PaulGrecaud/iStock via Getty Images

PaulGrecaud/iStock via Getty Images

West Fraser Timber (NYSE:WFG ) has been a tremendous beneficiary of good timing begetting. WFG was able to trudge through harsh weather, flooding, logistics issues, container shortages, labor shortages, etc. and all the challenges 2020/2021 threw at them. What's more is that during this period they have leaned into opportunities to improve the company's long-term position in the wood products industry by acquiring additional capacity that further diversify their geographic asset profile and also investing in optimization type projects at their existing kit. For individuals and institutions focused on the smallest changes in the "rate of change" in the business, production/shipments may have gotten bogged down at various points in 2021 which seems to be driving some concern but, in my view, which is not focused on performance over the next 2-3 weeks, I tend to maintain a more favorable perspective. In a year loaded with more than ample ways for a company to blow itself up, West Fraser managed to bang out a strong 2021. Just look at the results:

I personally thought Q4 was good and believe the company deserves a more inspired applause for posting such a great year overall than they seemed to receive on the last shareholder call. Even management's tone on the earnings call struck me as somewhat underwhelmed. My perception from the Q&A session was that in December/January the company hit some outsized labor issues impacting production and potentially some additional off-take logistics constraints both due to the most recent COVID wave which may have put some clouds over the call so to speak. But I tend to think that this is a distraction worth reading through to the other side. So with that, what does the other side potentially look like at this point?

All I see around me is the demand for homes rising. In fact, builders are struggling to keep up with demand such that backlogs across many homebuilders have become quite substantial. On top of that rent across many of important markets have also been rising as well keeping the economics for a house vs. an apartment fairly compelling - if you can even find one. So, my baseline view is that housing is more likely to remain resilient going forward relative to what the market perceives as evidenced by extremely low multiples on stocks tied to the housing sector.

One of the primary metrics often referenced to measure the strength of the housing market is housing starts. From my understanding, in the context of current demand, housing starts below 1.5MM units actually drives a supply deficit which in my view will tend to extend the runway for the housing sector and suppliers to the housing sector to remain strong. So, with that in mind consider the following slide that WFG included in their earnings update package back in July 2021 covering housing starts:

With hindsight, we can see (in the chart below) that 2021 closed out towards the top end of the forecast range (in the chart above) while the range of estimates for 2022 narrowed towards the upper end of the range as well...based on the updated slide WFG included in their Q4 earnings package.

Furthermore, look at the preliminary estimates for 2023 in the bottom chart. Even the low end of the range is a strong number (i.e. >1.5MM starts) in the context of the past decade. Incidentally if this plays out it will likely have a direct impact on commodity pricing as well as profitability for lumber mills.

After a decade of bad-to-mediocre returns, plant rationalizations across the industry, the current lumber industry is positioned to support, according to WFG, approximately 1.5MM housing starts. This implies that housing starts above 1.5MM will tend to strain the system (maxing out utilization of existing mills) which will tend to exert upward pressure on lumber prices as price is the primary mechanism to balance supply with demand which naturally tends to result in strong profitability for the mills with most efficient, highest operational utilization, who are capable of getting their product to the right markets in a timely manner. Of course, inevitably this process tends to trigger consideration for capital projects to expand supply eventually, but I suspect this will take "some-time" to play out which I believe will likely be measured in years not months.

Add the fundamentally favorable backdrop the increasingly fragile supply chain and logistics system currently strained and prone to unpredictable disruptions to the overall relative tightness in mill capacity vs. demand and you have numerous drivers of sporadic price spikes as mills fight to get product to the right market at the right time to fulfil customer demand. If you look at the chart below you can see exactly what this looks like...

...a commodity market that swings from highs of $1,300-$1,500 per MBF down to lows between $500/$600 per MBF and back again. And while this cyclicality is a big turn off for a lot of investors out there, the fact is that every time the market runs up to high triple digits or even into four-digit territory, it provides WFG with opportunities to lock in forward sales, or hedges, at much higher prices than what anyone was thought possible this time last year. And I guess one of my primary points of variance in my point of view is that even if/when the lumber market falls off in subsequent periods, WFG will still stand to generate a sick amount of cash during that process surfing down the curve of record prices. And what do we know about WFG and excess cash so far? Management has been a terrific steward of capital and how they allocate surplus capital back to shareholders vs. squandering it in an undisciplined fashion - at least so far.

Bottom line, 2022 is currently shaping up to be a much stronger year than previously forecast. Lumber prices year to date are WAY above prior forecasts which best I can tell have not been incorporated into WFG share price - at least from my perspective although there is more than enough stuff going on in the world to side-track people's fundamental analysis on individual stock picks at the moment, so I guess it is understandable.

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Disclosure: I/we have a beneficial long position in the shares of WFG either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.