The lumber and wood products industry saw one of the most significant increases to input costs during the COVID-19 pandemic, as the price of lumber rose from the low USD 400 per one thousand board feet to USD 1,680 per one thousand board feet in 2021. This rapid increase in the primary material caused severe slowdowns in the construction of residential multi-family real estate and other sectors dependent on these products. Further, since the cost to build and replace new or existing homes rose along with the cost of lumber, inflation inputs took over the homebuyer audience. As a result, would-be homebuyers effectively had to postpone any near-term plans to purchase or renovate a home in the United States.
According to the FED capacity utilization monthly readings, the wood products industry saw a capacity utilization rate decline throughout the second half of 2022. This decline can be expressed in the utilization rate, going from 80.2% in the second quarter to 80.1% in the third quarter and ending the year at 76.3%, a dramatic decline. A capacity utilization rate effectively conveys the balance of supply and demand at a given time, where a reading within 70-75% is typically considered normal across the board.
The elevated utilization rates experienced in the wood industry during the first half of 2022 can be tied to the madness seen in the real estate market, which accompanied lumber by rising prices in housing and rents across the country. Conversely, the contraction of the rate in the second half can be attributed to the rise of interest rates, which caused a decline in real estate prices and slowed the demand for new transactions as mortgage costs rose significantly.
A Rebound in Construction, Good for WY?
The same capacity utilization rate for wood products that told markets the industry was cooling down has now pivoted in 2023 by reading 74.9% in December 2022 as its low point and rallying to 75.7% as of February. This upper bound for the past two quarters effectively signals the developments brewing in the United States real estate value chain.
Weyerhaeuser (NYSE: WY) derives more than 50% of its revenue from their lumber and OSB (Oriented Standard Board) segments, generating over half of their revenues from a combination of new residential construction along with repair and remodeling activity in existing structures. The business's economics seems to clarify how vital the trends in U.S. construction and real estate are for value creation.
Building permits in the United States have reported a rally in February, signaling upcoming construction and housing start increments across the country. What is essential about these building permits is the bulk of locations; given that Weyerhaeuser operates mainly in the South region of the U.S., they will benefit from most of the permits going to states like Florida, Georgia, and Texas, where rents have risen significantly, and thus the need for new supply is driving permit applications to build.
While building permits provide a possible window into construction activity in the next three to six months as lots are prepared, and any plumbing preparation is completed, the current driver of the capacity utilization rate rise comes from housing starts (ready lots where foundations have been poured thus beginning construction). The housing starts indicator has bottomed in December 2022 and showcased a recent rally to close the first quarter of 2023, giving way to incoming demand for lumber and OSB units to deliver new real estate.
Shareholder Benefits and Upside
While Weyerhaeuser experienced relatively flat revenue growth in 2022 (-0.2%) due to the first half of the year delivering compressions across the real estate and construction sector in the United States, shareholders are sitting on a five-year CAGR (compounded average growth rate) of 6%, an attractive feat for a mere manufacturing firm.
Despite experiencing slowdowns in demand throughout the second half of 2022, management could still return significant cash to shareholders via dividends and share buybacks, effectively paying out USD 0.68 per share annually and retiring eight million shares from the open market. For 2023, this dividend has been increased to USD 0.72 per share, and further buybacks are expected to be implemented throughout the year.
Management attributes their ability to accomplish this to spotting the pivot in demand for lumber and OSB from the construction and real estate sector for the southern region of the United States and also for being prepared to fulfill this demand by having increased their inventory levels by USD 30 million even after some discounts in the open market price of lumber.
Management has guided moderate to significantly higher EBITDA and earnings for the coming quarter compared to the fourth quarter of 2022. This upside expectation can be derived from the increased momentum and ensuing demand described in the U.S. construction and real estate sector, as well as decreased transportation and raw materials costs.
Analysts seem to have caught onto this idea, pointing to a 24% upside in the stock, and with earnings coming due by the end of April, investors can be in for a pleasant surprise.
