Louisiana-Pacific - A Fully-Valued Timber And Construction Materials Play
Summary
- A reader contacted me about a company in his area - Louisiana-Pacific, or "LP", a business that's heavily invested in the timber and building materials area.
- The company pioneered OSB panels in North America and today is the world's largest producer of OSB and engineered wood building products.
- In this article, we look at the company and decide whether it's worth investing in.
- I do much more than just articles at iREIT on Alpha: Members get access to model portfolios, regular updates, a chat room, and more. Learn More »
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In this article, we'll take a longer look at the Louisiana-Pacific company (NYSE:LPX), a business focusing on building materials. We'll look at valuation, company volatility (there's a lot to be said here, unfortunately), once we've gone through some fundamentals as to what the company actually does.
This is a reader request and one I'm happy to fill, given just how many timber/forest companies I invest in my home markets. Aside from investing in many of the companies, I actually come from a relatively rural area and grew up with a neighbor who ran a sawmill and a wood product factory, where I worked as a teenager - so working with these sorts of products is something I've been doing since I was young, to some degree or another.
Let's get going and see what we have.
(Source: Louisiana-Pacific)
What does the company do?
The company was founded back in 1972 and is headquartered in Nashville, TS. It's the world leader in strand-based engineered siding wood products, with the primary end markets for these products being residential construction as well as the repair/remodel market.
Company operations are split into the following segments, which also make up the company's reportable segments.
- Siding, focusing on the company's world-leading production of siding products. These are for outdoor buildings and feature a full line of siding, trim, fascia, and other products, which offer protection against various weather and pests, and are used in new home construction as well as the repair/reno markets.
- Oriented Strand Board (OSB), a sustainable and affordable product made from wood strands arranged in layers, with bonding of wax/resin. OSB serves much of the same uses as plywood but can be manufactured at a substantially lower cost. The company focuses on OSB structural panels and its VAP OSB segments, with products specifically engineered for various applications, such as subflooring, flame-resistant material, water barriers, and so forth.
- Engineered Wood Products (EWP), focusing on various types of veneer lumber, strand lumber, specifically engineered joist products, and products like SolidStart, a product surpassing the load-carrying capacity and dimensional consistency of traditional lumber. These products are warp/twist-resistant and rarely bow or crown.
- South America, is the company's SA segment, focusing on manufacturing and distribution of OSB, Siding, and wood products in South America and certain export markets.
On a segment size basis, OSB makes up by far the largest segment with 44% of net sales revenues, with Siding around 34%. EWP and South America are small, with a combined sales revenue of 20%, with the remaining 2% in a corporate/other segment.
The company markets its products through traditional distribution in professional product dealers, home centers, and third-party buying groups as well as end-users such as homeowners. LPX has both DIY and professionals as their customers.
Customers-wise, the company's top ten customers accounted for around 46% of sales. These include wholesale regional/state distribution companies, distributors, and professional dealers specializing in sales directly to professionals and distribution firms, as well as Retail home centers such as Home Depot (HD) or Lowe's (LOW).
Competition? Oh , there's some in certain segments - a lot in others. The company competes with several thousand forest and building products firms, ranging from 10-man operations to international enterprises. Competitors/Public Comps I keep an eye on, even though they operate in different markets, include Stora Enso (OTCPK:SEOJF), UPM-Kymmene (OTCQX:UPMKY) on an international basis, as well as more local comps such as West Fraser (WFG) and Resolute Forest Products (RFP), though some of these are more in paper/pulp/forest or even biofuel as opposed to just building materials.
(Source: LPX)
Whenever I look at a timber company or a company in this field, my first question is always how and where do they source their feedstock/lumber?
While owning forests and sourcing comes with its own sets of risks and challenges, my overall view on the European side is that owning your sourcing as a timber company is preferable to relying on third-party sourcing. Given the increased risks of climate-related issues over in North America, these dynamics may be considered different.
Factually, LPX does not own its forests/sourcing. LPX relies instead on various suppliers for its inputs used in manufacturing, and the company has a central strategic sourcing group consolidating purchases.
The company of course uses other input products from timber, and also uses significant amounts of resins, wax, and other chemicals.
What this sourcing strategy means is that LPX is entirely dependent on market pricing for all of its input products, as opposed to other companies which own their own supply, and therefore can net higher gains during times of higher demand.
The company operates 25 mills across the US, Canada, Chile, and Brazil, and to date employs around 4,500 people. It has a BB+ credit rating and is not IG-rated, but it has a conservative, sub-22% long-term debt/cap. The dividend yield is extremely modest, at around 0.92%, with an average over the last four years of 1.58%. However, the payout ratio of that dividend is less than 6%, which is one of the lowest I've ever covered. The company has no real track record of DGR, at only 3 years.
This is what the company does - I don't believe LPX needs much more introduction than this.
The business characteristics of a lumber company operating mills across multiple geographies without owning its own sourcing mean that if you're somewhat versed in accounting and economics, you realize that it leaves the company with PP&E on the balance sheet, requiring maintenance CapEx, while not having the environmental risk of its sourcing being disrupted by climate events.
On the flip side, its ability to generate attractive margins in its business is limited to its purchase-side margins, which are dictated by feedstock spot pricing, as well as its pricing power towards customers - whomever they may be.
As a company with these sorts of operations, this company is also extremely strongly tied to the housing and building market. Not globally, but in the geographies where it is active. This means that a strong downturn in these markets would directly influence demand and profitability, and given its operational scope, LPX has very few non-cyclical segments or businesses to offset these downcycles, where CapEx still needs to be funded, but now at a pressured supply/demand ratio.
Let's look at recent results.
How has the company been doing?
So, first things first. LPX has been doing extremely well. That's not a formulation I use often, but I believe that a 2021E EPS growth of 212% following a 2020 EPS growth rate of 1065% warrants this sort of formulation.
How can this be?
Well, first it came from the doldrums. 2019 was a horrible year with an 87% EPS decline down to a sub-$0.5 EPS level. Second, remember what I said about the housing/construction/reno market.
LPX is all about that.
When you start looking through the company's material, it's very clear that the company considers itself extremely well-positioned to benefit from current trends in this market.
(Source: LPX)
The simple fact is you won't see me arguing one bit with this assessment. LPX is very well-positioned any time there's a housing boom in the US - and we're currently in the middle of one. That means that the demand for LPX products is extremely high, and as the company showcases, the fundamentals are in favor of this continuing for some time, due to population growth, undersupply, underbuilding following the financial crisis, current demand for homes, and demographical trends.
The company tries to showcase a "track record of growth"....
(Source: LPX)
...but to my mind, these fail to showcase the cyclical uncertainty in how these revenue numbers trickle down to earnings in case of a downcycle - which we'll look at later.
The company boasts impressive market shares of double digits in Repair & Remodel, new single-family construction, and new outdoor construction. No doubt in my mind that the company has an excellent moat here. Furthermore, as of 2021 3Q, the company believes there to be a significant runway for further market share, considering its 12% overall share of a $6.4 TAM.
In this market climate, LPX is also increasing capacity at some of its main production facilities. Recent results have been excellent, with Siding solution sales up 19% YoY, a 53% YoY sales increase despite strong comps and more than doubling in YoY EBITDA. LPX has also been buying back plenty of shares.
These excellent trends have left the company with large amounts of cash, parts of which are being used to fund investments/CapEx, with ongoing conversions of facilities, over $110M of maintenance CapEx, and strategic growth, coming to $250M of full-year CapEx for 2021.
The picture that is given by the company, and me as well, is that LPX will do extremely well as long as the strong housing market trends continue. While the company has been working to diversify its portfolios, OSB among them, even the diversification and margin improvements since 2010 have done little to actually separate the company from its fundamental trends - nor perhaps should the goal be to do this. The company argues that OSB is no longer a "boom and bust" business, because of its ambition to match capacity to ongoing demand. However OSB is not even 50% of sales revenues - even if the company perfectly manages to scale up and down capacity to match demand, this doesn't separate the other segments from cyclicality.
I'm not arguing that this is a bad thing, all I'm saying is that the company's presentation of trying to separate itself from the cyclicality is no more than wishful thinking without more fundamental changes - which the company perhaps should not make.
Order-wise and backlog-wise, the company has a strong situation here that's likely going to be maintained until 2Q22. The company has seen capacity constraints, where it's barely able to push out enough product to market to meet demand - but as of right now and 3Q21, the company is still able to produce more than it can sell. All incremental production of SmartSide is being sold.
The company is moving towards portfolio changes, and one major change is potentially selling its EWP segment, which accounts for less than 20% of sales revenues.
Due to the loss of LSL from its portfolio, "coupled with an inability to consistently earn the cost of capital in engineered wood products", the company will evaluate strategic alternatives for its remaining engineered wood business.
(Source: WoodWorkingNetwork)
As of yet, no word on potential interest, sales multiples, or other factors.
On the pricing side, typical pricing discussions for 2022 products are done by January 1st - meaning we should see numbers here very soon, but the company feels that strong demand for its products will make certain that 2022E sales prices will be coming in very strong, and LPX is guiding for a 25% margin profile for its business. For now, even raw material inflation is no more than a rounding error when compared to the conversions in many of its businesses.
Let's look at the valuation to try and get a picture of things here.
What is the valuation?
So, the issue is the degree of earnings cyclicality here, because LPX is one of the worst cyclical businesses I've ever reviewed. This wouldn't be as much of an issue if the company had dividend floor strategies and EU-like trends like say, Norsk Hydro (OTCQX:NHYDY), but it doesn't.
What it means is that despite sales revenue, earnings looks like this.
(Source: F.A.S.T graphs)
Again, I don't mind trends like these, because you can't just look at EPS and expect it to give you the whole picture. But from what I see, the company itself isn't all that forward-considering, at times, when considering their strategy or sales. Granted, visibility for this sector is at times extremely low, but an investor trying to make decent returns with safety here is often left at the mercy of very cyclical trends.
LPX didn't reintroduce the -08 canceled dividend until 2018. It also had several years of negative or very poor returns, and even after extremely good trends as we're currently seeing, the main questions become just how the company can manage the cash flows coming in, as well as how long we can expect this boom to continue for.
To the first question, the company is doing things somewhat right. CapEx is up, and the company is investing in its capacity (even if the timing of it all can be argued) - but I'm somewhat hesitant about praising them for the share buybacks that, during 2021, have been higher than CapEx.
It should be evident to anyone that the current trend in housing and demand is situational and cyclical. It will not last, and the company should be using all of its energy not used on maintaining and expanding capacity to meet demands to try and soften some of the cyclical lows beyond what we've seen for the past 20 years.
While investors in 2021 would have just about outperformed the market if investing in 2001, this outperformance is only a result of the 2020-2021 demand spike. If the corresponding valuation increase had not occurred, both your capital appreciation and dividends would have been less than most index averages.
What's more, if you bought the company at P/E highs of around 10.5X, you wouldn't actually have outperformed the market even now.
(Source: F.A.S.T Graphs)
So, this company is a great cautionary tale of what could happen if you don't pay attention to valuation and trends. The simple fact is most European lumber companies have delivered performance well above this.
This company cannot really be forecasted accurately. It either beats or it fails forecasts to a degree that highlights just how low the visibility is, with negative earnings misses of between 89-1142%
(Source: F.A.S.T graphs)
Unfortunately, the prospect of investing in this company at this time reminds me of a client I have who is the former CEO of a similar, Swedish company and who had a portfolio consisting entirely of businesses like this upon retirement. While I never doubt his business acumen in the field, we spent hours talking about how to change his investments portfolio to not reflect his previous business knowledge, but to reflect his investment goals of forecastable, conservative earnings and dividends.
These sorts of companies rarely offer this - and LPX certainly does not.
We expect the company to deliver growth in 2021E, but for 2022E the demand is expected to soften somewhat, followed by further softening in 2023E, amounting to an EPS decline of more than 55%. (Source: FactSet). EBITDA is expected to decline by around 45% while maintaining strong 27.8% margins, and an overall 2022E 50-60% decline is expected across the board in FCF, EPS, and income. Income is expected to decline not primarily as an effect of sales revenues (which are only expected to decline 15%) but as a function of margins, which are expected to drop from 43.1% to 25-27% on an EBITDA basis, as the company itself guided towards. (Source: S&P Global)
Using P/E valuations for this company is a moot point because the company has had negative P/E for almost 50% of the last 20 years. Instead, I will argue that the current EV/Sales multiple is already high, as well as revenue, EBITDA, and cash flow multiples.
The company gives us 1.8X to sales multiple, whereas most peers are well below 1x. Every comparable multiple that I mentioned is inflated here on a public comp basis and historical EBITDA basis, excluding negative years. This also includes international peers. Stora Enso is trading at lower revenue multiples, and the Scandinavian business has, to my mind, a structure far less susceptible to the housing market.
The time to invest in LPX is at the beginning of a boom in the housing market - or when there is potential further upside in the ongoing boom. I don't see this as clearly being the case at the current valuations and earnings trends for the company. I view LPX as overvalued.
While analysts don't technically disagree, they would argue that LPX is .5% overvalued to an average stock price target of $78.75/share, based on 8 analysts with currently more than 50% having a "SELL" or "HOLD" target.
I don't see a good reason to buy LPX at anything above a 1X sales multiple, and preferably lower than that. I would argue that LPX is buyable at below $40/share, which we saw less than a year ago. At current pricing, we're basing our valuation on inflated trends that I don't see lasting beyond this housing boom - which is already expected to start softening in terms of LPX product demand beginning next year.
The company is a "HOLD". If you want to hold it here, you can, though to be truthful with you I don't see much potential for further outperformance unless you give the company an earnings premium - which I would not do. Averaging up-cycle P/E valuations of around 8-12X P/E, we get 2023E RoR targets of negative 10%, and even a 13X 2023E P/E gives us barely break-even returns including dividends.
Thesis
My thesis for LPX is:
- A very pure building materials play with some degrees of fundamental strength. However, neither current structural changes nor the company's more resilient South American segment at less than 20% of sales act as catalysts for a more predictable or profitable down-cycle, meaning the company's numbers are only as strong and as long as the housing boom/demand.
- There is little the company can do to change this. The company is, to my mind, well-managed and has upside at the right time, but today's valuation includes a too high risk in terms of potential reward.
- LPX is a "HOLD" here. A price target that I would consider attractive for investment based on my goals would be around $40/share - though every investor of course needs to look at their own targets, goals, and strategies. I would also always consult with a finance professional before making investment decisions such as this.
Remember, I'm all about :
1. Buying undervalued - even if that undervaluation is slight, and not mind-numbingly massive - companies at a discount, allowing them to normalize over time and harvesting capital gains and dividends in the meantime.
2. If the company goes well beyond normalization and goes into overvaluation, I harvest gains and rotate my position into other undervalued stocks, repeating #1.
3. If the company doesn't go into overvaluation, but hovers within a fair value, or goes back down to undervaluation, I buy more as time allows.
4. I reinvest proceeds from dividends, savings from work, or other cash inflows as specified in #1.
This process has allowed me to triple my net worth in less than 7 years - and that is all I intend to continue doing (even if I don't expect the same rates of return for the next few years).
If you're interested in significantly higher returns, then I'm probably not for you. If you're interested in 10% yields, I'm not for you either.
If you however want to grow your money conservatively, safely, and harvest well-covered dividends while doing so, and your timeframe is 5-30 years, then I might be for you.
Louisiana-Pacific Corporation is currently a "HOLD".
Thank you for reading.
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This article was written by
Wolf Report is a senior analyst and private portfolio manager with over 10 years generating value ideas in European and North American markets.
He is a contributing author for the investing group iREIT on Alpha where in addition to the U.S. market, he covers the markets of Scandinavia, Germany, France, UK, Italy, Spain, Portugal and Eastern Europe in search of reasonably valued stock ideas. Learn more.Analyst’s Disclosure: I/we have a beneficial long position in the shares of HD, LOW, SEOJF, UPMKY either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
While this article may sound like financial advice, please observe that the author is not a CFA or in any way licensed to give financial advice. It may be structured as such, but it is not financial advice. Investors are required and expected to do their own due diligence and research prior to any investment. Short-term trading, options trading/investment, and futures trading are potentially extremely risky investment styles. They generally are not appropriate for someone with limited capital, limited investment experience, or a lack of understanding for the necessary risk tolerance involved. The author's intent is never to give personalized financial advice, and publications are to be viewed as research and company interest pieces.
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