Several US housing economists have yet to update their US housing starts forecasts for 2020 to reflect the economic impact of COVID-19, but the consensus forecast among those who have is approximately 1.15 million units, or about 10% below 2019 levels.
More broad economic forecasts about the speed of the recovery and how sharp the ‘V’ or ‘U’ shape will be abound. That is a good indication to me that with so many uncertainties and uncharted policies going into effect, no one can know or does know, even more than usual.
Against that backdrop, I looked at Norbold(OSB) Inc. a manufacturer of Oriented Strand Board and other wood products as a cyclical recovery play on the economy and housing market bouncing back to pre-crisis level.
2018 & 2019
Looking back briefly, 2018 was a blockbuster year for Norbold. Prices for their main OSB products were well above expectations and the housing market was rocking.
Strangely, 2019 was a much worse year. Even before COVID-19 ever existed, the US housing market started cooling off, at least from their perspective, and they were forced into executing some shift reductions and closed two mills in North America.
It was nice to see that management did reduce their dividend in accordance with their flexible policy and also opportunistically bought back $58 million in shares during 2019. This type of active management is a nice change as I often see companies, in some industries more than others, stick to their set dividend to their own detriment. For a cyclical company, I don’t see how any other approach is viable short of delusion about the industry you operate in.
Balance sheet-wise the company was in a good place going into 2020. The debt to equity ratio was solid for a capital intensive industry and their debt maturities had been properly managed to avoid a large amount of debt due anytime in the next 3 years.
Source: 2019 Annual Report
Q1 2020 & COVID-19
The quarter was actually a decent one, with positive operating income and decent EPS, both improving substantially over Q1 2019.
Source: Q1 2020 Earnings Release
On the bright side, Norbold is still operational being in an essential industry and supporting the essential construction industry. However, they have taken the drastic step of reducing production by 35% in NA and Europe. Norbold is a company that has high fixed costs and very low margins, with net profit margins usually coming in <5%. Q1 2020’s margin was 4.2%.
It is easy to see how a 35% drop in production and sales could wipe out any sliver of profit the company hoped to earn. The wildcard is of course pricing. With OSB being their main product, they are a pure commodity producer and thus have no brand or price control over their products. They are at the mercy of the market. Pricing was up in Q1 and continued to rise right up until the lock downs began.
I couldn’t find a up to date publicly available price quote for this product so I am not sure where it is at currently.
How the company does going forward really is dependent on demand. Even in their own reports they state that housing starts and other housing related data are the best indicators for their product, and it is difficult to tell how and if those will recover when the lockdowns begin to ease.
Source: Q1 2020 Earnings Release
My general macro view right now is there may be an immediate but short term boost as lockdowns ease, followed by a prolonged economic malaise as the new normal and second wave prevention policies become clear. Many do not expect real lasting economic damage to be done but I think it is clear that is not the case.
I think OSB has plenty of liquidity to survive as they have an untapped $245 million bank revolver which they are well within the covenants on. In addition, while they do not have a ton of cash on the books, they have a AR securitization scheme already active that helps them with working capital needs.
Ultimately, I think it just too early to buy Norbold at this point. It is clear that it is not a recession proof, wide moat business, but a cyclical commodity producer tied principally to the strength of the US housing market, and to the Canadian and EU housing markets to a lesser extent.
And that is perfectly fine–someone has to make OSB. But the nice thing about investing these days is with zero transactions fees, unlimited information, and the internet, one has so many options of what to invest their money in that there is no reason to settle for a inferior business which requires perfect market timing to make any money on.
I think if the future becomes less uncertain, Norbold could be a good call option play to get a different exposure to the housing cycle, but you could just buy a home builder and it probably would not be much different.
Norbold is a pass for me at this time.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.