North American Paper & Forest Products
Lumber and Panel Markets have Settled After a Wild Round Trip Valuations Already Discount H2/21 Consensus Estimate Reductions
After an unprecedented 18-month boom-bust price cycle, North American lumber and panel markets have settled in recent weeks. The price crash from May through August (66-74% for benchmark grades) was more severe than we thought would be the case, partly a function of B.C. downtime starting later than expected. We believe that wood product commodity markets are approaching balanced levels following an unsustainable Q2/21 peak.
Given the sharp collapse since Q2/21, we are lowering our H2/21 wood product price forecasts. Our average 2021 benchmark lumber and oriented strand board (OSB) price forecasts decline 13% (to US$817/Mfbm) and 17% (to US$791/Msf), respectively. Downward revisions to our 2022 lumber, OSB, and pulp price forecasts are relatively modest (average price reductions from 1-4%). As a result of the changes in our commodity price deck, currency, input cost, and volume forecasts, our average EBITDA forecasts decline 5% for 2021 and 4% for 2022. We expect reductions in H2/21 consensus earnings estimates in the weeks leading up to the Q3/21 earnings season, but believe that this is anticipated by investors.
No changes to our recommendations, but we are lowering our target prices for six of the 11 equities under coverage. In general, adjustments to our mid- term free cash flow estimates are not large enough to warrant material target price changes. The average adjusted target trend EV/EBITDA multiple of 5.4x matches the previous average. We are lowering our target prices for several wood-product- weighted equities, but leaving our target prices for West Fraser and Louisiana-Pacific unchanged (modest valuation expansion for large-cap names as commodity markets reach a floor).
We reiterate our sector OVERWEIGHT recommendation. The average share- price recovery for our coverage universe from July lows is 17%, but, on average, share prices are still 22% below Q2/21 peak levels. We attribute recent equity resilience to a few developments: 1) investors' comfort that wood product prices have bottomed out; 2) acknowledgment that the sector's balance sheets have improved at an unprecedented pace over the past year; and 3) value-accretive capital deployment initiatives, including aggressive share buyback activity. Adjusted for expected results through 2022, lumber-weighted equities are trading at, or below, pro forma book value. This normally happens only during periods of balance-sheet distress (not the case now). Our top pick in the sector is West Fraser.