With supply chain issues and labour shortage problems gloomed, CPI hits 8.5% on a year-over-year basis in March. Weyerhaeuser (NYSE:WY) is a rare choice that thrives in this inflationary era, which benefited from its upstream supply chain status. The company stayed flat in 2022, outperforming the S&P 500 index (SPY) and Vanguard Real Estate ETF (VNQ) so far this year.
In this article, I will discuss how WY benefited and continue to enjoy the sky-high lumber price amid inflationary times. I believe the stock will outperform the benchmarks for the rest of 2022.
Wood products are overwhelmingly important to WY. They are accountable for over 80% of earnings in FY 2021, where lumber and oriented strand board (OSB) contribute 48% and 34% of adjusted EBITDA in the period of 2019 to 2021 in this segment.
(In Million Dollar)
Real Estate, Energy & Natural Resources
Natural Climate Solutions
In terms of sales, the majority of the wood products is consumed by new residential developments, while 20% of them are absorbed for repair and remodeling works.
Lumber price (LB1:COM) surged to the record-high of $1,700 in May 2021 and continue to remain expensive in 2022. Despite the recent drop, the 52-week average price (shown in red) is still well above the pre-pandemic level. The chart below shows lumber price over the past five years.
Unsurprisingly, given that 80% of the earnings are from wood products, I found a certain correlation between WY's stock price and the lumber price. Benefiting from the surging lumber price last year, the gross margin of WY skyrocketed from 27.7% in FY 2020 to 40.2% in FY 2021. Also, earnings per share tripled from $1.07 in FY 2020 to $3.47 in FY 2021.
The chart below shows their correlation from 2018 to 2022. The closer the Correlation Coefficient is to 1, the higher their positive correlation.
Since the lumber price and WY's stock performance are positively correlated, the most important question to answer would be: Where will the lumber price go in 2022?
Log supply in British Columbia of Canada declined due to fires, pine beetle, and lower allowable cut. Together with the impact of labour shortage problems and supply chain issues disrupting the mills, buyers are unable to receive the lumber on time. Fortunately, we see signs of improvement in recent times and would help WY to improve its supply to achieve its target of 5% annual growth on lumber products.
We see the labor market showing signs of improvement. Apart from the improving macro environment, like the rising U.S. participation rate (62.4% in Mar 2022) and the decreasing U.S. unemployment rate (3.6% in Mar 2022), mills of WY are also seeing opportunities for recovery.
The mills of WY are distributed in Canada and the West and South of the U.S. Census Bureau report shows mega-cities like New York and LA lost more than 700,000 citizens during COVID times for cities in the South and West, like Dallas and Houston. I believe this would alleviate the labour shortage problem in these areas. So, it is anticipated that the mills would be able to increase productivity and cut the backlogs gradually.
The supply chain over the globe is still tight but is witnessing indications of improvement. The Baltic Exchange Dry Index, which measured changes in the cost of transporting various raw materials, including timber and lumber, dropped over 60% from its high in September 2021 and dropped over 20% from its peak in March this year. Costamare (CMRE) 2021 Q4 Earnings Presentation also shows the average spot earning of the dry bulk market has retreated from its peak. This indicates the worst time of maritime transport has already gone.
While the majority of the sales of WY are from North America, the company suffered from the tight trucker availability as well. As the weather improves and Omicron starts to trend down, transportation is going to improve a little bit better in recent terms. That said, the high turnover rate of truckers due to unacceptable working conditions, still avoiding the country to have enough truckers.
I believe the worst period has already passed. The supply of wood products and timber could pick up gradually to fill the outstanding orders and increase the productivity gradually.
The demand for lumber still remains high. Despite the consistently rising mortgage rates, homebuilders are having a considerable amount of backlogs in hand, which is at a record-high number. For example, D.R. Horton (DHI), the biggest homebuilder in the U.S., reported in the previous conference call that the company has around 30,000 homes in backlog.
Housing numbers also stay strong. Both U.S. building permits and housing starts are undisturbed by the mortgage rate, moving at a 5-year high level. While the former is a leading indicator to show the demand in the housing market, the latter shows the number of residential buildings that actually kicked start. All the above indicates the demand for this segment would continue to stay high, if not rise.
The mortgage rate keeps increasing and shows no signs of slowing down. The 30-year fixed-rate mortgage averaged 5.11% in the week of 21 April 2022, marking a seven-week consecutive increase. The increasing mortgage rate would be likely to reduce the incentives of homebuyers to purchase new homes, causing a slowing down housing market.
While the labor market is having a strong comeback from the pandemic, it is surprising that consumer sentiment plummeted to a level last seen in 2008/09. On one side, it shows the demand for woods products for home refurbishment and DIY market would stay low. On the other side, it demonstrates people are not willing to spend money on discretionary items, including property. Thus, we found the existing home sales dropped back to the pre-pandemic level.
The average lumber price in 2021 is $850 per 1,000 board feet, which is an over 50% increase from 2020. With the risk of a slowing down housing market, analysts from Russ Taylor Global and Domain Timber Advisors estimated that the lumber price will fluctuate between $600 to $1,000 this year.
With the analysis that I mentioned above, I believe the overall demand for wood products in new development projects will remain strong this year, but the DIY market would be depressing. As the latter takes account of about 40% of the total lumber sales, it would pose some negative impact on the lumber price. Thus, I concur with the analysts that the average lumber price would be slightly lower this year and will not hit the historic high again.
Research from the North Carolina State University shows both softwood and hardwood have a more inelastic supply than demand. It means if the supply increases to an extent greater than the demand decreases, the total sales of the product will still increase. I assume the average lumber price in 2022 will drop to $800, which is the mean of analysts' estimate mentioned above.
As the EBITDA in FY 2022 could be envisioned, EV/EBITDA is used to evaluate the stock.
The total EBITDA of WY will drop accordingly with the lumber price by 5.88%, as the average lumber price is expected to drop from $850 last year to $800.
Despite the lumber price dropping 5.88% in 2022, the company anticipates an increase in lumber productivity and strong improvement in the natural climate solutions sector. There would be a 5% increase in lumber productivity, leading to a 2.4% rise in EBITDA. For the latter sector, the company anticipates it to grow 13% CAGR, which brought a 0.15% increase in EBITDA.
Moreover, WY enjoys a strong new residential development market (single & multi-family), which is accountable for 65% of its wood products EBITDA. As the supply-side is anticipated to improve, while the demand-side tends to stay flat in this market, the EBITDA in the wood products segment may improve by 2%, and 1.64% in total EBITDA.
Given the scenario in 2021 is quite similar to 2022, we think the valuation of 2021 is worth making reference to. The current EV/EBITDA (as of 22 April 2022) is 8.34, while the 2021 average is 8.85. Assuming the amount of debt and cash held by the company remains unchanged, the stock will be targeted from $41.47 to $43.31 at the end of 2022.
With inflationary pressure still being a threat to many companies, WY would be the choice to outperform the benchmarks. Although the lumber price may drop slightly in the coming year, WY's focus on the new residential development market will benefit the company.
Analysts estimated the S&P 500 to reach 4,000 to 5,300 at the year-end, with a mean of 4,781 (0.31% increase from the 2021 closing price). I believe WY will outperform it since the stock will be targeted for a 0.70% to 5.25% increase from the 2021 closing price at $41.18.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. 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.
Additional disclosure: I am not a professional investment advisor. No information in this publication is intended as investment advice to buy/sell. The past performance data shown is not a guarantee of future results.