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As lumber prices slipped from record highs in May, shares of companies tied to the industry have followed. But as the lumber market stabilizes, some beaten-down stocks linked to the red-hot commodity will see strong upside into year-end as the housing boom continues, Royal Bank of Canada analysts said in a note.
The bank is recommending investors keep a close eye on Canfor, Conifex Timber, and Western Forest Products, which remain "deep value picks," as well as West Fraser Timber and Interfor, which have modest premiums. All have outperform ratings.
"Although lumber stocks are likely to remain under pressure until pricing starts to increase, we think that the worst of the declines are over and that it is a good time to start getting up to speed on the sector," the note, written by Analyst Paul Quinn and Senior Associate Marcus Campeau, said.
The analysts said they believe lumber producers should trade at a discount, but the current 50%-80% is "too punitive" given their positive outlook.
To close the valuation gap, the analysts said they are eyeing increased consolidation, production discipline, and shareholder-friendly capital allocation.
Apart from currency risks, price seasonalities, and COVID-19 threats that may affect the price target and the ratings of the stocks, the RBC analysts are optimistic their outlook will be met.
Lumber prices skyrocketed more than 500% in the 15 months after the COVID-19 outbreak as supply-chain disruptions collided with a demand for housing and activity from homebuilders.
As of August 25, lumber futures were hovering around $492.50 per thousand board feet, 71% lower than the record high of $1,711 achieved in May. During the same day last year, the price closed at $461 per thousand board feet.
The massive drop may be attributed to various factors from the surge in wildfires that cripple supply chains (such as the case with Canfor), China releasing stockpiles to cool surging prices, and people spending less time at home as the economy reopens, denting demand for home improvement projects.