Author: SC
1. Results Overview
Yields started to rise right from the start of the quarter until the end of April, both in Europe and the U.S. In the second half of the quarter, U.S. yields went back towards the levels from the beginning of April, while European yields stayed high or, as in the case of France (due to political uncertainty), went even higher. At the time of writing (mid-August), the U.S. 30-year mortgage rate fell below 7% as weaker U.S. macro data pushed yields lower.
Lumber prices in the U.S. were again weak, as demand from the construction sector, in particular from repair & remodelling, was subdued, not helped by the rise in yields during the quarter and depressed existing home sales activity, at historically low levels comparable to the period after the subprime crisis. Curtailments so far have not fixed the imbalance.
European construction is extraordinarily weak. German building permits continued to fall YoY and the weakness is evident also in other European countries including France, Finland and Sweden – key markets for durable wood products.
2. Timber Construction
North America – Timberland REITs
Weyerhaeuser’s results were mixed relative to expectations, but overall robust despite EBITDA being down -13% YoY on soft lumber markets. After the peak of 2021-2022, profitability has been normalising towards pre-pandemic levels. The company announced the acquisition of 84k acres of timberlands in Alabama for $244m, progressing towards its target of $1bn of timberland investments over 2022-2025. WY is also growing its solar land lease and carbon credit activities, with agreements for (potential) solar projects totalling 130k acres and confirming its expectations for 100’000 carbon credits to be issued in 2024. As far as demand for wood products is concerned, for the remainder of 2024 the company expects relatively stable demand but is optimistic with regards to the upside potential from lower rates. PotlatchDeltic beat estimates, helped by better-than-expected results from real estate and timberland offsetting weakness in wood products. PCH provided probably the most bullish outlook for lumber, with management going as far as calling the bottom for lumber prices in July and upside into 2025 for both new construction and R&R thanks to lower rates and underlying demand. The company is redesigning its carbon credit projects in order to achieve higher quality, in line with the ICVCM’s “Core Carbon Principles”, prioritising quality over timing, expecting that this should lead to significantly higher pricing. Acadian Timber, the Canadian timberland owner, delivered an exceptionally strong Q2 result, helped by the completed sale of 600’000 (already announced) carbon credits, while timberland operations were characterised by improved harvesting rates, thanks to better weather conditions and contractor availability, both challenging factors in 2023, offset by weaker pricing as demand for lumber was soft. Acadian is evaluating further opportunities in the area of carbon credits, where it is expected to have additional optionality between federal[1] and voluntary markets, depending on demand and pricing. While listed timberland owners generally increased harvesting, Rayonier was an exception: it reported significantly lower harvesting in all regions on softer markets from the Southern U.S. to China – Rayonier shares with other players the optimism on the impact on U.S. demand from potential rate cuts (but has it become too consensus?) and sees Chinese inventories normalising. Disappointing results on real estate activity were mostly explained by timing issues and management expects to reach previously given guidance; for the business as a whole, management is now guiding towards the lower end of the range.
North America – Primary and Secondary Wood Products
Lumber prices were particularly weak in Q2 as earlier announced production curtailments and mills closures did not rebalance demand and supply effectively. The expected seasonal pickup in demand was overall disappointing, based on insights from the quarterly updates. Without a significant pickup in demand, the industry’s hope for a rebound in prices may remain just a hope and continue to hurt profitability unless we see more capacity reductions. It should be noted that from a historical point of view, current lumber prices are not particularly depressed, so the issue for the industry appears to be higher costs rather than lower selling prices, at least relative to history (see Figure 1). While lower fibre costs could theoretically make current lumber price levels acceptable for mills from a profitability standpoint, such a scenario appears unrealistic at the moment.
Figure 1: Interfor’s selling prices vs. margins. Excluding pandemic period due to outlier characteristics.
Source: company reports
West Fraser beat expectations and reported higher sales YoY thanks to relatively robust OSB demand and pricing, offset by weaker lumber markets. Management’s outlook is soft for lumber while resilient for OSB, noting downside risks should the U.S. economy weaken and unemployment rise, despite the expectations for rate cuts. Western Forest Products’ results were strongly better than (pessimistic) expectations. The landscape for the company remains challenging, as it is challenged by weak lumber prices, weak export markets and log sourcing difficulties. Nevertheless, the company managed to significantly reduce its loss YoY, achieved positive EBITDA and generated higher operating cash flows. Canfor’s results were significantly below expectations in terms of profitability, with a wider than expected loss, even adjusting for write-downs. In line with comments by SCA, Canfor’s European operations reported good conditions in repair & remodelling; these were more than offset by lower North American lumber volumes. Interfor surprised the market positively on the EBITDA side with a narrower than expected loss. In response to the continued weakness in lumber prices, the company announced further production cuts of 280-350 mmbf between August and December representing 15-18% of its normal production, extending and increasing curtailments previously announced. To put things into perspective: North American softwood lumber production for 2023 has been estimated around 75’000 mmbf, so Interfor’s announcement represents ca. 1% of North American production on an annualised basis[2]. The company estimates that ca. 5-7% of total industry capacity has been removed so far this year.
UFP reported very solid margins and slightly beat expectations. The outlook for the rest of the year was very prudent, pointing to weakening demand and reduction in interest rates taking time to have an effect. Management, pragmatic as usual, stressed the importance of M&A discipline and highlighted the areas where it is focusing investments: industrial packaging, composite products for exterior applications, timber construction in new geographic markets and process automation, patented wood treatment solutions. CEO Matt Missad expressed particular optimism about the prospects for factory-built housing, given its affordability advantage. BlueLinx, the distributor of wood and other building products, reported slightly below expectations. In line with UFP, it is expecting a slow 2H24 while relatively optimistic on the prospects for 2025, especially in the multi-family segment. Boise Cascade, another wholesale distributor, beat expectations. Builders FirstSource beat estimates in terms of profitability and announced a new share buyback program, while at the same time lowering its guidance for FY24. BLDR has been beating consensus for adjusted earnings per share for 31 quarters in a row and GAAP EPS for 16 consecutive quarters. The company is facing headwinds especially in the multi-family segment while single-family remains resilient, both for new construction and R&R. The market initially reacted negatively to the announcement, while it quickly reverted into positive territory. Management has expressed surprise at the inertia in the lumber industry and its willingness to accept negative margins for so long, which ultimately also affects distributors’ revenues and profits. Trex slightly disappointed on revenues but beat on profitability. However, the company reduced its guidance for FY24 by -7% while maintaining margin guidance intact. The cut in guidance comes from softer than expected demand for entry-level products, as consumers face purchasing power challenges, and normalising inventories in the channels in general. The market heavily punished the stock after the announcement. Louisiana Pacific beat expectations by a solid margin, raised the FY guidance for its siding business, while lowering OSB guidance, for a net lower FY24 EBITDA outlook. The company managed to gain market share in sidings in an overall slower market, also in R&R despite the macroeconomic headwinds, and continues to invest in marketing, strengthen relationships with large builders, and ramp-up its ExpertFinish line and the most recent Brushed Smooth sub-line. LPX is seeing overall normal channel inventories at this stage and sees significant upside for R&R in the case of interest rate reductions due to strong pent-up demand. Mercer International’s mass timber segment increased production significantly (54% QoQ) as it continues to scale up, offsetting weaker lumber and pallet demand, as the European economy remains weak and German industry stays at relatively depressed levels. Mercer wrote-off the remaining goodwill from the Torgau acquisition in the context of this weakness. Doman, the Canadian distributor of building materials active in both Canada and the U.S. reported below expectations; management also noted how more curtailments would be needed for lumber prices to stabilise at a healthy level.
Europe – Integrated Forest Products and Secondary Wood Products
Europe was characterized by continuous strength in roundwood prices in the Nordics, as well as some improvement in demand for sawn wood in the region, supported by repair & remodeling, also supported by seasonal patterns.
Figure 2: Swedish Sawlog Prices. Source: Swedish Forest Agency
Stora Enso continued to report weak wood products sales, while it reached breakeven at EBIT level thanks to cost reduction efforts. The forest segment was particularly strong, helped by rising wood prices, especially in Finland. Management noted strong demand for wood fuel competing with other uses as the shortfall from the ban on Russian imports continues to weigh and there is less supply of chips from sawmills. SCA reported higher sales in both forest (driven by higher harvesting rates) and wood products divisions. Forest margins were lower and disappointed the market, while wood products surprised on the upside, with a 20% EBITDA margin for the quarter on a seasonal recovery in demand, driven in particular by repair & remodel, which helped support sawn wood prices. With a longer-term view, SCA’s management expressed its belief in the long-term attractiveness of forest assets, as they expect global demand for wood to increase more than supply, making wood an increasingly scarce resource. UPM reported weak sawn timber demand and prices – providing, interestingly, a quite different picture vs. SCA – while plywood markets recovered, although results in the plywood division were lower YoY. Management suggested that the structural undersupply of roundwood in the Nordics, caused by the ban on Russian imports, needs a “structural” solution in order to lower input costs for the industry. Holmen’s results were above expectations, with very strong forest results (even adjusting for the gain on biological assets) and profitable operations even in the wood products division, although the seasonal component, as highlighted above with SCA, should be kept in mind. Going forward, the company is working to improve the wood products mix (from joinery to construction wood) in order to increase profitability in a market that continues to be challenging, with weak demand and, as indicated by management, rather supply curtailments that helped stabilize prices.
3. Pulp, Paper & Packaging
Stora Enso’s results were only slightly below expectations at top-line and EBITDA level, while adjusted EBIT was slightly above expectations. There has been an improving trend in packaging materials and pulp, the latter delivering particularly strong margins. SCA’s results were below market expectations in terms of profitability; however, they were relatively solid, especially in pulp, supported by increases in pulp and containerboard prices, as well as solid demand. UPM-Kymmene’s results were below consensus, although profitability improved strongly YoY, helped by stronger pulp markets, recovering demand for self-adhesive paper after a massive destocking in the previous quarters, and good results in specialty papers. UPM expects to launch its first biochemicals refinery at the end of 2024, officially launching a new business division. Mercer’s pulp business was profitable but underperforming vs. a group of pulp peers (as depicted in Figure 3), which also includes pulp & paper pure-plays not active in durable wood products. Holmen’s results in paper and paperboard (now reported under one single segment) were driven by solid containerboard demand after the destocking in 2023 and at the same time weaker pricing YoY, although recently there has been some stabilisation.
Figure 3: Pulp operating margins – * as not all companies report pulp operating profits separately, proxies were selected within each company’s segment reporting. Note that some are not entirely comparable.
Sources: company reports. Calculations by Timber Finance.
4. Equipment Manufacturers
Husqvarna disappointed the market with revenues ca. 7% below consensus, as the company reported demand weakness accelerating during the quarter, in part linked to abnormal rain levels. Cost saving efforts helped to support margins. Ponsse’s results were below expectations, hit by weak demand in Europe (except Nordics, outperforming in line with the strong wood prices reported by integrated Swedish and Finnish forest owners) and the Brazilian full-service contract that continues to generate losses. Net sales for H1 were -13% YoY. As commented in the previous quarter, the company’s struggles with the Brazilian operations have been remarkable and to a certain extent worrying, as the situation appears not really under control or “moving in the right direction”, as previously guided by management – the expiry of the contract at the end of 2026 is getting closer but this offers limited reassurance. Ponsse lowered its 2024 guidance from “slightly weaker” to “significantly lower” than 2023. Deere beat expectations and maintained its FY2024 outlook with respect to net income; as far as the forestry and construction division is concerned, the company continues to expect a decrease in volumes of ca. 5-10% YoY, with forestry equipment at the low end with -10%. Adding price pressures, Deere expects net sales down 10-15% for the division, which is in line with Ponsse’s result for H1.
5. Homebuilding and Real Estate
U.S. leader D.R. Horton beat estimates, especially on the margins side, although orders came in below expectations. The significant reduction in yields at the end of June and beginning of July may however boost demand in Q3. During Q2 buyers’ incentives continued to play an important role, with DHI reporting ca. 60% of buyers relying on such incentives. U.S. insulation specialist TopBuild reported below expectations and revised its full-year guidance downwards, predominantly due to a slower commercial insulation business. These “disappointing” results should be put in the context of record revenues and adjusted earnings, while at the same time recognising potential continuous weakness in the multi-family space, until significantly lower interest rates materialise and support the segment.
Nordic construction company Veidekke reported generally weak construction activity, especially in Sweden, offset by solid infrastructure investments. French developer Nexity reported residential reservations down -16% YoY for 1H24 and backlog down -9%. The company has been going through a very difficult period, has sold its division focused on real estate services for individuals to a private equity firm in order to improve its liquidity profile, and announced that it is currently in talks with Crédit Agricole Immobilier to sell its property management business. One of the few, if not the only, positive note from the recent results is the confirmed (for now) stabilisation of residential retail sales. Bulk (institutional) sales are less uniformly distributed over time and it is hard to define trends, but so far the institutional business has continued to shrink – the chart below highlights the severity of the contraction in Nexity’s business, which is not an exception as the French residential market is estimated to have contracted by -21% as of end of June[3].
Figure 4: Nexity’s residential reservations by type and overall development backlog. Sources: company reports.
If long-term yields were to continue their downwards trajectory from their 2024 peak at the end of June, and absent an economic contraction, this would provide some much needed support to institutional real estate demand and, in the following step, construction activity.
[1] https://www.canada.ca/en/environment-climate-change/services/climate-change/pricing-pollution-how-it-will-work/output-based-pricing-system/federal-greenhouse-gas-offset-system/protocols/improved-forest-management-private-land.html
[2] https://forisk.com/blog/2024/02/20/top-10-north-american-and-u-s-lumber-producers-2023/
[3] https://adequation.fr/
6. 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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