5
Apr

Growth Strategies of Listed Timber Companies

Timber Cos Growth

Author: S.C.

 

A bigger picture commentary, briefly looking back at 10 interesting years, and forward at the specific growth strategies of timber companies.

 

1. An Extraordinary Decade

Over the last 10 years, world economies have gone through a rare series of macro events. After the great financial crisis and the European debt crisis, monetary policy has been extremely loose and housing markets have been progressively recovering. Then, the Covid pandemic arrived, disrupting global supply chains and changing habits as a consequence of the work-from-home trend. After this “once-in-a-century” event, with ultra-loose monetary policy, construction and renovation accelerated in many markets. Inflation started to rise, and the situation deteriorated further in the aftermath of the conflict between Russia and Ukraine – inflation spiked, sanctions against Russia were imposed, affecting also timber, and monetary policy was tightened aggressively, slowing down the real estate and construction sectors. The result for timber companies was a highly volatile 2020-2023 period.

 

2. Evolving Trends

Over this period, certain important trends accelerated, such as the need to decarbonise the construction sector, responsible for ca. 40% of global GHG emissions. This led to building regulations (such as in France and Denmark) that incentivise the use of timber in construction. Also, the ageing of the U.S. housing stock (with a median age of 40 years, up from 31 years in 2005)[1] and tight housing markets in several European countries[2], continue to represent a long-term opportunity for the construction sector and timber companies. Technological developments enabling high-rise construction with timber (so-called “mass timber”) are also opening up a new market for timber companies. Net-zero targets also create opportunities for large forest owners to monetise their timberland asset base through carbon credits and leases for renewable energy infrastructure and underground carbon storage (see also the recent updates by listed timberland owners, among others, in this report).

As we have been seeing inflation rates normalize, opening the door to a normalization of monetary policy, some of the monetary pressure on the construction sector should also ease and reactivate over time the European construction sector as well as the repair & remodel market in the U.S. that has been slowed down by the collapse in existing homes sales – at levels last seen after the subprime crisis – due to the rapid rise in mortgage costs. Monetary policy will be a key factor in the medium-term, as it has been in the past.

Figure 1: Inflation and monetary policy rates in the U.S., EU and Sweden. Sources: Bloomberg, Statistics Sweden, US Bureau of Labor Statistics, ECB, Riksbank.

 

[1] The Age of the U.S. Housing Stock | Eye On Housing

[2] Tackling the under-supply of housing in England – House of Commons Library (parliament.uk) as one example

 

 

3. The Growth of Timber Companies

Helped by a multi-year recovery in construction until 2022, and despite the sharp slowdown in 2023, growth rates for several timber companies have been in the double-digit range, especially for those manufacturing and distributing value-added (secondary) products and with a clear growth strategy. Not all business models can be scaled in the same way and certain business, by their very nature and the competitive landscape in which they operate, are in a better position than others to grow. The specificities of the different sub-sectors and companies are discussed below.

 

Figure 2: Timber companies’ growth in revenues and operating profits. Sources: Bloomberg. Certain companies have gone through restructurings and spin-offs, as in the case of SCA, so such factors need to be considered on a case-by-case basis.

 

 

Distributors of (Timber) Building Products

Distributors can grow through acquisitions, consolidating a fragmented market, or expanding their product range and adding services. A perfect example for these growth strategies comes from the U.S. distributor Builders FirstSource (BLDR), which delivered impressive growth through acquisitions and is investing strongly in a digital offer in order to differentiate against competitors. One strategy applied by multiple distributors is to focus on value-added products instead of commodity products. BLDR has implemented an aggressive M&A strategy, with a transformative acquisition in 2015, a large merger in 2021 and several acquisitions in 2021 and 2022. Among those, it acquired a software company, Paradigm, in 2021, providing project rendering, customisation, and integration from 3D home previews to ordering and order monitoring, setting its digital offer apart from several competitors that are still at the “e-commerce” interface stage. While it is still early to see whether these solutions will drive large incremental adoption and revenues (a $1bn goal by 2026), these differentiating efforts are a positive.

 

Engineered Wood Products Manufacturers

EWP manufacturers can grow market share by offering innovative products with strong brand recognition. Examples are Trex, the manufacturer of premium composite decking and railing products, or Louisiana Pacific (LPX), extending its product range with innovative solutions such XPS-insulated OSB panels. Other industry trends, such as high-rise mass timber construction, offer growth potential in areas including cross-laminated-timber (CLT). Disciplined capital management can also add significant value on a per-share basis, as in the case of Louisiana Pacific, which has been aggressively buying back shares instead of adding capacity.

 

Integrated Nordic Forest Owners

These companies have capital-intensive businesses: forest, pulp and wood products. They are limited in their growth as they generally cannot significantly scale their forest assets and their pulp & paper businesses require large capital investments – which is also not necessarily in their interests from a demand/supply point of view. That said, their forest assets are real assets linked to inflation and a diversified and vertically integrated forest products business smooths volatility, as companies transition away from secularly declining paper businesses and reinvest into higher-growth areas such as mass timber and more broadly biomaterials. Growth, although moderate, can come from investments higher up in the value chain (such as in engineered wood products, mass timber manufacturing, etc.) or in adjacent areas such as renewable energy (e.g. wind power on the vast owned lands). SCA, for example, leases land for wind projects and invests in its own wind power capacity, with an approximate 20% of Swedish wind power production being generated on land owned by SCA, according to company estimates.

 

Lumber and Commodity Products Manufacturers

These manufacturers can grow by expanding their product range or through disciplined M&A. Because their markets are particularly subject to supply/demand dynamics, underlying growth is more constrained and strong capital management is key, as excessive capacity expansion would hurt margins for all players. The way West Fraser (WFG), the leading lumber and OSB manufacturer, describes its strategy is remarkably pragmatic: “Our strategy is simple: keep costs low, reinvest profits, maintain a prudent balance sheet”. Prudent capital management is essential in cyclical and volatile commodity industries, where in order to grow, you first need to survive the next downturn, and where survivors will benefit from the next imbalance.

 

Timberland REITs and Equivalent

Forest owners can grow either by acquiring new timberlands, optimising their portfolio, or by improving the monetization of their timberland holdings. Strategies can include the sale and/or development of land for real estate projects, carbon credits linked to improved forest management (IFM) practices, or leasing land for clean energy and other projects – specifically solar, wind power, or underground carbon storage. Note that certain timber REITs are also strongly integrated in the value chain, with manufacturing and distribution of wood products such as lumber and OSB. It is not clear how carbon credit markets for IFM projects in North America will evolve, both in terms of size and pricing, but a positive development in this sense could provide new incentives to keep carbon stored in the forest and increase carbon sequestration. However, real estate development on those portions of land that are close enough to cities and efficient transport routes, still represent the financially more attractive monetization opportunities, even if that is not ideal from a carbon sequestration point of view. Nevertheless, there is also a positive social effect to consider arising from the development of new communities in green areas.

 

Equipment Manufacturers

Forestry machines are an essential component of the timber value chain and have somewhat different economics than wood product manufacturers. Equipment manufacturers tend to have higher returns on capital employed, as their value added is rather in the design (innovation) and assembly of their solutions, covering physical products and maintenance services, rather than in the operation of physical assets. While wood products manufacturers and forest owners to a significant extent profited from the sanctions against Russia, equipment manufacturers lost an important export market. Despite that, they delivered respectable growth rates. Due to their differing product portfolios – while Ponsse (PON1V) is a pure-play, Deere (DE) and Husqvarna (HUSQB) are more diversified into other areas as well – these companies have different growth strategies, including the transition to battery-powered machines and digital fleet management systems, aimed at decarbonising the timber and more broadly construction value chain.

 

Despite its niche nature and due to the different characteristics and economics of each business within the timber value chain, the listed timber sector offers a diverse range of growth profiles from which active investors can select their preferred exposure.

 

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. 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. 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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