Canadian forestry finding its footing despite market challenges

Less harvestable timber, shifting demographics and an innovation gap are just some of the challenges Canadian forestry companies face
A panel at PwC's forestry conference | Chung Chow

There was an embarrassing moment at the beginning of PwC’s annual Global Forest, Paper and Packaging Industry Conference in Vancouver May 4 when guest speaker Michael Walton, Google’s (Nasdaq:GOOG) head of manufacturing, asked if anyone in the room could share an innovation his or her company had implemented that was a game-changer.

Not a single hand went up.

Not that there haven’t been innovations in forestry science and technology in Canada. Tall wood buildings and biomaterials made from cellulose are among them.

But the no-show of hands points to an overall innovation deficit in the industry.

In B.C., lumber producers and pulp and paper mills are facing long-term timber constraints, thanks to the mountain pine beetle infestation, which means they’ll need to innovate to harvest timber that’s harder to reach.

And because cheap natural gas and liquefied natural gas are posing serious competition to wood pellets as a fuel source, companies that produce them from residual wood waste for export to Europe and Asia might need to find new value-added products for wood waste.

“That ship has kind of sailed,” said Brendan Lowney, macroeconomics principal for Forest Economic Advisers.

Forestry company executives might also need to start factoring more global economic data into their decisions. 

Their industry is increasingly affected by oil-linked currency fluctuations, changing demographics that affect home-building – their bread and butter – and a “choppy” and “risk-prone” global economy facing innovations of its own, including unprecedented low, and in some cases negative, interest rates.

The good news is that market conditions and profits are improving for Canadian lumber and pulp and paper producers.

The recent numbers are promising. 

First-quarter financials show that B.C.’s major forestry companies have been posting increased earnings, thanks to higher lumber prices, a low Canadian dollar and an improving U.S. housing market.

U.S. housing starts were up 6% in the fourth quarter of 2015 compared with Q4 2014, according to PwC. 

New housing starts in the U.S. have been recently calculated to be an average of 1.1 million. Business Council of BC chief economist Ken Peacock said they’re forecast to rise to 1.2 million to 1.4 million between now and 2025.

“Essentially, the story is low interest rates, better job market and demographics are going to continue to drive the U.S. home-building market over the next five to six years,” Peacock said.

Lowney said the baby boom “echo” generation will drive housing starts even further over the long term.

“We are going to see very strong housing starts, upward of two million again. The timing is going to be sometime within the next 10 years. It’s going to happen. There are too many people for that not to happen.”

Mergers and acquisitions in the forestry sector were also up, with 39 deals worth US$14.8 billion in Q4 2015, according to PwC. M&A activity for the sector overall in 2015 was valued at US$31.9 billion, compared with just US$9.4 billion in 2014.

Some of the acquisitions include Canadian companies buying American mills, due to shrinking timber supplies in Canada. 

For example, Catalyst Paper Corp. (TSX:CYT), which in 2012 was forced to declare bankruptcy and restructure, last year acquired mills in Maine and Wisconsin.

A slowdown in China’s economic growth, which has resulted in a dramatic fall-off of demand for low-end lumber, is being buffered somewhat by demand in the U.S. 

Exports of lumber to China have been falling for three years now.

Although China is growing more slowly now, Peacock pointed out that its economy is now 2.5 times larger than it was a decade ago and accounts for about a third of global economic growth.

“So, despite the slowdown, China is going to continue to have a very significant influence in global economics or global commodity markets,” he said. “I think, long-term, China is going to offer a lot and be very, very good for Canada and British Columbia.”

But the same factors that are good for Canadian producers are also good for Russia, which could start eating into Canada’s share of the American market.

“We’ve been talking about – for years – we’re going to see Russian wood come into North America when the U.S. housing market comes back,” Lowney said. “And that’s going to happen. We’re hearing now that we’re already starting to see some shipments of Russian wood into North America.”

One wild card for Canadian lumber producers is the prospect of a renewed softwood lumber war with the U.S.

“The softwood lumber agreement is causing a lot of uncertainty,” Kevin Bromley, PwC’s Canadian forest, paper and packaging lead, told Business in Vancouver

He expects any duties levied against Canadian lumber companies could be even more punitive than they have been in the past.

Higher duties force lumber prices up, and Bromley said American producers benefit from those higher prices. 

He added that it’s only when Canada goes to court and wins that there’s any incentive for Americans to come to the table.

One forestry sub-sector that’s facing serious challenges is paper production.

Catalyst CEO Joe Nemeth said paper demand has been declining 10% per year for the last three years. And what was once a B.C. advantage – cheap electricity – is no longer an advantage. High electricity bills and carbon taxes are making it increasingly challenging to keep mills operating in B.C.

Coming back from bankruptcy and adapting to market changes required some hard cost-cutting measures and innovations.

“We’ve had to make some tough decisions,” Nemeth said. “We will, over the process, lay off hundreds of people both in Canada and the U.S. We’ve had to shut two machines already indefinitely.”

Catalyst has been moving away from traditional paper production and into specialty pulp and paper products and bioproducts, like biodiesel and biogas.

West Fraser Timber Co. (TSX:WFT) has also been diversifying. 

In addition to its five pulp and paper mills, it now has several bioenergy plants and one new lignin plant in Hinton, Alberta. The lignin it extracts from black liquor is used as glue for plywood and other wood products.

One of the biggest challenges for B.C.’s industry and government will be addressing timber supply. Most B.C. sawmills are in the region most affected by the mountain pine beetle.

Bromley said B.C.’s chief forester, Diane Nicholls, will succeed in her efforts to find new timber sources.

“This is the top of her agenda, not only finding more fibre, but getting better use out of it.” 

2015 B.C. forestry lumber exports double 2009 numbers

Forest products – lumber and pulp and paper – remain B.C.’s most valuable export. 

According to BC Stats, exports of wood products, pulp and paper from B.C. hit a 10-year low in 2009, thanks largely to the U.S. financial crisis, which resulted in a severe decline in new housing starts.

Lumber and other wood product exports in 2009 fell to just $4 billion; pulp and paper exports were $3.5 billion. They have since nearly recovered to 2006 levels. 

In 2014 and 2015, lumber and wood product exports surpassed the $8 billion mark. Pulp and paper exports have also recovered somewhat to $4.4 billion in 2015, although PwC warns that the industry will be facing increased competition as new global supplies of pulp come online.

Higher lumber prices and a low Canadian dollar have generally translated into higher earnings for a number of B.C. forestry companies, according to recent first-quarter financials.

West Fraser Timber Co. Ltd. (TSX:WFT), B.C.’s largest forestry company by market cap, reported increased sales and earnings for 2016’s first quarter. The company reported sales of $1.08 billion, up from $1.01 billion, and earnings of $2 million, up from a $15 million loss in Q4 2015, and profits of $49 million in Q1 2015.

Canfor Corp. (TSX:CFP) reported higher lumber sales in Q1 ($750 million) compared with Q1 2015 ($626 million), but lower net income ($42 million) compared with Q1 2015 ($47 million). On the pulp and paper side, Canfor Pulp Products’ (TSX:CFX) also had increased sales but lower net income. It recorded $295 million in sales in Q1 compared with $274 million in Q1 2015, and a net income of $23 million in Q1, compared with $28 million in Q1 2015 and $30 million in Q4 2015.

Interfor Corp. (TSX: IFP) posted net income of $794,000 for 2016’s first quarter – the first time it has generated positive earnings since 2014. The company recorded a $3.5 million loss in Q4 2015. The company cites higher lumber prices, a low Canadian dollar and increased production at both its Canadian and American sawmills for the revenue increase. The company said it expects demand for lumber in the U.S. to continue to improve, thanks to an improving American housing market.

– Nelson Bennett

@bivnews

news@biv.com

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