Industries that come to mind for many dividend investors include perennial favorites such as consumer staples, utilities and healthcare. These sectors tend to provide predictable earnings, low capital expenditures and high levels of free cash flow. Those conditions are terrific for dividends, and those sectors tend to pay above-market yields as a result.
Commodities sectors may not necessarily come to mind, as they tend to be much more volatile in terms of revenue and earnings. This can lead to volatile dividend payments, which is generally undesirable for investors looking to rely upon income from their investment capital.
While it’s true that many commodities such as coal, natural gas, or even precious metals mining can be highly volatile, one commodity that has companies with good growth and dividend prospects is lumber stocks. In this article, we’ll take a look at the industry itself, as well as three companies we like in the sector for dividends and growth.
Lumber Stocks: A Look at the Industry
Lumber is a ubiquitous commodity that is integral to countless applications, particularly in construction. Buildings, residential dwellings, outdoor structures and just about any other kind of permanent structure requires a large amount of lumber, which helps stoke demand over time.
Given this, lumber is highly sensitive to the construction industry, the latter of which is sensitive to economic conditions. When the economy is strong, investment in new construction tends to be high. That fuels demand for lumber and prices can soar.
Wood products are also used in things like paper manufacturing, creating pellets for energy, and much more. These tend to be less cyclical than construction, and indeed, the companies in our list below are more heavily levered to these less cyclical uses of lumber, which helps them generate the cash to pay and raise their dividends.
Lumber demand is impacted by the strength of the economy, which drives construction activity. But lumber is also subject to availability of certain types of wood, environmental conditions such as fungi or diseases that can impact crop availability, and of course, inflation.
As with any commodity, if inflation expectations rise, the prices of commodities tend to rise in sympathy. That can lead to big swings in lumber pricing, which impacts profitability for the companies that rely upon it for revenue and earnings in one way or another.
Even considering these factors, we think that given the right choices for which components to invest in, lumber can be a great place for dividends and growth. Three lumber stocks to consider for dividends are:
Lumber Stocks: WestRock (WRK)
Our first example of lumber stocks for dividends and growth is WestRock, a company that provides paper and packaging solutions globally. WestRock produces products like containerboards, corrugated sheets for boxes, as well as operating recycling facilities. The company has a large consumer business as well, producing similar products for consumer products.
WestRock is a sizable company, generating more than $20 billion in annual revenue, while trading with a market capitalization of nearly $14 billion.
The company’s dividend history has been somewhat spotty, given it cut the distribution in the recent past. However, the current dividend of $1 per share annually is good for a yield of just over 2%, which is well in excess of the 1.2% average yield of the S&P 500. The dividend cut also reset the payout ratio much lower, as it now stands at just 21% of earnings. That leaves plenty of room for further increases from the current level.
We see WestRock producing 2% annual earnings growth from here, as the company is largely operating in mature markets. Demand for corrugated boxes and consumer packaging continues to rise, but given all competitors offer essentially the same product in these cases, pricing power is nearly nonexistent. Over time, that puts pressure on margins, but we like WestRock for its current yield and dividend growth potential.
International Paper (IP)
Our next stock is International Paper, a company that competes with WestRock globally for paper and packaging products. The company also makes things like containerboards and linings, as well as pulp products for end-user products like diapers, tissue products and more.
International Paper is of similar size to WestRock on revenue, also coming in at about $13 billion, annually, and its market capitalization is just over $18 billion.
We see International Paper with growth prospects of 4% annually, which again is due to fairly mature markets with stable but low growth and intense pricing competition. International Paper has scale on its side, but in a commodity industry, pricing is an ever-present risk.
International Paper does have a very strong yield, which comes in just under 4% today. That puts it at more than three times that of the S&P 500, so on a pure income basis, it’s a terrific stock. We also estimate the current payout ratio at just 40% of earnings, so the company has a long runway of potential dividend growth in front of it.
Lumber Stocks: Amcor (AMCR)
Our final entry on this list of lumber stocks is Amcor, a company that develops, produces and sells packaging products for food, beverage, pharmaceutical, medical and other products globally. The company operates through two segments, called flexibles and rigid packaging, respectively. Through these segments it produces various packaging and carton solutions, as well as bottles and jars.
Amcor is also expected to produce just over $13 billion in revenue this year, and trades with a market capitalization of $17 billion.
We see Amcor with the potential to produce 5% annual earnings growth from today’s levels, driven by ever-increasing demand for its specialty products, and its exposure to faster-growing markets, such as parts of Latin America.
Amcor’s dividend yield is the best of the bunch at 4.2%, and the payout ratio is reasonable at 60% of earnings. That makes Amcor a more favorable choice for investors looking for more current income, but with the potential for a bit less dividend growth down the road.
Final Thoughts
While lumber stocks may not come to mind first for dividend investors, we believe that if chosen carefully, companies in the sector can provide strong current yield and dividend growth potential.
The three examples highlighted here – WestRock, International Paper and Amcor – offer varying degrees of current yield and dividend growth potential. But all offer exposure to an often-forgotten commodity in a much less volatile fashion than owning the commodity itself.
