Money doesn't grow on trees, but trees can turn into money under the right circumstances, which seem to be aligning now for the long-suffering forest products sector. Shares in Tembec, which recapitalized itself in bankruptcy protection in 2008, are up fourfold in the past year. AbitibiBowater, fresh from restructuring, has fared nicely since its shares resumed trading in December. Domtar, which also restructured, is another winner over the past year, up by a third.
Yet it looks like there's still money to be made. Pulp used to be a necessary but unprofitable line of business, but it's shining now. Tembec CEO Jim Lopez says one factor in the recovery is consolidation, which has improved pricing discipline. The financial crisis of 2008 also helped constrain supply-about $1 billion worth of new pulp mills were never built as the funding vanished.
Tembec has another edge: two mills that make specialty dissolving pulp used in rayon and other value-added products. Dissolving pulp prices went up $200 a tonne on Jan. 1. That means the company's 300,000 tonnes of production will crank out an extra $60 million in cash flow this year. Tembec's market cap is still just $400 million.
Paper is more difficult. Unlike pulp, which trades on the global market and has benefited from Asian demand, paper is more of a regional business. AbitibiBowater still depends on newsprint for about 40% of its revenue. Restructuring eliminated $6 billion (U.S.) of the company's debt, and it closed several mills and slashed its payroll. But North American newsprint demand is only about half of what it was in 2001.
Investors who like newsprint and other printing papers, as well as pulp, can look at AbitibiBowater and Catalyst Paper of Richmond, B.C. Catalyst is a riskier bet. Its stock is cheap-like 40 cents-for a reason: The company didn't restructure, so it has a lot of debt. But Catalyst could get a lift from paper prices: an extra $50 (U.S.) per tonne on newsprint adds five cents a share to Catalyst's bottom line.
Then there's free-sheet paper-the stuff you put in your photocopier and printer. Domtar and Memphis-based International Paper have a commanding market share, and they can cope with falling demand by raising prices. Domtar looks cheap relative to cash flow, and analysts like it.
The wild card in the forest sector is lumber. Annual housing starts in the United States have crumpled to about 500,000. Demand in China, however, is soaring. The Chinese are adopting wood-frame construction, and Lopez says they'll use 2.5 billion board feet of wood this year. That's the equivalent of more than 200,000 U.S. housing starts.
Supply, meanwhile, is limited by forest fires in Russia, storms in Scandinavia and the mountain pine beetle in British Columbia. Lopez says that U.S. buyers are wondering why prices are so high when U.S. demand is so low. The answer is that the world has changed. A pure play on lumber is Montreal-based Eacom Timber, which bought Domtar's Eastern Canadian sawmills in 2010. Its shares trade near 60 cents, and it has no debt.
If U.S. lumber demand recovers over the next two years, there could be a wood shortage, and some analysts say a supercycle will kick in. That's when a real money harvest could begin.
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TIP SHEET
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600% revenue growth, 2006 to 2009
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VALUE: Tourmaline Oil Corp.
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