June 15, 2021
RBC ElementsTM:
Paper, Packaging & Forest Products
Q221 Preview
Gonna soak up the (free cash flow)
It's been a wild year, and we expect continued volatility in the Paper, Packaging, & Forest Product industries for the balance of 2021 and into 2022. In Wood Products, we forecast operating rates to remain high in both 2021 and 2022, resulting in very strong pricing. In lumber markets, we have increased our Trend pricing forecasts (see Exhibit 3) due to structurally declining SPF capacity and increased production costs in British Columbia. In pulp, we have slightly increased our 2021/2022 estimates given that the rally was faster and higher than our previous expectation. In containerboard, we have reflected the recent price increase in our forecasts, resulting in increases to our 2022 estimates.
In Canada, our favorite names include Interfor, Canfor, and Cascades. In the United States, our favorite names include Louisiana-Pacific, West Fraser, and Weyerhaeuser. In Australia, we still like James Hardie. In this note, we also introduce our 2023 estimates. Please see pages 2 and 15-20 for details on our price target and estimate changes.
Best positioned commodities into Q221 earnings
1) Oriented Strand Board – While lumber has received most of the attention, OSB remains the primary bottleneck in the building supply chain which has contributed to continued increases in pricing despite declines in other wood product markets. We expect that OSB producers (West Fraser, Louisiana-Pacific, and Weyerhaeuser) will deliver significant free cash flow during Q2 and the outlook remains bright going forward with demand significantly outstripping capacity. The primary risk is that producers miss analyst expectations, but we think that investors have painted all wood products with the same brush, leading to reduced buyside expectations going forward.
2) Lumber – Market sentiment has turned negative on the sector despite prices being over $1,000, which we think is a mistake given how much cash producers are adding to their balance sheets. We have seen a few different capital allocation strategies so far, with West Fraser and Western FP focusing on share repurchases, Canfor opting to be more conservative and invest in organic growth, and Interfor being more aggressive on acquisitions while also returning capital through a special dividend. Going forward, we think investors are looking for cash lumber markets to find support and stabilize.
3) Containerboard – We have been somewhat negative on the containerboard industry, but producers have demonstrated significant pricing power over the past year, leading to two price increases with a third increase now on the table. In our view, the price increases will more than offset cost inflation, including OCC and transportation. The biggest risk to the stocks remains valuation in our view , with only Cascades passing our hurdle to recommend to investors given its significant discount to US-peers.
Least preferred commodities into Q221 earnings
1) Pulp – Although Q2 results should be strong on the back of improved pricing, we think that the increase will be short-lived. Given that pricing has seemingly peaked in China, we think that it will be challenging for producers to push through further increases in North America and Europe. More negative company outlooks could put further pressure on pulp producers going forward.
2) Tissue – Despite their strong performance in 2020, tissue markets remain under pressure as the US economy shifts to “away-from-home”. In addition to reduced consumer tissue operating rates, rising pulp prices are starting to put pressure on margins. Under normal circumstances, this would lead producers to increase prices; however, lower demand is leading the majors to preserve market share. This could be particularly negative for private label tissue producers.