The housing market is grinding to a halt. Rising mortgage rates and still-elevated commodity prices caused new single-family housing starts to decline 4% in November (the latest period), while residential permits tumbled 11% for the period. The National Association of Home Builders housing market index sits just above the lowest point hit during the onset of the pandemic.
So why did Warren Buffett’s Berkshire Hathaway buy Louisiana-Pacific (LPX -0.36%), a leading manufacturer of building products, including engineered wood products, siding, and other products used in residential and commercial construction? And if Berkshire is buying, should you?
No place like home
Although existing home sales fell 7.7% in November, the 10th consecutive month they’ve been down, there is actually a housing shortage in the U.S. It’s considered a shortage when there is less than a six-month supply of existing homes for sale. The National Association of Realtors said in their most recent update that there are just 1.14 million unsold existing homes, or just 3.3 months’ worth of inventory.
For that reason alone, the housing industry isn’t expecting the same sort of wholesale plunge in pricing that marked the collapse of the housing market 15 years ago. Today, the median existing-home sale price is $370,700, an increase of 3.5% from last year. It may be more of a buyer’s market now, but it’s not the rout many have been expecting.
There may be some pessimism among homebuilders, but there are several reasons why Louisiana Pacific could still be a good investment opportunity.
The right price
Of primary interest is valuation. Even after news of Buffett’s purchase sent LP’s stock soaring in November, the stock remains 16% lower over the past year, and is 22% below the highs it hit in 2022.
Shares trade at an enviable 4 times trailing earnings and just 16 times next year’s estimates, while also going for a fraction of the company’s estimated earnings growth rate. Of course, at a compounded rate of 5% annually for the next five years, Wall Street isn’t expecting a massive growth spurt — but tradng at just 5 times the free cash flow Louisiana Pacific produces, shares certainly give the appearance of offering a bargain basement discount.
The wood products company itself doesn’t often trade at sky-high premiums, and sometimes a stock is cheap for a reason. Analysts are expecting the housing downturn could impair LP’s future prospects.
New opportunities for growth
Fortunately, the company has been transitioning to a more holistic approach to the industry, and is building up a greater presence in the repair and remodel market, as well as developing value-added products.
LP’s focus on innovation has been a key driver of growth, as it’s invested in research and development to develop new products and technologies. This, in turn, has helped the company to improve efficiency and lower costs, which has improved margins.
Its siding business saw a 27% increase in third-quarter sales, which it says helped set new records for pricing and volume, while its structural solutions unit saw sales volumes increase 10% year over year. Oriented strand board, or OSB, still comprises the largest component of Louisiana Pacific’s business, but it’s trying to take that in new and innovative directions.
For example, in the structural solutions division, it created a radiant barrier product for OSB, which is an aluminum panel affixed to the plywood that helps block heat from emitting into an attic space. Its air and water barrier panel protects against the elements, while also increasing the structural integrity of the house. During the quarter, the majority of the revenue for LP’s OSB segment came from its specialized structural solutions portfolio.
Solid stock at a good price
Louisiana Pacific has a solid balance sheet, with low debt levels and a strong cash position. This gives the company the financial flexibility to make additional investments in growth opportunities while weathering any short-term challenges.
But as a lumber stock it’s cyclical, and buying now means having the patience to let the sector rotation continue until the housing market is back in favor. It might not decline as sharply as it did a decade ago, but these depressed valuations may be with LP for a while.
In the meantime, the wood products company should continue to return value to shareholders through a nominal dividend payment that currently yields 1.4% annually, while buying back large tranches of stock. It has cut its outstanding share count in half over the last five years.
If you’re an investor with a long investment horizon — which you should be — Louisiana Pacific could make a solid addition to your portfolio.
Rich Duprey has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Berkshire Hathaway. The Motley Fool recommends the following options: long January 2023 $200 calls on Berkshire Hathaway, short January 2023 $200 puts on Berkshire Hathaway, and short January 2023 $265 calls on Berkshire Hathaway. The Motley Fool has a disclosure policy.