By Dodd Williams, CFA & President of American Timber and Agriculture
While the Canadian forest industry might take exception to the analogy, their infiltration of the U.S. South’s sawmills has been slow, methodical and under the radar. Certainly, “quiet” would be an exaggeration. After all, West Fraser Timber (WFT), Interfor (IFP), Canfor (CFP) and Conifex Timber (CFF) are all publicly-traded on the Toronto Stock Exchange, and each of their many acquisitions have come with press releases and industry commentary. But generally speaking, the encroachment has been undetected.
Not that long ago the Canadians were primarily only in Canada. In 2004, only two U.S. sawmills were owned by a Canadian company (West Fraser), but by the spring of 2015, 35 mills were owned by just three Canadian companies: West Fraser, Interfor and Canfor. According to the International WOOD MARKETS Group Inc., these three companies owned more mills in the U.S. than they did in Canada. In March 2018, FEA Canada/WOOD Markets reported that these three had increased their U.S. mill count to 45 (West Fraser 21, Interfor 13 and Canfor 11). To put the numbers in perspective, the top 10 companies owned 113 U.S. mills in total.
Conifex Timber did not even exist in 2004. Conifex was established in 2008 when it acquired its first idle sawmill in British Columbia. A second mill followed two years later, and then a biomass plant was added in 2015. Conifex also entered the U.S. in 2015, buying an idle Georgia-Pacific mill in El Dorado, Arkansas. In May of last year, Conifex bought two mills producing Southern Yellow Pine (SYP) dimensional lumber, Suwanee Lumber in Cross City, Florida and Caddo River Forest Products in Glenwood, Arkansas, from private-equity firm Blue Wolf Capital Partners. The 2018 acquisitions increased Conifex’s annual capacity by 50 percent boosting their potential annual output to 1.1 billion board feet. The expansion moves Conifex to the 6th largest softwood lumber producer in the South and the 9th in the U.S. as they join the other three big Canadian companies in the U.S. top 10. While the official numbers for 2018 have yet to be reported, it looks like Conifex’s move into the top 10 will give the (now) four big Canadians just under 20% market share in the U.S. and their share of the U.S. Southern market will exceed 40%.
Why have Canadians come to the U.S.?
We want to explore the reasons the Canadians have come to Dixie and what the effect has been and might be in the future. The list of reasons for the acquisition spree is lengthy:
High-quality wood supply in the South
The “dominant, low-cost lumber supply region of North America”
Skilled labor pool
Supply shortage in the interior region of British Columbia due to the mountain pine beetle infestation
“There is too much (mill capacity in B.C.) chasing too few sawlogs”
25 sawmills have closed in the B.C. interior since 2006 and another three to five may close by 2025
The South’s 210 million acres of fast-growing forests
An expanding housing market from Texas to Virginia to Florida
Southern mill operating margins are the highest in the world
Potentially avoid new tariffs or export restrictions
Ten years ago, the Canadians clearly saw the market landscape in British Columbia deteriorating, and they saw greener pastures in the U.S. South. Each of the ten potential reasons noted above are known around the industry, and there is no special insight required to consolidate the list.
The one reason that stands out is #9 – southern mills having the highest operating margins in the world. The high margin is clearly linked to the “wall of wood” – the supply glut created during the 2008/2009 economic recession and the South’s fast-growing supply base. The Canadians saw this phenomenon occurring in real time and acted quickly in order to take advantage of the South’s market.
We do wonder why Weyerhaeuser (#1 in 2008), Georgia-Pacific (#2) and Temple-Inland (#4) in their dominant positions ten years ago effectively let the Canadians buy up all these highly profitable mills. The answer is complex, and analysis with the benefit of ten years hindsight is still only an opinion.
While the Canadians were making a bigger bet on softwood mills, Weyerhaeuser was going in another direction. From 2007 to 2009, Weyerhaeuser was exiting the paper business (selling to Domtar which included selling two softwood lumber mills) and exiting the containerboard packaging business (selling to International Paper). Dan Fulton became Weyerhaeuser’s President and CEO in 2008 and set to reshape the company as a timberlands manager. In 2010, Weyerhaeuser converted to a REIT structure and thus began its mission to build acreage.
With Weyerhaeuser actually decreasing their MMBF capacity from 2008 through 2017, Georgia-Pacific did grow, albeit very slowly. Privately-held, Koch Industries bought the debt-laden Georgia Pacific in 2005. Koch directed GP’s focus on building their paper and pulp business and improving their financial position. In 2013, GP purchased Temple-Inland Building Products from parent International Paper. This purchase brought 16 new manufacturing facilities - five solid wood mills, four particle board plants, two medium density fiber board plants, one fiber board plant, and four gypsum wall board plants in the Southern U.S.
Temple-Inland was going through a major transformation themselves in 2007, splitting the company into three parts – Temple Inland Inc., Guaranty Financial Group Inc., and Forestar Real Estate Group Inc. Temple Inland Inc. became a manufacturing company focused on corrugated packaging and building products. International Paper bought Temple Inland Inc. in 2012, and subsequently sold off the building products segment to Georgia Pacific in 2013.
The #5 player in 2008, Georgia-based Gilman Companies, with 612 MMBF capacity was swallowed up by West Fraser in 2017, moving the Canadian company into the #1 position in South ahead of both Weyerhaeuser and Georgia-Pacific.
Evaluating the Effect
Context is such an important factor to consider in this analysis. We have already noted that the Canadian big four now control 40+% of the South’s MMBF capacity. That is a lot of concentration for four players, but the stark contrast comes when viewing how fragmented this industry was only twenty years prior. The concentration process has developed from two angles – local, privately-owned sawmills have sold out to big corporate interests, and the number of existing mills has shrunk considerably. From 1995 to 2009, the number of Southern-based softwood sawmills fell from 420 to 298.
The effect for the Canadians has been lucrative profit margins and lots of black ink. For Southern landowners, the effect has been subdued prices at the mill with the supply glut of sawlogs. Actually, the “wall of wood” would have been present even if the Canadians never bought in the South, but the concentration of mill ownership has probably meant more coordinated pricing discipline by the Canadians. This is not to imply price collusion on the part of the Canadians, but the price a mill pays for wood is typically public knowledge. One mill will base its pricing off what another one pays.
The Canadians do have their critics. Robert Crosby, President of the Forest Landowners Association, worries that during the next economic downturn, the Canadians will idle their mills in the Southern U.S. and keep the mills in British Columbia up and running. He sees the Canadian government’s (the owner of the Canadian forests) willingness to drop stumpage prices for sawlogs and its ability to apply political pressure keeping the Canadian mills running.
There is a positive aspect, and it is important to note that the Canadians have done far more than just purchase operating mills or reopen idle mills. They have also invested heavily in mill modernizations and expansion in board feet capacity. The mills have created jobs, and generally these are middle class jobs in rural locations (highly visible and highly politicized).
While we have only focused on the Canadian big four, there are smaller players in the market building their Southern presence. In February 2018, Canada’s privately-owned Tolko Industries announced they would build a $115 million sawmill in LaSalle Parish, Louisiana along with 50/50 partner, Ruston, Louisiana-based Hunt Forest Products. When completed, the new mill will consume 850,000 tons of Louisiana wood annually and produce 200 MMBF.
The Canadians have also made strategic investments outside of North America. In March 2019, Canfor announced a $508 million investment to purchase 70% of Sweden’s largest private sawmill company, VIDA Group.
What the Future Holds
It is our position that prices in the South will change behavior. As we noted last quarter in our commentary, we expect many individual landowners in the South (some against our advice) not to replant for the next 25-30 year softwood cycle. Replanting requires investment (about $250/acre), and the U.S. government’s CRP program is paring back, meaning less subsidy from the government to encourage planting trees. Additionally, the number of existing mills has declined over the past 25 years, which means some areas of the South are in dead zones – areas too far from a mill geographically to transport trees for a reasonable profit.
The mountain pine beetle epidemic started in British Columbia and Alberta in 1999 and the region has not experienced a cold enough (or long enough) winter in the past twenty years to eradicate the species. The resulting Canadian timber supply has probably flat lined, while international use of lumber continues to grow as population grows. Chinese imports of wood continue to increase and have generally been satisfied by Russian and Canadian exports. At some point, Canadian exports to the U.S will not keep up with demand, and prices for U.S. domestic wood will increase just as the Southern “wall of wood” is diminishing.