North American Paper & Forest Products: Q4/22 Preview
Expect Ugly Near-term Results; Close to Trough for Lumber Names Lumber and OSB Supply Response has Lagged Demand Correction
Q4/22 earnings season for our forest products coverage universe starts February 9. We expect near-trough results for most lumber and panel producers, driven by ongoing commodity price pressure, coupled with production curtailments in Q4/22. For context, we expect negative EBITDA for some lumber producers this quarter versus peak average quarterly EBITDA margins of 51% for sawmills and 74% for OSB mills in Q2/21. Our Q4/22 EBITDA estimates are below consensus forecasts this quarter for eight of the 10 companies in our coverage universe. Larger variances are weighted to companies with wood products exposure, many of which are expected to record material write-downs of log and finished product inventories.
Lumber and structural panel prices continued to capitulate in Q4/22. The average Q4/22 Random Lengths Framing Lumber composite price of US$452/Mfbm declined 24% q/q, setting the lowest quarterly average since Q2/20. The average OSB composite price of US$360/Msf (7/16" basis) fell 20% q/q. Lower wood product prices were accompanied by more moderate pressure on pulp and containerboard markets.
The only changes to our commodity price deck reflect reconciliation to actual Q4/22 averages, but we have tempered our earnings estimates to reflect incremental downtime costs (Q4/22 and H1/23) and inventory revaluations. Our target prices and recommendations are unchanged. Despite expectations of weaker near-term free cash flows for several companies, we are not inclined to take an overly negative view of share-price potential as wood product markets approach our assessment of a cyclical floor. We previously adjusted our outlook on December 19. Our average adjusted trend EV/EBITDA target-price multiple increases to 4.6x from 4.4x previously.
We reiterate our sector MARKET WEIGHT bias. Although lumber-weighted equities are trading at arguably distressed valuations (multi-year lows on trend EV/ EBITDA, P/BV, and EV/capacity), we believe that near-term consensus estimates remain excessive. Our only BUY ratings are commodity lumber-focused equities. Although the supply response has lagged cyclical demand pressure to this point, we anticipate permanent sawmill closures in the coming months, given the lack of economic fibre available in B.C. We reiterate our opinion that the sector is also better positioned than previous cycles, given balance-sheet flexibility. Our top picks are CFP and WFG.