North American Paper & Forest Products 2022 Outlook
Starting the Year with Resurgent Momentum
Balance Sheet Flexibility Even as Capital Deployment Accelerates
In 2021, the North American forest products sector experienced exceptional profitability, unprecedented volatility, and strong equity returns. Average total returns for our coverage universe were 49% last year, led by lumber- and OSB- weighted equities (+84%, on average), which outpaced gains of 25% for the S&P/ TSX Composite and 31% for the S&P 500. Although overall performance was positive, volatility was extreme. Record-shattering earnings for lumber and panel producers resulted in the fastest balance-sheet transition in the industry's history and subsequent acceleration in capital deployment.
We believe that a "stronger for longer" wood products price cycle is a reality.
Wood product prices are still below frenzied Q2/21 records, but are back well above our assessment of mid-cycle (trend) levels, reflecting buoyant U.S. demand and tight supply. We are raising our average 2021 Western SPF lumber benchmark price by 6% to US$874/Mfbm and our average 2022 price estimate by 24% to US$725/Mfbm. To varying degrees, we are increasing our price forecasts for other lumber and OSB grades. Adjustments to our pulp and paper price outlook are less material. We are also introducing our 2023 estimates, which call for a gradual moderation in wood product prices as supply catches up to demand.
We are increasing our earnings estimates and target prices for most names in our coverage universe. Higher earnings forecasts reflect positive changes to our commodity price deck and company-specific growth initiatives, mitigated by input/freight cost inflation. We are raising our target prices for seven of the 10 names, mostly to account for higher mid-term free cash flow (FCF) estimates and the inclusion of 2023 FCF in our valuation methodology. We forecast average annual FCF yields of 20% in 2022 and 9% in 2023 for wood product equities — down from an estimated average of 31% yield in 2021, but still robust, especially given an expectation of higher capex over the next two years. We are not making any recommendation changes.
We reiterate our sector OVERWEIGHT bias. Notwithstanding strong equity gains in 2021 and an expectation of ongoing commodity market volatility this year (a factor that we believe alienates a contingent of potential investors), valuations based on mid-cycle estimates remain below long-term averages. Our coverage universe is trading at 4.5x estimated trend EV/EBITDA, adjusted for FCF forecasts through 2023, versus a long-term average of 5.3x. We highlight Interfor as our top pick in the sector, based on value-accretive growth initiatives and balanced capital-allocation priorities.