Unless you work in the construction or home improvement industry, lumber may not be the first thing that comes to mind as an investment opportunity. This is a cyclical industry that’s largely driven by a strong housing market.
However, although it’s a cyclical industry, lumber has provided historical returns that are competitive with other sectors on a risk-adjusted basis. Lumber stocks also carry lower risk and can provide investors with exposure to the commodity sector. For those reasons alone, lumber stocks are worth every investor’s consideration.
In this article, we’ll give investors an overview of lumber stocks. The topics covered include why investors should consider investing in lumber stocks and what external factors cause lumber prices to rise. We’ll also look at some of the best lumber stocks to buy from a historical perspective. And for fund investors, we’ll provide a list of some of the best funds that provide exposure to lumber stocks.
Why Invest in Lumber Stocks?
Lumber is essential to the construction and remodeling industries. Although it’s a highly cyclical commodity, this is an industry where investors are more concerned about the ceiling than the floor. One reason for that is that the lumber industry is highly regulated. This keeps lumber prices stable in times when demand wanes and creates an opportunity for lumber prices to rise in times of high demand.
Built-In Optionality – At times of lower demand, suppliers will typically reduce the number of trees they cut down and process. This gives those trees time to grow which increases their long-term value. However, investors should be aware that not all lumber or timber producers own forest land.
Lumber prices are a lagging indicator - This means that prices for sheets of plywood or 2x4 boards will rise before many consumers realize how expensive they’ve become. This encourages investors to take a long position in lumber stocks that they can maintain without attempting to time the market.
Use of Wood in Other Applications – In addition to being used in commercial and residential real estate markets, wood is used extensively in the furniture industry. There is also strong growth in the packaging industry (e.g. corrugated packaging).
What Factors Cause Lumber Prices to Rise?
Like any commodity, lumber prices are impacted by supply and demand. With that said, there are several obvious catalysts for lumber prices.
A Strong Housing Market – There are many reasons why demand for homes increases. Mortgage rates play a role as does the availability of existing homes. However, as it relates to lumber prices, investors should pay attention to the amount of new construction (housing starts). When this number is rising, lumber prices (and lumber stocks) are likely to rise. Plus, this is a segment in which a backlog of projects builds up. This means demand for lumber generally remains steady independent of the overall housing market.
Demand for Remodeling – There’s a strong correlation between demand for new construction and a surge in remodeling activity. Simply put, as homes begin to sell (often for more than their purchase price), homeowners begin to experience fear of missing out (FOMO). This causes them to accelerate home improvement projects they may have put off in an effort to get their house ready to sell. Also, when new buyers enter the market, they will often spend on remodeling activity to make a house their own.
Natural Disasters – In the aftermath of a natural disaster, lumber prices may rise as demand in certain areas rises to meet the need to rebuild. On the supply side, the lumber industry is acutely impacted by wildfires which can limit supply.
Regulation – The lumber industry is heavily regulated. This results in fewer trees being cut down and a lack of available land to plant new trees.
What Are Some of the Best Lumber Stocks?
Weyerhaeuser (NYSE: WY) – Weyerhaeuser operates as a real estate investment trust (REIT) making the company a low risk alternative to traditional lumber stocks. The company has 14 million acres under management. And they collect rent from the companies that use these properties.
In addition to the acres they manage, Weyerhaeuser directly owns and operates an additional 12.4 million acres. This is important to investors because it means the company makes money on both sides of the timber trade. And like all REITs, the company pays out a significant portion of its earning as a dividend.
Rayonier (NYSE: RYN) – Rayonier is another lumber stock that has a REIT model. Rayonier has fewer acres under management than Weyerhaeuser, approximately 2.4 million acres, but the company continues to make acquisitions to increase their acres under management. However, the company also has gas and oil drilling leases that generate revenue. Like Weyerhaeuser, Rayonier pays a significant percentage of its earnings as a dividend.
Boise Cascade (NYSE: BCC) – Boise Cascade is a choice for growth investors who are bullish on the housing sector. The company is a small-cap company that is bordering on becoming a mid-cap. Boise Cascade specializes in making engineered wood products such as particle board, heavy-load bearing joists, and flexible beams. Boise Cascade’s business model has a heavy focus on directly selling to contractors. Ideally, this will allow the company to maintain respectable margins even if the housing market weakens.
West Fraser Timber (NYSE: WFG) – West Fraser Timber offers investors a nice combination of growth and income. This is a Canadian company has licenses to harvest wood from publicly owned forests in Canada. In 2020, the company generated over 75% of its revenue from lumber. But it also makes pulp, paper, and plywood panels. In 2021, the lumber company purchased another Canadian timber company, Norbord. This gave the company access to the world’s biggest producer of oriented strand board.
Lowe’s (NYSE: LOW) – The home improvement store is not a pure play on the lumber industry. But as one of the leading home improvement retailers, and one that is committed to servicing the contract channel, it gives investors low-risk exposure to this sector. In fairness, investors can also look at Home Depot (NYSE: HD) in this sector. For the purposes of this article, Lowe’s gets the nod due to its status as a Dividend Aristocrat. In this case, the company has increased its dividend in each of the last 48 years.
What Are the Best Mutual Funds/ETFs That Include Lumber Stocks?
Many investors choose to use mutual funds and exchange-traded funds (ETFs) as a way to get exposure to specific segments. A quality fund is an excellent way to get diversified exposure with low risk. And there are several funds that provide exposure to this sector. The largest ETF is the iShares Global Timber and Forestry ETF (NYSEARCA: WOOD). As of June 28, 2022, the fund had over $254 million in assets under management (AUM) and an appealing expense ratio of just 0.43%.
Another option is the Invesco MSCI Global Timber ETF (NYSEARCA: CUT). As of June 28, 2022 the fund had over $73 million in AUM and an expense ratio of 0.61%.
Some Final Thoughts on Lumber Stocks
Lumber will continue to have steady demand that is particularly strong when the housing sector is growing. The cyclical nature of the housing sector may steer investors away from lumber stocks. However, this is a commodity with many applications beyond the housing sector. This demand gives investors an opportunity to buy stocks that have a high floor and an even higher ceiling.
And because this is a highly regulated industry, there are built-in supply constraints that give producers pricing power during periods of high demand.
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