Wrapping up the North American Hardwood Marketplace for 2019

February 2020

VOLUME 14 ~ ISSUE 2 ~ February 2020 A HMR Publication Real average hourly earnings for all US employees were down 0.1% in December from November to $10.96 but were 0.6% higher than Wrapping Up the North American Hardwood one year earlier. Marketplace for 2019 US manufacturing capacity utili- Part II of II zation was 75.2% in December 2019, up from 75.1% in November but down from 77.3% in December Supply 2018.

US hardwood supplies for 2019 are estimated at 8.3B board feet. Vol- November total US exports were umes contributed each by Eastern and Western US sawmill production $208.6B; imports were $251.7B, leaving a deficit of $43.1B, down and imports decreased from 2018. $3.9B from October.

This change in supply, like all changes, resulted from motion. So as a There were 891,286 US business refresher, let’s turn to the person who wrote the book on motion. Sir applications in Q4 2019, up 3.4% Isaac Newton. from Q3 2019. The West posted the highest percentage increase, up 4.6%. The South had the most Newton’s Laws of Motion (paraphrased) applications at 388,934. 1. Every object will remain at rest or moving in a straight line unless compelled to change its state by an external net force. In 2019, retail sales in China grew 8.0% over 2018.

2. The velocity of an object changes when it is subjected to an external China’s GDP grew 6.1% in 2019 net force. For an external applied force, the change in velocity depends over 2018.

© 2020 HMR It is illegal to photocopy, reproduce, sell, publish, continued page 2 broadcast, or transmit this publication in any way, in whole or in part, without the express written permission of the owner. HMR Business Activity Snapshot TM 15%15% 14.8%

10%10%

5%5% Lumber Cabinet Exports 3.2% 4.2% 1.3% 2.1% (Imports$) 2.9% (Volume) 0%0% GDP Housing Furniture Flooring Crossties Sawmill Starts (Sales$) Shipments (Inventories) Production –-5% 5% (Volume)

–-10% 10% Percent Change Percent

–-15% 15%

-20.0% -21.4% –-20% 20%

–-25% 25% GDP – Q4 2019, Advance est. Housing Starts – 2019:2018, Unadj. Cabinet Imports – Y-T-D Nov '19:'18. Furniture – Y-T-D Nov ’19:’18, Unadj. Flooring – Y-T-D Jan '20:'19. Exports – Y-T-D Nov ’19:’18. Crossties – Dec1 '19 vs. '18. Sawmill Production – Y-T-D Jan '20:19. HMR Executive® February 2020 on the mass of the object. [Example: you attempting astern US hardwood lumber pro- to tackle Marshawn Lynch would not be a net force. "E duction fell in 2018 and again last In contrast, Marshawn Lynch running over you during year, with 2019 ending at the low- your feeble attempt to tackle him would be a net force est annual level since 2013." that dramatically changes your velocity.] Supply Perspective 3. For every action in nature there is an equal and op- To restate the opening line of this article, approximately posite reaction. (Consider the example set above for 8.3B board feet (BF) of new hardwood lumber produc- Newton’s Second Law.) tion entered the US supply stream in 2019. The makeup of the total for 2019 shown in Figure 1 includes 7.6B History has portrayed Newton as a physicist for more BF of Eastern US hardwood lumber production, 338 than 300 years. Who knew he really was talking about million BF of Western US production, and 350 million BF the North American hardwood marketplace? of imports* (as reported by USDA Foreign Agricultural Service). *Import data for December were not available Yes, US hardwood sawmill production decreased in at the time of this writing. 2019 because of external forces in the marketplace. The January issue of HMR Executive® identified those Eastern US hardwood lumber production fell in 2018 external forces and explained their impacts quite well. and again last year, with 2019 ending at the lowest Given Newton’s Laws of Motion, listed above, the re- annual level since 2013. Western US production was sponse by supply seems to be as much physics as it down from 2018 and at its lowest level since 2012. is business. The volume of hardwood lumber imported to the US dropped in three of the last four years and also ended But the important distinction of US hardwood supply at the lowest level since 2012. contraction in 2019 is not just that production changed, it is how production changed. There is no phenomenon driving the current production downturn other that the natural course of supply follow- This article will: ing demand. Whatever impacts there were from inclem- ¾¾ Provide a perspective of total US hardwood supply ent weather, labor shortages, or any other disruptive and how it has aligned with demand over time. outside force, the effects were incidental at most.Figure ¾¾ Discuss efforts made by sawmills and lumber yards 2 illustrates demand trends and the obligatory responses to control the volume of items produced and pro- by supply (think Newton’s Laws of Motion) and provides cessed. a sense of the supply and demand relationship. ¾¾ Highlight some of the obstacles mills and yards faced when attempting to control the items pro- For clarity and caution, the data points in Figure 2 duced. are supply and demand volumes cumulative for each ¾¾ Address the protracted amount of time it has taken year; they do not show direction of change or market for supply to measurably respond to declines in energy within any 12-month period. It is possible, and critical market sectors. sometimes likely, annual results shown in this graph are ¾¾ Consider potential lasting effects on the US hard- counterintuitive to what is happening in the marketplace wood lumber supply network caused by these lin- at the time the graph is published. gering external market forces. The lines connecting one year to the next are repre- One suggestion before getting too deep in the weeds sentative of the direction of business and the trajectory of this article … you might want to treat yourself to a (velocity) of change. The space between the Supply and snack while reading. Word has it that Newton fellow Demand graph lines represents inventory expansion and makes a good cookie. contraction as determined by the relationship of the lines.

2 HMR Executive® February 2020

Figure 1 Hardwood Lumber Supply Available to the US Market from All Sources 9.5

8.5

7.5

7 Imports Western US Hardwood Sawmill Production Billion Board Feet Billion Board 6.5 6.5 Eastern US Hardwood Sawmill Production

5.5 Source: US Census Bureau, USDA FAS, and HMR *Projected volumes based Graph: HMR on the latest available data 5 2008 2009 2010 2011 20122012 2013 2014 2015 2016 2017 2018 *2019*2019 Figure 2 Consumption of Hardwood Lumber by Major US Markets and Total Supply of Hardwood Lumber 1212 Consumption 1111 Supply

1010

88 Billion Board Feet Billion Board Feet Billion Board 77

3 HMR Executive® February 2020

Inasmuch as the graph shows supply and demand are ber products, as the market has dictated these past in balance for 2019, the implication is that business 18-plus months. But, merchandising timber does not conditions and prices for hardwood lumber were stable. alter the species or quality of logs flowing into the total production stream. It merely redistributes those logs to Supply Correction different producers. Of course, business conditions and prices were not stable in 2019. Figure 2 provides an excellent view of Lumber concentration yards (in the business of pur- total quantities, but it misses critical information about chasing green lumber and processing it for sale to kiln supply and demand … it does not detail market perfor- dried markets) are strategically located based on the mance by the eight individual major market sectors or species and quality of hardwood growing stocks that even the two hardwood market groups. are available. Proximity to markets and/or transportation hubs is another important factor, but without the right We are reminded once again that the US hardwood combinations of salable materials, efficient delivery to market is complex. There are multiple inputs and mul- customers is of no value. tiple outputs, all of which must achieve balance. Pulling materials from an adjacent wood supply basket, Had this latest business downturn resulted from a do- for example, is reasonable for augmenting supplies. But, mestic economic event, most markets would have con- relying on outside sources for the core supply of logs or tracted simultaneously. Therefore, production could have lumber is counterproductive and not sustainable, except responded to such a decline faster and more effectively. in specialized businesses. Sawmills are dependent on the local forest resource, as are green lumber markets Instead, this business downturn was influenced by – whether they are yards or secondary manufacturers. contraction in the Chinese market and hardwood's eroding share in domestic and international consumer This means there are limitations – limitations on how product markets. These circumstances affected only much additional volume can be produced and pro- high valued grade lumber items, whereas business for cessed of items in strong demand, and limitations on industrial hardwood products expanded on the strength how much or how long production can avoid processing of sound domestic economic conditions. items in weak demand.

Consequently, the supply contraction process was as "It is difficult to imagine any sawmill or disjointed as the marketplace itself. Correction has been lumber yard staying financially whole for protracted and is still incomplete, in spite of total supply the duration of this current downturn in and demand volumes being balanced. grade lumber business. In cases–likely most cases–inventory assets have been used to Challenges Faced offset revenue shortfalls." The goal: Be rewarded by making what the market wants. Reality: Make what the market wants with resources Managing input and outputs that are available. Yes, there are limitations, but mills and yards were not without options. In terms of producing sawn lumber products, the timber resource within each sawmill and lumber yard wood As these business types are production-based, op- basket determines what can and cannot be produced. eration costs are spread across processed volumes. Fixed costs plus whatever variable costs are necessary Merchandising logs is effective for altering the species require minimum quantities of production. Therefore, and quality of logs individual mills process. In turn, this there is a baseline of throughput (volume) necessary can influence the product distribution of mill output, to maintain when reducing production in response to a such as less grade lumber and more industrial tim- contracted market.

4 HMR Executive® February 2020

Identifying which items are most advantageous to The shifts to Poplar and Basswood were especially inter- produce for the financial benefit of the business is an- esting. Because of the lower sales prices compared to other component for managing inputs and outputs. So Red Oak, Cherry, and Ash at that time, greater volumes is knowing which species to avoid and knowing what had to be processed to cover manufacturing costs. A to produce from those species when production is no real example of addressing this problem was a yard longer avoidable. that increased total throughput volume 10% from the previous month with Poplar and Basswood, but revenue For more than a year, sawmills and yards strived to decreased 5%. However, demand and pricing for Red avoid producing and processing Red Oak, Cherry, Oak, Cherry, and Ash were in such sharp decline at and Ash. Given the makeup of Eastern US hardwood that time, the 5% variance in revenue from Poplar and forests (Figure 3), they were immensely successful Basswood was a far better outcome than if the shift in restricting production input of these species. They also species had not been made. were immensely successful controlling product output by directing a large percentage to industrial lumber and Hard Maple has had a very nice run in the market, timber markets and, as opportunities allowed, to prod- and Soft Maple is popular, too. The trend in species ucts meeting stringent size and quality requirements was certainly beneficial to Upper Midwest and New specified by customers. England producers, where Hard Maple growing stocks are prevalent. However, it was also critical to Appala- Poplar, Basswood, Hard Maple, Soft Maple, and White chian mills and yards by providing a viable alternative Oak have been species of choice for production at dif- to slow–moving, price–sensitive species. The forest ferent times during this past year-and-a-half because A) resource provided options for mills and yards in these they were salable, and B) they had potential for profit. regions.

Figure 3 Eastern US Hardwood Growing Stocks by Species

Other Eastern Black Cherry Hardwoods Yellow Poplar White Oak

Walnut

Basswood

Red Oak Cottonwood & Aspen

Ash

Sweetgum

Tupelo & Blackgum Hickory/Pecan

Beech Yellow Birch Hard Maple Soft Maple Source: US Forest Service Graph: HMR Source: USDA Forest Service Graph: HMR 5 HMR Executive® February 2020

So, chalk one up for expanding production in a contract- those has a part in keeping companies operational at ing market. It would not have been possible without the a time when market conditions say otherwise. But, no proper resource. And, it would have been impossible company can exist without cash. if the business was not there. The fact is, demand for Poplar, Basswood, Hard Maple, Soft Maple, and White It is difficult to imagine any sawmill or lumber yard Oak has been strong during much of this period of staying financially whole for the duration of this current downturn for Red Oak, Cherry, and Ash. downturn in grade lumber business. This has been a time of negative returns. At some point, dipping into As demand and the forest resource dictated, Red Oak, cash reserves funded by previously earned profits Cherry, and Ash production was steered toward indus- has been necessary. In cases – likely most cases – trial markets to the extent possible. As with processing inventory assets have been used to offset revenue the better moving species, producing ties, board road, shortfalls. crane mats, timber, and pallet material was a viable op- tion for sawmills only because the business was there. In general, the depth of inventory assets amounts to a few months for most lumber yards … perhaps several months Staying Power when factoring in the species and thicknesses of lumber How have hardwood businesses endured such a crush- involved. For larger sawmills, timber can be purchased as ing downturn in demand and pricing for high-valued long as a year or two in advance of intended use. Small grade lumber for what is now over a year-and-a-half? mill inventories can be a few weeks to essentially none at all. Whatever inventory has been available has helped We can discuss things like commitment, ingenuity, subsidize ongoing operations. The larger the inventory resiliency, and even luck if you choose. Each one of asset, the longer companies can exist.

8,0008,000

7,0007,000

6,0006,000

5,0005,000

4,0004,000 Million Board Feet Million Board Feet Million Board 3,0003,000

2,0002,000

1,0001,000

00 Jan FebFeb MarMar AprilApr MayMay JuneJun JulyJul AugAug SepSep OctOct NovNov DecDec 2016 2017 2018 2019

6 HMR Executive® February 2020

"During this market downturn, we have Some sawmills and lumber yards are operating reduced witnessed reductions in production of hours as a means to limit production volumes. Some slow moving, price sensitive species. sawmills and yards have ceased operations altogeth- There has been a meaningful shift in er, though far fewer than the harsh market conditions would suggest. production of these same species from grade lumber to industrial products." Among the options, running unabated is hardly a good choice unless raw material costs are aligned with sales Collateral Damage volumes and values. There has been progress on this Different companies have different circumstances. front, but again, more work is needed. Running at re- Some have been more successful than others in miti- duced rates has its problems, including higher unit man- gating the effects of contracted demand and prices for ufacturing costs. Shuttering operations is expensive and traditionally high valued lumber products. Again, how has long-lasting effects. There are options, but there is no the local forest resource aligns with demand is key to simple solution when it comes to contracting business. the results. The supply side of the US hardwood marketplace has During this market downturn, we have witnessed re- experienced all of these changes from mills and yards ductions in production of slow moving, price sensitive attempting to recalibrate production with demand. But, species. There has been a meaningful shift in pro- the thread that connects each of these actions and, duction of these same species from grade lumber to frankly, each company involved, is that the supply side industrial products. of the marketplace has been financing loses for more than a year. At this point in time, the changes in production have provided significant relief in supplies of certain grade The toll being paid by hardwood lumber producers is lumber items, but it is premature to consider this accom- impactful, but the final results are not yet known. How plishment much more than progress; the marketplace much more staying power do sawmills and concentra- is still unsettled. Furthermore, increases in Poplar and tion yards have? How many more assets do companies industrial product output, for example, have elevated have left to subsidize business after this extended pe- supplies of those items – some to the point of excess. riod of time? How many more of those assets are they

continued next page

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November 2018 Issue 11 ~ Volume III~

Market Commentary

Lead Story – Tariff Payments Climb 50% - In the January Issue ... Current Trends US companies spent $4.4 billion on import tariff payments in September 2018, up from $2.9 billion in September 2017. The Harvard Joint Cen- This according to a study by the Trade Partnership, an an 8.0% ter for Housing Studies ti-tariff consulting firm, on behalf of the Tariffs Hurt the 7.0% expects growth in US homeowner spending Heartland campaign. The study also found that US exports US imports of tropical hardwood lumber increased from every tropical region during 6.0% on improvements and of products subject to retaliatory tariffs by other countries 5.0% - repairs to reach 7.7% in were 26%, or $2.5 billion, lower this September than last.

4.0% 2018 and remain above The Trump Administration has planned to raise tariffs on

Q3-19

Q2-19

Q1-19 6% in 2019. Q4-18

3.0% Q3-18 Q2-18

Q1-18

Q4-17

Q3-17

Q2-17

Q1-17

Q4-16

Q3-16 hardwood lumber and a host of other wood products im

Q2-16

Q1-16 Q4-15 the first 11 months of 2019 compared to the same period in 2018. However, growth Q3-15 ported from China from the current rate of 10% to as high as 25% on January 1, 2019. - US imports of hardwood was much stronger from one region than all others. Read the January HMR Import lumber from Russia are on Market Overview pace to total 964,667 BF- North American markets for tropical hardwood lumber per in 2018. Shipments aver formed well during the last 30 days, according to surveyed aged 2,324,206 BF annually importers and distributors. Reports were decidedly more Newsletter for full details on trade flows and much, much more. during the preceding 10 upbeat from contacts in the East than in the West, which TM years. was in sharp contrast to the previous two months. Several import sales operations have decent order files for the last continue six weeks of the year, while others expect business to be

© 2018 HMR: It is illegal to photocopy, reproduce, sell, publish, broadcast, or Quarterly US Imports of- transmit this publication in any way, in whole or in part, without the express Sapele and African Ma written permission of the owner. hogany Lumber click here

Monthly US Import Values of Tropical and Temperate Hardwood Lumber from non-Canadian Sources Tropical Value -5% Year-over-Year Jan. - Sep. 2018 $30$30 ® 7 $25$25 HMR TropicalExecutive $20$20 Temperate

$15$15

Graph: HMR $10$10

Million US Dollars US Million Temperate Value -2% Year-over-Year Jan. - Sep. 2018

Sep-18

Jun-18

Jun-18 Mar-18

$5$5 Mar-18

Dec-17

Sep-17

Jun-17

Source: US International Trade Commission Jun-17

Mar-17

Dec-16 Dec-16

$0 Sep-16 Sep-16

$0 Jun-16

Jun-16

Mar-16

Dec-15

Sep-15 Sep-15 February 2020 willing to invest? throughout this industry’s history when the supply side of the marketplace faced seemingly insurmountable Will grade lumber markets improve and reverse the odds with no clear solution. It survived then, and it will trend in contraction? If so, will it happen soon enough survive these present challenges. to prevent lost production capacity? Even then, will all hardwood producers be able to participate in a market As long as there is opportunity – meaning, a positive rebound that undoubtedly will fuel higher prices for logs market force created by either supply correction, in- and green lumber? creased demand, or a combination of both – hardwood producers will be compelled to change with that market US hardwood producers have been financially strained force. After all, it’s physics. and, in many cases damaged. Yet, it is shortsighted to count this group out. There have been other times Anyone for an apple?

Figure 5 ConsumptionEastern byUS IndustrialHardwood Product Production Markets 13,00013,000 Proudction Peaked in 1999 at an est. 12,619,000,000 board feet 12,00012,000

11,00011,000 Estimated 60 year average is 9,318,760,300 10,00010,000 board feet.

9,0009,000 2018 production was 8,182,436,400 BF, 8,0008,000 down 1.5% from 2017. Million Board Feet Million Board

MILLION BOARD MILLION BOARD FEET 7,0007,000 2019 production was 1960 est. 7,593,963,200 BF, down 7,672,500,000 7.2% from 2018. 6,0006,000 board feet

5,0005,000 Sources: US Census Bureau, US Forest Service, and HMR Graph: HMR 4,0004,000 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019

1960 20111961 1962 1963 1964 1965 1966 1967 20121968 1969 1970 1971 1972 1973 20131974 1975 1976 1977 1978 1979 1980 20141981 1982 1983 1984 1985 1986 1987 20151988 1989 1990 1991 1992 1993 20161994 1995 1996 1997 1998 1999 2000 20172001 2002 2003 2004 2005 2006 2007 20182008 2009 2010 2011 2012 2013 2014 20192015 2016 2017 2018 2019

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8 HMR Executive®