West Fraser Timber Co Ltd T.WFG

TD Notes

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North American Paper & Forest Products

Fine-tuning Forecasts as Wood Product Price Correction Continues Lower Estimates Also Reflect Volume and Cost Assumption Changes

Forest product equity declines have outpaced broader markets in the past six months. Since equity markets peaked at the end of Q1/22, the average share- price decline for lumber and panel-weighted equities in our coverage universe is 18% versus respective declines of 13% for the S&P/TSX Composite and 16% for the S&P 500. The forest products sector is rate-sensitive; as such, associated pressure on lumber and panel prices is not surprising. We believe that the strength of sector balance sheets and anticipation of further M&A activity have prevented more significant valuation contraction for the sector.

Adjustments to our commodity price deck are relatively small. The wood product price collapse since mid-March (composite lumber and OSB prices down 60% and 72%, respectively) has lasted longer and cut deeper than we had previously expected. Lumber prices are below our estimate of cash costs for B.C. Interior sawmills, which is expected to accelerate permanent capacity closures. We are lowering our average 2022 and 2023 Western SPF lumber price forecast by 2% in each year to US$814/Mfbm and US$515/Mfbm, respectively. Changes to our OSB price outlook are more material: our North Central price estimate declines 6% in 2022 to an average price of US$638/Msf and 4% in 2023 to an average price of US$390/ Msf. OSB demand is more heavily weighted to new home construction than is lumber.

Lower earnings estimates also reflect tempered volume forecasts and higher cost assumptions for some inputs and transportation. With wood product demand trending lower for longer, we expect extended downtime through year end in North America and Europe — some companies have already announced these initiatives. On average, our 2022 and 2023 adjusted EBITDA forecasts decline 4% and 3%, respectively. As a result of lower mid-term free-cash-flow forecasts and, in some cases, more conservative target multiples, we are lowering our target prices for six of the 10 names. Our ratings are unchanged.

We reiterate our sector OVERWEIGHT bias. Unlike last year, we do not believe that lumber and panel markets are poised for a rapid bounce back, but we see limited commodity price downside from current levels as production curtailments seem inevitable. Lumber-weighted equities in our coverage universe are trading at 3.2x estimated trend EV/EBITDA, adjusted for FCF forecasts through 2023 versus the long-term average of 5.5x. We highlight WFG as our top pick in the sector.