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Morningstar | Canadian Log Costs Surge Despite Area Curtailments; Lowering West Fraser's FVE to $51 Per Share

Although wood product market conditions have improved versus the fourth quarter, pricing and input costs were a significant challenge for West Fraser to start the year. In the first quarter, stronger lumber and panel margins offset weaker pulp segment results. Consolidated EBITDA margins shrank slightly to roughly 9% on a sequential basis, but we expect profitability to improve gradually over the course of the year as seasonal issues pass and benchmark prices rise. Following the sustained surge in British Columbia log prices, we've reduced our EBITDA margin assumptions for West Fraser's lumber segment to reflect higher input costs over the long term. Accordingly, our fair value estimate falls to $51 per share from $55. Our no-moat rating is unchanged.

Lumber results improved versus the fourth quarter, with adjusted EBITDA margins nearing 10% as benchmark prices rose 8% to an average just over $380 per thousand board feet. This is roughly in line with our price expectations for the year. Management has guided toward a 200 mmbf production decline in 2019, assuming no additional curtailments are required during the year. While we expected an uptick in timber costs in British Columbia amid falling allowable cuts, the pace of timber price increases has outpaced our estimates. Having updated our valuation model, we've reduced our near- and medium-term EBITDA margin forecasts to account for higher input costs in Western Canada.

West Fraser's panel segment fared similarly to the lumber segment, with an adjusted EBITDA margin of just 10% versus nearly 20% last year. We expect pricing to rise over the next few years due to new homebuilding, which should support rising margins.

In both cases, our forecasts are underpinned by the expectation younger adults will head more households over the next 5-10 years amid rising wages and shrinking debt burdens. This will stimulate increased building activity, which is the principle component of demand for both lumber and panels.