North American Paper & Forest Products
Updating Outlook as Demand Headwinds Increase Hard Landing for Wood Product Prices Meets Expectations
Forest product equities remain under pressure as investors discount an increasingly negative macroeconomic outlook. The average share-price correction for lumber and panel-weighted equities in our coverage universe from the Q1/22 highs is 27% — a negative comparison versus declines of 14% for the S&P/ TSX Composite and 22% for the S&P 500 over similar durations. Steep inflation, a rapid interest-rate rebound, and deteriorating housing affordability have weighed on wood product commodity markets, which have crashed from near-record levels in Q1/22. Investors are seemingly assuming a rising possibility of a North American recession. Although this is not TD Economics' assumption (respective 2022 and 2023 GDP growth forecasts: 3.7% and 1.7% in Canada; 2.2% and 1.4% in the U.S.), this note provides context on precedent forest product sector performance and valuation trends during recessions.
The hard landing for lumber and OSB prices was anticipated; we are making modest revisions to our commodity deck. We are lowering our average 2022 Western SPF lumber price forecast by 3% to US$809/Mfbm and our average 2023 price estimate by 3% to US$525/Mfbm. Changes to our OSB price forecasts are a little more significant. With mounting demand headwinds, we expect that the cost to manage mill inventories and support prices (i.e., extended downtime) will increase. The net impact of the changes to our commodity deck, volume, and cost assumptions is an average 4% decrease in our 2022 adjusted EBITDA forecasts and an average 3% decrease in our 2023 estimates.
We are lowering our target prices for seven of the 10 companies in our coverage universe and downgrading our rating for West Fraser to BUY (from Action List Buy). The average adjusted trend EV/EBITDA target multiple declines to 4.4x from 4.9x previously, with more significant reductions for lumber and panel- weighted equities (higher risk to our demand outlook).
Although we do not qualify the sector as "catalyst-rich" in the near term, we reiterate our sector OVERWEIGHT bias. Sector balance sheets are in significantly better shape than was the case entering previous recessions and we believe that current valuations assume an overly negative outlook. Lumber-weighted equities in our coverage universe are trading at 2.4x estimated trend EV/EBITDA, adjusted for FCF forecasts through 2023, versus the long-term average of 5.2x. Our top picks in the sector for value-oriented investors are Interfor, Louisiana-Pacific, and West Fraser.