Lousiana Pacific Corporation (LPX)

lpx

Key Statistics

Enterprise Value = $2.76 billion

Operating Income = $669.4 million

EV/Operating Income = 4.12x

Earnings Yield = 15%

Price/Revenue = 1.15x

Debt/Equity = 20%

The Company

Lousiana Pacific (LPX) is a Nashville based company that manufactures building products. The core of the business is the manufacture of oriented strand board (OSB). OSB is created from wood flakes and then bound together with adhesives. OSB is used heavily in the construction of new homes.

LPX also has a siding business. They manufacture vinyl, stucco, brick, and fiber cement siding. They also have a business in engineered wood products (EWP), used mainly for flooring. LPX also possesses an operation in South America.

The revenue breakdown is below:

lpxrevenue

The fortunes of LPX are tied at the hip to the construction of new homes. While engineered wood products and siding help diversify the sources of revenue, OSB represents a massive component of total sales. The volatile pricing of OSB can dramatically affect LPX’s earnings power.

Currently, the market is concerned that LPX’s earnings are at a cyclical peak. From September 30th through October 22nd, the stock declined from a $30.93 high to a low of $21.42. The stock price reacted to a corresponding 60% collapse in the price of OSB.  As OSB is such a significant component of LPX’s business, the price move in OSB translated into a 30% stock decline for LPX.

The question at hand is whether the decline in the price for OSB was a rational response to supply and demand dynamics, or whether it was driven by irrational fear of a US recession, a fear which caused a sell off in many different markets last fall. Market participants clearly believe that OSB was at a cyclical peak last summer. The sentiment is that housing is peaking and is about to get crushed, at usually happens during a recession.

Fortunately, the collapse in the price of OSB has not yet caused a significant operational slip in LPX’s results. In Q3 2018, LPX earned 86 cents a share. This compared to 76 cents earned in Q3 2017.

My Take

The burning question right now is: are we going to have a recession in the next year? As I’ve chronicled on this blog, I don’t think so. I chronicled the reasons why in my year end post.

The fortunes of LPX depend on demand for brand new homes. New home construction is intensely cyclical and falls off a cliff when the economy enters a recession.

The conventional thinking right now is that the US is headed for a recession. The current expansion is 10 years old, the Fed is hiking, the party is over, and housing is utterly screwed.

I disagree. Not only do I think the US is not headed for a recession, I also think that housing construction is still low and has room to expand.

Here is a summary of US housing starts since 1959:

housingstarts

Because housing starts have been growing since 2009, it doesn’t mean that they are by any means robust when compared to past expansions. It merely feels that way because the previous bust was so sharp and severe. In reality, we’re still below the average level of starts since 1959, and we’re nowhere near a red-hot level of housing starts which we experienced in the mid-2000s, the mid-80s, late ’70s, or late ’60s.

It looks to me like housing starts have more room to run, which is why I think LPX’s earnings are not at a cyclical peak, which is the prevailing sentiment right now. This would also mean that the price decline in OSB was an overreaction to the intense fear of recession which gripped markets late last year.

If I’m wrong and we do have a recession, I doubt that housing starts will be decimated like they were in 2008. If the current boom never went to an extreme level, then it’s logical that the bust will not be as severe either. This is what happened in the early 2000s. In the late 1990s, the stock market went crazy, but the housing market remained subdued and didn’t participate in that financial mania. As a result, housing held up well during the bust of the early 2000s. Once the Fed cut interest rates to deal with the early 2000s bust, the housing market was actually buoyed. Ironically, this experience led to a widespread public perception that real estate was a safer alternative to stocks and this perception helped fuel the mid-2000s housing bubble.

The cheap valuation and excellent financial position of LPX also prevent a permanent loss of capital. LPX currently has a debt to equity ratio of 20% and possesses a cash-rich balance sheet with cash & equivalents presently at $6.86 per share. The Piotroski F-Score is currently a nearly perfect 8 out of 9.

The stock currently trades at multiples below the industry average and its historical averages. The P/E of 6.87 compares to an industry average of 11.17 and a 4-year average for LPX of 13.31. The enterprise multiple of 4.12x compares to a 4-year average of 9x, which is a sensible valuation for such a financially high-quality company.

In summary, I think LPX is undervalued because the market is incorrectly surmising that new home construction is at a cyclical peak. Additionally, I believe that the current valuation and financial quality of the company provides a sufficient margin of safety if this thesis is wrong.

Random

I’ve been listening to this a lot lately:

 

 

 

Which reminds me of this:

 

 

 

PLEASE NOTE: The information provided on this site is not financial advice and it is for informational and discussion purposes only. Do your own homework. Full disclosure: my current holdings.  Read the full disclaimer.