THE BOTTOM LINE: Wood producers caught in a vise

by Canadian Shipper

At the heart of the slowdown emerging in the U.S. economy is an outright recession in the housing sector. Although many companies, both in Canada and abroad, will feel the effects of this, none are more directly impacted than Canada’s wood product manufacturers.

Many wood products go into home production, from two-by-fours to plywood, to OSB panels, to windows, cabinets, hardwood flooring and perhaps even to the cedar front door. The degree of manufacturing value added varies greatly across these goods. Total exports of these products were on the order of $17 billion in 2006, a big business for Canada. Some 85% of these exports are to the U.S., while Japan and Europe account for another 10%.

The U.S. housing market is showing considerable stress. Housing starts are down to 1996 levels, some 40% lower than the peak in early 2006. There is a large inventory of unsold new homes, a large stock of existing homes on the market, and more potential sellers are waiting in the wings. The latest figures show that the rate of foreclosure has doubled compared to a year ago. It is expected that foreclosures will rise much more during the next few months, as a large swath of sub-prime mortgage borrowers transition from their low introductory interest rates and monthly payments to much higher payment schedules.

Looking at wood product exports, the signs of trouble actually began to show up in early 2006. Exports declined by 14% in 2006, led by a big drop in the U.S. market. So far in 2007, total wood product exports are down another 21.4% compared to year-ago levels. The situation is particularly acute in plywood (-34.5%), millwork (-17.4%) and other products (-22.7%). There continues to be some strength in exports to Europe, Japan and to some emerging economies in Asia, but these sources of growth are overwhelmed by the softness in the U.S. market.

Naturally, this situation has been made even more difficult by the rising Canadian dollar. These exports are almost invariably priced in U.S. dollars. With that price generally held in check through competition from other producers, especially American ones, each uptick in the Canadian dollar means that the Canadian exporter receives fewer Canadian dollars for its sale. As a consequence, the profit margin in the wood product manufacturing sector has declined from around 14% back in 2004, to -0.3% most recently. The most recent run-up in the dollar is yet to be reflected in these figures.

How long will this go on? It is impossible to say, because the collapse of a market bubble takes us into uncharted territory, more of a psychological one than one amenable to economic analysis. But we can look at the arithmetic of the situation. Even assuming that U.S. consumer psychology turns positive in the next month or two, it will take at least 10-12 months to work off the housing inventory overhang and return the market to normal conditions. It is likely to take longer than this.

The bottom line? Canadian wood product manufacturers face a difficult situation, one that is unlikely to improve in the near term. Increased market diversification and new product development will certainly help, but producers need to be prepared for worsening conditions.

Stephen Poloz is Senior Vice-President, Corporate Affairs and Chief Economist, Export Development Canada. His column on trade-related issues appears weekly on www.ctl.ca

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