One of the biggest stories of the ongoing economic recovery has been the fear of inflation, driven in particular by rising commodity prices. The pandemic caused all sorts of supply chain problems, and shortages have been the norm.
One commodity that has captured a lot of attention of late has been lumber. What does volatility in lumber prices mean for Weyerhaeuser (NYSE:WY), the biggest owner of forests in North America?
The high price of lumber
Weyerhaeuser controls, manages, or owns a total of 24.8 million acres of timberland in the United States and Canada. It is also one of the largest manufacturers of wood products in North America. Most of the products that come out of its 35 facilities end up supporting residential construction.
Lumber has been on a tear this year, rising from $382 per thousand board feet to $1,670 before falling back to $905. Those unusually high prices have contributed to depressed homebuilding, as builders have been unable to source materials at a reasonable price, and the labor market has tightened.
For a company like Weyerhaeuser, higher lumber prices more or less drop straight down to the bottom line. While the company has its own labor constraints and is affected by higher prices, its production costs have been little changed in 2021. As a result, it's on track right now to have a phenomenal year. According to Wall Street estimates, the company will earn $3.69 per share this year, compared to $1.29 per share in 2020 and a forecast of $1.75 per share in 2022.
Measuring cyclical stocks is tricky
Weyerhaeuser is a highly cyclical stock, although it marches more to the beat of the housing market than the overall economy. Because of this, its price-to-earnings (P/E) ratio rises and falls based on where we are in the housing cycle. Earnings for these types of companies are going to be lumpy, with a boom-and-bust pattern. So depending on where we are in the cycle, the same stock could trade at 30 times earnings and be cheap, or at 10 times earnings and be expensive.
For context, consider this chart, which shows just how volatile Weyerhaeuser's P/E ratio has been over the past 10 years.
In regards to its returns to shareholders, the company has a simple method for handling this sort of earnings volatility. As a real estate investment trust, Weyerhaeuser is obligated to pay out most of its earnings each year in dividends. So it distributes a regular quarterly dividend at a level meant to be sustainable over the entire economic cycle. But it also pays special dividends once a year that are meant to capture the variability of the cycle.
Weyerhaeuser shareholders should anticipate a big special dividend this year given that lumber prices are high, and this should represent peak earnings for a while. Given that analysts' average estimate is for the company to earn $3.69 per share this year, it's trading at a forward P/E of around 9. Is that cheap? Perhaps, but it depends on where you think the homebuilding sector will go from here.
Freddie Mac estimates that the U.S. housing deficit has grown to 3.8 million units, which is tremendous -- more than two years of housing starts in addition to the normal run rate. Weyerhaeuser's earnings may slide as lumber prices fall from their peak. However, its profitability should still be strong given that its longer-term growth story is independent of pricing.