If a tree falling in an empty forest doesn't make a sound, what about a tree stock going up in a crowded stock market?
To find out, look at Tembec Inc. which has shot up by nearly 300 per cent in the past year, but still barely registers on most investors' minds.
Look, too, at AbitibiBowater Inc. , which is pre-trading in Toronto and New York as it awaits its exit from restructuring jail. (Pre-trading means the new shares haven't been issued yet but they can be traded in advance of the issuance.) The posted price is higher than many analysts predicted.
These are only two signs of a quiet recovery in many forest industry stocks. Is it too late to profit from the rally? The answer isn't simple, because the forestry sector is really many industries packaged into one. But it looks like there's still money to be made if you do your homework.
One very positive factor is the increasing price for pulp. This material used to be the ugly duckling of the tree trade, but it's shining now.
Consolidation is one big reason for the recovery in prices, Tembec CEO Jim Lopez told me. Two big Brazilian producers of hardwood pulp got together and now own more than 20 per cent of the market, meaning they have imposed some discipline on production and therefore prices.
In addition, the recession meant that a billion dollars worth of new pulp mills were never built as financing disappeared. As a result, no big additions to capacity are going to materialize for two or three years. "I've never seen that before," Mr. Lopez says.
Tembec, which only recently restructured, makes pulp, lumber and paper - not exactly the stuff that flies off the shelf during a deep recession. But it has another ace up its sleeve: two pulp mills that make specialty dissolving pulp used in rayon and other value-added products.
Prices are going up $200 (U.S.) a tonne on Jan. 1, meaning Tembec's 300,000 tonnes of production will crank out an extra $60-million in cash flow for the year. This will help if regular pulp prices weaken as expected.
Some of the good news appears priced into Tembec's share price, but there may be decent gains yet to come.
Outlook
The outlook for other companies is more difficult to foresee and investors should proceed with caution. While Tembec is moving away from making paper, other companies still depend heavily on it. Unlike pulp, which benefits from demand in fast-growing Asia, paper is largely a regional market with regional prices.
Those prices are of vital importance to AbitibiBowater. Its restructuring took $6-billion of debt off its balance sheet. The company closed half of its mills and slashed its payroll. But its foray through restructuring didn't increase demand for newsprint, and that's still 40 per cent of the company's business.
One of the few positive things that can be said about the North American newsprint market is that after a few years in which demand has shrunk at double-digit rates, this year's decline will only be in the single digits.
But the surprising thing is that despite falling demand (down by half in North America since 2001) prices are actually going up.
Kevin Clarke, the CEO of Catalyst Paper Corp. , another sizable newsprint maker, says producer discipline has improved. Still, there's something of a cap on pricing because customers can only take so much of an increase.
Investors who like the pricing outlook for newsprint and other printing papers (Catalyst and Abitibi make both) can choose between the two stocks.
Abitibi's appeal is its restructured balance sheet. Many companies that have gone through a similar restructuring have done very well.
On the other hand, if you want to swing for the fences, consider Catalyst. It's cheap - and for good reason. It didn't restructure so it carries a lot of debt.
The good news? If paper prices go up, Catalyst stands to really benefit. A $50-a-tonne paper price increase adds 5 cents to its bottom line in the case of newsprint and 8 cents for specialty paper. On a penny stock, that's a lot.
The wild card in the forest sector is lumber. Single-family housing starts in the United States have crumpled to about 500,000 annually and are now running well below where they should be.
Demand elsewhere, though, is soaring. The Chinese are learning to build with wood, and this year, Mr. Lopez says, they will use 2.5 billion board feet of wood, mostly imported. That's the equivalent of more than 100,000 U.S. housing starts and demand is growing at double-digit rates. The same is happening in other emerging markets.
Supply, meanwhile, is constrained by forest fires in Russia, storms in Scandinavia and, most important, the mountain pine beetle in British Columbia.
The effect is already apparent. Although prices aren't particularly high - most eastern lumber mills are barely keeping one nostril above water - Mr. Lopez reports that U.S. buyers are scratching their heads wondering why prices haven't fallen more given the lack of U.S. demand. The world has changed.
When U.S. demand begins to recover over the next couple of years, there may be a shortage of lumber. If that happens, hewers of wood - which all these companies are, to varying degrees - will make piles of cash for shareholders.
Forest figures
60:
Percentage of North American lumber capacity being used
40:
Percentage drop in North American newsprint shipments from 2005 to 2009
$582:
Newsprint prices in 2010, in U.S. dollars per tonne
$639:
Forecast newsprint prices in 2011
$653:
Forecast newsprint prices in 2012
Sources: Random Lengths, RISI, Bank of Montreal