Higher lumber prices and robust demand from the U.S. homebuilding market have been driving the industry of late.
A major factor pushing up lumber prices recently is the imposition of U.S. import duties on Canadian lumber. Last year, tariff was imposed on lumber/wood, a major input material in the construction industry.
In addition to tariffs, the price of lumber has been supported by last year’s wildfires in Canada’s British Columbia – the world’s top exporter of softwood lumber. Also, insect damage to live trees in the Western portions of the United States and Canada has constrained supply, as well as transportation bottlenecks in the railroad and trucking industries that have been impeding the flow of finished product to the markets.
Despite the increase in prices, demand remains unaffected, given the increased level of construction activity in United States. Notably, wood and wood products are a major input in construction activity. Construction spending in the United States has increased lately supported by a steady increase in outlays on private as well as public construction projects.
Though myriad problems have been denting the homebuilding industry of late, the larger picture is convincingly strong. Overall fundamentals of the housing market have been encouraging courtesy of steady job and wage growth, solid economy, rising rentals, rapidly increasing household formations and a limited supply of inventory — all pointing to strong demand through the remainder of 2018.
The industry also stands to benefit from increased government spending, particularly on infrastructure projects.
Industry Performance versus the S&P 500
The Zacks Wood Industry, which is an eleven-stock group within the broader Zacks Construction Sector, has outperformed the S&P 500 and its sector over the past year.
While stocks in this industry have collectively gained 17% over the past year, the Zacks S&P 500 Composite and the Zacks Construction Sector have rallied 14.4% and 4.7% respectively. The gains have been supported especially by strength in residential construction activity, leading to higher demand for wood and wood products.
One-Year Price Performance
One might get a good sense of the industry’s relative valuation by looking at its price-to-earnings ratio (P/E), which essentially shows how much an investor is willing to pay for each unit of earnings. Typically, a lower P/E ratio is better, though the interpretation is not so straightforward for deep cyclical industries, like this one.
The space looks slightly expensive when compared with the market at large, as the forward 12-month P/E ratio for the S&P 500 is 18.2X while the industry is currently trading at 20.1X forward 12-month earnings estimates.
Price/ Earnings Forward 12 Months
The industry is also trading at a premium to the Zacks Construction sector, as the chart below shows
Price/ Earnings Forward 12 Months
Since the industry is expected to register solid earnings growth thanks to robust demand, a higher P/E than the S&P 500 and sector is justified.
Moreover, the Building Products- Wood industry’s valuation looks fairly valued when compared with its own range. The industry currently has a forward 12-month P/E ratio of 20.1X, which is close to the lowest level scaled over the past year. When compared with the one-year high of 25.4X and median level of 23.4X over that period, there is apparently plenty of upside left.
Outperformance May Continue With Solid Earnings Outlook
What really matters to investors is whether this group has the potential to perform better than the broader market in the quarters ahead.
One reliable measure that can help investors understand the Wood industry’s prospects for a solid price performance going forward is its earnings outlook. Empirical research shows that earnings outlook for the industry, a reflection of the earnings revisions trend for the constituent companies, has a direct bearing on its stock market performance.
One could get a good sense of a company’s earnings outlook by comparing the consensus earnings expectation for the current financial year with the last year’s reported number, but an effective measure could be the magnitude and direction of the recent change in earnings estimates.
The Price & Consensus chart for the industry shows the market's evolving bottom-up earnings expectations for the industry and the industry's aggregate stock market performance. The red line in the chart represents the Zacks measure of consensus earnings expectations for 2019, while the light blue line represents the same for 2018.
Price and Consensus: Wood Industry
This becomes even clearer by focusing on the aggregate bottom-up EPS revisions trend. The chart below shows the evolution of aggregate consensus expectations for 2018.
Please note that the $1.88 EPS estimate for the industry for 2018 is not the actual bottom-up dollar EPS estimate for every company in the Zacks Wood industry, but rather an illustrative aggregate number created by our proprietary analytics model. The key factor to keep in mind is not the earnings per share of the industry for 2018, but how this number has evolved recently.
Current Fiscal Year EPS Estimate Revision
As you can see here, the EPS estimate for 2018 is up from $1.70 at the end of March 2018 and $1.42 at the end of July last year. In other words, the sell-side analysts covering the companies in the Zacks Wood industry have been steadily raising their estimates.
Zacks Industry Rank Indicates Solid Prospects
The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates outperformance in the near term.
The Zacks Wood industry currently carries a Zacks Industry Rank #15, which places it at the top 6% of more than 250 Zacks industries. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.
Our proprietary Heat Map shows that the industry’s rank has continually improved over the past few weeks.
Now, looking at past revenue performances, the prospect of the industry also looks attractive. Revenues have shown a marked improvement since 2015. The growth can be attributed to an increase in lumber prices and strong demand from the housing market.
Another important indication of solid prospect is the improvement in the group’s return on equity (ROE).
We believe the countervailing and anti-dumping duties on Canadian lumber will keep lumber prices high in the near future. With demand from the residential and non-residential space remaining robust, the momentum is expected to continue.
Consumer demand is robust considering the solid economic scenario, backed by low unemployment and solid wage growth. The solid economic growth is expected to continue with Federal Reserve expecting economic growth of 2.8% for 2018, highlighting an increase of 0.1 percentage point from the estimates issued in March 2018. Fed also expects the rate of unemployment rate at 3.6% in 2018, down from the previous expectation of 3.8%.
Therefore, this is a great place to invest in right now. Investors could take advantage of the attractive valuation and bet on a few wood stocks with a strong earnings outlook.
Below are four stocks with positive earnings estimate revisions and a bullish Zacks Rank.
Norbord Inc. (OSB - Free Report) carries a Zacks Rank #1 (Strong Buy). The expected earnings growth rate for the current year is 6.5%. The Zacks Consensus Estimate for the current year has improved 6.2% over the last 60 days. The stock has gained 25.8% in a year’s time. You can see the complete list of today’s Zacks #1 Rank stocks here
Price and Consensus: OSB
Louisiana-Pacific Corporation (LPX - Free Report) sports a Zacks Rank #2 (Buy). The expected earnings growth rate for the current year is 26.2%. The Zacks Consensus Estimate for the current year has improved 1% over the last 60 days. The stock has gained 12.5% in a year’s time.
Price and Consensus: LPX
Trex Company, Inc. (TREX - Free Report) carries a Zacks Rank #2 (Buy). The expected earnings growth rate for the current year is 35.4%. The Zacks Consensus Estimate for the current year has improved 0.5% over the last 60 days. The stock has gained 87.9% in a year’s time.
Price and Consensus: TREX
Weyerhaeuser Company (WY - Free Report) carries a Zacks Rank #2. The expected earnings growth rate for the current year is 7%. The Zacks Consensus Estimate for the current year has improved 13.4% over the last 60 days. The stock has gained 20% in a year’s time.
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