UNIVERSITY OF MINNESOTA

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1 UNIVERSITY OF MINNESOTA DEPARTMENT OF BIO-BASED PRODUCTS CASE STUDY SERIES Department of Bio-based Products College of Natural Resources Kaufert Laboratory 2004 Folwell Avenue St. Paul, MN Phone: Fax: ROOM TO ROAM IN THE WOOD-PLASTIC RESIDENTIAL DECKING MARKET? Sitting on the floor of your new downtown apartment, you spread out the stacks of papers related to your first real project across a number of yet-to-be unpacked boxes. After only two weeks on the job, senior management has tasked your group with reviewing the opportunities related to a new wood-plastic composite technology. The new technology is a new generation of woodplastic composite using a solid phase processing technique, linking wood and polymers at the molecular level. This process allows for products to be extruded into net shapes and yields a product with much improved mechanical properties. In addition to these improved properties, the process allows for a greater proportion of wood to be used in the mixture, improving strength to weight ratios and reducing manufacturing costs. It is estimated that the end product could be comprised of up to percent wood fiber, providing a very attractive use for the corporation s current fiber waste streams. COMPANY OVERVIEW Louisiana-Pacific Corp. (LP) is a major building products firm, operating approximately 50 facilities in the United States and Canada. LP divides its businesses into four business-segments: (1) Structural Products; (2) Exterior Products; (3) Industrial Panel Products and (4) Pulp. With the exception of pulp, LP s products are used primarily in new home construction, repair, remodeling and manufactured housing. LP distributes its building products primarily through third-party distributors and home centers. Assistant Professor Timothy M. Smith prepared this cases as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation Copyright Reproduced with permission of the copyright owner. Further reproduction prohibited without permission. 1

2 STRUCTURAL PRODUCTS LP is one of the largest North America producers of OSB and is a major manufacturer of plywood. OSB is a manufactured composite wood product that is generally used as a lower cost substitute for plywood. These structural panel products are primarily used in new residential construction and remodeling applications such as sub floors, walls and roofs. LP has 15 OSB mills with a combined annual production capacity of approximately 5.8 billion square feet. LP has four plywood mills in the southern United States with a combined annual production capacity of approximately one billion square feet and one plywood mill in Canada with an annual production capacity of approximately 200 million square feet. Certain of these mills also produce veneers used in the manufacture of laminated veneer lumber. LP produces lumber in a variety of standard and specialty grades and sizes, and is one of the largest North American producers of stud lumber. LP has fourteen sawmills in the United States with a combined annual production capacity of approximately 1.2 billion board feet, three sawmills in Canada with a combined annual production of approximately 200 million board feet. LP is one of the largest North American manufacturers of EWP, including I-joists and laminated veneer lumber ("LVL"). LP believes that its engineered I-joists, which are used primarily in residential and commercial flooring and roofing systems and other structural applications, are stronger, lighter and straighter than conventional lumber joists. LP's LVL is a high-grade, valueadded structural product used in applications where extra strength is required, such as headers and beams. It is also used, together with OSB and lumber, in the manufacture of engineered I- joists. LP's mills are generally located in areas that are in close proximity to large and diverse supplies of wood fiber. In areas where LP does not own a significant amount of timberlands, its mills generally have the ability to procure wood fiber at competitive prices from third-party sources. EXTERIOR PRODUCTS LP manufactures exterior siding and other cladding products for the residential and commercial building markets. LP's siding product offerings fall into three categories: (1) OSB siding products, (2) hardboard siding products, (3) and vinyl siding products. These products are distributed through retail outlets and to builders and siding contractors OSB siding products consist of a full line of OSB-based sidings, trim, soffit and facia. These products have quality and performance characteristics similar to solid wood at relatively more attractive prices due to lower raw material and production costs. Additionally, LP produces specialty OSB products. LP manufactures its products at four facilities, which have a combined annual production capacity of approximately 800 million square feet. 2

3 LP's product offerings include a number of lap and panel siding products in a variety of patterns and textures, as well as trim products. LP operates a hardboard siding products facility in the northeastern United States with an annual production capacity of 250 million square feet. In addition, LP's midwest facility has the ability to produce hardboard siding as needed. LP also manufactures vinyl siding products and accessories. These products are available in various styles and colors. LP manufactures these products at two facilities, with a combined annual production capacity of three million squares (i.e., units consisting of 100 square feet of material with an average weight of 32 pounds). INDUSTRIAL PANEL PRODUCTS LP manufactures industrial panel products, particleboard, medium density fiberboard ("MDF"), hardboard and decorative panels, at five plants. The combined annual production capacity of these plants is approximately 320 million square feet of particleboard, 50 million square feet of MDF and 750 million square feet of hardboard and decorative panels. PULP LP has two pulp mills. Pulp accounted for approximately 5% of LP's net sales in WASTE During the production of most above-mentioned products, a certain amount of waste is generated. The majority of this waste comes in the form of sawdust. This sawdust is used to generate power for some of the plants, is sold to composite producers as raw material, and any left over is land filled. Money is saved by not having to land fill the waste and by generating their needed power. Exhibits 1 and 2 provide sales and profits by buisness segment and LPs consolidated income statement for calendar year The following sections represent a synopsis of the available information assembled by one of the marketing analysts in your management team. PLASTIC LUMBER AND WOOD PLASTIC COMPOSITES Five general plastic lumber product categories have been identified in the literature: mixed plastic lumber, HDPE lumber, Glass-reinforced lumber, rubber-plastic lumber, and wood- filled lumber. The $40 to $60 million plastic lumber industry is an emerging growth industry. Since 1995 the market has double each year. Current projections are for the total market to be more than $350 million by 2005 and $600 million by Manufacturers are feeling their way through a myriad of issues as technologies compete to find market areas where their product's 3

4 physical property strengths and weaknesses are appropriately matched. In addition, manufacturers must find distribution channels that will not only satisfy current needs, but also growing future needs - a difficult task for an industry predominately made of small entrepreneurial companies. Plastic lumber products, including wood-plastic composite materials, have typically been relegated to non-structural periphery applications due to comparably weaker mechanical properties to the more traditional wood products. Three primary markets have emerged for plastic lumber: 1) park and recreation, 2) residential decking, and 3) industrial/agricultural. Increased durability, maintenance, and environmental friendliness have allowed plastic lumber to be most successful in the commercial park and recreation industry. Approximately 50%-70% of plastic lumber sold is sold to this segment. Residential decking is thought to account for 10%- 20% of plastic lumber sold, and various industrial (primarily industrial flooring) and agricultural (primarily fencing) applications account for 20%-30%. Woodfiber-plastic composites usually contain recycled or commingled thermoplastics and less than 50 percent wood filler providing enhanced physical properties and production economies. Wood-plastic composites have made significant inroads in automotive applications, exterior construction, and window and door applications. Approximately 142 million pounds of woodplastic composites each year are made into door panels, consoles, roof headliners, and other substrates typically covered with overlays for the automotive industry. Exterior construction applications typically include deck and dock surface boards, landscape timbers, picnic tables, and industrial flooring. Solid wood in window and door components is becoming increasingly sparse and expensive. In addition, extensive cutting, edge gluing, and finger- jointing is necessary to get sufficiently clear sections. In response to these pressures, a number of window and door manufacturers have developed WPC component parts from vinyl and wood residues. Exhibit 3 compares the wood/plastic composition of various commercially available WPC products. THE RESIDENTIAL DECKING MARKET The US Residential Deck Board market has remained fairly stable during the past decade. In 1987, homeowners built 3.6 million decks and spent approximately $4.0 billion on these additions. It was estimated that $1.9 billion was spent on lumber for these decks. Structural members (posts and joists) accounted for 30% of all materials used in decks during 1987, while non-structural members (deck boards, steps, rails and benches) accounted for the remaining 70% of materials used in Using these figures, it is estimated that $1.3 billion was spent on nonstructural decking lumber in Assuming that labor and materials have increased by about 30% to 40% over the past 10 years and comparing R&R activity levels ($101 billion spent in 1988 vs. $114 billion in 1996 and an estimated $125 billion spent in 1997), and new housing starts (1.5 million in 1988 vs. 1.5 million in 1996 and an estimated 1.4 million in 1997), we could look at the total deck market as being roughly a $5.2 to $5.6 billion market in 1997 (labor and materials). The 1997 market for non-structural decking lumber is estimated at $1.7 to $1.8 billion ($1.3 x 1.3/1.4) at the retail level. 4

5 Decking markets have remained stable over the past few years, even in the face of fluctuations in housing starts. This has been due to a wave of deck replacements in the 1990's. Chromate copper arsenate (CCA) decks are not yet due for replacement due to biological degradation; however, due to the aesthetic deterioration typical of pressure-treated lumber after 5-10 years, the market for a viable deck board replacement is expected to be significant in the next few years. In terms of materials, in 1988, pressure-treated lumber represented about 82.5% of the decking materials market followed by redwood (I 1.5%), cedar (3.2%), and other materials (2.8%). Today's decking materials are estimated to consist of the following: See Exhibit 4 for estimates of decking materials market share data. Redwood and cedar are limited by production factors such as access to raw materials, the 46 old growth" forest issue. This limits their potential for expanded market share. Pressure-treated lumber is being attacked by the environmental as a poison. In the decking market this would primarily be CCA among other waterborne formulations. Plastic lumber is spending an extraordinary amount of dollars on product promotion and image building, and doing so at the expense of the "environmental villains" - old growth and carcinogenic chemicals used in treated lumber. Several recent articles in trade publications have been highly critical of pressure-treated wood, contending that decks built with arsenic-treated wood contaminate the soil beneath them to a degree that exceeds state standards for toxic waste on contaminated sites. Environmental Building News called for a phase out of the arsenictreated wood (CCA), indicating, "the value of the material's durability does not outweigh the environmental costs of production and disposal - particularly when arsenic-free alternatives exist." This environmental backlash against p-t wood products could translate directly to market share for an environmentally friendly alternative In addition, it is estimated that 68% of homeowners undertake deck additions as do-it-yourself (DIY) projects. Customer satisfaction with CCA p-t decking products, in this segment, is also relatively low. Customers didn't understand the amount of maintenance required to retain the aesthetics of a CCA treated deck. Many p-t decks are being replaced not because of decay, but due to the unsightly weathering (and splintering) of the product. Value plots have been developed based on survey results provided by an independent consultant s examination of the Top 100 US home centers (See Exhibit 5). Key to these value plots is the vast perceived difference in competitive price between p-t pine and WPC decking products (with cedar and redwood rated intermediate). Cost of WPC deck boards were compared to wood deck boards - and were rated as "performs much worse than wood" whereas resistance to wear, resistance to decay, straightness and environmental friendliness were rated as "performing much better than wood." This disparity may be the result of the newness of WPC's in the marketplace and the lack of knowledge, awareness, acceptance and product use/performance information available. Quality, straightness and resistance to decay are the three most important deck board attributes to this segment, followed by cost. WPC decking is perceived by large home centers to outperform p-t pine in terms of resistance to wear, resistance to decay, straightness, recyclability, and environmental friendliness. When compared 5

6 to other regions, the North Central home centers view the environmental friendliness of WPC decking as substantially worse than other materials. The top 100 residential homebuilders were also surveyed. An attribute comparison of the various decking product alternatives produced the value plots presented in Exhibit 6. As compared to home centers, builders were asked to rate alternative decking products (cedar, redwood, p-t pine, wood-plastic lumber and plastic lumber) on various attributes (rather than compare them directly to wood deck boards as was done with home centers). This resulted in WPC decking products being perceived as intermediate in price - higher than p-t pine, but somewhat lower versus cedar, redwood and plastic lumber. In terms of the three key attributes of straightness, resistance to decay, resistance to wear and environmental friendliness WPC products are perceived to be superior to current wood decking products. CURRENT PLAYERS IN THE WPC DECKING MARKET Trex Currently, Trex cannot keep up with demand for its decking -- its Virginia plant operates three shifts per day, but the company still has a tremendous backlog. Sales in 2000 were $117.5 million, up 63% since ''We expected growth in the percent range, not 40 percent,'' said Chief Financial Officer Anthony Cavanna. ''That growth has led us to some interesting problems,'' such as sourcing. The company purchases 80 million pounds of polyethylene scrap annually. Trex goes to grocery and department store chains to buy the bags customers return. In addition, Trex buys scrap linear low density Polyethylene pallet wrap. Trex estimates it takes back half of the available grocery bags and 20 percent of the available pallet wrap on the recycling market. Trex buys its sawdust scraps from furniture factories and cabinetmakers. The sawdust is mixed with the plastic, then extruded into 2-by-6 deck boards. The planks are not strong enough for structural use but are plenty strong enough -- and comparably priced -- for decking. Although a deck built with Trex lumber costs about 20 percent more than one built with treated lumber, the Trex deck needs no sealing or staining. Timbertech Timbertech is Crane Plastics line of plastic and wood composite decking, which it introduced three years ago. Timbertech will continue to operate out of Crane's Columbus headquarters, but became its own entity in the summer of 1999 under the Crane corporate umbrella. Timbertech is the only major player in the WPC decking marketing selling an extruded decking product, however, the product s wood content is still hovering around the 40-50% range resulting in higher polymer costs. Timbertech has recently entered a joint venture with Crane subsidiary Compression Polymers to build a new plant in Scranton, Pa. The new facility will be in operation by late July and will increase Timbertech's capacity by 50 percent, Kemper said. 6

7 Crane manufactures vinyl siding and gutters, wood piling and various custom profile extrusions and moldings. Crane ranked No. 21 in Plastics News' recent survey of North American pipe, profile and tubing extruders, with $148 million in annual sales. It placed eighth among profilers. The firm has 790 employees at two plants. Despite Trex s advantage in board pricing ($1.35 to $1.60) versus Timbertech ($1.95-$2.30), Timbertech claims the cost differences narrow when above-deck components are considered. Timbertech above-deck products (spindles, rails, etc.) cost approximately 20% less than comparable Trex products on a linear foot basis. SmartDeck The SmartDeck deck board is a 50/50 composite of wood and plastic. SmartDeck is a division of U.S. Plastic Lumber, LTD, the nation's largest manufacturer of lumber made from recycled plastics. U.S. Plastic Lumber is a fast growing company that develops beneficial re-use options and end product solutions for distinct types of waste streams. The company has two main business lines: the manufacture of plastic lumber and other value added products from recycled plastic, and the operation of an array of interrelated environmental recycling services. For the year ended December 31, 1998, revenues increased 85% to $45,705,000 from prior year revenues of $24,739,000. Operating income for the twelve months ended December 31, 1998, increased to $1,437,000 from a loss of ($321,000) for year ended EBITDA for year ended December 31, 1998 increased to $3,492,000 from $468,000 in year USPL projects revenue of the combined plastic lumber entities to exceed $50 million in 1999, up from $15.7 million in USPL, as a whole, is projecting sales in 1999 from its plastic lumber and environmental divisions to aggregate in excess of $100 million, assuming it achieves its current internal growth projections, closes additional acquisitions currently under negotiation, and commences work under currently planned dredge contracts in New Jersey. USPL has purchased approximately 12 companies in the last 24 months and continues to aggressively seek acquisition candidates that can be vertically integrated into either of its two segments -- the recycled plastic lumber or environmental recycling operations. The Timbertech deck board produced by Crane Plastics shows tremendous opportunity despite a weak marketing effort and limited product line. Trex products have shown phenomenal growth despite its structural limitations. Nexwood Nexwood is slightly different in that it combines recycled plastic and cellulose fiber in the form of rice hulls. The nominal 2x6 planking spans 24-in. o.c. framing and can be through-nailed or installed with concealed fasteners. One side has a brushed surface that improves both traction and aesthetics. Nexwood says it hopes to offer the decking, which costs between $1.70 and $2 per lin. Ft. in the United States by the end of In addition to these players, Andersen Corporation has developed a semi-structural wood-plastic component that it is currently being used in its window and door products. Rumors are 7

8 beginning to surface that this product may be introduced in a decking line in the near future. Other smaller companies are also emerging, based on licensing agreements with various technology firms. Although these players are relatively small, the technology is very similar to that of the technology you intend to implement in your operations, should you decide to introduce the product. Exhibit 7 summarizes LPs best material cost estimations across decking options. The Vice President of Marketing is expecting your report in the morning and the following questions still remain: Is there room in the residential decking market for another WPC decking product? What market segments should be targeted? How should a new wood-plastic composite decking product be positioned in today s marketplace? Are there distribution issues to be addressed? And, Given the potential cost savings associated with lower levels of polymer inputs in production, what recommendations would you provide in terms of pricing? Our material sourcing processes certainly out-perform the competition, as well as our expertise in manufacturing; these will certainly affect costs. Will these affect price? It is going to be a late night. 8

9 EXHIBIT 1. SALES AND PROFITS BY BUSINESS SEGMENT. SALES BY BUSINESS SEGMENT(3) Structural products $1,817 62% $1,876 61% $1,307 53% $1,223 48% $1,398 53% Exterior products Industrial panel products Other products Building products 2, , , , , Pulp Total sales $2, $3, $2, $2, $2, PROFIT (LOSS) BY BUSINESS SEGMENT Structural products $ 173 $ 440 $ 198 $ 21 $ 135 Exterior products Industrial panel products Other products (12) (11) (20) (24) (9) Building products Pulp 13 (15) (38) (29) (91) Unusual credits and charges, net (71) (8) (48) (32) (350) General corporate and other expense, net (99) (103) (94) (80) (52) Interest, net (43) (12) (13) (29) Income (loss) before taxes, minority interest and equity in earnings of unconsolidated affiliate $ (18) $ 357 $ 13 $ (151) $ (327)

10 EXHIBIT 2. CONSOLIDATED STATEMENTS OF INCOME (dollar amounts in millions, except per share) year ended December Net sales $2,932.8 $3,071.6 $2,451.1 Operating costs and expenses: Cost of sales 2, , ,007.8 Depreciation and amortization Cost of timber harvested Selling and administrative Unusual credits and charges, net Total operating costs and expenses 2, , ,425.7 Income from operations Non-operating income (expense): Interest expense, net of capitalized interest (81.0) (47.9) (37.5) Interest income Foreign exchange gains (losses) (4.6) (0.6) -- Total non-operating income (expense) (47.7) (12.5) (12.8) Income (loss) before taxes, minority interest and equity in earnings of unconsolidated affiliate (18.2) Provision (benefit) for income taxes (11.5) Minority interest in net income (loss) of consolidated subsidiaries (3.8) Equity in earnings of unconsolidated affiliate Net income (loss) $ (13.8) $ $ 2.0 Net income (loss) per share--basic and diluted $ (0.13) $ 2.04 $ 0.02 Cash dividends per share of common stock $ 0.56 $ 0.56 $ 0.56 Average shares of common stock outstanding (millions) Basic Diluted

11 EXHIBIT 3. COMPARISON OF WPC DECKING COMPOSITION. Wood Percentage Plastic Percentage HDPE Cost* Cost of Plastic/Board** Trex 50% 50% $0.30/lb $3.15 TimberTech 50% 50% $0.38/lb*** $3.99 Smartdeck 67% 33% $0.30/lb $2.80 Nexwood 0% (40% rice hulls) 60% $0.30/lb $3.78 * Cost of recycled high density polyethylene pellets. ** Based on a 2 X6 X8 board. 1 lineal ft. weighs on average 2.625lbs. *** TimberTech is made from virgin HDPE pellets. 11

12 EXHIBIT 4. ESTIMATED DECKING MATERIALS MARKET SHARE. Pressure treated lumber % Western Red Cedar 18.5% Concrete 14.1% Redwood 11.1% Wood Fiber/plastic 4.0% Untreated Lumber 2.6% Plastic Lumber 0.7% 1 Of this amount, 71 % is Southern Pine, 4% is other pine, 7% is hem-fir, 12% are hardwoods and 6% are classified as "other. 12

13 EXHIBIT 5. VALUE PLOTS OF HOME CENTERS PERCEPTION OF RESIDENTIAL DECKING. 13

14 EXHIBIT 6. VALUE PLOTS OF HOME BUILDERS PERCEPTIONS ON RESIDENTIAL DECKING. 14

15 EXHIBIT 7. DECKING COST PER LINEAR FOOT. Decking Cost Per Linear Foot Cost (Dollars) Treated SYP Treated Hem-Fir W. Red Cedar Alaska Yellow Cedar Trex Nexwood Timbertech Decking Material 15