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Our Favorite Way to Invest in a Rebounding Housing Market

Canadian lumber producer Canfor should see its profitability grow alongside demand for houses in the U.S., says Morningstar’s Charles Gross.

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Charles Gross: U.S. housing demand has been strong during the first quarter of 2016, with starts growing 15% year-over-year on a seasonally adjusted basis. Better yet, single family starts were up 20% in the quarter, thanks to upward revisions for January and February.

Since 2007, starts have remained depressed by historical standards. As millennials age, they become more likely to rent or own property. Vacancies are already being soaked up by new households, after which point, robust homebuilding activity will be required to meet housing demand. Although new home prices are at all-time highs, this should drive starts higher as homebuilders seek to capitalize on an attractive pricing environment.

We expect housing demand to remain robust as the labor market continues to tighten, putting upward pressure on wages. More accommodating lending standards by banks, matched with rates at their lowest levels since 2013 should further bolster U.S. housing demand.

We believe these conditions could lead to starts growing nearly 75% to 1.9 million by 2019, before fading to a demographically sustainable 1.5 million starts in 2024. Canfor Corp., a Canadian lumber producer, is our favorite way to play a rebound in U.S. housing demand. Softwood lumber demand is primarily driven by U.S. homebuilding. We expect constrained capacity to lead to substantially higher softwood lumber prices, nearly tripling operating margins by 2019. Although the stock can be volatile, we believe it will be worthwhile as Canfor currently trades at a steep 45% discount to our fair value estimate.

Charles Gross does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.