EUR 850.00 For Business Accounts Only

Morningstar | Reducing Wood Product Company Fair Value Estimates by 15%-25% on Weaker Housing Outlook

Having reassessed our housing starts projections in light of recent trends in key housing data, we've lowered our expectations for new construction activity over the next decade. We now expect roughly 15 million cumulative housing starts between 2018 and 2027, an 11% reduction from our previous forecast of 16.8 million.

However, with some pundits proclaiming that the housing market has peaked, our revised forecast is still bullish relative to the consensus view. Indeed, we still see several more years of solid residential construction activity ahead. This will be driven by the large and aging millennial population, continued job and wage growth, and an increased supply of entry level homes. Our revised forecast calls for total starts to improve from 1.28 million in 2018 to 1.61 million in 2022 before moderating to 1.47 million by 2027. Previously, we projected that total starts would grow from 1.30 million in 2018 to 1.93 million in 2021 and then moderate to 1.52 million by 2027. The main factors behind our moderated forecast are slower population growth driven by reduced immigration and a more difficult affordability environment than we had previously envisioned.

Given the high degree of exposure that wood product companies have to new home construction volumes, we have reduced our fair value estimates across the industry by roughly 15%-25%. After removing our previously anticipated period of elevated pricing as capacity grew strained, our medium term cash flow outlooks have been reduced considerably. Canfor's fair value estimate falls to CAD 24 per share from CAD 31, while West Fraser's declines to CAD 59 from CAD 79. Louisiana Pacific's fair value estimate declines to $18.50 from $25, and Norbord's falls to CAD 38 from CAD 46. Lastly, timber producer Weyerhaeuser's fair value estimate declines to $23 from $29.50, and Rayonier's falls to $26 from $30. Our moat and trend ratings are unchanged.

Our fair value estimate declines are attributable to two factors. First, we've materially reduced our expectations for peak lumber, panel, and timber prices over the coming five years. Previously, we anticipated that the rapid run-up in housing starts would necessitate meaningful capacity expansions throughout North America in the wood product industry. At our revised peak of just over 1.6 million units, existing capacity will be stretched but expansion needs will be more limited, leading to fewer years of strong commodity prices. The second factor is that incremental margins in these businesses are often substantial. Accordingly, the bottom line is impacted even more harshly than sales during our 10-year explicit forecast period.

After revising our outlook and fair value estimates, the broader wood product space appears overvalued. 2018 is on track to be the strongest year in a decade for lumber, panel, and pulp prices. Many of the factors that have driven prices higher will prove temporary. Labor disputes, rail congestion, and tariffs are some of the factors that have now started to ease from earlier this year. Over the long run, we expect tariffs to decline on lumber, which will impact prices further. Accordingly, we expect average benchmark prices for lumber and panel products to fall, on average, over the coming five years versus 2018 levels. Though we see timber prices rising in the future, we see far less upside than we did previously as harvest volumes fall short of our prior expectations.

Our fourth-quarter U.S. housing outlook, which we expect to publish in October, will provide investors with a more detailed review of our housing forecast revisions as well our top picks within housing-related sectors.