Sunday, March 6, 2011
Green Shoots In The Forest
A couple of articles ago, I wrote about the shipping industry. I noted how it's currently out of favour, which is usually good (creates low priced stocks), but the industry lacks improving earnings power due to a super-surplus of ships. So it's a pass for me. However, there's another out of favour industry that is starting to show improved earnings power. The pulp/paper and lumber products industry has undergone significant change over the past few years. The forest products sector has traditionally been very cyclical. Pulp and paper ( newsprint )volumes have been in decline for most of the last 10 years, as media has moved to the internet. I think I'm the last person on my street who still subscribes to an actual newspaper. Lumber prices have been in decline since 2005 until bottoming out during the recession of 2008-2009. However, there are some fundamental changes for the better that the market hasn't fully priced in. Firstly, many weak lumber producers have buckled under heavy debt loads and have ceased operations. By removing this dead wood ( pardon the pun ) the industry has reduced supply and been able to rationalize pricing ( raise prices to where they can make money ). The academics say that lumber has "inelasticity of supply", which means supply can not come online very quickly, as trees take a longtime to grow. That places additional pressure on prices when demand perks up. Newsprint volumes in emerging markets ( China, India, Brazil ) are actually on the rise as there is less digital media available. Also, China has begun to embrace western building techniques. They are building 2X4 framed houses similar to ours. This is a whole new market that lumber producers of the past did not supply and it's a big market. Lastly, housing starts in the U.S. have been very low (500K per year) over the past 3 years. Eventually housing will turn, and America will build 1.5 million homes per year, as they have done on average for much of the past 20 years. All these factors will bode well for the few producers that are left. There is value in companies like Catalyst Paper, Acadian Timber (for income investors), Canfor, AbitibiBowater and Weyerhaeuser. Many of these companies are trading at less than replacement value. Some are of higher quality than others, so do your homework. Some still have significant debt. I am particularly intrigued by AbitibiBowter, which just emerged from bankruptcy in December of 2010. They shed over $5.5 billion of debt and are now one of the lower cost producers.They continue to sell non-core assets to improve their balance sheet. Abitibi could earn $2.50/share this year. Abitibi could be worth $37-$40 a few years out. These companies ( the ones who own a lot of standing timber ) could also be a good hedge against inflation as their assets would be worth more during a period of rising prices.