The Most Depressed Industry In North America

"This town is dead," snarled Jim Rimmel.

Jim lives in Mackenzie, British Columbia. Mackenzie is a beautiful small town in western Canada. Lakes, mountains, and forests surround it for hundreds of miles in every direction. Tourists love Mackenzie. They come for the lakes in the summer and the snowmobiling, skiing, and skating in the winter. The town's population is 4,500 people, but its workforce is more like 2,200.

Apart from tourists, MacKenzie has only one other source of employment: the logging industry. Three or four major Canadian forest companies operate sawmills there... or, at least, they used to.

You see, over the past few years, Canadian logging companies have been closing their sawmills in Mackenzie. The big blow came this summer. Logging giant Canfor announced it will close its Mackenzie mill. This will ultimately cost Mackenzie 450 jobs at the mill and another 400 or so trucking jobs in the area. Jim was one of the casualties.

"Forestry, to us, is the backbone of our economy here," said the mayor when she heard the news. "In fact, we're considered the most forest-dependent community in B.C. This indefinite shutdown is devastating."

We've written at length about the natural resources boom taking place in western Canada. By now, you're familiar with the Athabasca oil sands, the coal mines in Elk Valley, the gold and silver deposits in the Yukon, the bull market in corn and wheat from the prairies, and the natural gas rush in Alberta...

But there's one Canadian natural resource that no one wants. And it's arguably the most important product to many of the small towns in Canada's interior... towns like Mackenzie. I'm talking about forest products.

I think the Canadian forest products industry may be the most depressed industry in the whole of North America right now. The exact figures are hard to find, but from my research this weekend, I'd estimate forest companies across Canada have closed almost 100 sawmills, pulp mills, and paper mills over the past five years. These shutdowns have eliminated more than 20,000 Canadian jobs.

Here is a list of reasons for this misery:

1. The Internet. Demand for paper for newspaper and telephone-directory production is falling off a cliff as users turn to the Internet for news and information. North American consumption of newsprint has fallen 60% since the late 1980s, per unit of real GDP.

2. The U.S. housing slump. Construction of new houses has slowed dramatically and so has demand for lumber. Lumber prices are close to their lowest levels of the last 15 years.

3. Mills use enormous quantities of energy. Energy prices are rising fast.

4. Canadian forestry companies export – on average – 85% of their products to U.S. and Asia. The Canadian dollar's bull market (it has increased 60% against the U.S. dollar in the last five years) has undermined revenues. One medium–sized paper company I looked at loses $200,000 in profits for every penny the Canadian "loonie" moves toward the U.S. dollar. The soft-lumber trade dispute with the U.S. government has made the situation worse.

5. Unions on strike. Many mill workers in British Columbia are members of the United Steelworkers Union. The union has been on strike for two months. This has virtually shuttered the entire coastal logging and paper industry for the past two months. Many companies may not survive.

6. Pests. According to the Canadian Ministry of Forests, the mountain pine beetle will kill more than 75% of B.C.'s marketable pine forests in the next eight years. If trends don't change, the beetle will cripple B.C.'s timber industry in the long term.

As you can probably guess, stock prices of the major forest and paper companies in Canada have taken a beating. Most of them haven't turned a profit in five years. They are trying desperately to cut costs by closing mills and laying off workers.

Here's the thing: Investors have beaten down the stock prices in this sector so far, I just can't see any more downside. Buying into distress like this can feel crazy, but no downside is really the ultimate protection for investors. You can't lose.

The stock market always overreacts. In booming industries, investors get carried away and push prices too high. The situation in this catastrophic industry is the opposite. I think investors have become more disgusted than the situation warrants... and they've dumped shares, even though they were already too cheap.

In other words, the market has overreacted on the downside. I think the brave investors who buy into these depressed stocks will get a nice return as prices catch back up with reality, even if the industry stays in the doldrums for a while.

The trick is, pick the survivors and wait until an uptrend forms in their stock prices. We haven't reached that point yet though...

Good investing,

Tom