Description

Summary  / Thesis

Buy LPX - Louisiana Pacific.  30%+ upside.  

Basically I think LPX and other wood products stocks have under-reacted to this historic upward price move in oriented strand board and lumber.  It trades at 3.7x EV/run rate EBITDA and 19% FCF yield,  with upside to #s on better prices and volumes.  The stocks didn't do much during the initial unprecedented historic surge in wood products prices in Q3 2020.  Weirdly they shrugged it off;   I think people thought it was going to be a brief spike, and didn't want to buy them ahead of the inevitable drop in prices.   But now that prices have bounced and stayed at very elevated levels in a seasonally weak period, looks like other investors are starting to believe it this time.  

If prices are so strong in the seasonally weak Q4, it'll likely still be very strong for most of next year as well.  This housing cycle and wood products pricing still has legs for at least a few more quarters I think

In that meantime they'll produce a ton of cash and have very low gross leverage (~0.4x) and are in net cash position.  They've fixed their pension/OPEB as well.   LPX and others have actually been disciplined with capital and used it to pay down debt and buyback stock over the last 5 years.    

LPX is trading at ~20% FCF yield (on an annualized basis),  most of which they'll use to buyback stock aggressively and maybe do tender offer or raise the dividend.  Simplistically and theoretically, that should drive around a 20% increase in the stock price over a year,  plus a 1.5% dividend yield 

Given the current strong and seemingly more durable price and demand environment, people will likely also bump up their multiples and normalized EBITDA assumptions as well.  The stock trades at 7.7x current normalized EBITDA assumptions of $570mm.   Not unreasonable for people to assume a target 8.5x EV/EBITDA multiple on $650mm of normalized EBITDA, 7% FCF yield = $50 price target, or 30% upside

LPX has also become a better company over time as they've cleaned up their balance sheet, OSB has gotten more rational.  Plus their siding companies has done very well, and comps trade at much higher multiples.  So there's room for people to bump its SOTP valuation / multiple also as this becomes a bigger part of the company.  

Norbord (the pure play OSB competitor) just got taken out by a timber company (West Fraiser).  There will probably be more M&A in the sector given seemingly cheap valuations and how clean their balance sheets are

So to summarize, LPX is a housing play that hasn't made that much of a move yet with price & volumes at unprecedented great levels, and the chart looks like it's still getting started

I admit this is a commodity and very cyclical company,  so it's always tricky to trade these.  But the tailwinds will last for a while, valuation is cheap, and they’re being prudent with supply and capital allocation,  which gives me comfort.  Plus it’s not like the stocks have moved much despite the strength in fundamentals.  

Business overview

LPX makes OSB and siding mainly.  It also has a small engineered wood segment and small South American operations that aren’t too meaningful.  

Typically OSB is around 60% of LPX's EBITDA (but volatile), and siding is 30%, and engineered wood products/South America is 10% 

OSB -  oriented strand board

OSB is extremely volatile and effectively is tied to spot prices with a few months lag, which causes the huge swings in rev and EBITDA and margin.  1/3rd of LPX sales are pure open market spot, and 2/3rd is contract.  However, the contracts are basically tied to the Random Lengths prices but lag by a few months

The industry is still pretty fragmented.  LPX has ~16% market share.  5 other producers, such as Norbord, Weyerhauser, etc. have teens market shares.   

To recap, lumber and OSB prices shot to the moon because of extremely strong home building demand and repair/remodel post COVID.  Meanwhile, supply went down a lot because all the producers shut mills right when COVID started and inventories got low across the supply chain (of course they've since brought it all back online).    Supply was further impacted due to COVID, forest fires, and the hurricanes.  Hence this historic price spike.  This supply / demand imbalance has gone on far longer than everyone expected

OSB prices have stayed very strong due to a bunch of reasons:  

- OSB products have more demand given higher usage in resi and tied more to new construction

- there was a shortage of chems used in OSB (e.g. MDI) 

- there are fewer OSB imports than in other products

- OSB plants already running near full capacity and the industry is being disciplined 

- COVID disruptions limiting supply 

- there are long order files for OSB

- low inventory and supply in the channel

- there has been limited substation from OSB to plywood 

LPX’s OSB segment has been running at 93% utilization YTD,  but 76% including a huge idled plant (Peace Valley in Canada)

OSB margins swing a lot with prices while costs are relatively stable since timber, wood chips, chems, don’t move nearly as much. 

Overtime, they’ve actually become more profitable and the downturns (while sharp and still pretty bad) aren’t as bad as they used to be:

OSB margins since 2010

LPX has a huge 800mm sq ft mill in Canada (Peace Valley) that is currently idled (which is 18% of their capacity). They’re being very cautious and hesitant to start it up again.  Depending on the supply/demand they may start it back up.  Given how careful they are being,  I think if they ever decide to start it back up again, it would be a big value creator given the very strong demand.  

Of course the risk in a commodity industry is how much capacity everyone brings on.  But given the ongoing level of demand outpacing supply, I think there’s plenty of room to bring on capacity and still have very healthy prices and margins

Siding

They’re the #1 producer of engineered wood siding.  

Siding is the more steady and consistently growing segment (where prices are listed annually and they increase prices by around 3-4% a year)

This has been a consistent steady grower with relatively stable margins.  Revs have grown at a 12% CAGR over the last 5 years, and EBITDA at 19%,  well above the housing industry.  Arguably this deserves a much higher multiple 

Their products are durable, look good, and easier to install and finish,  hence why it’s been taking share. 

They’re expanding capacity, which should be a net positive

Siding margins since 2010

LPX stock Technicals

The stock didn't do anything for 3 years, while they were generating a lot of FCF and buying back stock a lot of stock (shrunk share count by 23% over the last 3 years).  In years before that, they cleaned up their balance sheet

Unlike prior periods, the stock hasn't react much to the historic price increase in wood products (charts below)

It's starting to break out now after a cup and handle

Seasonality wise, it's usually worked to buy wood products stocks in Oct/Nov and sell in the Spring (I forget the exact study,  but this seasonal trade has worked like 75% of the time with a good slugging average in addition to the good batting average).  

LPX 5 year

Here’s a chart of Norbord stock prices vs. OSB prices (a chart for LPX looks similar, but I don't have one)

- note that historically there is a linear relationship between OSB prices and the LPX & Norbord's stock price,  but lately the stocks are weirdly ignoring it, which is the opportunity 

LPX stock price top panel vs. lumber futures prices bottom panel since 2015.  You can see the stock under-reacting and ignoring the big spike in prices.  I use lumber here as a proxy for OSB since it was easier to chart.  But you get the picture

I heard investors didn’t react initially since they thought it would be temporary into the seasonally weak Q4 (didn’t want to buy the stocks before prices corrected or normalized first).  Also, in the 2017-2018 cycle the industry brought on a lot of supply, levered up, or made bad acquisitions,  so people thought that this would end in tears as it usually does.  But so far the industry has been very rational and disciplined, which is good.  

LPX stock price top panel / lumber futures prices bottom panel since 1980

Valuation / #s

On run-rate #s, it's trading at 3.7x EV/EBITDA, and 19% FCF yield.  They've been buying back lotsof  stock and are in a net cash position,  so the balance sheet is clean.  I think they'll keep buying back stock and have been doing so

Of course for such a cyclical biz, people also guesstimate what 'normalized' EBITDA is and use that to value it.  EBITDA at LPX can range from -$200mm annually to ~$1bn over the last 20 years, although the company has become better over time and more profitable thanks to siding and a better cost structure in OSB.  Most estimate normalized / average EBITDA to be ~$570mm,  so it's trading at 7.7x 'normalized' EBITDA (usual range people use is 6-8.5x),  8% FCF yield 

$4.4bn mkt cap

$420mm cash

$348mm debt

Q4 EBITDA I think is $290mm (with room for upside on better volumes and price flow through),  vs. $273mm in Q3  (up from $97mm in Q2, $83mm in Q1, and around $50mm/quarter in 2019)

Q4 annualized, it's trading at 3.7x EV/EBITDA

Q4 FCF of $209mm vs. $204mm in Q3 and around $30mm/quarter in 2019

Q4 annualized, trading at 19% FCF yield

Historical EBITDA and EBITDA Margin

LPX stock chart since 1980

Making a big base, ready to rocket higher?

Recent Randon Length’s wood product trade commentary summaries

- buyers scouring for coverage as tightness on the supply side led to price moves similar to the historic summer surge

- demand strong helped by ideal weather keeping construction sites busy.  Demand strong in all regions and order files extending into mid-January

- people out of stock of 2x4s

- demand very strong in China and Japan as well 

- Trade magazine saying activity in December resembles a typical Spring

   - mild winter also helping

- inventories thin and supplies tightening.  Some producers ran at reduced utilization due to COVID staffing shortages 

- buyers coming back into the market due to strength in new residential construction to make sure they have enough inventory for a strong Spring 

- imports from Canada were lower than expected, actually 8% MoM.  People had thought lower duties would bring in more imports. 

Housing - booming with staying power

I don’t have to explain why housing is booming. 

Conversations with real estate brokers, builders, & friends and surveys are consistently saying that the demand for houses will be very strong now and well into 2021, even through the seasonally weaker winter periods.  

They think the housing movement / boom still has legs through 2021 as people continue to move around the country, work-from-home, flee cities, etc.   I know many who are still trying to figure out where they’re going to live longer term and will keep buying houses around the country.  People from NYC, SF, etc. are moving to cheaper areas all over the country now that they have the flexibility.  It’s driving up prices everywhere.  More and more people will have multiple homes as well

Companies around the US and the world are much more open to allowing people to work from home as that opens the pool of talent and can reduce salaries (e.g. MSFT cutting people’s pay by 20% if they want to work from home,  which makes a lot of sense for people to get out of high cost coastal cities).  

There’s just not enough homes out there, prices are spiking, hence we need more new homes to be built

OSB prices

Lumber prices

Risks

Of course the main risk is that this is a cyclical commodity industry,  supply could overwhelm demand. 

Maybe COVID goes away and people all go back to cities and homes won't need to be built

Costs could go up, squeezing margins 

Catalyst

- Wood products prices stay higher for longer, or go up

- M&A in the space

- more stock buybacks / dividends

- continued strong housing dynamics