TD sees upswing for lumber in late 2013

TD economist Leslie Preston said patience will pay off for the sector that is suffering with prices still 36% below the previous cyclical highs, despite gains in other commodities.

“Moreover, after considerable restructuring over the past ten years, the lumber sector is leaner and more competitive,” TD economist Leslie Preston wrote in a report Thursday.

“We expect further capacity reductions this year, setting the stage for an upswing in prices once U.S. demand starts coming back on stream.”

The sector was hammered as the bottom fell out of the U.S. homebuilding market and demand evaporated in the wake of the financial crisis.

Shares of Canada’s big lumber producers had been heading higher in the spring, but fell off sharply after it became clear the U.S. economic recovery would be slower than expected.

Since the downturn in the U.S. market, the companies have looked to Asian markets and B.C. producers have benefited.

The Canadian firms, with the help of the B.C. and federal government, have worked to promote the use of wood in construction in China which traditionally has not used wood frame building techniques.

Canfor (TSX:CFP) CEO Don Kayne said earlier this year that he believed the industry could double the volume of wood going to China over the next five years, while West Fraser Timber (TSX:WFT) CEO Hank Ketcham said in July that his company set a record in the second quarter by shipping more than 30% of its Canadian production to China and Japan.

The TD report said China now imports more lumber from B.C. than from the United States and anecdotally the B.C. government estimates that the U.S. and China each account for about 40% of the province’s lumber production.

“Healthy demand growth from China is expected to continue over the medium term. Analysts expect China’s imports of wood products to grow at 10% per year through 2015, and those are deemed conservative estimates,” Preston wrote.

The industry has also honed its competitive edge, especially in B.C., home to some of North America’s lowest cost producers.

Canfor, Canada’s biggest lumber producer, is in the midst of a three-year plan to spend $300 million on sawmill improvement projects to increase productivity and efficiency.

However, Preston noted that the fortunes of the lumber market still depend on the recovery of the U.S. homebuilding market.

At its peak, the U.S. market hit a pace of more than two million housing starts per year and lumber prices were north of $400 per 1,000 board feet.

Lumber prices averaged around $269 per 1,000 board feet in August, while the U.S. Commerce Department reported builders broke ground on a seasonally adjusted 571,000 homes, a three month low.

“Chinese demand may have kept mills running, but low capacity use rates mean there is little scope for higher prices until improved demand from our biggest customer starts filling order books,” Preston wrote.

“The U.S. is still our number one market, accounting for roughly 60% of Canadian lumber exports in 2010 despite the housing downturn. The share has fallen from a recent peak of 83% in 2005, but the importance of a recovery in U.S. demand to Canada’s lumber industry remains crucial.”