Forisk Forecast, Part II: Sawmill Capacity and Utilization

30 08 2012

This is the second in a three-part series related to Forisk’s modeling of future softwood stumpage prices in the US South and Pacific Northwest.

In Tony Hillerman’s Navajo Tribal police novel Dance Hall of the Dead, Lieutenant Joe Leaphorn remembers what mentor Hosteen Nashibitti told him.  “When the dung beetle moves, know that something has moved it.”  The lesson reinforced the interdependency of things; each movement has its reason, cause and effect. [Drum beat] And so it is with wood flows and stumpage prices.  When wood moves, something has demanded it.

When forecasting stumpage prices, we care deeply about the sources of demand for pulpwood and softwood logs over time. In Part I of Forisk Forecast (Studying US Housing Starts), I outlined a view of the housing industry, a critical “macroeconomic” source of wood demand.  In this post, I summarize at a regional level a critical “microeconomic” source of wood demand: the productive capacity of sawmills in local markets.  In aggregate, localized clusters of softwood sawmills produce the lumber required to satisfy national demand from the housing sector.  And these sawmills represent the primary source of sawlog demand and cash flows to timberland owners.

According to the U.S. Forest Service, total U.S. softwood lumber capacity peaked in 2006 (Figure 1).  In the U.S South, softwood lumber capacity also peaked in 2006, hitting 20.6 billion board feet.  When housing declined, the lumber industry “rationalized” capacity, increasing our stock of idled and closed sawmills. In the U.S. South, the number of mills declined by nearly one-third, from 440 in 1995 to fewer than 300 in 2011.  This period also saw the industry move towards larger, more efficient sawmills.

In modeling a given U.S. region, we might ask, “How does current lumber production in the South compare to current lumber capacity in the region?”  According to the Southern Forest Products Association (SFPA), the U.S. South produced 13.61 billion board feet in 2011.  According to Forisk analysis of the Forest Industry Shapefiles from the Center for Forest Business at the University of Georgia, the U.S. South has 16.7 billion board feet of open capacity and another 0.3 BBFT of idled capacity, for a total of 17 billion board feet.  This implies a capacity utilization of 80%.  This estimate falls in line with tracking of actual wood raw material consumption in the U.S. South.  According to the Wood Demand Report, effective capacity utilization in the U.S. South at sawmills as of Q1 2012 was 77%.

Carrying this forward, we see that as housing starts “return to trend”, demand for softwood lumber will outstrip current capacity.  This is also true in the U.S. West.  Mitigating factors that affect the forecasting of issues such as “capacity constraints” include, for example, the ability of mills to run in excess of 100% by adding extra shifts and by the reopening of closed mills.  And localized productive capacity and demand alter the trajectories of potential stumpage prices in different timber markets.

Part III addresses prices and localized stumpage forecasts.

Forisk Forecast, Part I: Studying US Housing Starts

26 08 2012

This is the first in a three-part series related to Forisk’s modeling of future softwood stumpage prices in the US South and Pacific Northwest.

Increasing housing starts prime the pump during an economic recovery.  The Economist magazine describes the upside for housing in the United States, noting that “its share of GDP, at 2.7%, is half the average of the past 30 years” (“The Housing Market: Pulling Its Weight at Last”, August 4, 12).  We care about this because, in the timber industry, growth in housing leads to periods of strengthening stumpage prices.  In addition to growing wood demand from the increased use of lumber and other building products, the constructing and buying of new homes fuel added spending on wood products such as cabinets, furniture and hardwood floors.

At Forisk, I study US housing starts as part of an explicit forecasting framework:

  • Given assumptions about the US economy and housing markets,
  • How will demand for wood raw materials drive stumpage prices in each local market,
  • Subject to constraints and surpluses in manufacturing capacity and forest supplies.

In the end, our primary interest is the movement of stumpage prices in each local market as it plays out its role in satisfying national and export markets for forest products and wood bioenergy.

Forisk builds a composite housing starts forecast by relying on publicly-available, independent forecasts from professionals in the housing industry.  These include Fannie Mae, Freddie Mac, Mesirow Financial and the National Association of Home Builders (NAHB), as well as long-term assumptions from the Energy Information Administration’s (EIA) model of the US economy (Figure 1).

In studying the impact of housing starts on markets for timber, we track how home size, wood volume use per square foot and the ratio of single versus multi-family housing affects the demand for wood products.  Our August 2012 Base Case peaks at 1.78 million housing starts in 2017.  In this Composite Outlook, the primary source of sensitivity is the assumed single-to-multi-family housing mix, as multi-family housing construction accelerated in response to (1) rents rising from low vacancy rates and (2) strong interest from institutional investors.

Part II addresses assumptions related to end markets for wood-using manufacturers.

Analyzing Timber Markets and Boiling the Ocean

5 08 2012

A successful timber market analysis answers the question “what matters, and what does not, in this timber or wood raw material market?”  While we care about forest inventories and supplies, wood demand and competition, and stumpage prices and forecasts, we do this in order to identify the key variables that let us:

  • Understand historic relationships between prices and flows;
  • Assess future impacts as changes occur; and
  • Make investment decisions based on relationships as we interpret them.

The work for analyzing timber markets builds on three fundamental exercises.

First, understand the local wood market.  Timber markets are uniquely local.  The same tree in two different markets will have two different values.  Understanding the local basket extends beyond mapping all of the mills that might buy your trees.  It includes understanding the logistics and limitations of how you will access these markets.  Will you work through a forestry consultant?  If so, who?  Will you work directly with loggers?  If so, who?  What is the situation with respect to roads, rail, ports and bridges?

Second, question your forest industry data.  In forestry, everything is a sample.  A forest cruise, which estimates the volume and value of the standing forest on a given property, is a sample of what’s out there.  If we use data from the US Forest Service, it’s based on samples.  If we use a timber pricing service, whether public or private, all reported prices are based on samples.  Ask questions about the data.

Third, know what’s knowable with respect to this market and these assets (but avoid “boiling the ocean”).  In your valuation model, confirm what’s left over each year after revenues are generated and bills paid. Be specific about the property taxes for THIS property, the annual management costs for THIS property, and the fees paid to consultants, accountants and lawyers to acquire and manage THIS property.

Analyzing timber markets, while straightforward, requires discipline.  Become familiar with local markets and patiently seek and evaluate timberland investment opportunities.  This approach leads to building solid models with tested assumptions for buying properties.  Then, when the numbers look good, move fast.

For investors and analysts evaluating wood and timber markets, Forisk offers “Timber Market Analysis” on August 15th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of timber markets and wood baskets. For more information, click here