North American Paper & Forest Products
Harder-than-expected Landing for Wood Product Commodity Prices Tempering 2023 Estimates and Rolling Out 2024 Forecasts
The lumber and panel commodity price capitulation headed into year end has exceeded our forecasts as supply curtailments have not kept pace with demand pressure. With a lower starting point next year, we are reducing our average 2023 Western SPF lumber price by 11% to US$460/Mfbm — 28% above the current price, but down 42% from the expected 2022 average. Reductions to our oriented strand board (OSB) forecast, which is more heavily exposed to new home construction pressure, are more severe: our average annual 2023 North Central OSB price estimate declines 16% to US$326/Msf. Our 2024 wood product commodity price forecasts call for modest y/y improvement as demand pressure moderates.
On average, our 2023 EBITDA forecasts decline 13% from previous estimates (-21% for lumber/panel producers and flat for pulp and paper producers). Our new 2024 EBITDA estimates are, on average, 5% above our revised 2023 forecasts. We have lowered our target prices for six of the 10 names in our coverage universe (lower mid-term FCF estimates and, in some cases, more conservative target multiples). We are making one recommendation change: our Louisiana-Pacific rating moves to HOLD from Buy after recent share-price outperformance.
Expected capital-allocation themes for 2023: 1) Less aggressive returns of capital to shareholders. On average, wood-focused companies in our coverage universe have repurchased 23% of their shares over the past three years, often supplemented by dividends. With an expectation of neutral sector free cash flow, we anticipate that returns to shareholders will moderate. 2) Ongoing M&A activity.The lumber sector is fragmented and, with substantial industry liquidity, we believe that consolidation is inevitable. We also expect that the commodity price collapse will lower potential sellers' valuation parameters. 3) A focus on sustaining balance- sheet flexibility. We believe that most wood-product-focused management teams are conditioned to sustaining low leverage ratios.
We are changing our sector bias to MARKETWEIGHT from Overweight. We believe that consensus estimates are poised for negative revisions in the coming weeks as lower commodity prices are compounded by incremental costs associated with downtime. Although we have more Hold than Buy ratings, positive biases skew towards mid- to large-cap lumber producers, which are trading at <70% of book value and a 72-85% discount to replacement cost. The sector is not immune to recession risk and is not "catalyst-rich", but is, in our view, better positioned than previous down- cycles, given balance-sheet flexibility. Our top pick is WFG.