Investors Judge Housing Strength Using UFPI and LP Performance

Originally published by: NASDAQAugust 12, 2016

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A healthier economy, stable job growth and low mortgage interest rates have led to a slow but steady recovery in the housing market after seven lean years of new home construction.

Moreover, home prices continue to increase across the country, resulting in increased equity for homeowners, helping to boost the home remodeling market.

All this is good news for the providers of lumber and other wood products used in construction, fueling the prospects for two of the largest pure-play suppliers, Universal Forest and Louisiana-Pacific.

"People think that the housing recovery, although it's been modest, is fairly stable with more upside opportunity," said Matthew Missad, CEO of Universal Forest Products. "The fact that it's steadier, albeit at a lower level, is still a positive."

Like the actual industry, various types of building supply stocks are scattered across numerous groups among IBD's 197 industries. Combined, they are a small piece of the single-family home construction market, which the National Association of Home Builders estimated to have grown 12.9% in 2015 to $218.3 billion. (The market set its record above $413 billion in 2006.) And, although many of the sectors across this market have been consolidating over the past 25 years, it remains a fragmented industry punctuated by a number of large names.

Louisiana-Pacific and Universal Forest Products don't rank in the top 10 among suppliers, competing with and often supplying names such as Beloit, Wis.-based ABC Supply, with $5.9 billion in 2015 revenue. Builders FirstSource last year bought No. 3-ranked ProBuild in a $1.63 billion deal, ending the year with $3.56 billion in revenue. Next in line are Allied Building Products in New Jersey and Beacon Roofing Supply in Virginia.

IBD'S TAKE : Stocks within an industry group generally tend to show similar trends, helping reveal hot spots within the economy as well as markets targeted by institutional investors.

Universal Forest Products designs, produces and markets wood and wood products, with about a third of its sales through national home centers and other retailers, and two-thirds from direct sales to distributors and to contractors and builders of residential, commercial and industrial projects.

Louisiana-Pacific is a pioneer manufacturer of engineered wood products, mainly oriented strand board, a lower-cost alternative to plywood and solid wood building products. Oriented strand board is made by dicing low-quality softwood timber into strands, adding resin, heat and pressure to create a wood composite. Louisiana-Pacific sells OSB in sheet form, shaped into various lumber substitute and engineered components as well as siding.

OSB sales were 43% of 2015 revenue, vs. 34% for siding and 15% for engineered products.

Homeowner Remodeling Set To Accelerate

The U.S. housing market has recovered substantially from the housing crash and Great Recession. The recovery gained traction in 2015, with total housing starts climbing 11% year over year to 1.1 million units. That was still well below the 2006 average of 1.81 million starts, and residential starts and permits slowed in the first half of this year, causing Morningstar analyst Charles Gross to lower his residential construction forecast to 1.22 million starts in 2016, down from an earlier estimate of 1.3 million.

But his long-term outlook on U.S. housing remains unchanged. Gross continues to expect starts to peak at nearly 1.9 million in 2020, as household formation strengthens amid tighter labor markets and looser financial constraints.

"The intrinsic demand is there for new homes down the road," said Gross. "We're still ramping up and think there's a huge amount of growth ahead."

Gross expects favorable demographics, a tighter labor market, and looser mortgage availability to catalyze a major improvement in homebuilding activity in the coming decade. Longer term, Gross expects starts to fade to 1.5 million as this source of pent-up demand is fully exhausted.

The national housing market has now regained enough momentum to provide an engine of growth for the U.S. economy, according to the " State of the Nation's Housing 2016 " by the Joint Center for Housing Studies of Harvard University. It also says homeowner remodeling activity over the next year is projected to accelerate, keeping the rate of growth above its long-term trend. The Leading Indicator of Remodeling Activity anticipates growth in home improvement and repair expenditures will reach 8% by the start of 2017, above its 4.9% historical average.

As more homeowners are enticed to list their properties, that should lead to increased remodeling and repair in preparation for sales, coupled with spending by the new owners who are looking to customize their homes to fit their needs, the Harvard report said. By the middle of next year, the national remodeling market should be very close to a full recovery from its worst downturn on record.

Universal Forest beat revenue and earnings estimates when it reported second quarter results. Revenue rose 4% to $872 million while earnings per share minus special items rose 28% to $1.64 a share. Wall Street expects revenue to climb a healthy 11% in Q3 to $848.4 million. EPS are forecast to rise 7%, with a 22% gain for the year.

Louisiana-Pacific reported Q2 revenue of $582.4 million, up 18%, with EPS of 28 cents, vs. an 8-cent loss a year ago. In Q3, revenue is projected to rise a solid 29%, moving toward an 83-cent profit this year -- the company's annual profit since 2013.

Improved Activity In Second Half

During the earnings call on Aug. 4, Louisiana-Pacific CEO Curtis Stevens discussed the improved outlook for housing growth.

"The Q2 news from the housing market was good, but it did reaffirm that we'll likely be in the 8% to 10% annual growth rate for starts over the next few years," he said. While that's below previous forecasts the outlook still remains healthy, he said.

While housing starts in the first half of this year rose 7% year over year, the better news for Louisiana-Pacific is that single family starts jumped 13%. More of the company's products are consumed per unit in a single family start than in a multifamily start, Stevens said. The consensus for housing starts in 2016 now stands at 1.2 million, 9% higher than last year, and 1.34 million for 2017, an 11% increase over this year's forecast, he said.

"As I look to the rest of the year and into 2017, to achieve the forecast 9% growth in housing starts, with the first half being at 7%, we will need to see an acceleration in activity in the second half of the year," Stevens said. "Based on our conversations with builders and the demand we are seeing for our products, I'm optimistic that this will happen."

Still, plenty of risks remain that could thwart the housing recovery. First among them is a deterioration in the economy. Another is a rapid rise in interest rates that would reduce the affordability of housing.

But as the worst elements of the housing crash fade and economic conditions improve, homeownership should regain some lost ground. How soon and how much are open to question.

Investors have played that uncertainty by leaning harder on suppliers of building products. While homebuilder stocks as a group are up a scant 3% from Dec. 31 through Thursday, the miscellaneous building products suppliers group has gained 12% and retail-wholesale suppliers are up 14%.

The wood products group that is home to Louisiana-Pacific and Universal, meanwhile, has soared 40% -- propelled largely by Universal's merger-fed 58% gain.

School Debt A Deal Killer

The question is not so much whether families will want to buy homes in the future, but whether they will be able to do so.

Income growth has picked up, particularly among the huge millennial population that is poised to form millions of new households over the coming decade. But uncertainty is here, too.

"One problem for this housing recovery is millennials have an astonishing amount of student debt," said Steven Chercover, analyst at D.A. Davidson. "That has been a real governor on their ability to put a down payment on a house."

Major factors constraining a more robust recovery remain a shortage of available and affordable lots, tough access to credit for the first-time homebuyer and the difficulty of obtaining labor to build homes

"People who were involved in residential construction have been out of business for a long time," Chercover said. The permit systems has also bogged down due to downsizing at city governments, among other things that have been headwinds to recovery beyond just demand, he said.