North American Paper & Forest Products: Q2/21 Preview
As Good as it Gets for Lumber and Panel Margins Weaker Results Expected for H2/21; Strong FCF Profile Intact
We forecast record Q2/21 results for companies with exposure to exceptional lumber and structural panel (OSB and plywood) markets, supported by robust volumes. We anticipate record quarterly earnings that will significantly outpace our estimates of annual mid-cycle results for six of the 11 companies under coverage. We estimate that the average Q2/21 free cash flow yield for lumber- and panel-focused equities will be 21% (for the quarter alone; not annualized) and that five of the 11 companies in our coverage universe exited Q2/21 with net cash on their balance sheet. Many management teams are putting strong balance sheets to work via asset- base growth initiatives and returns of capital to shareholders.
Q2/21 results will reflect record average prices of lumber and structural panels.
The average Q2/21 lumber composite price of US$1,260/Mfbm increased 210% y/ y and 30% q/q. The average OSB composite price of US$1,373/Msf (7/16" basis) increased 367% y/y and 54% q/q. Although wood product market momentum was the most notable development in Q2/21, prices also improved across key pulp, graphic paper, and packaging grades. We believe that synchronized commodity price gains were mitigated by a weaker U.S. dollar and input cost inflation.
Our Q2/21 adjusted EBITDA estimates are above consensus forecasts for six of the 11 names in our coverage universe. We expect y/y EBITDA growth for nine companies and q/q EBITDA growth for 10 companies, led by companies with high earnings leverage to wood product markets. Based on our estimates, the largest upside earnings outlier this earnings season is West Fraser.
We have no illusions that Q2/21 results are sustainable for wood-weighted equities. Lumber prices have crashed from the May peak and, more recently, were followed by OSB and pulp. We also note that pronounced log cost inflation in western Canada is expected in H2/21. Despite these caveats, we still forecast well-above- trend results for most companies through 2022. Adjusted for expected free cash flow estimates, we still believe that several equities are undervalued, led by West Fraser.
We are not changing any estimates or recommendations, but we have raised our West Fraser target price to US$115.00 from US$113.00 to align with TD Securities' policy of rounding to the nearest $5.00 per share increment.