less than three times enterprise-value-to-2023 EBITDA (a valuation ratio that compares a company’s total value, including debt and cash, to forecasted earnings before interest, taxes, depreciation and amortization).

That’s a low valuation, he argues, especially with EBITDA estimates based on a five-year average lumber price that is about half the current price.

“Bullish fundamentals stand in stark contrast to valuations,” Mr. Swetlishoff said in a note this week.

To be sure, the forestry sector has been gyrating along with a shifting outlook for the economy, which has turned the market’s attention from strong quarterly financial reports to prospects for weaker economic activity – perhaps even a recession.

The U.S. Federal Reserve and the Bank of Canada have become more aggressive in their fight against inflation. Though the central banks last year dismissed rising inflation as a transitory issue that would fade, they are now fighting it with bigger-than-expected rate hikes.

That’s driving up mortgage rates and raising concerns about the housing market. U.S. single-family housing starts – a measure of home construction activity, which is a key driver of lumber prices – declined 1.7 per cent in March.

Still, some economists expect that the low inventory of U.S. homes will support a homebuilding market that is recovering from a shortage of building materials and pandemic-related labour interruptions.

“As such, the market may have some room to run yet before the Fed’s tightening cycle becomes a binding constraint,” Shernette McLeod, an economist at Toronto-Dominion Bank, said in a note last week.

Though lumber prices are down from last year’s record highs and have slid since March, analysts believe prices may have found some stability at elevated levels.

Western spruce-pine-fir lumber traded at US$1,040 per thousand board feet of two-by-fours last week, according to Random Lengths, a trade publication.

While that’s down more than 35 per cent from last year’s historic highs, the current price is more than double the 10-year average. Mr. Duncanson expects that sanctions against Russian exports will add support.

Forestry companies are about to show that they produced a lot of cash in the first quarter. The gusher is still going.

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