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Sell Lumber Liquidators, But Buy Lumber Futures

Lumber Liquidators (LL) has been under pressure since the start of the month.

A 60 Minutes report revealed that some of the company’s products contained unhealthy levels of formaldehyde.

Apparently the company sourced this wood from China at a 10% discount to the going rate (for now-obvious reasons) to make a few basis points on its market share.

Now consumers and the press are out for blood. Not surprisingly, the company’s stock plummeted.

While it’s definitely time to sell LL stock, don’t shun the lumber industry altogether. The scandal has opened up some new opportunities that could pay big.

Burning at the Media Stake

60 Minutes tested Lumber Liquidators’ flooring in Virginia, Florida, Texas, Illinois, and New York, and found that only one in 31 samples of Chinese-made laminate flooring was compliant with formaldehyde emissions standards. Some samples were over 13 times the California limit!

The flooring is made with compressed saw wood and saturated with formaldehyde to give it a drywall-like consistency and appearance.

Because of the scandal, Lumber Liquidators’ stock lost about 45% of its value since February 24.

Going Down in Flames: Lumber Liquidators Stock Price

Some investors are saying that the company is ripe for bottom fishing, as they believe the stock will rise again after the news cycle moves on. But I say it’s better to short.

Whether the stock will recover is dependent on what deeper investigations and lawsuits reveal.

The question is: Did the company know it was selling toxic wood? We’ll get more details, but likely not the full answer, next week.

What we do know now is that Lumber Liquidators didn’t participate in the Raymond James Annual Institutional Investors Conference, which was held this week. Instead, the company will hold a conference call on March 12 and provide a business update to its investors.

Whatever the outcome, unless Lumber Liquidators drastically and immediately changes its policies, I would short and cover below $15 per share in light of the plethora of lawsuits headed its way.

But that doesn’t mean there isn’t an opportunity to cash in…

Indeed, lumber prices in general might be heading south. But, unlike Lumber Liquidators, it may actually be time to buy.

Looking Under Charred Bark

There are two reasons I think lumber futures are a good idea right now.

First, from a technical standpoint, the markets are approaching oversold levels. While moving averages are still pointing lower, there’s some decent support below $280.

Secondly, because of Lumber Liquidators’ current controversy, households and businesses seeking flooring have one less vendor to choose from. Plus, lumber buyers will more likely pay a premium for quality flooring now that health risks are on their radar.

Toxic Scandal Opens Up Demand: Random-Length Lumber Futures Contract

Just think of all of the tens of thousands of households in California alone that are looking to replace their formaldehyde-infused homes.

Investors should be aware, though, that lumber futures can be unpredictable and volatile. Supplies can change due to mill closings, environmental policies, and a myriad of economic statistics released almost daily.

Demand also tends to shift rapidly based on interest rates, currency rates, and the rate of new housing projects. Lumber isn’t a buy-and-hold kind of trade, but rather a tactical one with eyes focused well beyond pure lumber and more broadly on macro moves.

Reading Between the Tree Rings

Of course, like all commodity futures, there are contract restrictions. These are enforced in terms of the species of the tree wood delivered and the locations of the provider’s mills, which can be found on cmegroup.com.

Each lumber contract represents 110,000 board feet (bd. ft.) of random length 2x4s. The price point descriptions are 1 point = $0.10 per 1,000 bd. ft., or $11 per contract. Contract for delivery months are January, March, May, July, September, and November.

I also suggest learning the production cycles of lumber cultivation and processing. This knowledge should be combined with an understanding of economic factors that affect each aspect of getting the lumber from forest to jobsite.

Traders should also examine the relationship between worldwide economic conditions and lumber prices and trends.

For instance, the lumber market had been looking to China to add more stimulus. But Premier Li Keqiang’s recent work report outlined a lower growth target of 7%, the slowest in 24 years.

Good investing,

Shelley Goldberg

Shelley Goldberg

, Senior Correspondent

View More By Shelley Goldberg