I recently covered the outlook for the timber industry in 2013 and briefly touched on how the housing recovery trends played into that outlook. I now want to take a step back and look at this from the other side. Given the structural changes in the timber market, what does that mean for housing?
Structurally unsound? As with any market, timber's pricing is determined by simple supply and demand. Over the past few years two major shifts have begun to disrupt this market. On the supply side is the mountain pine beetle infestation in Canada that's ravaged its forestland and forced producers to flood the market with timber before it became unmarketable. Now, the long-term supply coming out of Canada will be reduced for decades.
This comes on the heels of skyrocketing demand for lumber by China. In 2008, North American lumber exports to China were about a half a billion board feet, with U.S. exports representing just a fraction of that number. In 2011, exports to China hit more than 3.5 billion board feet, with U.S. exports hitting nearly half a billion board feet.
It's estimated that between 5% and 7% of the total North American lumber market will be exported to China. Couple that with 7%-15% of the market being cut by Canadian harvest reductions, and all told there is a 12%-22% estimated effect on the market. On the low end of things, these structural changes will impact 15% of the total North American timber market. That's equal to 600,000 housing starts or, put another way, 40% of the long-term average for housing starts.
When housing recovers to normal levels it means much higher timber prices. This has many leading timber producers planning to boost harvests for the foreseeable future to capture this upside.
Will housing even recover? As you can see in the graph below, housing has started to climb back over the past year, but it's still nowhere near its historical norm of 1.5 million units annually.
Just last month, housing starts came in at an annualized 954,000 which was well above the estimated rate of 885,000, and a huge jump from November's rate of 851,000. That's giving rise to a number of estimates that see housing shifting into high gear over the next two years. This is before settling into a range of 1.6 million-1.9 million annual units by 2015 in order to make up for several years of underinvestment.
Sure, one month does not make a trend, but take a look at what those closest to the situation are saying. Hovnanian Enterprises, Inc. (NYSE:HOV) CEO Ara Hovnanian late last year told CNBC:
We are undoubtedly well on the recovery route. It's not a question of are we beginning it. I'd say it began at the beginning of this year and that's not just for Hovnanian, that's for the entire industry.
Or take luxury homebuilder Toll Brothers Inc (NYSE:TOL) CEO Douglas Yearley's comments on the company's fourth-quarter conference call last month:
We have been positively surprised that the growth in contracts, because traffic has been relatively consistent with recent years, meaning weak. We're experiencing our highest converging ratio from visitor to agreement in the history of the company, as the quality of the traffic is superb and visitors are very serious about buying. When traffic returns to normalize levels, we believe there is strong possibility of significant increases in absorptions and therefore pricing power.
It's not a matter of if housing will ever recover; it's already happening. What will be key to watch is how quick the pace becomes and if it starts to yield any commodity inflation. The comments from Yearley are important to keep in mind, especially when it comes to pricing power.