The U.S. housing market may not be back to business as usual, but business has gotten a lot better. A range of companies with exposure to residential building materials, including Headwaters (HW) and Universal Forest Products (UFPI), seen solid demand in recent quarters. Louisiana-Pacific (LPX) is having a little more difficult on the pricing and cost sides of things, but bringing Ainsworth (OTCPK:ANSBF) into the fold in 2014 should be a big help.
Louisiana-Pacific needs to execute better on costs and has to keep the momentum moving forward for products like SmartSide and engineered wood products. Provided that they execute on the opportunities that Ainsworth will bring, and that the U.S. housing recovery doesn't get knocked off stride, I continue to believe that Louisiana-Pacific is undervalued and should trade at $20 or higher.
Pricing Undermines The Fourth Quarter
Oriented strand broad (or OSB, for short) pricing was not very conducive to a strong quarter for Louisiana-Pacific, and the company did miss the target for its results. Revenue rose more than 4% for the quarter, but the core OSB business saw revenue fall more than 5% on a 20% decline in pricing. Siding revenue improved almost 19% and engineered wood product sales were up almost 39%.
Although volumes have picked up considerably, the weak pricing environment sapped profits. Gross margin fell about eight points from the year-ago period, leading segment profits down 71% and adjusted EBITDA down about 66% from the year-ago period. LPX also spend almost one-third more on SG&A in the quarter, some of which was due to the impending Ainsworth deal and some from a corporate systems upgrade project.
It looks as though considerable capacity came back on line through 2013, adding about 25% of recent demand to the market and moving industry operating rates from about 70% to 80%. At the same time, housing demand has been erratic, leading to lower prices in recent months but also dwindling stocks in inventory.
Ainsworth Taking Some Time
Due to second requests from regulators, the final approvals for the Louisiana-Pacific/Ainsworth deal are taking longer than expected. I still believe that this deal gets done, but it may be a stretch to get the deal closed in the first quarter.
I continue to believe that this deal is a very significant opportunity for the company to expand its business, add a little stability to the supply side, and improve its mix and margins. About 30% of Ainsworth's products are not made by Louisiana-Pacific, and Ainsworth's business skews to higher-margin products like specialty flooring, insulated panels, and markets designed for the Japanese construction market.
If the deal goes through, it will put about 25% to 30% of the country's OSB capacity under the control of LPX. While some sell-side analysts have suggested that this will bring more stability and rationality to the OSB market, I don't necessarily share that viewpoint. If Ainsworth had a reputation for being an aggressive player with respect to pricing or capacity additions I could see that argument, but I don't really believe that to be the case. More capacity should give Louisiana-Pacific some attractive opportunities for synergies and cost savings, but I don't believe that Georgia Pacific or Weyerhaeuser (WY) are going to display any more (or less) restraint as a result of this deal.
Growth Opportunities Are There
OSB already has a significant share of the U.S. residential construction market, but that does not mean that Louisiana-Pacific does not have attractive growth opportunities to exploits. As Ainsworth's higher-value mix might suggest, not all OSB products are the same and there are opportunities for the company to gain share in higher-value niche markets and/or develop new products within OSB.
Louisiana-Pacific also has an opportunity to gain share in its EWP business, which includes products like veneer lumber and I-joists. While LPX is the leading company in the OSB space, it is a somewhat distant third place in this EQP category with only about 40% of the market share of Weyerhaeuser and less than half the share of Boise Cascade (BCC). There's no magic formula to this market - success stems from the quality and breadth of products offered, the price of those products, and the distribution. As many builders are already familiar with LP's OSB, I don't think enlarging the EWP business and gaining share will be as difficult as it might be for a newcomer.
Last and not least is the siding business. LP already has more than 80% share of the wood siding category, but this category is basically a niche (5%) in the larger siding market. Vinyl siding's 30% share may be vulnerable in new home construction, but it is going to be harder to unseat in repair/remodeling.
That still leaves LP with alternative targets like stucco (almost 25% share) and brick (about 25%). Engineered wood siding is already substantially cheaper than brick, and the cost competitiveness with stucco isn't bad when you factor in the 50-year warranty on LP's SmartSide siding. It's worth mentioning, though, that Headwaters is also hoping to increase the share of architectural stone within the siding market.
The Opportunity Is Coming And Execution Is A Must
The pace of the housing market recovery may be shaky from one month or quarter to the next, but I believe the recovery is going to continue for several years. That should give Louisiana-Pacific ample opportunity to drive better utilization and margins and leverage that Ainsworth acquisition (assuming final approval comes through). Execution risk cannot be entirely ruled out, though, as the company has not always outperformed peers like Weyerhaeuser or Ainsworth on various profitability metrics.
The Bottom Line
I continue to believe that Louisiana-Pacific shares are worth about $20 to $23 on the basis of discounted cash flow and a 6.5x to 7.0x multiple to EBITDA. Having to abandon the Ainsworth deal would be a significant blow to my long-term value calculation and there are still concerns about whether the company can boost margins as demand and volumes grow in the coming years. I am still bullish on these shares, though, as I believe Louisiana-Pacific will execute on those opportunities and answer the remaining skeptics.