Four stocks to ride the U.S. real estate rebound

As U.S. housing demand gains momentum, it fuels the growth of production, prices and profitability of companies that feed on homebuilding activity. The trend has created attractive investment opportunities in select Canadian and U.S. companies that benefit both from an uptick in demand for their goods and services, and the U.S. dollar strength, according to Morningstar equity research.

 Norbord (OSB) is one of the largest global producers of oriented strand board (OSB) used as a structural panel for building applications. It produces and sells wall and flooring panels, as well as boards for decking, roofing, shelving and furniture in the U.S., Canada and Northern Europe.

The five-star-rated company rode on the back of rising U.S. housing starts in the fourth quarter of 2015 to register an 11% growth in shipments of OSB, Morningstar equity analyst Charles Gross said in a report.

“In 2016, strong growth in housing starts will push OSB composite prices up 18%,” Gross said. This growth outlook, combined with a weaker loonie, prompted him to raise the stock’s fair value from $31 to $34, implying “a larger Canadian dollar value for Norbord's future cash flows, which are generated largely in the U.S.”

He forecasted robust profit growth for Norbord's North American OSB business (70% of revenue) over the next several years. Favourable demographics, a tighter labour market and looser mortgage rules could spur a major improvement in homebuilding activity, creating a positive tailwind for Norbord’s business, added Gross.

 West Fraser Timber (WFT) is one of the largest softwood lumber producers in the world. The firm has 6.2 billion board feet of production capacity split between Western Canada (63% of the total) and the Southeastern United States (37%).

“Despite challenging market conditions, West Fraser has been reinvesting in its business with an eye on housing recovery,” Gross said in a Morningstar equity report. “The company bought lumber capacity in the Southeastern U.S. and Alberta, amplifying its exposure to a U.S. housing upturn.”

The company is paring back its reliance on Canadian production, which is hampered by the mountain pine beetle infestation of regional forests.

Gross forecasted sound profit growth for West Fraser's lumber and panel businesses, which accounts for about 80% of revenue. Further, as the company translates U.S. revenue into a weaker Canadian dollar, revenues and EBITDA margin will prove stronger, which prompted Gross to increase the stock’s fair value to $70 from $65. “We see lumber and panel EBITDA rising to roughly $1.5 billion in 2019, from about $400 million in 2015, as the housing cycle turns in West Fraser's favour,” he said.

A well-known brand in the global commercial real estate industry,  Jones Lang LaSalle (JLL) serves real estate owners, occupiers and investors in nearly 80 countries. The five-star-rated firm's many industry awards and recognitions include a nod by Forbes as one of America's Most Trustworthy Companies.

“The firm is well positioned to win a larger share of commercial real estate services (CRE),” said a Morningstar equity report, noting that “organizations are increasingly willing to outsource the non-core tasks of managing their property needs” to firms like JLL that can handle all of a company's CRE-related requirements globally.

While it operates in a cyclical industry, JLL's business is geographically diversified, with more than half of its revenue from locations with a functional currency other than the U.S. dollar, said Morningstar sector director Stephen Ellis, who recently upped the stock’s fair value to US$172 from US$169.

“JLL has rapidly expanded its business over the years, through both internal growth and strategic acquisitions,” Ellis said. Due to its scope and scale, JLL is among a handful of firms that can realistically bid for the largest commercial real estate deals, thus gaining access to a larger market than smaller peers, he added.

 Ventas (VTR) is a real estate investment trust that owns roughly 1,300 healthcare properties including senior housing communities (58% of net operating income), medical office buildings (20%), hospitals (13%) and skilled nursing facilities (4%). These properties are located throughout the United States and in two Canadian provinces.

“Ventas's strategy allows it to consider a range of opportunities across property type, leasing model and means of external growth, each of which may be more or less attractive at any point in the commercial real estate cycle,” Ellis said in a Morningstar equity report.

Ellis asserted that the long-term demand outlook for healthcare real estate bodes well for the company’s growth prospects. “Ventas will continue to benefit from in-place long-term leases, well-located senior housing properties, and future opportunities for profitable external growth,” he said.

Calling management's capital-allocation strategies exemplary, Ellis said the company has increased its dividend 9% a year on average since 2001, with the total average annual shareholder returns of 13% since going public in 1997. Ellis recently revised the stock’s fair value from US$ 81 to US$83, incorporating a mid-5% cap rate -- net operating income (NOI) divided by the current market value of the property -- on the 2016 NOI forecast, and a 3.6% dividend yield.

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