Author: SC
1. Results Overview
From a macro point of view, the first quarter of the year was characterised by rising sovereign bond yields on worries that central banks, especially the Fed, would keep interest rates higher for longer given the very resilient U.S. economy.
Lumber prices trended higher during the quarter (before falling rapidly in April). The lumber market is very challenging, with the industry running at low capacity and progressively adjusting the demand/supply imbalance through curtailments.
U.S. homebuilders reported very strong results, beating expectations by a wide margin. New home construction in the U.S. remains solid despite higher interest rates, as incentives provided by homebuilders to buyers prove effective. Repair & remodelling remains subdued, especially in the DIY segment, waiting for existing home sales to improve from historically extremely low levels.
Despite the European slowdown in the construction sector, companies like Steico still delivered very robust results, helped by renovation. Steico’s numbers also pointed to diverging trends within Europe, with UK and Ireland particularly resilient.
2. Timber Construction
North America – Timberland REITs
Timberland REITs in their quarterly calls provided some useful insights on lumber and pulp markets. Rayonier noted an improving inventory situation in pulp, especially in China, a key market for its New Zealand timberland business. All REITs confirmed the challenging market environment on the lumber side, with sawmills running at low capacities and many not reaching cash breakeven. PotlatchDeltic, however, was generally optimistic that lumber prices are bottoming out, as this level of cash-burning is unsustainable for many players. There appears to be strong demand for timberland from investors, with Rayonier estimating approximately $4bn from TMOs looking for opportunities to deploy funds in the U.S. All REITs are moving forward on natural climate solutions – carbon credits as well as leases for solar plants and carbon capture and storage (CCS) – while Weyerhaeuser noted that players in the space are still figuring out how to more precisely value the optionality of carbon projects as the market is evolving.
North America – Primary and Secondary Wood Products
Canadian lumber and OSB leader West Fraser reported revenues above expectations and delivered a strong beat at (adjusted) EBITDA level, with strong North American EWP performance on solid new home construction, while Europe, cyclically weak, and lumber, more dependent on repair & remodel (R&R) activity, were soft. Canfor reported again a loss, albeit narrower than consensus and previous quarters. In line with comments by other companies, soft SYP pricing affected the profitability of its U.S. South operations and resilience in DIY demand in Europe and particularly in the UK was offset by weak European construction activity. Interestingly, while many see the glass half-empty when it comes to R&R, noting it would be stronger on lower interest rates, Canfor saw it half-full, noting at least some stability. Operations in B.C. continue to remain challenging on the fibre sourcing side. Western Forest Products continues to be challenged by the weakness in lumber prices, the overall situation in B.C., and other headwinds including competition in the Chinese market and the weak Japanese Yen – Japan being a key market for the company. The stock trades at a dramatic discount to book value and management recognises it needs to prove it can return the company to profitability. The returns on the recent kiln drying investments, as indicated by management, are remarkable, but the stock needs some catalyst to narrow the discount, primarily a recovery in lumber prices, and secondarily some progress on assets such as the curtailed Alberni facility.
Figure 1: lumber prices – SPF (Spruce/Pine/Fir) and SYP (Southern Yellow Pine). Sources: Canfor.
UFP Industries reported soft market conditions overall, with revenues below expectations, but managed to beat on margins as costs were managed accordingly. Despite the softness, the company improved its cash positions thanks to a significantly shorted cash cycle and operated at historically elevated margins. Boise Cascade, more exposed to new homes construction than R&R, reported very solid results, with sales and volumes up year-on-year, and beat expectations. The stock has been one of the best performing since inclusion in the index and tracker and the company continues to enjoy a strong net-cash position. Builders FirstSource, by far the top-performing stock since launch of the Timber Finance Forest-Based Construction Basket, reported profits above consensus and confirmed its FY24 EBITDA guidance around the mid-point of $2.6bn, which yields an EV/EBITDA multiple of ca. 10x and EV/EBIT around 12x. The market, however, reacted very negatively to the guidance and comments on margin normalization – management highlighted that multifamily is expected to keep deteriorating, while guidance assumes a slight recovery from current single-family activity that is somewhat below “normal”. Despite the fact that this level of valuation is not particularly cheap for a cyclical business (but neither blatantly expensive), a combination of continued strong operational execution, resilient housing market, buy-backs and further acquisitions can still boost the growth story. Louisiana Pacific, the manufacturer of engineered wood sidings and innovative OSB solutions, beat expectations on the top-line and literally smashed them in terms of profitability, which led the stock to pop around +20% on the day of the announcement – a similar magnitude as Builders FirstSource (BLDR) but obviously in the right direction, after having underperformed vs. BLDR since the beginning of the year. Revenues were up +24% YoY and, more importantly, LPX significantly increased their EBITDA guidance for 2024. Both strategic aspects and market conditions helped: OSB pricing provided a major tailwind and the OSB product mix with stronger structural (value-added) solutions also boosted margins. With major capex project now completed, free cash flow also gets additional support going forward. During the quarter, the company signed a new partnership with Lennar, a leading U.S. homebuilder, and an extended deal with Home Depot, the largest home improvement store, highlighting the penetration the company has in different channels with customers of the highest level; the Lennar deal is expected to expand LPX’s geographic reach and the company indicated more deals could come. TREX revenues were up +56% YoY (in line with consensus) and net income more than doubled (beating consensus). The company confirmed its guidance for 2024 around +12% revenue growth – in line with the long-term strategic goal to 2028 – on normalising channel demand.
Europe – Integrated Forest Products and Secondary Wood Products
In Europe, German wood fiber insulation specialist Steico reported slightly decreasing revenues but delivered impressive margins in such a challenging environment, with an EBITDA margin of 19.1%, which is on the higher end historically. Despite very weak permitting in Europe, Steico was able to profit from a resilient renovation activity, and growth in wood- fiber insulation offset weakness in its structural products portfolio. The company also noted a particularly positive trend in the UK and Irish market, where we have another significant holding – James Latham.
Stora Enso sees continued tightness in wood markets and expects rising wood prices going forward. With regards to durable wood products, despite natural seasonal strength that should come in Q2, the company expects construction markets in Europe to remain weak. UPM’s timber businesses reported similarly weak sawn timber demand, as expected, but on the other side improving demand for plywood and veneer. SCA’s results in the wood products segment were in line with the picture provided by Stora Enso – weak demand and high input prices, pressuring margins – but management also pointed to some recovery in repair and remodel activity. Holmen’s management was vocal about the extreme wood price situation in Sweden and how that poses challenges for wood products manufacturers in the current economic environment. Despite the challenging construction sector and looking longer-term, the company is investing in CLT and glulam capacity.
3. Paper & Packaging
Stora Enso reported significant declines YoY in all divisions except forest, driven in particular by lower sales prices, but also some facilities closures that had been announced in June last year as part of the restructuring. Despite this weakness, margins were overall acceptable and beat expectations; going forward, the company expects support for pulp and packaging material demand as well as prices, in the context of below-average inventories in Europe. UPM-Kymmene’s results were better than expected, as far as the bottom line is concerned. The company sees an end to the destocking trends from previous quarters and support from the ramp-up of its major investment in pulp capacity – the Paso de los Toros pulp mill. SCA’s management is quite bullish on (round)wood and pulp prices, seeing tight fibre supply, driven by the well-known import bans from Russia but also by lower state-controlled harvesting, and a normalised pulp market; it also commented on the supply risks with regards to the European regulation on deforestation-free products – while it is too early to judge, there are uncertainties as to how it will be implemented at national level and whether it will have a negative impact on supply, which would then affect industry capacity and prices. Holmen’s management view of the pulp market was somewhat more prudent than SCA’s, while results overall were solid given the challenges. We see in this kind of macro environment how the vertically integrated and diversified business model of Nordic companies offers some stability over the cycle, despite limiting growth potential due to capital intensity.
4. Equipment Manufacturers
Ponsse, the Finnish family-controlled manufacturer of forestry machines, issued a profit warning and revised downwards its guidance for 2024 just a few days ahead of the publication of its 1Q results and only two months after the previous guidance. That said, the company expects 2024 to be only “slightly weaker” than 2023, compared to its previous expectations of being in line with the previous year. Ponsse highlighted the strikes in Finland at the end of March, affecting ports and export activities, reported a weak order intake and the continuing challenges in its Brazilian operations. The Brazilian issues are taking a long time to get fixed, as they have been around for more than a year now – the head of the local operations has been replaced at the beginning of the year and it will be important to see whether Latin America will return to acceptable operating performance, also in the context of a broader reorganization of the business that will see the new market areas become effective from June. The company has gone through a complicated period: supply chain issues during the pandemic, high inflation, exit from the profitable Russian market, and then the issues with the Latin American business. Despite all this, the business continued to be profitable overall until the end of 2023 – it will be interesting to monitor the progress and degree of success of this turnaround during 2024. We currently do not hold Ponsse stock.
Swedish forestry, gardening and construction equipment manufacturer Husqvarna overall met expectations in a weak environment, especially as far as forestry and construction are concerned, although that was partly explained YoY by a record 1Q23. Despite all this, operating margins were solid.
5. Homebuilding and Real Estate
The first major homebuilder to report was D.R. Horton, who beat expectations by a wide margin and even raised its FY24 outlook. Homebuilding activity was supported by a low supply of homes – higher interest rates reduce demand, but they also reduce the supply of existing homes as potential sellers don’t want to have their lower mortgage rates reset to a higher level. Pulte Group also beat expectations, to an extent comparable to D.R. Horton at the top-line, and even more at the bottom-line level. Despite the use of incentives such as mortgage buy-downs, gross margin was very strong and the company is guiding towards the higher end of the range for 2024 on continued tightness. NVR Inc, the most capital-light of the large homebuilders, reported revenues in line with expectations while profits beat consensus. Overall, U.S. homebuilders’ orders are still in line with the highs of the post-subprime recovery, that reached a peak around 2021. Meritage Homes, particularly strong in energy-efficient homebuilding, also reported an extremely strong quarter, with an impressive beat against consensus, on the topline and even more on the bottom line. In this environment characterised by extremely low existing home sales, homebuilders with a spec-home orientation, like Meritage, have been major beneficiaries. As highlighted by other datapoints[1], there appears to have been a regime change in terms of speed of move-ins buy buyers; without necessarily making assumptions on which direction the causality relationship between quick move-ins and spec-home construction goes, the current market environment is peculiar.
French developer Nexity, a pioneer of timber construction, completed the sale of its property management business for individuals for EUR 400m, generating liquidity that helps it navigate this difficult economic environment. YoY the results were weak, although they may be affected by timing factors, especially for bulk sales, that will smooth out over the next quarters. The main positive sign came from stable retail sales – although both residential and commercial sales overall were down around -15%, this was enough for a rebound in the stock price, highlighting the level of pessimism already priced in. Austrian developer UBM, focused on mass timber construction, will report 1Q numbers only at the end of May, but in their annual results call in April noted that while the environment is extremely challenging for real estate developers and overall the real estate transaction market, there is a lack of supply in several areas and interesting emerging trends like business parks in connection with supply chain onshoring plans.
Figure 2: YoY revenues and EBITDA for selected homebuilders and developers. Sources: company reports.
[1] https://zondahome.com/new-home-market-update/
5. 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. Timber Finance Management and/or the Timber Finance Initiative may have commercial relationships or be in discussions with some of the companies mentioned in this report. Specifically, Stora Enso is a member of the Timber Finance Initiative association.
Please note that this research is prepared for information purposes and targeted to institutional investors in Switzerland. They do not represent investment advice and do 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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