Timber in Turmoil, Part III: Public Timber Liquidity

This is the third in a three-part series related to the financial performance, current trends and changing structure of the timberland investment sector.

Newspaper headlines scream distractions.  They make us forget that investments in timberland assets are somewhat insulated from every daily front page story, regardless the tenor or topic.  However, investments in publicly-traded timber REITs have tremendous exposure to the moods of the market.  The driving distinction, like the difference between owning a soup factory versus holding shares in Campbell’s, is liquidity.  Liquidity provides a pathway to extract opportunistic profits and to inflict instantaneous losses.

US timberland markets continue to seek firm ground (see Private Timberland Purgatory).  In response, investors now pursue alternate, sector-shaping investment strategies, while picking through a tangle of low timberland supply, high timberland demand and few ready deals (see Timberland Ownership Paradox).  They also revisit the relevance and tradeoffs of investing in public timberland-owning real estate investment trusts (timber REITs). By the power of Grayskull (and Excel), Table 1 captures, in hypothetical 10-year plays, key benefits and exposures of private versus public timberland investments.

The results emphasize important realities and reminders for investors.  First, timber vehicles outperformed the S&P over the 10-year holding period across all metrics.  Second, liquidity unnecessarily burdens open-eyed long horizon timberland investors.  While private timberlands do not offer the “upside” available to liquid equities, they do provide sturdier protection.  Not once in the example did private timberland investors fall into the red.  Third, public timber REITs demonstrate total internal rates of return (IRR including dividends) exceeding 12% with less volatility than the S&P 500.  While the S&P investment ends below $1,000 in four years (2002, 2003, 2008 and 2009), the Forisk Timber REIT (FTR) investment ends below $1,000 just once (2002).

Implications for Investors

In the US, timber falls squarely in the domain of value and yield (income) investors.  Trees grow while investors earn, assuming the strategy matches the asset.  Regardless the timber investment vehicle, I observe consistent and repeated timberland investment success associated with four attributes: 

1. Localized asset-specific knowledge.  Timber markets are uniquely local. While every Hardy Boys book has 20 chapters and every year has four quarters, each timberland asset has no guaranteed cookie-cutter market structure or return profile.  These localized distinctions are relevant to both private and public timberland investments.
2. Patience.  Just because you became aware of timberland and timber REITs last Thursday does not mean investing on Friday is a good idea.  Valuation models and price forecasts function well only if you assume you’re the only one using them.
3. Diligence.  Successful timber investors and managers do homework.  Lots of it.  Hunting opportunities includes an ongoing process of ranking timber markets, identifying potential candidate properties, studying prices and building relationships.  For equity investors, this includes a process of localized timber asset valuation and firm-level benchmarking.
4. Long time horizon.  Timber returns, like those of any asset class, go up and down each year.  However, the distinguishing characteristics of timberland assets reveal themselves over long time frames.  During this time, investors manage actively, reducing costs and identifying opportunistic sources of revenue.

To receive the free FTR Weekly Summary with historical performance data in Excel, contact Heather Clark at hclark@forisk.com, 770.725.8447.  Forisk will offer “Timber Market Analysis” on August 15^th in Atlanta, a one-day course for anyone who wants a step-by-step process to understand, track, and analyze the price, demand, supply, and competitive dynamics of local timber markets and wood baskets. For more information, click here.

Timber in Turmoil, Part II: Timberland Ownership Paradox

This is the second in a three-part series related to the financial performance, current trends and changing structure of the timberland investment sector.

Part I of Timber in Turmoil (Private Timberland Purgatory) focused on the history versus current reality of US timberland returns.  The “purgatory” reflects the sluggish willingness of investors to resolve disparate timberland return expectations even though buyers and sellers have clear, unadulterated understandings of the return potential of forestry assets.  To paraphrase a quote attributed to a salty Winston Churchill story, we have established what you are, we’re simply haggling over price.

This purgatory highlights a paradox:  even with increased transparency into the viable financial performance of timberland, we observe few transactions during a period of high demand.  Hmmm. Perhaps it’s too simplistic to ask “why do buyers and sellers ignore forestry fundamentals and cling to unrealistic return expectations?”  In fact, if we autopsy the market, we see active restructuring as timberland investment professionals grapple with the limited availability of investment-grade timberland properties in the US.

How can timberland be in short supply for investors? In a country of 2.2 billion acres, the US boasts over 745 million acres of forests.  This includes 504 million timberland acres, of which 48% is privately owned. However, the reality remains that industrial forest production and institutional investment occurs on a small slice of real estate, accounting for about 75 million acres, or 3.3% of the US land base (Figure 1).  Most of these acres are owned and managed by a few dozen entities.  In short, the US timberland market comprises (relatively) constrained acreages and (relatively) few scalable participants.

Insistent timberland investors have four primary strategies in the US.

1. Pay more today (in exchange for lower returns tomorrow).
2. Wait for markets to firm (and spend time filling the queue with candidate properties and timber markets of interest).
3. Reallocate capital away from timberland assets.
4. Consider alternate timberland investment strategies, including timber leases, multi-asset packages (that include mills), and traditional M&A (mergers and acquisitions) driven consolidation among TIMOs and REITs.

In practice, we see investors employing all of the above.

Consolidation deserves special note because it represents a bellwether. Consolidation reflects the arrival of mature markets; we’re past adolescence.  The boys are back from the war.  And as Lt. Frank Drebin said in The Naked Gun 2 ½, “the cows have come home to roost.” While traditional timberland investment strategies mirror a game of musical chairs, investors have reopened the playbook.  They now willingly consider a broader set of timberland investment approaches that leverage opportunities afforded by time, localized expertise and complexity.

Part III addresses the role of publicly-traded timberland-owner REITs in the timberland investment sector.  For detailed data on US timberland ownership and more information on Forisk’s 2012 US Timberland Owner List, click here.

Timber in Turmoil, Part I: Private Timberland Purgatory

This is the first in a three-part series related to the financial performance, current trends and changing structure of the timberland investment sector.

While trees continue grow, timberland values continue to fall.  In the world of mortals, every financial return and policy development implicates current timberland investment vehicles and future capital allocation decisions.  As an analyst reviewing the data and observing events in the field, I hear Earl Weaver, the former Baltimore Orioles’ manager, screaming in my ear, “Everything changes everything!”

Recent returns from the NCREIF Timberland Index affirm that turmoil reigns in timber.  For four consecutive quarters, NCREIF has reported negative appreciation returns for private US timberlands (Table 1).  And for three consecutive years, NCREIF reported negative appreciation returns for private US timberlands (Table 2).  Meanwhile, these timberlands continue to generate on the order of 1.5 – 2.5% annual cash returns.

Turmoil reflects uncertainty and confusion, and timberland returns, even in the face of positive signs from housing markets, incur disquiet.  While cash returns improve with increased harvest volumes and stronger stumpage (timber) prices, timberland appreciation builds on prices paid – and received – by institutional investors.  So where are we?

High transparency undermines high growth.  In the US, forestry investment professionals understand the market, which remains undersupplied with timberland relative to demand from institutions and available capital.   The purgatory – this (temporary) period of miserable waiting and scratching at Excel valuation models – resolves itself when the market decides whether or not timberland is a “6% business.”  If investors expect or demand 6% real returns from new acquisitions, then math dictates additional depreciation in timberland values.

Part II addresses a paradox in US timberland ownership and how this effectively reshapes the timberland investing sector.

Wood Bioenergy Sector Continues to Shake Out; Viable Projects Down; Wood Volume Up

Wood bioenergy projects continue to either gain traction or fall to the sidelines as investors shake the sector like a sack of Scrabble tiles.  While the number of projects that pass Forisk’s screening methodology in April fell from 297 to 295, the estimated volume of wood consumed by viable projects edged up 2.4%.  As of April 29, 2012, Wood Bioenergy US reports that projected wood demand for all 452 announced projects in the U.S. totaled 123.7 million tons, while the 295 projects that passed Forisk’s screen could consume up to 72.1 million tons of wood annually by 2022.

Project specific activities include:

• Green Circle Bioenergy announced plans to expand its plant in Cottondale, FL to produce 600,000 metric tons of pellets per year. The company hopes to complete the expansion in 2012.
• Traxys Power Group plans to purchase the former General Motors Fiero assembly plant to convert it to a biomass power plant in Pontiac, MI. (Trivia:  Ferris Bueller’s sister, Jeanie, drives a white Pontiac Fiero in the 1986 movie “Ferris Bueller’s Day Off”.)
• Cate Street Capital met with the Millinocket, ME town council to discuss plans for a $35 million torrefied biomass machine at the Millinocket paper mill site.
• Russell Biomass received a Clean Water Act permit for its proposed 50 MW cogeneration facility in Russell, MA. The project was originally a stand-alone electricity plant, but Russell Biomass changed the project to a cogeneration plant to meet Massachusetts efficiency standards. Construction is currently on hold pending the finalized RPS standards for the state.

For a complete Wood Bioenergy US summary of projects and associated wood demand statistics, click here.

Clear Communications and Strong Relationships Strengthen the Wood Supply Chain

This week in Jacksonville, Florida, the Wood Supply Research Institute (WSRI) held its annual meeting.  WSRI is a non-profit organization that funds research to improve efficiencies in wood supply systems in the U.S. forest products industry. Amanda Lang, Senior Consultant at Forisk and Managing Editor of Wood Bioenergy US, attended the meeting and contributed the following post:

How valuable are good working relationships in forestry?  Or, from the other side, what are measurable impacts on loggers and wood-using mills from poor communications or strained relationships?  At the WSRI annual meeting, Don Taylor with Sustainable Resource Systems LLC presented the findings of a supplier-consumer relations project. The project interviewed over 220 wood suppliers and wood consumers (procurement foresters) in the U.S. to evaluate the working relationships between the two groups. The study findings are timely and relevant as the U.S. forest products industry emerges from the recession, and as new and announced wood bioenergy projects develop their wood procurement strategies.

The study found that logging contractors reduced investments in their businesses during the recession, by closing, downsizing, or foregoing normal equipment replacement and maintenance to reduce costs. More frequent equipment break-downs resulted in lost production.

Poor relations between mill procurement personnel and logging contractors also resulted in lost production. Examples include frequent variable quotas, truck delays due to poor woodyard management, poor communications and poor planning. The study found that, on average, 7% of annual production in the U.S. is lost due to poor relationship management. In addition, some consumer-supplier relationships deteriorated as the recession hit. For example, some wood-consumers cancelled pre-recession commitments and put orders on a week-by-week basis with no firm commitment for volume or delivered pricing.  The demise of these relationships contributed to reduced investment in logging capacity.

The WSRI study highlights the importance of clear communications and relationships in the wood supply chain. Many procurement organizations are concerned about future logging capacity as wood demand returns to pre-recession levels. Strong relationships, communication, and support between procurement teams and wood suppliers will be critical as the industry moves forward.

For more information about WSRI or the Supplier-Consumer Relationship Study, click here or contact Jim Fendig.

ForiskForecast for Stumpage Prices: What Do We Expect?

In 2011 for the second consecutive year, Forisk’s localized pine sawtimber forecast hit within 4% of actual on average at the state-level.  South-wide, Forisk’s regional pine sawtimber average of $26.57 per ton exceeded Timber Mart-South’s actual price of $23.97 for 2011 by 4.7%.  The just published 2012 ForiskForecast takes on 11 states in the US South and Oregon’s and Washington’s Douglas-fir and hemlock markets in the Pacific Northwest.

Our research develops three economic and forest industry scenarios.  The baseline and “low growth” forecasts expect more of the same, with relatively flat to negative pricing in 2012 for pine sawtimber, with modest strengthening in 2014 as housing returns.  Higher sawtimber prices require more than simply increased housing starts; prices require a suitable balance of forest industry capacity to lumber demand and production, with sawmills exceeding 85% utilization for six to twelve months to “reset the floor.”  Pine pulpwood markets vary across the US South, as those states with concentrated pulp mills and “viable” bioenergy projects – as specified in Wood Bioenergy US – show strong pulpwood stumpage markets.

Meanwhile, other market activities provide opportunities to supplement needed demand, including active export markets and the expansion of the Panama Canal.  Forisk developed a “high growth” scenario that accounts for both strong economic and housing market growth, and potential increased log export activity from the US South by state.  This scenario expects pine sawtimber strengthening in 2012-2013, with prices in 2014 $2.86 per ton higher than the baseline forecast.

To learn more about the 2012 ForiskForecast, click here.

Forisk’s Equity Research and Timber REITs in the Spotlight

As of March 30th, publicly-traded timberland-owning REITs, as measured by the Forisk Timber REIT (FTR) Index, returned 11.45% year-to-date.  This culminated a month of coverage and articles that highlighted both Forisk’s equity research of timber REITs and the performance and characteristics of timber REIT investments generally.  Key takeaways included:

• Individual timber REIT performance varies.  Clay Risher, in his REIT Magazine article “Planting the Seeds for Timber REIT Growth” (March 14, 2012), focused on this theme from our research.  While Rayonier (RYN) lapped the field in 2011 thanks to its specialty fibers business, other firms, such as Weyerhaeuser (WY) have led in 2012.  In addition, he summarizes Steve Chercover’s thesis that timber REIT conversions have run their course for now….
• Investing in timber REITs differs from investing in timberland.  Ellie Winninghoff, in her Financial Advisor Magazine article “Balance Sheets that Always Keep Growing” (March 28, 2012), summarizes our emphasis on the local and regional nature of timber REITs and timberland investment performance.  Geography matters for both publicly-traded and private-placement investment vehicles.  In the article, Winningham also captures Clark Binkley’s assessment of the realizable versus theoretic portfolio diversification benefits from timberland investments.
• Timber REITs “were strong performers” this quarter, according to the Wall Street Journal, in the A.D. Pruitt article “Small REITs Put UP a Big First Quarter” (April 4, 2012).  While correctly recognizing recent timber REIT strength, this article was more notable for getting its facts and insights wrong on the sector.  For example, there are four (4) timber REITs (PCH, PCL, RYN and WY), not three (3) as reported (it’s unclear who got left out by A.D.).   And multiple factors outside of housing have driven recent timber REIT peformance….[A.D. - As Alvin the Chipmunk says, next time, "call me." ]

Timber REIT Returns Pass S&P 500 YTD

Just over two months into 2012, the public timber REIT sector pulled ahead of the S&P 500.  According to the Forisk Timber REIT (FTR) Index, timberland owning REITs returned 9.84% YTD relative to 9.01% for the S&P 500.  Weyerhaeuser (WY) and Plum Creek (PCL) led the sector’s surge, with 15% and 10% ten-week price appreciations respectively since the New Year (see table).

Timberland-owning REITs comprise 5.91% of the market capitalization of all public REITs.

For FTR Index methodology, click here.  For detailed, historical FTR Index data in Excel, contact Brooks Mendell, bmendell@forisk.com.

Wood Bioenergy Sector Active; Projected Net Wood Use Changes <1% since January

Since January 2012, multiple wood bioenergy projects in the United States have opened, closed or advanced their move towards operational viability.  However, the implications on potential wood use were insignificant.  Total potential wood use from announced and operating projects decreased less than 0.5% while potential wood use from operationally “viable” projects increased approximately 1%.  As of February 27, 2012, Wood Bioenergy US reports that projected wood demand for all announced projects in the U.S. totaled 122.7 million tons, while the 297 projects that passed Forisk’s screening methodology could consume up to 69.5 million tons of wood annually by 2022.

Project specific activities include:

• Eagle Valley Clean Energy plans to build an 11.5 MW biomass power plant in Gypsum, CO that will use logging residues, pre-commercial thinnings, and fuel treatments as well as urban wood waste from a local landfill. Construction could be complete by the end of 2013.
• Beaver Wood Energy received an air permit for its proposed wood pellet and 29.5 MW CHP plant in Fair Haven, VT. The group is pursuing an interconnection agreement and waste water permit.
• Mt. Poso Cogeneration is operating and producing 44 MW of power at full capacity in Bakersfield, CA. Macpherson Energy Company and DTE Energy Services converted the former coal plant to 100 percent biomass. The plant runs on urban wood waste and agricultural residue.
• ZeaChem will receive $12 million from USDA’s National Institute of Food and Agriculture (NIFA) through the Agriculture and Food Research Initiative (AFRI) Regional Coordinated Agricultural Project (CAP). Zeachem is targeting to produce drop-in fuels, including jet, diesel, and gasoline fuels, starting in 2013 at its biorefinery in Boardman, OR.
• Enviva continues to expand its pipeline of activities.  The firm signed an agreement with E.ON to provide 240,000 metric tons per year of wood pellets beginning in 2013.

For a complete Wood Bioenergy US summary of projects and associated wood demand statistics, click here.

Southern Yellow Pine “Design Values”: Likely Impacts of Changes are Overstated

Amanda Lang recently presented an overview of timber markets and wood bioenergy demand at the Southeastern Society of American Foresters Meeting at Jekyll Island, Georgia.  Here is an excerpt specific to the topic of Southern Yellow Pine “Design Values”:

The Southern Pine Inspection Bureau (SPIB) recently issued new design values effective June 1, 2012. We have fielded multiple questions from clients regarding the new design values and the potential effects on Southern pine sawtimber markets. Here is our take on the situation and potential effects.

The situation: The changes only apply to visually graded Southern Yellow Pine lumber in No. 2 and lower grades for 2×2’s through 4×4’s. The new design values are 20-35% lower than previous values for four strength properties. This means that, at a high level, 2x2s through 4x4s produced from Southern Pine visually graded lumber are not rated as strong as they were previously. Design values for other grades will remain the same pending 2012 testing.

Potential effects: It is our view that the overall market effect will be minimal. We do not foresee substantive changes to the overall prices or market demand for Southern pine sawtimber, although we could see some changes in the types of lumber produced. Building designers/mill customers will ultimately dictate these effects. We see some shifting from visual graded lumber to machine graded lumber. Conversely, building designers may change designs to accommodate new design values (and still use visual grades). Individual mills that produce majority visual grade could be affected the most by these changes, but the specific effects will be determined by mill customers.

For more information, please contact Amanda Lang, ahlang@forisk.com.