Louisiana-Pacific Stock Will Likely Boost Investor Portfolios (NYSE:LPX)

American building materials manufacturer, Louisiana-Pacific Corporation (NYSE:LPX), has easily outperformed the stock market for the past five years. One is tempted to believe that the good times are over and that investors should look elsewhere. Added to this are fears of inflation have made investors skeptical about the company’s future profitability. However, the industry’s underlying economic data suggests that the company’s profitability is sustainable. In addition, the company trades at an attractive relative valuation and has a very high FCF yield.

Louisiana-Pacific has been one of the enduring stars of the pandemic boom. Over the past five years, the stock has gained over 130%, compared to nearly 45.5% for the S&P 500.

Even when the stock market plummeted last year, with Louisiana-Pacific down 0.33%, the stock still outperformed the S&P 500, which was down 11%

The company’s continued success in the stock market is based on a strong underlying economy and favorable secular tailwinds.

Strong financial performance

Revenue grew from $2.73 billion in 2017 to $4.56 billion in 2021, at a 5-year compound annual revenue growth rate (CAGR) of 10.74%. Using Credit Suisse’s The Base Rate Book, we can see that only 12.6% of companies experienced similar growth rates over a 5-year period. The average 5-year sales CAGR across the corporate universe was 6.9% and the median was 5.2%. Its trailing-12-month (or TTM) revenue was $4.3 billion.

Gross profitability increased from 0.34 in 2017 to 0.94 in 2021. According to Robert Novy-Marx’s The Other Side of Value, 0.33 and above is the level above which profitability is attractive.

Operating income increased from $523.4 in 2017 to $1.8 billion in 2021, at a 5-year operating income CAGR of 28.36%. Operating income for the TTM period was $1.52 billion.

Operating margin increased from 19.14% in 2017 to 40.06% in 2021. The company’s operating margin is better than the average materials operating margin, which was 12%, and the average operating margin of 11.4 %. The company’s operating margin is in the highest quintile in the materials sector. In the TTM period, the operating margin declined somewhat to 35.26%.

Net income grew from $389.8 million in 2017 to $1.38 billion in 2021, at a 5-year net income CAGR of 28.71%. Only 8.8% of companies had a similar earnings growth rate over a 5-year period. The average 5-year earnings CAGR across the corporate universe was 7.3% and the median was 5.9%.

Free cash flow (or FCF) grew from $325.1 million in 2017 to $1.23 billion in 2021, a 5-year FCF CAGR of 30.49%. In the TTM period, FCF was $902 million. The FCF margin increased from 11.89% in 2017 to 27.02% in 2021, showing that FCF growth is ahead of the sales growth rate.

The company’s return on invested capital (ROIC) from 24.03% in 2017 to 98.97% in 2021. According to New Constructs, the average ROIC of the 2,000 largest companies in the United States was 9.3%. That’s elite-level profitability. In the TTM period, the ROIC decreased by 8.81%.

Profitability is sustainable

Superforecasters from the Good Judgment Project expect the personal consumption expenditure (PCE) price index to average 2.24% between Q4 2023 and Q4 2024, compared to 5% in December 2022. The pre-pandemic level was 2%. With inflation falling, there is hope that the Fed’s interest rate hikes will be lower than initially expected. While there were fears that we were entering an era of inflation or even stagflation, the reality is very different.

With inflation at a 15-month low, the question is whether Louisiana-Pacific can sustain profitability as prices fall. This fear is particularly relevant when we consider that the supply chain constraints that fueled post-pandemic inflation spikes have disappeared. The housing and construction boom is over, and Louisiana-Pacific’s profitability has certainly taken a hit over the past year, contributing to the company’s weak stock market performance over the past year.

Still, the S&P/Case-Shiller US National Home Price Index fell just 2.5% between May 2022 and November 2022, and levels remain historically high.

If we analyze the housing market, we find that the broader assumption that mortgage rates are driving home prices is wrong. Instead, according to research by the Federal Reserve, construction prices for new buildings have developed in parallel with construction prices since 1963.

In other words, let’s look at home prices, not mortgage rates, to see where house prices are headed. Over the decades, construction prices have continued to rise across different interest rate regimes and periods of inflation. Aside from the Great Recession of 2008, there has been no deep housing market deflation that has lasted for any length of time. If we look at lumber, iron and steel prices, crucial materials in construction processes, despite falling sharply from their pandemic highs, levels are still high by historical standards.

This tells us that as input prices rise, Louisiana-Pacific will be able to pass these costs on to builders and homeowners, which of course will result in higher home prices. Yes, input prices remain historically high, but that won’t stop the company from passing on those costs.

Supply is the greatest force in the world and explains why Louisiana-Pacific Corporation’s profitability is sustainable. In recent decades there has been significant underinvestment in lumber and iron and steel. There is still a major shortage of lumber, which has led to a price increase of 14% in 2023. With the housing season approaching, the analysis we have performed indicates that Louisiana-Pacific will be able to pass on these costs. In addition, builder sentiment appears to have bottomed out after rising in January this year.

Supply is also a factor driving housing activity. According to data from Redfin, the stock of homes for sale has steadily declined over the past decade. Data from FRED shows a similar pattern, with housing stocks in long-term decline.

In addition, the United States is experiencing what is known as the Great Migration, with people migrating to the South and West—the fastest-growing areas in the United States—in search of larger homes and better living standards. This pattern of migration from state to state has created tremendous opportunity for construction. This in turn means that there is an enormous housing shortage in the south and west. This gives Louisiana-Pacific more opportunities to pass on any cost increases to builders and homeowners.

Capital discipline has become part of the industry

The OSB or OSB industry and the building materials industry in general have been defined by a boom and bust cycle. This has made it difficult to maintain profitability over the long term. In times of growth, managers have been tempted to over-borrow and over-spend on investments, leading to oversupply in the market. What makes this so challenging is that the time it takes to build new capacity is so remote that it’s easy to miscalculate the future price and end up with new capacity that can’t earn its cost of capital . After this period of wealth growth, the bubble bursts and capital exits until profitability returns to the market. Obviously, no long-term oriented investor wants to invest in such an industry.

However, in the last decade the market has consolidated. This has enhanced the pricing power of the four remaining players. This is because as consolidation goes, the barriers to entry are getting higher and there is less fear that the only way to be profitable is to pursue growth. Instead, companies can and have been more conservative and have resisted the temptation to increase capital spending. In fact, Louisiana-Pacific’s capacity projections through 2024 show that the company is pursuing a very conservative strategy.

Shareholder-friendly policy

In his 2021 letter to shareholders, Chief Executive Officer Brad Southern was the architect of the company’s turnaround. He has been able to improve efficiencies, increase profitability, close unprofitable plants and turn to growth opportunities, particularly in siding solutions, which grew 27% in the third quarter of 2022.

Southern said the company is committed to delivering excess returns to shareholders. Management has already successfully executed its 2019-2022 strategy, delivered incredible returns for shareholders and there is enough management deliverables to lead us to believe management will be successful over the next 3 year cycle.

valuation

At 4.24 times earnings, Louisiana-Pacific appears to be trading at an attractive relative valuation compared to the S&P 500, which is trading at 21.59 times earnings. Additionally, with FCF of $902 million and enterprise value of $4.73 billion, Louisiana-Pacific has a FCF yield of 19.07%. This is well above the 2.1% average FCF return of the 2000 largest companies in the United States, as calculated by New Constructs. This indicates that the company has outperformed the market in generating FCF and that the company is likely to generate higher returns going forward.

Conclusion

Louisiana-Pacific has been one of the best performing stocks on the market over the past several years. However, fears that inflation could hurt the company’s growth have caused investors to underestimate the company’s growth prospects. Historically, construction prices have driven house prices, and these construction prices have been driven by secular input price inflation. This, in addition to consolidation in the industry, tells us that Louisiana-Pacific can pass on any inflation it experiences and that in the event of a market downturn, the company will have the option to raise prices to protect its returns. With management doing a great job, investors can have confidence that management will deliver results for years to come.