Forestry stocks profit from a strong economy

The US Department of Commerce has set final duties on lumber imports from Canada. This is likely to hurt the profits of some Canadian lumber producers. But a stronger economy helps mitigate the damage, and the hurricanes in Texas and Florida have raised the need for lumber.

forestry_StocksThe US Department of Commerce has set final punitive duties on Canadian lumber. This is likely to trim the exports, sales and earnings of Canadian lumber producers. So will the higher loonie.

On the positive side, the hurricane damage in Texas and Florida has raised the need for lumber. This will increase the price of lumber. That could make it more profitable for Canadian producers, despite the countervailing duties.

Home-improvement chains such as The Home Depot and Lowe’s Companies sell lumber. Much higher prices will squeeze their profit margins. Home builders will also face substantially higher costs. These are natural allies of Canadian producers. But the ‘America first’ approach makes the American market less welcoming.

Canada is diversifying its export markets

Then again, the American, Canadian, Japanese, Chinese and some European economies continue to grow more quickly. Canada’s trade agreement with the European Union could open up new opportunities for Canadian forestry producers. Until this trade agreement gains traction, the US, China and Japan are likely to remain Canada’s top three markets for exports of forestry products.

Buy-rated Western Forest Products says China and Japan are its “key markets”. That’s likely why it’s doing relatively well. The company says Chinese urbanization has created a need to build 20 million new homes a year. Pacific Rim demand for lumber may rise since wood homes are safer than concrete buildings during Asian earthquakes.

Policy makers outside of North America are using low interest rates to stimulate their economies and reduce unemployment. North American interest rates are low by historical standards. As long as rates remain low, we expect demand for housing in Canada and the US to remain brisk. This, in turn, should raise lumber demand. And relatively-low oil prices reduce production and shipping costs.

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Canadian producers face other problems. One is Canada’s aging plant and equipment. A second is the pine beetle that’s killing trees in Western Canada. So restrain your enthusiasm for forestry stocks. An experienced and successful investor told us: “I wouldn’t touch forest stocks with a 10-foot pole.”

However, if you want to diversify your portfolio, we rate seven of 11 producers ‘buys’. This is based on our six-criteria rating system which awards up to a maximum of 13 points for: profit (up to 3 points); forward price-to-earnings ratio (up to 2 points); dividends (up to 2 points); operating margins and returns on assets (up to 2 points);  share price relative to book value (up to 2 points); and low debt (up to 2 points).

The seven stocks we rate ‘buy’ scored eight points or more:

11 points: Norbord Inc. (TSX—OSB);

10 points: West Fraser Timber (TSX—WFT);

9 points: Canfor Pulp Products (TSX—CFP);

8 points: Acadian Timber (TSX—ADN); Conifex Timber (TSX—CFF); Domtar Corp. (TSX—UFS); and Western Forest Products (TSX—WEF).

Just remember that forestry stocks are often viewed as trading buys as opposed to buy-and-hold investments.

This is an edited version of an article that was originally published for subscribers in the November 17, 2017, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

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