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Morningstar | West Fraser Will Face Narrower Margins in 2019 Despite Our Bullish Housing Outlook

West Fraser Timber is one of the largest softwood lumber producers in the world, with over 7 billion board feet of production capacity in western Canada (63% of the total) and the southeastern United States (37%). The company's panel business produces plywood, medium-density fiberboard, and laminated veneer lumber. North American homebuilding and remodeling are West Fraser's key end markets, although it exports significant volume to China, constituting 12% of total sales in 2018.West Fraser sees dramatic profit variations depending on the health of the U.S. housing market. After seven lean years for residential construction, we expect favorable demographics, a tighter labor market, and looser mortgage availability to catalyze some improvement in homebuilding activity over the coming decade. We forecast U.S. housing starts peaking at 1.6 million in 2023 as pent-up demand is unleashed, before fading to a demographically sustainable 1.4 million in 2028.We forecast profits to weaken in the near term for West Fraser's lumber and panel businesses, accounting for around 80% of revenue. Lumber and panel adjusted EBITDA will be pressured by the easing of short-term supply constraints in 2018, leading to narrower margins despite increased homebuilding. On a midcycle basis, we forecast segment adjusted EBITDA margins of roughly 15% as housing normalizes and heady profits attract new supply.Despite challenging market conditions, West Fraser has been reinvesting in its business with an eye on housing recovery. Management has been executing capital plans to bolster its cost position. Meanwhile, the company bought lumber capacity in the Southeastern U.S. and Alberta, amplifying exposure to a U.S. housing upturn and reducing reliance on western Canadian mills, which will struggle with timber availability due to the mountain pine beetle's devastation of regional forests.West Fraser’s pulp segment accounts for about 20% of revenue. We assume EBITDA margins will fade from recent highs as old corrugated containers become viable competition for export business again.