Wood Products 2022 Outlook
Does history repeat or rhyme?
Flying high on record earnings, 2022 is likely a pivotal year for wood products producers
We expect a repeat of record market conditions – While we might not surpass the record pricing levels seen in 2021, the pricing trends are looking very similar to last year as we rally into year-end (see Exhibits 2 and 3). We expect that logistics will play an even more pivotal role in the upcoming year, with recent flooding in the BC Interior disrupting the flow of lumber to market and forcing some producers to curtail production. While new capacity could have a negative impact on pricing, new sawmills are generally slow to ramp to nameplate capacity; there could be upside to our forecasts should the BC Provincial Government's Old Growth policy (link) result in sawmill closures and/or curtailments during the year. Looking ahead to the new year, some key themes we have identified include:
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Pricing should be very strong, especially in the first half of the year: Given the continuation of strong demand and supply chain disruptions, we expect that pricing in the first half of 2022 will be very strong. Although we expect prices to drift lower in the second half of the year as seasonal demand cools and transportation bottlenecks are addressed, we think pricing will remain well above historical levels as the supply-demand balance remains tight.
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With strong balance sheets, M&A activity is likely to remain elevated: The past year was a record year for Wood Products M&A activity, with >$2.0 billion of transaction activity globally. Given our expectation for continued strong cash generation and already strong balance sheets, we suspect that 2022 will bring more of the same.
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Mass timber will continue to grow: In our view, the long-term incremental demand from mass timber construction remains underappreciated by investors. We expect 2022 to be a pivotal year, with the recent introduction of new standards allowing taller wood buildings likely to spur additional investment in the industry. We believe Canfor or Weyerhaeuser are best positioned to benefit.
Stock recommendations into 2022
In Canada, our Top Idea for 2022 is West Fraser Timber (TSX: WFG; NYSE: WFG). Due to record lumber and very strong OSB pricing, we think that the company will be in a good position to continue to return capital to shareholders through its regular dividend and share repurchases. We think US investors will see West Fraser as the best way to play this cycle. Our top SMID Cap idea is Interfor (TSX: IFP), which should benefit from record lumber pricing, particularly in the US South.
In the US, our Top Idea for 2022 is Louisiana-Pacific (NYSE: LPX). In addition to benefiting from record OSB prices, we think that the company's growing (and highly profitable) siding business remains underappreciated by investors. We view LP as a growing free cash flow generator. We recently highlighted Louisiana-Pacific in a deep-dive RBC Fusion report (link). Our favorite Timber REIT is Weyerhaeuser (NYSE: WY) due to the company's wood product exposure and high quality timberlands.
Rating and price target revisions
We are not changing any ratings.
In Canada, we are increasing our price targets for Canfor and Interfor, largely reflecting the impact of recently completed acquisitions. In Australia, we are increasing our price target for James Hardie. In the United States, we are increasing our price targets for Louisiana-Pacific, PotlatchDeltic, and Weyerhaeuser while reducing our price target for CatchMark Timber Trust.
Commodity forecast changes
Lumber & OSB: We are adjusting our 2021 forecast to reflect actual pricing. We are reiterating our 2022, 2023, and Trend pricing forecasts.
West Fraser Timber Co. Ltd.
West Fraser Timber Co. Ltd. (“West Fraser”) is a North American wood products company that produces lumber, panels, pulp, and newsprint. The company is the largest producer of lumber in North America, with operations in British Columbia, Alberta, and the US South. The company’s panel operations include plywood, MDF, and LVL production in BC and Alberta. Finally, it owns three pulp mills in Canada and has a 50% interest in Cariboo Pulp & Paper Company and Alberta Newsprint Company.
Valuation
Our $125 price target supports our Outperform rating and reflects a blended ~6.75x EV/EBITDA multiple on our trend EBITDA of $1,525MM (weighted 85%) and our 2022E EBITDA (weighted 15%) of $3.2B. We believe West Fraser should trade at a multiple at the high end of the typical Canadian Forest Products trading range (5.0x to 7.0x), reflecting strong levels of profitability, strong operational performance, a solid balance sheet, and an emphasis on returning capital to shareholders.
Risks
Currency risk: West Fraser’s operating results are sensitive to fluctuation in the exchange rate of the Canadian dollar relative to the US dollar. An increase in the value of the Canadian dollar reduces the company’s realized sales, which are mostly priced in US dollars.
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Cyclicality of lumber pricing: The company’s financial performance is dependent upon the selling prices of its products, which has historically been quite volatile.
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Capital requirements: The forest products industry is capital intensive, with regular capital expenditures to maintain equipment, increase operating efficiency, and comply with environmental laws.