2011: setting up for a repeat of 2010 - pwc · pwc‟s annual global forest & paper conference...

PWC‟s Annual Global Forest & Paper Conference

2011: Setting Up for a Repeat of 2010

EQUITY I RESEARCH

RBC Dominion Securities Inc.

Paul Quinn (Analyst) (604) 257-7048 [email protected]

Hamir Patel (Associate) (604) 257-7145 [email protected]

May 11, 2011

This report is priced at the close on May 9, 2011 ET.

All values in Canadian dollars unless otherwise noted.

For Required Non-U.S. Analyst and Conflicts Disclosures, please see page 17.

Paul Quinn 604 257 7048 [email protected] 2

RBC Capital Markets

Paul Quinn

Commodity Overview

We estimate that changes in commodity pricing are responsible for 70% of

the changes in valuation

We like Pulp and Paper, but are not fond of Lumber, OSB and

Timberlands at this time

Relevance of the Forest Products Sector to North American Capital Markets

Valuation – Cost, Margin, Liquidity, Return on Equity

How to Improve the Industry‟s Access to Capital

What I will Attempt to Cover this Morning


RBC and Paul Quinn

RBC Capital Markets

Best Investment Bank in Canada (Euromoney 2010)

12th largest investment bank globally (by fees)

Over 75 offices in 15 countries

RBC Capital Markets Global Research

#1 for Canadian Equity Research (2011 Greenwich Associates)

Highest number of TopGun (top 3) ranked analysts in Brendan Wood 2010 survey

1,340+ stocks under coverage, including nearly 800 U.S. stocks

Paul Quinn

Canadian and U.S. Paper and Forest Products analyst at RBC since 2008

TopGun analyst (Brendan Wood 2010 survey)

StarMine rankings for stock picking

Former Assistant Director of Research at Salman Partners

Industry experience at MacMillan Bloedel and Weyerhaeuser


RBC CM Paper & Forest Products Coverage Universe

Paul Quinn, Canadian and U.S. Paper & Forest Products analyst at RBC since 2008

19 companies under coverage


Even with Solid Canadian and Robust Chinese Activity, Total “Starts” are Weak

North American lumber shipments to China totalled 2.8 Bfbm in 2010 (~300K Starts)

RBC Forest Products Forecast is for 625K US Starts in 2011, 850K in 2012 and we believe we are very “Optimistic”

Source: WWPA, COFI, RBC Capital Markets estimates

North American Housing Starts - US, Canada and Chinese Export Equivalent

-

500

1,000

1,500

2,000

2,500

1986

1987

1988

1989

1990

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011E

2012E

Housi

ng S

tart

s or

Equiv

ale

nts

(000's)

US Canada Chinese Export Equivalent

Forecast


The Decline in US Home Prices is the Single Biggest Hurdle to a Recovery

Home prices have started to drop at a faster pace

FHFA index fell 1.6% m/m, after declining ant an average of 0.6% m/m for the three previous months

Case-Shiller 20-city index down for 8 straight m/m comparisons, 6 straight on y/y comparisons (C-S is a 3-month average)

Source: Case-Shiller, RBC Capital Markets

Double Dip Likely for US Home Prices in 2011

100.00

125.00

150.00

175.00

200.00

225.00

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

20-C

ity Index (

Jan 2

000 =

100)


The Lumber “Super Cycle” – Not Now, But When

Strong Chinese demand has led many to start to believe that the US Housing market isn‟t important, but it is!

We consider C$250/mfbm to be the break-even level for Average BC Interior Sawmillers.

Source: Random Lengths, Pacific Fx Retrieval Service, RBC Capital Markets

Non-existant US Home Buying Season this Spring More that Offset Strong Asian Shipments

200

225

250

275

300

325

8-O

ct-1

0

22-O

ct-1

0

5-N

ov-1

0

19-N

ov-1

0

3-D

ec-1

0

17-D

ec-1

0

31-D

ec-1

0

14-J

an-1

1

28-J

an-1

1

11-F

eb-1

1

25-F

eb-1

1

11-M

ar-1

1

25-M

ar-1

1

8-A

pr-1

1

22-A

pr-1

1

6-M

ay-1

1

West

ern

SPF 2

x4 (

$/m

fbm

)

Cdn$ US$


OSB Capacity Overhang – Not As Big as it Appears

All OSB producers are trading at significant discounts to replacement value (US$325/msf), with Norbord‟s discount at 40%, LP‟s 36% and Ainsworth at 19%

We consider US$165/msf to be the break-even level for the North American Industry with current benchmark prices at US$167/msf

Source: APA, Company reports, RBC Capital Markets estimates

6

Mothballed Mills

Never Certified Production

2010 Production 15.3 Bsf

Operating at Under Full Capacity

Operating at Full Capacity

North American OSB Industry Operated at 55% in 2010

4.8

27.1

15.3

5.54.8

2.4

5.4

0

5

10

15

20

25

30

35

2005 Capacity Permanently Shut Additions Current Capacity

Nort

h A

meri

can O

SB C

apacit

y/Pro

ducti

on (

Bsf

)


Softwood Pulp Prices will Soon Disconnect from Hardwood Pulp

Source: Pulp & Paper Week, Pacific Fx Retrieval Service, RBC Capital Markets

NBSK Prices have Returned to Record Levels in US$, But Not in Loonies or

Euros

300

400

500

600

700

800

900

1000

1100

1200

1300

1400

1500

Jan-9

5

Jan-9

6

Jan-9

7

Jan-9

8

Jan-9

9

Jan-0

0

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1N

BSK

Pri

ce (

$/to

nne)

C$ Prices U.S.$ Prices Euros


With World-20 Softwood Stocks at 24 Days of Supply, Prices will Keep Rising

Source: Pulp & Paper Products Council, Pulp & Paper Week, RBC Capital Markets estimates

0

5

10

15

20

25

30

35

40

45

50

Jan-02 Jan-03 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11

Soft

wood P

ulp

Invento

ry (

days)

-80

-60

-40

-20

0

20

40

60

Month

ly P

rice C

hange (U

S$/m

t)

Days of Supply Monthly Price Change


Uncoated Freesheet Papers – Why this is a Great Business

Source: Pulp & Paper Products Council, Pulp & Paper Week, RBC Capital Markets estimates

UFS/Pulp Disconnect and Stability of UFS Pricing

$0

$100

$200

$300

$400

$500

Jan-0

1

Jan-0

2

Jan-0

3

Jan-0

4

Jan-0

5

Jan-0

6

Jan-0

7

Jan-0

8

Jan-0

9

Jan-1

0

Jan-1

1

Pri

ce S

pre

ad b

etw

een U

FS

and N

BH

K P

ulp

(U

S$/m

t)

84

88

92

96

100

UFS O

pera

ting R

ate

12-

month

rollin

g a

vera

ge (%

)

Price Spread UFS Operating Rate


$18B

$26B$32B

$52B

$59B

$44B

$31B

2.0%

1.6%

1.2%1.1%

0.4% 0.4%0.2%

0

10

20

30

40

50

60

70

1980 1985 1990 1995 2000 2005 2010

$B

illio

n

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

Pe

rce

nt in

S&

P 5

00

Market Cap of Paper and Forest Products Companies in S&P500 Paper and Forest Products Percent Share of S&P500 Index

$2B $1B $3B

$11B $9B $9B $10B

3.3%

1.8%2.1%

1.5%

0.8% 0.5%

4.7%

0

10

20

30

40

50

60

70

1980 1985 1990 1995 2000 2005 2010

$B

illio

n

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0% Pe

rcen

t in T

SX

Co

mp

osite

Market Cap of Paper and Forest Products in TSX Composite Paper and Forest Products Percent Share of TSX Composite

Is the Forest Products Sector Still Relevant in Global Capital Markets?

Declining Share of the S&P 500 Index Over the Last 30 Years

Paper and Forest Products Share of the TSX Composite Over the Last 30 Years

Source: Bloomberg, RBC Capital Markets


Who Has the Higher Valuation - Company A or Company B?

Source: Company reports, RBC Capital Markets estimates

Using consensus 2011 and 2012 EBITDA estimates, we note that both companies trade at multiples of 6.0x 2011 and 4.6x 2012.

However, Company B only owns 50.2% of another firm which it consolidates into its results. So when you reduce EBITDA for the 49.8% that Company B doesn‟t own, the Company B-only multiples jump to 9.5x 2011 and 6.3x 2012.

Company A's Lumber Margins are Consistently

Higher

(30%)

(20%)

(10%)

0%

10%

20%

Q1 '06

Q2 '06

Q3 '06

Q4 '06

Q1/07

Q2/07

Q3/07

Q4/07

Q1/08

Pulp

Marg

ins

(%)

Company B Company A

Pulp & Paper Margins are Surprisingly Similar

(10%)

0%

10%

20%

30%

40%

Q1 '06

Q3 '06

Q1/07

Q3/07

Q1/08

Q3/08

Q109

Q309

Q110

Q310

Q111

Pulp

Marg

ins

(%)

Company B Company A


Valuation Multiple Increases with Liquidity

TMB

NBD

MERC

IFP.A

FTP

CTLCFX

WY

WFT

TRE

MWV

LPX

IP

UFSCAS

CFP

ABH

0.0x

2.0x

4.0x

6.0x

8.0x

10.0x

12.0x

0% 100% 200% 300% 400% 500% 600%

Liquidity (% traded of shares outstanding)

EV/E

BIT

DA

2012

Liquidity Matters in Valuation…

Source: Company reports, Thomson ONE, RBC Capital Markets estimates


Higher Market Cap Increases Liquidity

TWF.UN

TM BNBD

M ERCIFP.AFTP

CTL

CFX

ADN

WY

WFT

TRE

M WV

LPX

IP

UFS

CAS

CFP

ABH

$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$12.0

$14.0

$16.0

0% 100% 200% 300% 400% 500% 600%

$Bil

lion

….So Does Size



ADNCTL

CFXNBD

FTP

CAS

TRELPX

CFP

WFT

IFP.A

TM B

WY

UFS

ABH

M ERC

M WV

IP

$0.0

$2.0

$4.0

$6.0

$8.0

$10.0

$0 $2 $4 $6 $8 $10 $12 $14 $16

Market Capitalization ($B)

Avera

ge E

xecuti

ve C

om

pensa

tion

($M

M)

Executive Compensation is Clearly Linked to Market Capitalization

Source: U.S. Census Bureau, NAHB, NAR, MBA, Freddie Mac and RBC Capital Markets estimates


Performance vs. Executive Compensation


ROE Vs. Total Compensation

ADNCTL

CFXNBD

FTP

CAS

TRE

LPX

CFP

WFT

IFP.A

TMB

WY

UFS

ABH

MERC

MWV

IP

$0.0

$1.0

$2.0

$3.0

$4.0

$5.0

$6.0

$7.0

$8.0

$9.0

$10.0

0% 10% 20% 30% 40% 50%

Millions


How the Forest Products Sector Can Improve Access to Capital

1. Improved financial disclosure

2. Proactive marketing to the investment community

3. Supply Discipline – It works!

4. Merge, Acquire and Consolidate the Sub-sectors

Good – UFS, Tissue, OSB, Specialty Dissolving Pulp

Moderate – Containerboard, Groundwood Papers, Softwood Pulp

Poor – Hardwood Pulp, Lumber

5. Provide Quarterly Guidance and Sensitivities

“The pessimist is the man who believe things couldn‟t possibly be worse, to which the optimist replies: „Oh yes they could‟”

Vladimir BukovskyRussian writer and activist


Required Disclosures

Non-U.S. Analyst Disclosure

Paul Quinn (i) is not registered/qualified as a research analyst with the NYSE and/or FINRA and (ii) may not be an associated

person of the RBC Capital Markets Corporation and therefore may not be subject to FINRA Rule 2711 and NYSE Rule 472

restrictions on communications with a subject company, public appearances and trading securities held by a research analyst

account.

Conflicts Disclosures

This product constitutes a compendium report (covers six or more subject companies). As such, RBC Capital Markets chooses to

provide specific disclosures for the subject companies by reference. To access current disclosures for the subject companies,

clients should refer to https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1 or send a request to

RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J

2W7.

The analyst(s) responsible for preparing this research report received compensation that is based upon various factors, including

total revenues of the member companies of RBC Capital Markets and its affiliates, a portion of which are or have been generated

by investment banking activities of the member companies of RBC Capital Markets and its affiliates.

Distribution of Ratings

For the purpose of ratings distributions, regulatory rules require member firms to assign ratings to one of three rating categories -

Buy, Hold/Neutral, or Sell - regardless of a firm's own rating categories. Although RBC Capital Markets' ratings of Top

Pick/Outperform, Sector Perform and Underperform most closely correspond to Buy, Hold/Neutral and Sell, respectively, the

meanings are not the same because our ratings are determined on a relative basis (as described above).

Rating Count Percent Count Percent

BUY[TP/O] 713 52.7 213 29.87

HOLD[SP] 587 43.3 128 21.81

SELL[U] 55 4.1 12 21.82

RBC Capital Markets, Equity Research

Distribution of Ratings

Investment Banking

Serv./Past 12 Mos.

https://www.rbccm.com/GLDisclosure/PublicWeb/DisclosureLookup.aspx?entityId=1


Required Disclosures

Conflicts Policy

RBC Capital Markets Policy for Managing Conflicts of Interest in Relation to Investment Research is available from us on request. To access our current policy, clients should refer to https://www.rbccm.com/global/file-414164.pdf or send a request to RBC CM Research Publishing, P.O. Box 50, 200 Bay Street, Royal Bank Plaza, 29th Floor, South Tower, Toronto, Ontario M5J 2W7. We reserve the right to amend or supplement this policy at any time.

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RBC Capital Markets endeavors to make all reasonable efforts to provide research simultaneously to all eligible clients, having

regard to local time zones in overseas jurisdictions. RBC Capital Markets‟ equity research is posted to our proprietary websites to

ensure eligible clients receive coverage initiations and changes in ratings, targets and opinions in a timely manner. Additional

distribution may be done by the sales personnel via email, fax or regular mail. Clients may also receive our research via third-

party vendors. Please contact your investment advisor or institutional salesperson for more information regarding RBC Capital

Markets‟ research. RBC Capital Markets also provides eligible clients with access to SPARC on the Firm‟s proprietary INSIGHT

website. SPARC contains market color and commentary, and may also contain Short-Term Trade Ideas regarding the publicly-

traded common equity of subject companies on which the Firm currently provides equity research coverage. SPARC may be

accessed via the following hyperlink: www.rbcinsight.com. A Short-Term Trade Idea reflects the research analyst‟s directional

view regarding the price of the subject company‟s publicly-traded common equity in the coming days or weeks, based on market

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Disclaimer

RBC Capital Markets is the business name used by certain subsidiaries of Royal Bank of Canada, including RBC Dominion Securities Inc., RBC Capital Markets, LLC, Royal Bank of CanadaEurope Limited and Royal Bank of Canada - Sydney Branch. The information contained in this report has been compiled by RBC Capital Markets from sources believed to be reliable, but norepresentation or warranty, express or implied, is made by Royal Bank of Canada, RBC Capital Markets, its affiliates or any other person as to its accuracy, completeness or correctness. Allopinions and estimates contained in this report constitute RBC Capital Markets‟ judgment as of the date of this report, are subject to change without notice and are provided in good faith butwithout legal responsibility. Nothing in this report constitutes legal, accounting or tax advice or individually tailored investment advice. This material is prepared for general circulation to clientsand has been prepared without regard to the individual financial circumstances and objectives of persons who receive it. The investments or services contained in this report may not be suitablefor you and it is recommended that you consult an independent investment advisor if you are in doubt about the suitability of such investments or services. This report is not an offer to sell or asolicitation of an offer to buy any securities. Past performance is not a guide to future performance, future returns are not guaranteed, and a loss of original capital may occur. RBC CapitalMarkets research analyst compensation is based in part on the overall profitability of RBC Capital Markets, which includes profits attributable to investment banking revenues. Every province inCanada, state in the U.S., and most countries throughout the world have their own laws regulating the types of securities and other investment products which may be offered to their residents,as well as the process for doing so. As a result, the securities discussed in this report may not be eligible for sale in some jurisdictions. This report is not, and under no circumstances should beconstrued as, a solicitation to act as securities broker or dealer in any jurisdiction by any person or company that is not legally permitted to carry on the business of a securities broker or dealerin that jurisdiction. To the full extent permitted by law neither RBC Capital Markets nor any of its affiliates, nor any other person, accepts any liability whatsoever for any direct or consequentialloss arising from any use of this report or the information contained herein. No matter contained in this document may be reproduced or copied by any means without the prior consent of RBCCapital Markets.

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2011: setting up for a repeat of 2010 - pwc · pwc‟s annual global forest & paper conference...

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