1. Executive Summary
The Timber Finance Carbon & Storage Index was up +9.5% in the first six months of 2023, delivering a robust performance despite clear macroeconomic headwinds in both Europe and North America.
The European and U.S. construction markets display different dynamics, with the U.S. showing so far much more resilience to the violent rise in interest rates that has contributed to slowing down the construction sector on both sides of the Atlantic.
2. Macro Overview
The overall macro picture for the construction sector in Western economies continues to be challenging. European economies are struggling the most with construction activity slowing already in some countries and being expected to slow down significantly in others. In Germany, construction activity remained stable, but building permits were down -33% YoY in the latest readings. Sweden’s housing starts were down a dramatic -57% YoY and permits remained weak at -47% YoY. The collapse from the peak in 2021 to the lowest point reached in February 2022 is comparable in magnitude (over -70%) to that occurring during the great financial crisis in 2007-2009. Residential building permits in France were -26% YoY based on the latest April readings.
The US situation is also challenging due to the rise in interest rates which drove mortgage rates to levels not seen in over 20 years: the 30-year mortgage rate, at over 7%, is above the levels seen right before the US subprime crisis. Permits in the US have also been declining after peaking at the end of 2021, but the declines have been modest (-5% for single-family houses) in comparison to Europe. The US housing market is in a very different situation compared to the years right before the US subprime crisis: the reported inventory of single-family homes for sale is around the 20-year lows, while it peaked in 2007. This is one of the indicators supporting the widespread thesis that there is a fundamental shortage in the US single-family homes market. Construction activity in the US (Figure 1) has dropped vs. the peak but is down (only) -1% YoY for single-family housing, with a surprising jump of +15% for multi-family homes.
Overall, economic indicators should be expected to find support once central banks shift from tightening to loosening, or, at least, once it will be clear that policy rates, inflation and growth have normalised.
Figure 1: US housing starts. Sources: U.S. Census Bureau and U.S. Department of Housing and Urban Development, New Privately-Owned Housing Units Started
3. Timber Stocks
The impact of these macro headwinds on cyclical stocks, including timber stocks, is significant. As reported in the 1Q companies’ results update, the slowdown in construction activity started to bite into revenues and margins. German wood-fibre insulation manufacturer Steico was forced to revise its 2023 revenue outlook down from flattish to an estimated -15% in revenues, citing a normalisation of purchases by customers and wholesalers who are no longer seeking to increase their inventories due to fears over supply chain risks. On the other side of the Atlantic, companies like Builders FirstSource, a timber-focused distributor of building materials, provided different scenarios for FY2023, ranging from -16% to -32% in terms of top-line declines. The company, however, managed to beat margin expectations in Q1 and raised its long-term margin target, after having managed to increase its EBITDA margin, despite 1Q23 revenues that were down -32% YoY. The margin beat and the upward adjustments to long-term margin targets led the stock to literally skyrocket, showing that a large degree of pessimism was already priced in. Also, interesting to note that while Builders FirstSource suffered from weak single-family homes (revenues YoY down -34%), multi-family was strong (+12%), highlighting different dynamics in the two areas.
The weakness in building permits, highlighted above, should lead to strong decreases in revenues for European companies and we cannot exclude further downward revisions to the outlooks of companies most exposed to the construction sector, as the building permits are leading indicators – and have been pointing South for some time.
While it is too early to call the rise in new home sales in the United Sates a trend reversal, the fact that the US housing market is going through this challenging phase in a completely different shape than at the beginning of the subprime crisis, provides reasons for cautious optimism, especially with a long-term view.
The different underlying housing market dynamics can help explain the large performance differential between European and North American timber companies: the Timber Finance Carbon & Storage Index delivered a robust positive performance in 1H23 of +9.5%, driven by the North American portfolio, which contributed +11.3% while the European portfolio was negative -1.7%. Top contributors were building materials retailer Builders FirstSource (+109.6% performance) and engineered wood product manufacturer Louisiana Pacific (+27.4%). The main detractors were French real estate promoter Nexity (-21.4% performance) and Finnish forestry and wood products company Stora Enso (-14.3%); Germany insulation specialist Steico was the worst-performing European stock with -27.3% performance YTD but was only the third largest detractor due to rebalancing and timing effects.
4. Disclosures and Conflicts of Interest
Some or all the companies mentioned in this report may be included in the Timber Finance Forest-Based Construction Basket tracker and are part of the Timber Finance Carbon Capture & Storage Index.
Please note that this research is prepared for informational purposes and targeted to institutional investors in Switzerland. It does not represent investment advice and does not take into consideration the individual requirements, risk tolerance and goals of an investor. Recipients who are not Swiss institutional investors should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents.
The information presented in this report is obtained from several different public sources that we consider to be reliable. Nevertheless, we cannot guarantee the accuracy of the presented information. The information used may change quickly and we are not committed or obliged to modify the reports base on new information. The opinions and views expressed in this report reflect those of the author at the point in time of its compilation and may vary at any time. Valuation methods like DCF and any other analysis or expert judgement do not provide any guarantee that the target price or fair value will be reached, for example because of unforeseen changes in financial or economic conditions.
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