[Updated on June 27, 2017]
A long-standing trade rift between Canada and the United States has intensified in recent months after U.S. President Donald Trump slapped a hefty import duty on Canadian softwood lumber. The trade rift soon devolved into a minor diplomatic row between the neighbors, who share the world’s longest land border and one of the deepest trade ties.
Canada-U.S. trade relations took a turn for the worse in April after President Trump announced a 20% tariff on Canadian softwood lumber. The anti-subsidy duties, which threaten to spill over into several other sectors, are a major blow to Canada’s $22 billion lumber industry, which employs more than 200,000 people, including indigenous communities. To lessen the economic blowback, Canada announced an $867 million aid package for softwood lumber producers.
U.S. Imposes Countervailing Duties
The United States has levied countervailing duties on Canadian lumber imports ranging from 3% to 24%. Countervailing duties are used to level the playing field when one country believes its trade partner’s product is unfairly subsidized. President Trump’s stated objective is to “make America great again,” and he’s seeking to re-negotiate trade deals he believes are unfair for his country. From a North American perspective, this means creating a more competitive lumber industry.
The five Canadian companies affected by the import duty are outlined below, along with their respective tax rates:
- Canfor: 20.26%
- Resolute: 12.82%
- Tolko: 19.50%
- West Fraser: 24.12%
All other Canadian imports will be subject to duties of 19.88%. In some cases, taxes will be levied on a retroactive basis going as far back as 90 days.
Click here to read about why owning timber REITs and letting dividends compound could be one of the best producers of wealth.
Anti-Dumping Duties Set to Begin
The United States announced a preliminary determination in the anti-dumping duty investigation of softwood lumber from Canada on June 26, 2017. The final determination in the investigation will be announced on September 7, 2017. An anti-dumping duty is a protectionist tariff that a country places on imports that, it believes, are priced below fair market value.
The announced anti-dumping rates are within a range of 4.59% to 7.72%, which will be levied on top of the countervailing duties announced earlier. This will bring the combined duties, including the countervailing and anti-dumping duties, within a range of 17.41% to 30.88%. The announced dumping rates on several Canadian companies are outlined below:
- Canfor: 7.72%
- Resolute: 4.59%
- Tolko: 7.53%
- West Fraser: 6.76%
- All Others: 6.87%
The combined tax rate will come into effect sometime next year. Canadian companies will not be able to file for arbitration until the combined tax rate is implemented, leading to a potentially long and costly process (for starters, Canada must wait at least two years before it can challenge the duties).
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Impact on Canadian Companies
The Conference Board of Canada says Canadian softwood producers will pay $1.7 billion in duties a year, resulting in 2,200 job cuts and $700 million in lost U.S. export revenue over the next two years. Canada’s export- and commodity-driven economy is expected to be heavily impacted by the latest round of tariffs, not to mention Washington’s increasingly protectionist rhetoric.
In 2016, Canada’s top-five softwood lumber producers (in order) were: West Fraser, Canfor, Tolko, Resolute FP and Western FP.
There are already signs that Canadian producers are suffering from President Trump’s protectionist policies. Interfor, which operates on both sides of the border, saw its share price plunge nearly 10% during the month of May. West Fraser saw its share price plunge 7% before rebounding to break even for the month. Despite having to pay a much smaller tariff, Maritime producer J.D. Irving also faces an unclear future.
Impact on U.S. Companies
For U.S. lumber companies, the new trade barriers facing Canadian producers provide an opportunity for increasing critical market share. Weyerhaeuser Co (WY ) and Georgia-Pacific (now a part of Koch Industries), America’s two biggest softwood lumber producers, are ideally situated to capitalize on the demand. In 2016, these companies produced 3,640 million Bf and 2,507 million Bf 2016 of lumber, respectively. That represents an annual increase of 7% apiece.
In 2016, the top-five U.S. softwood lumber companies accounted for 36.3% of total U.S. shipments. Rounding out the top-five are West Fraser, Sierra Pacific and Interfor.
The latest wave of protectionist policies has yet to benefit U.S. lumber stocks. Weyerhaeuser broke even during the month of May. The same fate befell CatchMark Timber Trust (CTT ), a Georgia-based company with investments in the prime timberlands industry.
Check out here how US is using Lumber as a bargaining chip in NAFTA renegotiation and also, about the history of the dispute.
Strategic Lumber Plays Over the Next Two Years
For income investors looking to navigate the volatile lumber investment climate over the next two years, it’s important to develop a strategic approach to the sector. This means investing in companies that have operations in both the United States and Canada. These companies offer a potential hedge over the next two years while duties are in place and in the years after that should Canada successfully challenge the order.
West Fraser fits this bill perfectly. The company is Canada’s top softwood producer and the third-largest producer south of the border. Between its Canadian and U.S. operations, West Fraser produced 5,935 million Bf of lumber in 2016. Share prices have also surged this year, giving the company a market cap of nearly $5 billion.
Canfor is another company with operations on both sides of the border, ranking No. 2 in Canada and No. 7 in the U.S. Canfor’s stock has rebounded this year after declining sharply through 2015 and 2016. It continues to trade well below its peak, which could provide a good opportunity to buy on discount should its U.S. operations scale up quickly.
In this environment, it may be beneficial to avoid Canadian companies entirely, and instead focus on U.S. producers keen on snatching up market share. However, before adding them to your portfolio, consider whether they have the capacity to scale up to meet demand. A publicly-listed company like Weyerhaeuser, which has a dividend yield of 3.73% market cap of nearly $25 billion, certainly fits the bill. Another potential gainer is Universal Forest Products (UFPI ), which has enjoyed strong performance over the past five years.
The Bottom Line
If history is any indication, it’ll be a while before Canadian producers rebound from U.S. protectionism. It took Canada four years to negotiate an agreement during the previous softwood dispute with its southern neighbor, resulting in the loss of 15,000 workers in the first year alone. Canadian producers paid about $5 billion in duties during the previous dispute, 80% of which had to be reimbursed as part of the settlement.
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