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Canada's Forest Industry, Canadian Forestry Issues, BC to Aid in Rebuilding China, Softwood Pulp, The Story of Cedar, Ainsworth Takeover, North American 2007 Lumber Production Statistics
While it may seem illogical, now is an excellent time to invest in forestry, wood products, and building materials companies. Businesses related to these industries are currently so undervalued on the stock market that the term ‘it’s a steal’ is not an exaggeration. Of course, there is likely a two-year wait before companies begin showing profits again, but when they do - those that survive - there will be a big payout. Brokerage firms and investment companies all across North America, in the United States especially, have been buying up enormous amounts of shares in forest and wood products companies of all kinds. Particularly those connected to sizable tracts of timberland.
Parliamentary Committee
The primary purpose of “Canada’s Forest Industry: Recognizing the Challenges and Opportunities” is to “describe the elements likely to contribute to the industry’s renewal, prosperity and sustainability”. Most useful in the short term perhaps, are the sections on bioenergy, biomass and bioproducts. As recently reported here at Madison’s, the use of formerly termed ‘wood waste’ as a potentially lucrative source of biofuel is coming under increased interest both within the forest industry and from the periphery.
Through its eight meetings including 25 organizations and individuals connected to the industry, the House of Commons Standing Committee on Natural Resources declares that, “Besides the traditional wood and pulp and paper markets, there now exist entirely new markets for wood fibre.” Given that ‘bio waste’ has historically been the scourge of wood products companies, and that such material scatters forest floors and timberlands across the continent, such a declaration can only been seen as good news. Of course primary products such as panel, dimension lumber and pulp will continue to be a driving force, but lumber companies will benefit from expanding their market base while these opportunities are just beginning.
With this in mind, the Committee has recommended immediate tax credits, and provincial and federal government investments for research and development of new technologies, and for an increased role, scope and funding of both the Canada Wood Export and the International Forests Partnership Programs. A great deal of insight was provided to the Committee, particularly by the Forest Products Association of Canada, regarding the stifling requirements of the Competition Bureau. The most striking example of a Bureau decision bringing about poor results was the sawmill currently owned by Pope & Talbot in Fort St. James, BC. In 2005 Canfor was forced to sell the then-profitable mill in order to complete their merger with Slocan Forest Products. It changed hands for $39 million; currently receiver PricewaterhouseCoopers is hoping to get slightly more than $6 million for the now-idled mill.
The striking fact was revealed that, given Canada’s vast forest resources and proximity to the world’s largest market for wood products, there is no Canadian presence on the list of 20 largest lumber companies. Witnesses before the Committee on this subject were of the unanimous opinion that the industry must be allowed to consolidate and restructure. The obvious point was made, again by the FPAC, that - as lumber is a global product, with commodity prices set in the international marketplace - Canadian consumers cannot be significantly harmed by the merging of Canadian forest products companies. Pulp and paper producers now generate 60% of their energy needs from readily available biomass. This figure is projected to be 100% in the next decade.
Based on presented material, the Committee has recommended that the scope of the ecoENERGY program be expanded to include incentives for the production of thermal energy from biomass (in addition to the currently funded gasification process). While desire for expansion of bioenergy from harvesting waste was widely proclaimed by all witnesses, some pointed out the danger of overuse. The risk of the forest floor becoming impoverished due to lack of organic material being left behind to decompose can not be ignored.
The Committee went on to learn that “Canadian lumber shipments (by volume) to China have increased by 350%, to South Korea by 290%, and to the U.K. by 320%” in recent years. While clearly the United States will continue to be the world’s single largest consumer of lumber and wood products, Canada’s reliance on a steady level of exports to that country has become less beneficial of late, given the challenges facing US home building and construction in general. In one of the most immediately applicable topics, the Committee learned about transportation woes, particularly on the rail lines.
As the forest sector accounts for a full 25 per cent of Canadian railway’s total revenue, industry leaders were baffled at the comparatively high rates and poor service offered by rail companies. Understanding that the monopoly situation in Canada could be skewing rail charges, the Committee recommends a review of rail rates, in comparison to the global marketplace. The full text of the House of Commons of Commons Standing Committee on Natural Resources report titled Canada’s Forest Industry: Recognizing the Challenges and Opportunities can be found at http://cmte. parl.gc.ca/cmte/CommitteePublication. aspx?SourceId=242322.
While it may seem illogical, now is an excellent time to invest in forestry, wood products, and building materials companies. Businesses related to these industries are currently so undervalued on the stock market that the term ‘it’s a steal’ is not an exaggeration. Of course, there is likely a two-year wait before companies begin showing profits again, but when they do - those that survive - there will be a big payout. Brokerage firms and investment companies all across North America, in the United States especially, have been buying up enormous amounts of shares in forest and wood products companies of all kinds. Particularly those connected to sizable tracts of timberland.
Forestry Investment
Timberlands are the anchor holding any kind of profits whatsoever for wood products companies. This is not only due to the real estate value, but because the fibre can only become more profitable if unused. A number of large, high profile investment firms in the US have been deliberately targeting forestry companies with sizable timberlands and very weak bottom lines. Often a principal at the investment firm will gain a place on the board of the lumber company, thereby having a hand in driving future direction. Right now all these new investors know they will have to wait for a return on their money, but they also know that when it comes it will be a very large return indeed.
Interest in forestry companies as a profitable long term investment began in earnest during 2007, but was already an established practice before that. At the end of 2003 investors of varying types had approximately US$12 billion vested in timberlands (mostly in America). In February of 2004 Harvard University, the Massachusetts Pension Fund and the Robert Wood Johnson Foundation kicked things off in earnest by significantly increasing their stake in timberland assets. While in 2004 lumber would have made an attractive investment because prices were high and demand was rising, more recently the attraction is due to largely devalued companies.
Benchmark WSPF 2x4 #2&Btr was selling for US$460 per TBF in August of 2004; the same month in 2007 saw the highest price of that year for the commodity at just US$268 per TBF. Clearly there is room to grow and investors can see that. In some cases the interested parties have been whipped up into a bit of a buying frenzy, going so far as to embark on bidding wars and to take each other to court over disputed ownership of some lumber company or another. Perhaps the most dramatic case is the heated battle for bankrupt Pacific Lumber Company (Palco) out of Scotia, CA. With defaulted loans of over $160 million to Marathon Asset Management, Palco filed for Chapter 11 at the end of January 2007; by December the prominent Gap family was making plans for a $200 million investment in Palco. Having started Mendocino Redwood Company nine years earlier, the family is no stranger to the forest products industry.
In May of 2008 the Harvard Management Company (HMC) continued with its practice of heavily investing in timberlands by making an offer on 81, 000 hectares (200,000 acres) owned by Palco. The ensuing battle went on for several weeks, with the courts just recently ruling in favour of the Mendocino Redwood Company and the Gap family. Former HMC executive Jack Meyer explained the appeal of timberlands as a long term investment by saying, “We think that timber is quite attractive to what other asset classes have to offer. Timber is also a good diversifier since its returns will not correlate closely with returns from equity markets.’
He’s not the only one that thinks so. Many brokers and investors sing the praises of timberlands by explaining that if lumber prices are low and there is not much logging going on, the eventual value of the fibre - left standing - can only increase. In addition there is very little cost of maintenance or upkeep while waiting out a soft lumber market. A good example of money to be made in a seemingly sagging industry is Plum Creek Timber (Seattle, WA), the largest private landowner in the United States. Plum Creek shares rose 17 per cent by 3Q 2007 from the beginning of that year, and 11 per cent in the year before. Global investment in timberlands has risen to US$40 billion (from $1 billion in 1990), with 90 per cent of that in North America. Some analysts suggest waiting until lumber prices start to rise before getting into timberland investment (or futures hedging, for that matter), while others clearly think now is a good time before all the good remaining land is snapped up. The single most deciding factor for anyone considering such a move should be: how long can one wait for a return?
Barring a natural disaster or major forest fire of some kind, the lumber market in North America will remain weak until well into 2010 at the soonest. A quick look at the graph on this page shows that since August of 2007 building materials companies’ stocks have dropped significantly in relation to Standard & Poor’s top 500. Despite extremely poor financial results, almost all lumber companies (especially in Canada) carry a ‘buy’ rating. Again, an investment is only viable if one can wait at least two years to start seeing a return. But, with nowhere to go but up, up, UP, such a stock would bring an investor a very tidy sum.
In addition to other aid already promised by both the Federal Government of Canada and the Provincial Government of British Columbia, a major initiative was announced today to rebuild homes in China. BC wood products will be used to construct temporary shelters immediately, and a permanent wood-framed community by August in a two phase project involving $5 million from BC and $3 million from Ottawa.
Rebuilding China
Traditional distrust of wood-framed homes in Asian cultures was soundly shaken in China when it was widely reported that the only building left standing in an area completely demolished by the earthquake was of postand- beam construction. Termed the “miracle house” by Chinese media, that structure will make an excellent selling point for this new BC wood export project. Work on putting up the temporary wood-framed shelters will begin immediately and should be completed by August. A 1,000 home village, including a school and retail outlets is expected to be build by spring of 2009. It will then be used as a model for further development.
The Coast Forest Products Association, the Canada Wood Group and Forestry Innovation Investment have all worked together to present the plan to BC Premier Gordon Campbell’s office. In addition to providing immediate relief for the housing crisis currently faced in China, the government of BC hopes to nurture a stronger trading relationship between China and Canada.
European northern bleached softwood kraft prices were up once more this week by US1.36 to US$904.72/ton (SOURCE: www. foex.fi), bringing the total increase from the beginning of the year to US$33.56. United States NBSK prices remained stable at US$880/ton with a more modest increase from the beginning of 2008 of US$15.29. Reduced sawmill production througout North America is causing a scarcity of wood chips, in addition to the usual summer competition from the agriculture sector, forcing the use of small roundwood logs for chipping.
A Scarcity of Wood Chips
Roundwood log chips are traditionally 30-50 per cent more expensive than chips from sawmill residuals. American softwood chip price trends have fluctuated between US$60-70/oven-dry metric ton (odmt) during most of the past two decades, while the pulp mills in the Northwest have seen swings between US$60/ odmt and US$160/odmt.
FOEX reports that the double edged sword of high chip costs and reduced North American pulp production in recent months could actually serve to drive European pulp prices even higher.
Once the specialty product giant of the British Columbia coast, cedar production at present is the domain of only two companies. Changes to the industry in recent years, and the growing challenges of bringing large logs down from steep hillsides has pushed medium-sized players out of the business. The cost of harvesting cedar, a mixed-species product, is affected by low prices for coastal Hemlock and other timber that must be cleared at the same time.
Times Have Changed
There used to be a lot of players in the cedar business. In recent years, company mergers and acquisitions, reduced supply of old growth logs, increasingly inaccessible fibre supply and a major reduction in US home building has brought the number of cedar producers on the BC coast down to two.
Always a specialty product, cedar prices are fast rising out of reach for all but the most upscale building projects. In practical terms, cedar is not like western spruce where the daily fluctuations of supply of finished lumber and the immediate demand for it establish selling prices. Instead, cedar prices are determined by a combination of projected supply of cedar logs and composite materials, needed for a wide variety of finished products, and demand for those products that is also projected through program buying. Unlike order files in other market segments, program buying is the practice of obtaining estimates of future purchases by large customers and distributors over several months or more.
Such estimates may be a rough agreement to order during the period designated; could be actual orders at a fixed price to be shipped three or more months in the future; or they may be scheduled shipments with the price left open, to be billed at the market price at the time of shipment (PTS). In late May and early June, cedar producers gather their program buyers’ estimates and orders of what will be manufactured for shipment for the third quarter, between July and September. Besides program sales, there are always spot sales that come up from just-in-time buyers. History has shown that waiting to pre-order desirable cedar products has been a disappointment to those who hesitated. The process of program buying means that price adjustments often lag behind the reality of seasonal weather conditions.
In February – if programs buys for the first and second quarter are good and if the forest roads are good - loggers go out to gather timber for the mills. However, the price of the finished cedar lumber moves extremely slowly unless some combination of factors swings the whole market, usually as programs are being designed for a following quarter. At the beginning of summer retailers (generally large retailers and big box stores) stock up on product. By mid summer, demand starts to taper off.
However, as cedar is generally a finish wood, the mix of product changes with the seasons. In the fall, finished cedar product for interiors is at a premium while in summer decking is hot. In a wider view of forest operations, cedar is a mixed-species harvest, taken when logging for hemlock, a lowmargin product. When there is light demand for coastal hemlock (such as exists at present), less cedar trees will be taken down as well. Coastal logging usually ends in September but the season in the coastal forest is weather dependent. Very little logging gets done if the winter is soggy and there is a deep, wet, lingering snow pack such as was experienced in the spring of 2008.
Given these circumstances, cedar producers must look forward from the beginning of every year and try to make plans for 3Q. In 2007, materials for the rich mix of cedar products were undersupplied. Company projections at the beginning of 2007 underestimated how much fibre would be needed, and the forestry workers strike (July to October) caused a constriction in log supply. Orders were backlogged for many weeks from summer to the end of 2007. It remains to be seen whether the forest operations curtailments by the world’s largest cedar producer in July and August 2008 will affect its ability to deliver the fall program orders and continue to sustain spot business.
In an unpleasant reminder of what happened to the Doman family after the takeover by bondholders and the creation of Western Forest Products, the Ainsworths are no longer the majority owners of Ainsworth Lumber. On July 20 bondholders HBK Master Fund L.P., Tricap Partners II L.P and Barclays Bank PLC will have 96 per cent control of the company in a restructuring plan negotiated to pay down $823 million in debt.
Share value fell by 62 per cent to $1.08 per share when the news broke. With 1Q 2008 results of a loss of $88.2 million (compared to a loss of $22.8 million of the same period one year ago) the company attempted a major refinancing plan in March with no success. Panel prices have fallen dramatically from a record high US$713 Msf in May of 2004 to US$210 today (OSB 7/16” ON). Two members of the Ainsworth family, Michael and Catherine, are expected to stay on the board of directors as consultants in the short term at least.
With the usual mid-summer seasonal lull upon us, and a significant portion of the lumber industry across Canada and the United States taking the full July 1/July 4 week off, Madison’s is using the opportunity to print some of the interesting statistics we have come across in our research this year. North American lumber and panel production, sales, and exports to Japan as well as log exports are highlighted.
Mid-Year Status Report
• The number of timber jobs in the US fell almost 13 per cent to 8,790 in 2006 from 9,910 in 2000. Likewise, the number of logging equipment operators has declined more than 17 per cent to 28,300 in 2006 from 34,180 in 2000.
• U.S lumber consumption is expected to drop, from 64 billion board feet to 43 billion board feet from 2006 to 2008. A drop of 21 billion board feet in the span of three years is simply staggering, equal to the total production of the Top 20 softwood lumber producers in the U.S. market for all of 2007.
• Lumber companies in the Billion Board Foot Club, a measurement of the largest lumber companies in the world, was reduced from 22 to 15 in 2007. Six of the victims to be cut were in North America.
• In the first three months of 2008, U.S. sawmills shipped about 114 million board feet of lumber per day. That’s down from 135 million board feet per day the first three months of last year, and 160 million board feet in 2006.
• Wood harvested today has about three to four rings per inch, whereas these old growth strains have 10 to 20 rings per inch.
• In the United States, single-family- housing starts in April were down a jaw-dropping 42% below 2007.
• Sawmills, which typically supply the least expensive wood fiber to pulp producers, have reduced production by over 15 per cent in 2007, thus tightening wood chip supply and forcing pulpmills to increase their usage of expensive roundwood chips.
• North American lumber at the Chicago Mercantile Exchange has fallen as low as $209 per mfbm, down a whopping 56 per centfrom its peak of $473 in 2004 - at the apex of the housing boom.
• The United States has about 500 million acres of potentially productive timberland, more than two-thirds of which is now privately held.
• About 4.5 million acres of timberland, worth about $3.3 billion, were sold last year. Lumber and paper companies unloaded about 70 per cent of that total.
• According to the NCREIF Timberland Index, timberland has returned 15 per cent per year since 1987. Over the same period, large-cap U.S. stocks returned about 12 per cent, small-cap U.S. stocks returned 13 per cent, corporate and government bonds returned 9 per cent, and commercial real estate returned 8 per cent.
• Of the total forest area available for timber production in the U.S. -- about 504 million acres, according to the U.S. Department of Agriculture Forest Service -- institutional investors own about 3 per cent, and lumber and paper companies hold 17 per cent. Individuals, along with federal and state governments, control the balance.
• BC timber sales value dropped about 13 per cent from year-end 2006 to 2007.
• 28 Msf of panel products were produced in 2006, compared to 21.5 Msf in 2000 and 12 Msf in 1995. North American Exports
• In 2006, alone, China’s imports of wood pulp jumped 150 per cent to 7.5 million tons.
• In 2007 there were 5,400 wood floor manufacturers in China, with total flooring output amounting to 361 Msf (a 9 per cent growth from 2006).
• In 2007, over 800,000 logs and 2.5 Msf of lumber were shipped from Canada to Japan. 2.1 million logs and 194 msf of lumber were shipped from the US.
• By 3Q 2007, Canadian lumber shipments were at 2.6 billion board feet (a drop of 9 per cent from the year before) and US lumber shipments were at 2.9 billion board feet (a drop of 12 per cent).
