Forest companies’ consensus forecasts continued declining sharply during the earnings season

Translation: Original comment published in Finnish on 9/25/2023 at 7:27 am EEST

We have reviewed UPM’s, Stora Enso’s and Metsä Board’s post-Q2 consensus forecasts and their changes. Among the forest sector companies no consensus forecasts are available for Koskisen. Forest companies’ consensus forecasts for 2023 started to decline last fall, when the slowdown in economic growth began to affect the demand outlook (incl. a drop in inventories), global supply improved as COVID bottlenecks eased, and inflation continued. The downhill even steepened in connection with the Q2 earnings period, as consensus forecasts were updated to reflect the market situation in the pulp and board industry that weakened historically quickly in the spring and summer. For Koskisen that operates in the wood products sector, our estimates for 2023 have, by contrast, increased as the company’s sawn timber businesses have continued performing better than its peers and the performance in the panel industry has remained strong supported by the war-based supply disruption.

Next year’s estimates also dipped clearly in connection with the Q2 earnings period

Although the rapidly weakened market situation sharpened the downward trend in the 2024 consensus forecasts of UPM, Stora Enso and the Metsä Board, which began at the turn of the year, the consensus expects forest companies’ performance to pick up next year. We estimate that the turnaround is based on expectations of volume recovery after the deep dip (incl. inventory adjustment) in 2023, a slightly improving economic growth outlook and calming inflation. We believe this is a realistic scenario, at least in terms of direction, despite the great uncertainties connected to the economic situation in Europe, as the forest sector has traditionally been seen as a pre-cyclical industry. Many product groups are also starting to show signs of hitting volume and price bottoms (but not really of a turn for the better).

Thus, the preconditions for generating profit in the forest sector are typically weakest in the early stages of a deteriorating cycle, when problems include a drop in demand with a lever due to inventory adjustment, price pressure and typically high cost levels. All these factors have driven the earnings collapse of UPM, Stora Enso and Metsä Board this year. Our estimates for the three are in line with the consensus, although we are on average slightly more pessimistic than the consensus in our 2024 estimates and believe even reaching our estimates requires Europe avoiding a deep recession. Our 2024 estimates for Koskisen are lower than for 2023 but Koskisen’s comparison figure is also likely to be more demanding. In a positive scenario (i.e. the very high margin level in the Panel Industry is maintained) Koskisen may also surprise positively compared to our estimates.

Sector valuation has recovered with both earnings and balance sheet based multiples

Recently, there has been budding optimism concerning forest companies on the markets as the share prices of large companies have risen by close on 10% in the past month. However, Koskisen’s share price has remained fairly stable. The drop in consensus forecasts and the rise in share prices seen in connection with the Q2 reports has naturally raised valuations from two directions and Stora Enso’s current P/E ratio is 18x, UPM’s 14x and Metsä Board’s 13x. There is dispersion between the companies, and the earnings-based valuation is starting to reasonably reflect 5-year averages of the three companies. Relative to the prevailing interest rate level, we no longer find the valuation level cheap with 2024 estimates and cheap multiples are only visible for 2025. Koskisen’s P/E ratio for 2024 in line with our estimates is very moderate at 9x, although we do not think Koskisen’s valuation should be compared to the forest giants.

Our view of the at least partly normalized pricing of the sector is also supported by balance sheet based valuations, which for UPM and Metsä Board are on par with the 5-year median levels. For Stora Enso, we feel comparing it to the company’s history or peers is not useful due to the current accounting practices for forest assets. Koskisen has no history of balance sheet multiples, but the P/B ratio below 1x is, in our opinion, quite moderate for the company. Thus, we do not believe that the prevailing earnings and balance sheet based valuation of the sector protects the shares against the concrete risks of negative surprise but falling more clearly short of next year’s consensus estimates would probably create downward pressure in the shares. Correspondingly, a continued share price rise would probably require that 2024 consensus estimates made an upturn.