- Single family housing conditions are picking up, but the remodeling market is faltering.
- WY's EWP segment looks poised to have another resilient quarter, although the export market could be weak.
- WY offers decent EBITDA growth relative to its peers and is priced at a significant discount.
- WY's current yield is not compelling enough.
- We are not enthused by the risk-reward on the charts.
The stock of one of the world’s largest private owners of timberlands- Weyerhaeuser Company (NYSE:WY), has experienced a relatively mixed journey in 2023 so far. Its price movements all through the year have been quite erratic, but yet, it has managed to deliver over 3x the returns of the flagship- XLRE ETF; that still hasn’t been enough to prevent over 700bps of underperformance relative to the broader markets.
With another 4-5 months to go this year, we think WY’s erratic performance may well persist as we see good enough reasons for both the bulls and the bears to get on board. Here are some of the key narratives behind our neutral stance on WY stock.
Reasons To Pursue
It’s encouraging to note that WY’s largest division- Wood Products (which accounts for 78% of group sales and EBITDA) has been benefiting from some nice housing tailwinds which could well linger in the quarters ahead. In Q2, group EBITDA saw a 19% sequential improvement (the woods product division itself saw a mammoth 82% improvement), and the key drivers here were better pricing for wood products, and strong engineered wood product (EWP) volumes.
Note that the prospects of WY’s EWP products are closely linked to conditions in the single-family housing market, and it looks like things could continue to improve (management noted that strong order activity as carried on to Q3) as permits for future construction are currently at 12-month highs. WP is well poised to step-up its volumes with the EWP portfolio as their plants were only operating at 60% in Q1 and mid-to-low 70s in Q2.
Also consider that OSB (Orient strand board) related inventories in the industry have been quite low of late, and a potential pickup in building activity, could galvanize prices for that segment as well.
WY’s endeavours in the carbon capture space are also worth monitoring, as this could potentially generate $100m of EBITDA by FY25 (Source: June Investor Meeting). WY has been piloting a forest carbon project for a while, and in Q2, after a third party audit, it submitted this project for final approval by the American Carbon Registry. If approved, management believes the initial issuance could amount to 30k of credits in the first year itself. Besides the pilot project, WY also has two other similar carbon capture projects in the anvil. These two projects are located in the Gulf South where the economics are believed to be more supportive than the Northern region.
Compared to other alternatives in this market, we also like WY’s forward valuations particularly when one considers the decent level of EBITDA growth you could be getting for that multiple. Granted, after a remarkably strong 2022, it would be unrealistic to expect these timber REITs to maintain the same level of EBITDA in 2023, but if one takes a medium-term viewpoint stretching to 2025, WY’s prospects are not bad.
According to consensus estimates, WY could generate 14% EBITDA growth between FY23 and FY25 which may not be as dazzling as PotlatchDeltic Corporation (PCH)’s outlook, but it’s still around 300bps better than Rayonier’s prospects.
Crucially, the valuation discount relative to both those entities is too stark to ignore. WY is priced at only 16x forward EV/EBITDA, a 25-30% discount to its peers.
Reasons To Avoid
Housing data, by and large, may be looking up, but there’s one component where trends appear to be rather iffy, and that’s the remodelling market where WY’s wood products are keenly exposed. Within the remodelling report, we would pay particular attention to the forward-looking future indicators index which hit a 13-quarter low. Crucially, the index measuring the backlog of future remodelling projects dropped by 11% sequentially, highlighting the likely weakness on the anvil.
WY’s Timberland segment, which accounts for 18% of the group topline hasn’t been faring too well, and the pressure is likely to linger in Q3 as well. In Q2, this segment reported a 9% sequential decline at the EBITDA level. In Q3, the sequential decline could be a lot worse than what was seen in Q2 (potentially a $25m drag on segment EBITDA or -14% q-o-q decline). There are a few reasons for this.
Firstly, the key Western export markets of Japan and China are already dealing with excess lumber supplies from the likes of Europe and New Zealand, and whilst the Japanese situation could improve, China’s sub-par log consumption could still dampen sales realizations. Domestically as well, on account of seasonal trends, there will likely be a spike in logs from the nontraditional timber cohort which could leave an adverse impact on sales realizations there.
We know that investors who put money to work in this area are rather fastidious about the income narrative, but as things stand WY is poorly positioned relative to its peers. WY has a fluid dividend policy (this consists of a base dividend regardless of where they are in the cycle, and then a flexible component linked to FCF). Whilst it was encouraging to see the CFO trend up in Q2, it would be unreasonable to expect a much higher cadence in line with what was seen last year.
Compared to the other two timber REITs- RYN and PCH, WY's stock not only currently offers the lowest yield (2.23%), but the differential relative to its 3-year average is also the widest (over 110bps). Conversely, RYN currently offers a 31bps premium over its long-term average yield figure.
Finally, based on the picture provided by both the relative strength, and standalone charts, it does not look like the reward-to-risk equation at this juncture is too conducive for a long position in WY.
The chart below- which measures WY’s long-term monthly price imprints - shows that for over two decades now, the stock has been chopping along, and trending up within a broad ascending channel. Now if one were to contemplate a long position at this juncture, using the upper and lower boundaries as potential pivot zones, the reward-risk (R:R) certainly doesn’t look too appealing at only around 0.66x (you ideally want to get in when this crosses 1x)
Then, one can also see how WY is positioned relative to its peers from the timber and forestry space. Even though there’s been a correction from the 0.47 levels in recent months, the chart below highlights how overextended WY still looks, relative to its peers; the current relative strength ratio is still around ~11% away from the mid-point of the range.
This article was written by
Analyst’s 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.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.