The Top 3 Forestry Companies of 2013

The forestry industry is composed of a small universe of companies, most of which have had to sell alternative wood products in order to offset weak economic conditions. Last year, two companies in particular had superior returns: Trex (NYSE: TREX  ) and Universal Forest Products  (NASDAQ: UFPI  )  both had 1-year price returns of 72%, and 28%, respectively. Due to the size of the industry, Weyerhaeuser Company (NYSE: WY  ) had the third highest 1-year price return at .62%, which is rather unimpressive by itself, but the company has a great deal of potential for 2014. Let's compare these three companies to see what 2013's performance can tell us about 2014.

TREX 1 Year Price Returns Chart

Data by YCharts

Trex Company -- No. 1
Trex is the world's largest manufacturer of wood alternative products. Customers use products primarily for residential and commercial decking applications. The manufacturing process for Trex is unique -- it combines waste-wood fibers and reclaimed polyethylene. In other words, Trex reuses wood and plastic, which is why the company tops the list of many socially responsible investment opportunities.

The price return in the last 52 weeks is an unbelievable 72%, but some of that appreciation is likely due to stock buybacks rather than business performance. In the first three quarters of 2013 the company announced net sales of $279 million, a 7% increase over 2012. Net income was $19.5 million, compared to $6.3 million in 2012. While the third quarter exceeded revenue guidance, it produced a $15.3 million net loss, which the company attributes to market share expansion, price resetting, and a host of other charges that look like trends rather than one-time events.

Universal Forest Products  -- No. 2
Universal Forest Products is a holding company that provides wood and wood-alternative products and services to home building centers. It also sells structural lumber and other products for the manufactured housing industry. The 1-year price return on the stock is 28% which is supported by strong earnings growth -- Q3 earnings more than tripled as sales grew 22%. "We saw robust growth in each of our markets, and we enhanced margins in a number of areas," said CEO Matthew J. Missad. Even though lumber prices were up 7%, the company delivered on growth objectives for the year, and there's no reason why the company can't do the same thing in 2014.

Weyerhaeuser Company -- No. 3
Weyerhaeuser Company grows and harvests trees, builds homes, and makes a wide range of forestry products. 

Over the last year, shares have gained less than 1%; however, it was up as much as 75% at one point in that period. "Solid operating results in the quarter contributed to a significant improvement in our year-over-year earnings," said Doyle Simons, President and CEO. Net earnings for the company rose 34% compared to 2012, which the company attributes to a 23% increase in sales.

Repeat performance in 2014?
Compared to the overall sector, the forestry and wood products industry looks slightly undervalued compared to its sector peers, but not by much.

Metrics  TREX  UFPI  WY Industry Avg Sector Avg S&P Avg
Price/Earnings  79.2x  34.0x  27.1x 21.9x 26.6x 18.7x
Return on Equity  16.54%  4.88%  12.30% 12.81% 10.06% 14.45%
Total Debt/Equity  0.0x  11.6x  49.9x 0.6x 0.8x 0.7x

 Source: Morningstar & Market Edge

Trex has achieved phenomenal share price growth, however, that growth may be unsupported by earnings, which were negative last quarter. I believe much of the company's share price appreciation is coming from stock buybacks rather than business performance, since every valuation shows the stock as grossly overpriced compared to the industry. On a positive note, the company has no long-term debt and an ROE of almost 17%, nearly 4% higher than the industry and 6% higher than the sector average.
 
While it is unlikely that Trex will achieve the same level of price appreciation next year based on business performance, the Board of Directors just approved another wave of buybacks, which will help to artificially boost the stock throughout the year.
 
Universal Forest Products had a 1-year price return of 28%, supported by earnings that actually tripled in the third quarter. Price valuations support the current price, though the P/E ratio is higher than the industry and sector average. The company also has the lowest ROE, which is troublesome, but strong sales growth rates are hard to ignore for the average investor. For all these reasons, Universal Forest Products may have a repeat performance if it can continue to meet revenue growth objectives.
 
Weyerhaeuser's net earnings rose 34% in the third quarter, 11% more than sales. The company expects significantly higher earnings from single family home-building and the Cellulose Fibers segment in the fourth quarter. Compared to Trex, and Universal Forest Products, Weyerhaeser appears to have the most potential. 

The Foolish bottom line
The trend is your friend, and these three companies are the current contenders in the forest and wood products industry. The momentum from last year's success can help to drive the same success this year, but only if the company's price is supported by solid earnings growth.

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