The aftermath of the U.S. housing collapse is underway as we see nationwide prices holding steady along the bottom. Prices of homes are likely to remain depressed for several more years, as foreclosures continue to be worked through the system and homeowners regain confidence that buying a house makes financial sense. Despite housing prices remaining near their recent bottom, we are seeing an uptick in the number of new housing starts. This pickup in housing starts is helping the lumber and forestry industry after massive amounts of capacity have been taken offline in the past 5 years.
In the above chart you can see the annual household formations since 1995. The historical average has been roughly 1.3M new households per year; however, from 2007-2011 that number has slumped to 400-700k household formations per year. As we continue to slowly recover, the number of household formations and housing starts will increase back toward the historical average. In the chart below (from the U.S. Census Bureau) you can see the sharp drop off in housing starts since late 2006. The excesses of the early 2000's are being worked out of the market, and we should see a slow climb higher in the coming years.
The Lumber sector looks ready to benefit from this pick up in housing starts. One name, Louisiana Pacific (LPX), engages in manufacturing and distributing building products for new home construction, repair and remodeling, manufactured housing, and light industrial and commercial construction. LPX is the number one producer of Oriented Strand Board (OSB) in North America with 20-21% market share. LPX is highly levered to the price of OSB. It has reported numerous years of losses as the lumber market has remained weak. The recent strength in OSB pricing has allowed LPX to report a smaller than expected loss in Q1 and a possible return to profitability in Q2.
There have been sharp capacity cuts in OSB due to years of weak pricing. At its peak, OSB capacity was 28 billion sq. ft. annually; this has been cut down to 19.5-20 billion sq. ft. The big picture was discussed during the LPX Q1 Conference Call:
"I think last year, the demand was 15.5 billion to 16 billion square feet. So there's another 3 billion that we could add. And think about housing starts, every 100,000 housing starts is 1 billion square feet. So if you increase your housing starts with 300,000 over the 580,000 that we had last year, that says when you get close to 900,000 you're going to be out of OSB capacity."
This year, U.S. housing starts have been in the low 700,000's, building off of last year's 580,000 average. LPX is running at 76% of capacity right now, and can quickly ramp up supply if demand picks up. Also mentioned in the conference call was that it takes 9-12 months for a producer of OSB to bring new capacity online. If we see a large pickup in housing starts above 900,000 units, the price of lumber and OSB will surge higher leading to significant profits for LPX and others. In LPX's 10-Q, they talked about sensitivity of OSB prices to their profits, saying:
"… a $1 change in the annual average price per square foot on 7/16" basis would change annual pre-tax profits by approximately $4.3 million."
So a $50 change in OSB pricing would incrementally add $215M in pretax profits to the bottom line of LPX. Given OSB is only 50% of their business, they would see increasing profits in their other divisions as well.
On June 4th and 5th, a director more than doubled his holdings in LPX by buying 383,500 shares at an average price of $8.63. This is significant buying for an insider, and shows further confidence that management believes LPX's business is about to turn the corner.
Three analysts have upgraded LPX since their Q1 earnings. There have been 9 positive analyst revisions on 2012 earnings in the past 30 days and 7 for 2013. 90 days ago analyst expected LPX to report a ($.50) for 2012, now expectations are for a ($.22). Also for 2013, estimates have risen from a ($.09) to a profit of $.17 expected. If lumber prices hold steady or rise further, we will continue to see estimates rise, and could even see LPX earn $1.00 in 2013 if housing starts rise to 900,000.
LPX is highly levered to the price of lumber and housing starts. If housing starts continue to rebound and head above 1M starts per year, LPX will start to mint money. The stock is a great buy on market weakness in the high $8's to near $9. The stock could return to near $20 within 2 years if the housing recovery continues. LPX is highly speculative stock, and if an investor is looking for a less risky play on lumber the companies below might be worth a look.
Four companies in the Lumber industry trade as REITs. REITs have to distribute 90% of their annual profits in dividend distributions. By doing this, they avoid having to pay corporate income taxes on their profits. They will pay you dividends unlike LPX, and will be less volatile.
Plum Creek Timber (PCL) owns and manages 6.6M acres of timberland as a REIT. They have land in multiple states, with the majority concentrated in the southeast and northeast. They own and operate eight mills including: sawmills, plywood mills, MDF mills, and re-manufacturing mills. They have 900,000 acres of land that is considered real estate. Throughout the credit crisis, management was able to maintain a $.42/share quarterly dividend, which is currently a 4.5% dividend yield.
Potlach (PCH) is very similar to Plum Creek. Potlach is a REIT that owns and manages timberland. They own 1.4M acres of land and also have manufacture timber and plywood. The company is about 1/5th the size of Plum Creek and pays a 4.3% dividend yield.
Weyerhaeuser (WY) is a REIT that owns 6.4M acres of land in the United States. They also manage 13.9M acres in Canada as long-term leases. The company is one of the largest building product producers in the U.S. 48% of their sales come from the sale of Lumber, while the rest is in engineered wood products, OSB and plywood, and specialty products. The company pays a 3% dividend yield, however, it doesn't have the prettiest balance sheet with more than $4B in long-term debt and another $1.47B in pension liabilities.
Rayonier (RYN) is a partial REIT that owns and operates 2.7M acres in the United States and New Zealand. They pay normal taxes (except for income) on their forest resources. Included in the 2.7M acres is 200,000 acres of real estate land from Savannah, Georgia to Daytona Beach, FL. The company generates the majority of its revenues and income from the Performance Fibers segment. The Performance Fibers business is one of the world's leading producers of high-value specialty cellulose fibers, which are used in products such as filters, pharmaceuticals, and LCD screens. Approximately 45% of the company's sales are outside of the U.S. The company has a solid 3.7% dividend yield that has steadily increased despite the housing and real estate woes of the past 5 years.