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  • Forestry Fortunes Turn for the Better

    2010 - 05.26

    Over the past three years the forestry sector has suffered through one of the worst periods in its history.

    First in the latter half of 2006 the US housing bubble popped and sparked what experts have dubbed the ‘lumber depression’. In 2008, the global industry’s worst performer was Canada’s forest, paper and packaging sector. The biggest companies accounted for half of the sector’s losses of US$8 billion. 2009 was no better for companies focused on building products. Paul Quinn a RBC Capital Markets analyst estimates that one third of building material suppliers were driven out of business by severly curtailed demand.

    Now into 2010 the forestry sector’s fortunes have turned around. The supply chain is empty. Inventory levels are extremely low. Combine this with the modest demand that has increased in recent months and there’s a formula to send market prices through the rood and equities of forestry companies skyward.

    However, there is still plenty of uncertainy surrounding the demand and prices. The challenge facing investors is guessing which forestry stocks have room to grow and which are poised to be cut down, having risen too far, too fast.

    According to Daryl Swetlishoff, an analyst at Raymond James the answer lies in putting money into lumber for long term gains. Pulp and paper are probably the best bet for the momentum trader looking to capitalise on inflated prices.

    In Canada the forestry industry is intimately tied to the fluctuations of the US housing market. In 2009, housing starts in the US totalled 553,000 which was down by almost 75% from its peak in 2005. Despite this a marginal increase in housing starts this year combined with emerging demand in China has put some upward pressure on lumber prices.

    But depleted inventories have been the true driving force, Mr. Swetlishoff says. “It’s more of a supply-side event.”

    The composite price for western pine stands at roughly US$320 per thousand board feet, which is up by more than 50% since the end of 2009, according to price tracker Random Lengths.

    “The big question in the building material space is: Are today’s high prices sustainable? And have the stocks gotten ahead of themselves?” Mr. Swetlishoff says.

    Due to the variation in recommendations the majority of analysts monitoring lumber stocks have ‘hold’ or ‘sector perform’ recommendations on large solid wood companies.

    However, Mr. Swetlishoff says he believes those equities are currently trading at mid-cycle valuations and still have room to run. “Our take is that if you’re looking at these stocks, it’s not for a six-month trade, because we see an emerging cycle in lumber products.” He said.

    On the opposite end of this spectrum the less optimistic believe that prices are due to fall and compress valuations.

    “To the extent that forest-product stocks need on going lumber-price gains to outperform, we are doubtful that the recent spurt of share-price strength will persist,” said a report by Montreal-based think-tank BCA Research Inc.

    This lack of consensus reflects the uncertainty surrounding market forces. The timing of the U.S. housing recovery is far from certain, with some experts predicting a surge of shadow inventory from foreclosures and a double dip in prices.

    However the price of lumber could be somewhat insulated from demand fluctuations by other supply constraints. In fact even though demand has picked up the reduction in capacity over the past three years is not immediately reversible.

    “While restarting mills is relatively easy, a strong Canadian dollar would prolong the lean supply backdrop. The latter raises the break-even cost of restarting Canadian mills and/or adding capacity, given that lumber is priced in U.S. dollars,” the BCA report said.

    Mr Swetlishoff predicts that a number of demand and supply factors will combine to produce a lumber ‘super cycle’. He writes that this will lead to, “sustained elevated pricing associated with structural supply deficits.”

    Mr Swetlishoff also predicts that, while the peak lumber theory applies in the long term, the seasonal industry decline expected in the latter half of 2010 will not push prices below break even levels.

    The Timber Investment Blog is sponsored by Greenwood Management. For more information on investing in Forestry please click here

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    One Response to “Forestry Fortunes Turn for the Better”

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