Don’t Miss These Stock Picks for the Lumber Price Surge

Key Points

• Lumber prices are starting to show a bottoming pattern, and fundamental factors could push it to new cycle highs.
• Cheaper mortgages and normalized lumber prices could help Lennar see better treatment from analysts.
• Wall Street analysts now expect over 60% upside in West Fraser Timber Company, driven by the Fed's potential interest rate cuts.

Some stocks depend on commodity prices for their success – or failure – and the main ones that come to mind may be inside the energy sector. If Warren Buffett chooses to buy an oil company, as he did through a nine-day buying streak in shares of Occidental Petroleum Co. NYSE: OXY, it may be because he sees a fundamental reason for oil prices to move higher and bring the company’s valuation up with it.

Today, investors can step outside the most commonly watched commodities, such as oil and precious metals. While gold makes a breakout, taking silver along for a ride, some mining stocks can become an excellent space to watch today. But note that today’s soon-to-be hot commodity is the least expected: lumber.

That’s right, lumber prices crashed after their stratospheric rallies in 2020 through 2022, raising the cost of building homes. Today, there are reasons to believe that lumber could make a comeback soon, backed by housing and economic fundamentals. Because of this, investors can have their top pick between stocks like West Fraser Timber Co. NYSE: WFG, Weyerhaeuser NYSE: WY, and even Lennar Co. NYSE: LEN.

Why Analysts' Downgrade of Lennar Stock Might Be Wrong

Recently, analysts at Citigroup decided to lower their targets on Lennar stock from $174 a share to $164 a share, roughly a 6% decline in forecasted valuations. These analysts lowered their targets due to bearish expectations for the housing sector moving forward.

Weaker readings in the national building permits, roughly 7% down on the year and 3.5% on the month, can be attributed to these bearish views. Lower building permits may indicate weaker housing demand and financial situations among homebuilders and would-be homebuyers.

But that could be about to change. The Federal Reserve postponed interest rate cuts throughout 2024. Still, the CME’s FedWatch tool now sees over 60% probability for a rate cut as soon as September of this year. That could spark new housing demand as mortgage rates also come down.

Cheaper mortgages could spark new housing demand. Now that lumber prices are back to normal, margins for newly built homes could help Lennar see better treatment from Wall Street analysts. In fact, some in the construction sector may be already aware of these coming trends.

According to their second quarter 2024 earnings results, Lennar reports a 19% increase in new orders, bringing the total to 21,293 homes today.

The company’s backlog is now worth up to $8.2 billion, and according to the latest employment situation report (NFP), out of the total 206,000 jobs added to the economy, roughly 27,000 (or 13%) jobs went to the construction sector. New hands are needed to respond to the potential demand breakout if and when the Fed cuts rates in September.

The One Stock to Watch as Housing Demand Surges: West Fraser Timber

Of course, analysts could be wrong about lowering Lennar’s price targets, but investors shouldn’t risk their capital on ‘what ifs’; rather, they can take a safer view on stocks that provide homebuilders with the main commodity they need, which is lumber.

Because lumber prices are so low compared to their 2020-2022 peaks, the profit margin cycle is also lower for companies in the sector. Despite the cycle’s lows, analysts at TD Securities still see a price target of $118 a share for West Fraser Timber stock, daring it to rally by roughly 60% from where it trades today.

But West Fraser Timber isn’t the only lumber provider in the block. Weyerhaeuser is also an honorable mention, but here’s how that stock compares to West Fraser.

Wall Street analysts only forecast 17.2% earnings per share (EPS) growth for Weyerhaeuser in the next 12 months, where those covering West Fraser Timber see up to 72.7% EPS growth this year as well, backing up the upside set by price targets.

On a valuation basis, this upside spread is just as evident. Trading at a 9.2x forward P/E multiple today, West Fraser Timber offers a discount of 61% to Weyerhaeuser’s 23.7x forward P/E valuation. If price action can be taken as another gauge of market sentiment, here’s what it looks like for both stocks.

Weyerhaeuser stock traded down to 75% of its 52-week high price, showing investors some bearish momentum. On the other hand, West Fraser Timber stock has traded up to 83% of its 52-week high, spreading the two companies into bearish and bullish momentum separately.