Is WY’s bear market a great buying opportunity or a bad risk?

In a rising interest rate environment, with housing demand and loan applications starting to show signs to decline, companies that are closely tied to the health of the housing market tend to be especially sensitive. That includes industries like Wood Products.

Housing-related industries proved to be surprising areas of strength in the economy in 2020 and 2021. Against the backdrop of economic pressures from the pandemic, normally economically sensitive industries like Homebuilders, Construction, and others saw unexpected increases in demand. The shift of corporate America to work-from-home models, along with the release of pent-up consumer demand from federal stimulus fed high demand for both new and existing homes in areas across the country, with the average price of homes seeing outsized increases throughout the period.

2022 has seen the narrative begun to shift. That isn’t too surprising as the Fed has increased rates multiple times through the year at an accelerated pace that is now starting to show its effect on housing; this week’s latest numbers show not only that sales have begun to decline, but also that mortgage applications are starting to tumble. That’s a combination of the two realities: interest rates that increasing mortgage payments, along with still-elevated real estate prices that are beyond affordability for most middle-class workers.

Weyerhauser Company (WY) is an interesting example. If you’ve had to buy lumber for a home improvement project, you’ve probably acquired it from their Wood Products segment, which emphasizes the production and distribution of wood products. That, along with homebuilding in general, ties this company to the Construction and Homebuilders industries; however, this is a company whose primary focus is on the timberlands and forest acreage that makes all of its segments possible. That puts the company in the category of a Real Estate Investment Trust (REIT), a segment of the sector that tends to see a different kind attention from the market, especially from income seekers when interest rates from more traditional instruments like Treasury bonds and regular stock dividends remain low.

REIT’s are interesting because stocks in this segment tend to pay higher annual dividends than stocks in other industries. WY suspended their dividend earlier this year due to COVID concerns, but reinstated it (at a lower than previous rate) before the end of 2020. Of course, dividend yield alone shouldn’t be the only basis for any investment decision, especially if your plan is to hold onto the stock for any extended length of time. That means that diving in to the stock’s fundamental profile becomes very important. Even as housing demand has tapered and begun to fall, this is a company with healthy Free Cash Flow and operating profits. The stock has dropped from its yearly high in February at about $43 to a low early this month at around $32, but has managed to rally a bit from that low since then. Does the stock’s drop in price, against the backdrop of its healthy fundamentals, provide a smart opportunity for a bargain hunter, or do broader economic headwinds make WY a stock you should keep at arm’s length? Let’s find out.

Fundamental and Value Profile

Weyerhaeuser Company is a timber, land and forest products company. As of December 31, 2016, the Company owned or controlled 13.1 million acres of timberlands, primarily in the United States, and manages additional timberlands under long-term licenses in Canada. The Company’s segments include Timberlands; Real Estate, Energy and Natural Resources (Real Estate & ENR), and Wood Products. The Timberlands segment’s offerings include logs, timber and recreational access via leases. The Real Estate & ENR segment includes sales of timberlands; rights to explore for and extract hard minerals, oil and gas production, and coal, and equity interests in its Real Estate Development Ventures. The Wood Products segment includes the manufacturing and distribution of wood products. The Wood Products segment is engaged in softwood lumber, engineered wood products, structural panels, medium density fiberboard and building materials distribution. WY’s current market cap is $26.4 billion.

Earnings and Sales Growth: Over the last twelve months, earnings increased 44%, while sales improved about 24%. In the last quarter, earnings were 167.35% higher, while sales grew by a little over 41%. WY’s margin profile is stable and healthy; over the last twelve months, Net Income was nearly 25% of Revenues, and decreased only slightly to 24.78% in the last quarter.

Free Cash Flow: WY’s free cash flow is healthy and growing, at almost $3 billion for the trailing twelve month period; that translates to a Free Cash Flow yield of about 11.64%. It is also noteworthy that this metric has increased steadily over the past year from a starting point at about $2.5 billion, and from around $550 million in mid-2019.

Debt to Equity: WY has a debt/equity ratio of .49, a low number that implies a conservative approach to leverage. WY’s balance sheet shows about $1.2 billion in cash and liquid assets against $5 billion in long-term debt. While the proportion between the two is a bit high, their healthy margin profile and improving free cash flow suggest that servicing their debt won’t be a problem.

Dividend: WY pays an annual dividend of $.72 per share, which translates to a yield of 2.03% at the stock’s current price. WY suspended its dividend after the first quarter of 2020 but reinstated it in December of that year at 1/2 its pre-pandemic levels, and then increased it from $.68 per share in the first quarter of this year.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but I like to work with a combination of Price/Book and Price/Cash Flow analysis. Together, these measurements provide a long-term, fair value target at around $46 per share. That suggests that the stock is temptingly undervalued, with about 29% upside from its current price.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above displays the last year of market activity for WY. The red diagonal line traces the stock’s downward trend from a high at around $43 to its 52-week low reached this month at around $32.50 per share; it also provides the baseline for the Fibonacci retracement lines shown on the right side of the chart. From that low point, the stock has managed to rally quite a bit, with immediate resistance sitting at around $36.50 where the 38.2% retracement line sits, and current support at around $34 per share. A drop below $34 should see the stock retest its yearly low at around $32.50, while a push above $36.50 should find next resistance at around $39 per share.

Near-term Keys: With the stock’s healthy Net Income, improving Free Cash Flow, healthy balance sheet, and reinstated dividend, I think WY is a very interesting example of a company that offers a tempting, if potentially risky value proposition under current market conditions. If you prefer to work with short-term trading strategies, a push above $36.50 could offer a strong signal to consider buying the stock or working with call options, with a profit target price at around $39. A drop below $34 doesn’t have a ton of downside, but it could be a signal to use next support at around $32.50 as a target on a bearish trade, either by shorting the stock or buying put options so long as you’re willing to act quickly to claim profits and move on.

X