Upgrade RBC Dominion Securities analyst Paul Quinn expects wood products producers to post “very strong (if not record)” third-quarter results driven by healthy demand and “a record pricing environment.”
Conversely, in a research note previewing earnings seasons for Paper, Packaging & Forest Products companies, he thinks pulp markets “continue to overpromised and under deliver.”
“The highlights of Q3 included the record wood product pricing in North America, strong demand conditions in the U.S. housing market, and the surprising resilience of North American containerboard demand (which appears set to result in the first price increase since 2018),” he said. "Although there is some hope that seasonally stronger winter demand will support pulp markets, we see continued weakness due to elevated global inventory levels. Key questions looking ahead include: 1) how quickly could wood product pricing fall, and to what level; 2) how will the incoming containerboard capacity impact operating rates; and, 3) will more graphic paper producers exit the market through closures or conversions to packaging grades.
“In Canada, our favorite names include West Fraser, Norbord, and Interfor. In the United States, our favorite names include Louisiana-Pacific and Weyerhaeuser.”
Mr. Quinn feels wood producers, including lumber, oriented strand board (OSB) and plywood, are best positioned for strength heading into earnings season.
“For lumber and OSB producers in particular, we expect that record (or near record) results will lead to reduced leverage and increased return of capital to shareholders through share repurchases and special dividends,” he said. "We believe a key risk to results would be if realizations were to substantially lag reported prices during the quarter, which would push results below forecasts. If this were to occur, we expect that more of the uplift would come through during Q4, so the net effect would be minimal.
Conversely, he feels pulp producers “can’t seem to catch a break.”
“Despite seasonal weakness over the summer, September was supposed to be the turning point for global pulp markets, with back-to-school (and some offices) demand supposed to spur additional demand in addition to seasonal improvements in tissue consumption,” he said. “Furthermore, a heavy fall maintenance schedule was supposed to reduce supplies. This prompted NBSK producers to announce a slurry of price increases for October deliveries; so far, it looks as though those price increases are only partially taking (if at all). In our view, inventories are still too high, demand is still too low, and hardwood prices remain stubbornly low. These factors have combined to leave pulp prices at a low level and discounting to become more aggressive.”
“While global pulp inventories have fallen from the record levels experienced in summer 2019, they still remain above historical levels.”
Pointing to its current valuation, Mr. Quinn downgraded KP Tissue Inc. (
KPT-T) to “sector perform” from “outperform.” His target remains $14, which falls 8 cents short of the consensus on the Street.
“We believe that KP Tissue should trade above the typical Canadian Paper & Forest Products trading range (5.0 times to 7.0 times), reflecting its market-leading position and the noncyclical nature of the tissue business,” he said.
Citing the “strong U.S. housing market and improved free cash flow generation,” Mr. Quinn raised Rayonier Advanced Materials Inc. (RYAM-N) to “outperform” from “sector perform” with a US$5.50 target, up from US$3.50. The average is US$5.63. “With lumber prices setting record levels during Q3, we expect that the business will generate improved free cash flow which can be used to reduce leverage,” the analyst said. “As the debt overhang clears up, we expect that more investors could become attracted to the Rayonier Advanced story. In addition, Georgia-Pacific’s specialty cellulose line at its Foley Plant in Florida remains down, which should help with contract negotiations this fall. These factors combine to bring us back to an Outperform rating.”
Mr. Quinn also made the following target price changes:
- Acadian Timber Corp. (ADN-T, “sector perform”) to $16 from $15. Average: $17.10.
- Canfor Corp. (CFP-T, “outperform”) to $27 from $26. Average: $23.92.
- CanWel Building Materials Group Ltd. (CWX-T, “outperform”) to $8 from $7.50. Average: $7.14.
- Conifex Timber Inc. (CFF-T, “outperform”) to $2 from $1.50. Average: $1.78.
- Clearwater Paper Corp. (CLW-N, “outperform”) to US$50 from US$48. Average: US$51.50.
- Domtar Corp. (UFS-N/UFS-T, “sector perform”) to US$27 from US$26. Average: US$31.45.
- International Paper Co. (IP-N, “sector perform”) to US$41 from US$36. Average: US$42.77.
- Resolute Forest Products Inc. (RFP-N/RFP-T, “outperform”) to US$7.50 from US$5.50. Average: US$5.63.
-