Bank of America Materials Analyst George Staphos joins Yahoo Finance Live to discuss the outlook for materials, global recessionary risks, the operating rate, and why the bank downgraded housing and building products.

Video Transcript

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BRIAN SOZZI: Welcome back. The materials space is under increasing pressure as global recession fears kick into overdrive. That has caused B of A to make a few key stock calls from within the sector. Joining us now to discuss is George Staphos, Bank of America Materials Analyst. George, good to see you here. So all morning long, we've been talking about recession, perhaps seeing something more than a mild recession in the United States. How does that impact your coverage list?

GEORGE STAPHOS: Well, certainly-- and first of all, thanks for having me here this morning. My universe covers everything from more consumer-oriented companies more cyclical industrial companies. Certainly, the areas that I look at that are more impacted by the economy include containerboard and corrugated, and certainly wood products, lumber, oriented strand board, and those sorts of materials.

- OK. So based upon what you've been tracking, how does that then dovetail into key sectors of the economy right now that are seeing weakness-- especially, as we were discussing earlier, in the homebuilding space, where some of those materials are being looked for, but they're hard to come by?

GEORGE STAPHOS: Yeah, sure. So specific to that sector, we cover the lumber and oriented strand board space. And those are materials that are used to frame and sheet homes as they're going up, and certainly also use quite a bit in terms of repair remodel activity.

And so what we do is we pivot off of what our colleagues in B of A are saying about homebuilding and repair remodel activity. And then that we run through our supply-demand models, we come up with a price forecast. And then we take that through our earnings models and, ultimately, a valuation and a stock call. And we recently had the opportunity to take our new forecasts as a team through our models, and we wound up downgrading Louisiana-Pacific to underperform from neutral and warehouses to neutral from a buy rating.

BRIAN SOZZI: George, I think the market is still shocked from what they heard out of FedEx. Now, FedEx ships boxes. Now, when you talk to your packaging players, do those executives tell you-- or does it feel like this is a global economy already in a recession?

GEORGE STAPHOS: Certainly, what we've seen from our industry data in the corrugated sector suggests things are weakening. And I'll go back to some of the things that we said in our past research. First of, all B of A, we have done a proprietary survey on corrugated boxes going back about 20 years. And the readings that we've been seeing in our box survey are continuing to weaken. That's one point.

Number two, as a firm, we do a global supply-demand model on containerboard. And that's the paperboard that goes into corrugated boxes. And even before things were starting to weaken further, we were looking for a 300-basis-point drop in operating rates this year globally in the containerboard sector. And so that was one of the reasons we were not recommending many of the containerboard companies. And we had downgraded some of them back in January.

And then lastly, we refer to what comes out of our trade press, our dialogues. And also, that tone has been weakening as well, as we've discussed in our past research.

- Certainly. And so what can we glean into and correlate to the end consumer from all of the materials downgrades-- not just downgrades, but particularly the lowering of some of the outlooks from materials companies that we've seen over recent weeks?

GEORGE STAPHOS: Yeah, sure. I guess I would lead you to a couple of things. All products have a cycle to them. Consumer spending has a cycle to it. And what drives it both is cycles tend to overshoot on the demand side and undershoot on the demand side. And also, cost curves can move up and down.

And what that basically means is that when you're in a period where things are going really, really well, demand and pricing tends to overshoot because you're interested in getting something that might be in short supply that you've had difficulty obtaining, as you were mentioning in your opening remarks.

When you start to feel like maybe I'll be able to get that product because I think inventory levels are getting better, you pull back, and you wait to see how far prices might drop. And so we're in that period right now where supply chains, at least from the ones that we look at for corrugated, for wood products, and all the other markets that we look at, are starting to normalize and stabilize.

For example, in the containerboard space, which, again, is the paperboard that feeds corrugated boxes, that market was white hot last year, very, very tight in terms of operating rates. As we mentioned, we're seeing operating rates now beginning to decline. And supply is starting to come into the market in containerboard in North America and globally.

In turn, we're forecasting as a firm prices in containerboard to drop about $30 per ton through the beginning of next year, which in turn is leading to-- and this expectation is out there in the market as well-- buyers starting to pull back in terms of their purchase of containerboard. And you're also seeing from the trade press consumers aren't seeing the normal pickup in demand in boxes that you normally see in September ahead of the holidays. So cycles tend to move up and down and overshoot on demand, and we're seeing that pullback right now. And that's pretty normal.

BRIAN SOZZI: And George, within your coverage universe, are there certain stocks that have still not sold off enough, that you crunch the numbers again, and you think, wow, this stock has another 10%-plus downside?

GEORGE STAPHOS: Well, sure. We came in to this meeting today talking about some of the wood product names. And so in B of A, we tend to look at our ratings on a relative basis versus the rest of the market and the rest of our coverage. So whether or not stocks will correct 10% off to where they're at or not, one of the names that we did downgrade to underperform-- very fine company-- is Louisiana-Pacific, where we think that numbers will likely have to come down for LP because what we're seeing in the cycle.

You're likely to see OSB-- that's oriented strand board, one of their two key products-- likely to move from roughly, right now, about $360 per 1,000 square feet as the benchmark price to around $300 or so, if we're correct, by the end of this year as you see some destocking and a reduction in demand. And that reduction in pricing will feed through into lower earnings estimates.

And right now, I believe we're below the Street. And likely, in turn, you'll see LPX lag the market. And in terms of the way we position that, that would be an underperform rating even though it's a fine company.

- Yeah. It's been some really important previews that we've been getting from materials names over the course of the past two weeks. George, thanks for helping us break these down and joining us this morning. George Staphos, who is the Bank of America materials analyst, appreciate it.