TD Notes North American Paper & Forest Products
2024 Outlook: The Haves and Have-Nots
Expect Divergent Paths to Capital Deployment
Forest product equities endured another year of extreme volatility in 2023, but
have started 2024 with positive momentum. Average gains from 52-week lows
— late-October for most wood-weighted equities — are 32.7%, albeit from a low
base in most cases. Over the last two months of 2023, sentiment turned positive with
moderating interest rates and an associated uplift in new home construction activity.
Expected Themes for 2024
Forest product commodity markets are starting 2024 on a relatively firm
footing. Wood product supply has been managed around weakening demand
from repair and remodelling channels. U.S. new home construction ended 2023
with positive momentum as mortgage rates settled. Pulp and containerboard
inventories have cleared.
A bias towards sustaining low leverage and strong available liquidity. We
believe that share buyback activity will be limited to normal course repurchases.
Divergent paths for capex. Among our coverage, WFG and CFP are expected to
pursue relatively aggressive 2024 capex. Several other companies are expected
to slow capex y/y, following recent completion of major discretionary initiatives or
to focus on reducing leverage.
We expect that measured M&A activity in the wood products sector will
remain a theme. Sector leaders WFG and CFP retain net cash balances, and we
believe that both companies are open to consolidation opportunities.
We are making three rating changes: 1) upgrading CAS to BUY from Hold,
reflecting higher mid-term free-cash-flow estimates; 2) downgrading LPX and IFP to
HOLD from Buy, following recent valuation expansion.
Sector investment bias: MARKET WEIGHT. Given recent valuation expansion,
we are more cautious on share-price prospects at the margin. At an average trend
trailing EV/EBITDA of 4.2x (below the long-term average of 5.6x), there is a case to
be made that valuations for wood-weighted equities are compelling, but we note an
uncertain demand outlook across the commodity spectrum and mid-term capacity
growth for both lumber and OSB. WFG remains our top pick in the sector.