Louisiana Pacific: Riding Out Housing Slump

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By Nathan Slaughter

The cooling housing market has battered the stocks of most homebuilders lately. While I am closely monitoring this sector for signs of a potential turnaround, I am also well aware the "ripple effect" of the housing slowdown has trickled into other industries -- like the materials suppliers.

One firm that has felt the impact is Louisiana Pacific (NYSE:LPX), a leading lumber company that has lost more than one-fourth of its market cap so far this year.

LPX has several different product lines, but is best known as a leading producer of oriented-strand board [OSB] -- which accounts for more than 90% of the firm's operating income.

When investing in a company whose fortunes are essentially tied to just one good, it pays to familiarize yourself with that product. Here are a few quick facts on oriented-strand board:

* OSB is an engineered composite wood product that is similar to plywood, except uniform in strength and less expensive to produce.
* Most commonly used in walls, floors, and roofs, OSB is quickly replacing plywood as the most common sheathing material in manufactured housing and new home construction.
* In 1990, OSB production was approximately 7.6 billion square feet; by 2001 that total had tripled to 22.0 billion. That amount is enough to encircle the Earth 41 times.
* OSB has consistently gobbled up market share, and now controls more than 60% of the panel market in North America.

While OSB is a commodity (which tends to limit any pricing power), just seven producers claim 90% of the nation's OSB manufacturing capacity. Generally speaking, I love industries where only a handful of suppliers dominate, as that concentration almost always leads to bargaining power over customers.

Of these seven, Louisiana Pacific is the clear-cut leader, capturing nearly one-fourth of the market.

As the table below shows, the company has delivered steady top-and bottom-line growth over the past few years.

LPX Investment

Not surprisingly, LPX's growth trajectory has slowed somewhat over the past year. Furthermore, rising raw materials costs have pressured margins industry-wide.

The strong OSB market has also attracted some competition, which is expected to lead to a double-digit capacity increases going forward. As a result, the near-term operating environment could remain challenging.

Nevertheless, with builders (like most other firms) looking to shave costs wherever possible, more and more are frequently choosing OSB, which is around 25% less expensive than plywood, but comparable in terms of quality. As such, there is little question long-term demand will remain robust.

In the meantime, Louisiana Pacific is better positioned than its rivals to weather any storm. The construction boom of the last few years fueled record results at LPX, which allowed the firm to shore up its balance sheet and stockpile more than $1.2 billion in cash (around $11.50 per share).

Strong cash flows also enabled the company to boost its dividend by +20% last year to $0.60 per share. Those who invest now can enjoy a hefty dividend yield of 3.1% -- nearly double the 1.7% payout offered last year before the shares began falling.

Things might get worse before they get better at LPX, but history has shown the best time to invest in cyclical industries is when the short-term outlook is bleak and investor sentiment is highly bearish.

After the selloff, LPX is currently trading for less than its book value. It's also trading at a compelling enterprise value/cash flow ratio of less than three.

In other words, given the firm's current annual cash flow generation, it would take less than three years to cover the entire cost of the company's stock (after backing out cash and debt from the purchase price).

Based on a conservative growth forecast of +6%, I arrive at a fair value of $36 for LPX -- nearly double where the shares currently trade.

Disclosure: The author has no position in this stock.

LPX 1-yr. chart:

LPX Investment

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