You've heard of peak oil and maybe even peak gold - but peak lumber?
Okay, it's a little bit of a stretch, but it's no exaggeration to say that investors are probably going to make a lot of money betting on trees, particularly Eastern Canadian stands. The stars are aligning to create what looks to be a supply crunch for lumber once demand normalizes. That means high prices and big profits for hewers of wood.
The case is best made by Rick Doman, who is no stranger to the lumber business. His father, Herb, was a legend in British Columbia and best known as the head of Doman Industries Ltd.
The younger Mr. Doman resigned from the company's board over disagreements on strategy, but eventually took over after his father's death. His timing was unlucky: He stepped into the job at the height of the softwood lumber wars which, combined with the debt load he had argued against earlier, forced the company into creditor protection, from which it emerged as Western Forest Products Inc.
Mr. Doman's latest venture is Eacom Timber Corp., which he started in 2008. He raised $145-million earlier this year to buy Domtar's lumber mills in Quebec and Ontario.
Any analysis of Eacom's value starts with the purchase of those mills. In 2007, the same assets were almost sold for $285-million - the deal fell apart at the last minute. Eacom paid $130-million, less than half the previous offer.
To cast that another way, the purchase price came in at about $20 per cubic metre of timber production. Prior transactions, Mr. Doman says, peaked above $100 per cubic metre. And current transactions are happening for twice what he paid. Domtar took pretty good care of its forests, so it looks like Eacom got good assets at a very good price.
Now let's look at the supply side. Trees don't, um, grow on trees. The mountain pine beetle has ravaged production in the B.C. interior and is spreading to Alberta and the U.S. Northwest. The upshot is that lumber production is expected to drop 20 to 30 per cent in British Columbia, which is, of course, a huge supplier to North American home builders. On top of that, last Friday the U.S. formally accused British Columbia of subsidizing producers hurt by the pine beetle. If the complaint is successful, B.C. lumber could become even less competitive.
Internationally, Russia has imposed taxes on log exports, and its prime forests - those closest to Europe - were severely damaged by fire. Scandinavian forests were also devastated by recent storms. The storm damage led, temporarily, to higher supply as felled logs were turned into two-by-fours, but will eventually lead to a longer-term shortage.
"You can't make supply," Mr. Doman says. "It takes 70 years to grow trees."
Now let's look at demand. In 2005, North American demand for lumber was about 77 billion board feet. In 2009, it was 42 billion. This year consumption will probably come in around 45 billion board feet and, as housing normalizes, it will rise to 60 billion by 2013.
The figure will continue to grow because populations are still increasing and new households demand housing. While there are a lot of homes sitting empty today in the United States, they will at some point either be sold or, in some cases, bulldozed.
There's more: Wood is starting to be used in places where it was overlooked in the past. Chinese imports, for instance, are set to rise by 50 million cubic metres this year, according to China itself.
Chinese consumption is surging, in part because of the country's growing wealth but also because wood is being used as a substitute for traditional materials like concrete. One reason for the change? Earthquakes. Wood holds up better than concrete during tremors.
Wood consumption is also growing in New Zealand, Haiti, Chile and India. All of that should increase global demand for lumber.
Finally, let's consider pricing. Earlier this year, when lumber demand rose only about 10 per cent on an annualized basis, lumber prices doubled. You can already see the supply-demand imbalance at work. Prices have since come down along with housing starts but futures prices are picking up briskly.
It's not clear when demand will rebound. What is much more clear is that when it does, the supply will be severely constrained. That means prices are going up sharply - eventually.
Eacom is burning a little cash but it should be able to make productivity improvements and find new markets to get close to break-even without any other changes in fundamentals. The balance sheet is healthy - there's lots of cash and no debt - and management is conservative. Small increases in lumber prices will lead to big swings on the bottom line.
The company trades at roughly book value. If you think it bought the assets at a bargain price - and Domtar appears to think so since it took part of the purchase price for its mills in Eacom stock - then you have to think this is an appealing stock.