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Wood Industry Outlook: Volatile Lumber Market Raises Concerns

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The Zacks Building Products – Wood industry includes manufacturers of lumber and other wood products that are used in home construction, repair and remodeling, and development of outdoor structures. Companies in the industry also design, manufacture, source and sell flooring products.

Let’s take a look at the industry’s three major themes:

  • Volatility in lumber price has been a major concern for the industry. An unusual rise in cost of lumber products sold by primary producers will increase the cost of inventory and limit margins on fixed-priced lumber products while a decrease in costs will lead to lower profits by selling products indexed to the current lumber market. Lumber price, which touched record high of $639 per 1,000 board feet in May 2018, is currently trading around $330 per 1,000 board feet. Though lumber prices have declined sharply in the recent months, they rose steadily for years. A major factor that has contributed to the increase in lumber prices in the past year is the imposition of U.S. import duties on Canadian lumber. However, the recent decline in lumber prices can be primarily attributed to sharp increase in supply.
  • The industry’s prospects are highly correlated with the U.S. housing market conditions. As increasing raw materials costs and higher mortgage rates are hurting homebuilders, the manufacturers of lumber and other wood products are witnessing lower demand. Further, higher labor and transportation costs are also hurting the industry.
  • Though myriad problems have been denting the home building industry of late, the larger picture is reassuring enough. Overall, fundamentals of the housing market have been encouraging, thanks to steady job and wage growth and solid economy. The industry also stands to benefit from increased government spending on infrastructure projects.

Zacks Industry Rank Indicates Dismal Prospects

The Zacks Building Products – Wood industry is grouped within the broader Construction Sector.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates gloomy near-term prospects. The Zacks Wood industry currently carries a Zacks Industry Rank #244, which places it in the bottom 5% of 257 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.

The industry’s position in the bottom 50% of the Zacks-ranked industries is a result of negative earnings outlook for the constituent companies in aggregate. Looking at the aggregate earnings estimate revisions, it appears that analysts are gradually losing confidence in this group’s earnings growth potential. Since Sep 30, 2018, the industry’s earnings estimate for the current year has gone down 16%.

Our proprietary Heat Map shows that the industry’s rank has remained in the bottom half in the past eight weeks.

Despite the industry’s drab near-term prospects, we will present a few wood stocks that one can hold on to. But it’s worth taking a look at the industry’s shareholder return and current valuation first.

Industry Outperforms Sector but Lags S&P 500

The Zacks Building Products – Wood industry has outperformed its own sector over the past year. However, it has underperformed the Zacks S&P 500 composite over the same time frame.

Over this period, the industry has fallen 16.5% compared with the sector’s decline of 18.2%. Meanwhile, the Zacks S&P 500 composite has witnessed growth of 8.2%.

One-Year Price Performance

Wood Industry Looks Expensive

On the basis of forward 12-month price-to-earnings ratio, which is a commonly used multiple for valuing wood stocks, the industry trades at 18.89X versus the S&P 500’s 16.73X and the sector’s 13.17X.

Over the last five years, the industry has traded as high as 27.49X, as low as 16.95X and at the median of 23.34X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500

Bottom Line

Solid economic recovery and a strong labor market along with increased government spending bode well for the industry. However, volatility in lumber prices is a major concern. The housing industry is cyclical and is affected by consumer confidence levels, prevailing economic conditions and interest rates. The federal government’s actions related to economic stimulus, taxation and borrowing limits can affect consumer confidence and spending levels, which in turn can hurt the economy and the industry.

Below we have discussed three stocks that investors may want to hold on to for the time being.

You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Floor & Decor Holdings, Inc. (FND - Free Report) : This, Smyrna, GA based multi-channel specialty retailer of hard surface flooring as well as related accessories has a Zacks Rank #3 (Hold). The Zacks Consensus Estimate for 2018 EPS indicates year-over-year growth of 37.7%. EPS estimates have been stable over the past 30 days.

Price and Consensus: FND

Rayonier Inc. (RYN - Free Report) : This timberland real estate investment trust with assets located in the United States and New Zealand has a Zacks Rank #3. The consensus estimate for 2018 earnings indicates year-over-year growth of 24.6%. It delivered average positive earnings surprise of 114% in the trailing four quarters. EPS estimates for current year have witnessed upward revision of 6.6% in the past 30 days.

Price and Consensus: RYN

Trex Company, Inc. (TREX - Free Report) : This Winchester, VA based company’s 2018 earnings are expected to witness growth of 44.9%. The Zacks Rank #3 company reported better-than-expected EPS over the past four quarters, with the average being 8%. EPS estimates for 2018 have been stable over the past 30 days.

Price and Consensus: TREX

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