Timber REIT Comparative Analysis: Who Wins as Housing Markets Return?

26 01 2011

Forisk Equity Research completed a comparative analysis of timber REIT forest harvesting activities to address the question, “who wins as housing markets return?”  The Executive Summary is below.  The complete Technical Note (January 2011) is available here.

Executive Summary

While US annual housing starts declined 72% between 2005 and 2010, timberland-owning REITs – Potlatch (PCH), Plum Creek (PCL), Rayonier (RYN) and Weyerhaeuser (WY) – deferred forest harvests and shifted harvest mix away from sawtimber (the logs for manufacturing lumber and building houses) towards pulpwood (the raw material for paper and paperboard), where pricing and demand remained relatively stable.  While summarizing the overall exposure to housing markets across firms, this technical note focuses on volumes and product mix from forest operations.  Unlike capacity rationalization decisions associated with manufacturing, which reduce the capacity to produce volume in the future, forest harvest deferrals effectively increase capacity to produce in the future as trees continue to grow.

The REIT structure optimizes income from timberlands, with respect to taxes, under current IRS code.  As such, timber REITS emphasize the centrality of timberlands and forest products to their businesses.  However, less than 50% – in cases, much less – of firm revenues derive from timber sales.  Rather, direct exposure to housing – as measured by revenues from Timber, Wood Products and Homebuilding segments – exceeds 60% of revenues for three of four REITs. However, these exposures represent distinct amalgams of regional timber harvesting, forest products manufacturing, homebuilding and real estate activities.

In assessing the future operating performance of timber REIT equities as housing recovers, we analyzed potential revenue implications from (1) direct exposure to housing markets; (2) the capacity to increase harvest volumes; and (3) the ability to improve harvest mix.  Weyerhaeuser and Potlatch, followed by Plum Creek, have the highest direct exposure to, and potential revenue growth from, improved housing markets. Within this group, Weyerhaeuser’s operating exposure runs deepest across the housing supply chain.

What is the implied value impact from shifting mix relative to deferring volume for timber revenues?  Each per-unit shift in harvest mix has twice the timber revenue impact, at minimum, as each per unit change in volume. In other words, holding all else constant, twice the revenue upside exists from increasing sawtimber percentages than from increasing volumes harvested.  That said, the four timber REITs exhibit different combinations of volume-versus-mix upside from timber harvesting revenues.

While timber revenues will increase for all timber REITs from increased harvesting, Weyerhaeuser will lead on an aggregate and relative basis, assuming no significant change in timberland acres owned across companies.  Also, with its ongoing sawtimber heavy mix and focus on logs for export markets, which command premium prices relative to domestic markets, Weyerhaeuser has a higher revenue upside potential.

Alternately, Rayonier retains the greatest potential for increasing mix-driven margins from timber harvesting. However, at the firm level, this benefit has modest implications as Rayonier derives most of its revenue from its Performance Fibers segment.

To access the complete Forisk Equity Research Technical Note, click here.


Forisk Named to “Bulldog 100 Fastest Growing Businesses” for 2nd Year in a Row

23 01 2011

Forisk Consulting was named to the “Bulldog 100 Fastest Growing Businesses” by the University of Georgia Alumni Association at an awards banquet in Atlanta on January 22, 2011.  In total, the “Bulldog 100”, based on revenue growth over the past three years from 750+ nominated firms, generated over $54 billion in revenue in 2009.  Forisk was one of 46 firms to make the list for the 2nd consecutive year.

For the complete “Bulldog 100” listing, click here.

Timber REITs and Weyerhaeuser (WY): Tax Treatment of 2010 Dividends

19 01 2011

REIT investors specify the relatively high and stable dividends as a key benefit of investing in real estate investment trusts. Timberland-owning REITs (timber REITs) offer additional tax benefits.  Most timber REIT distributions (related to income from the sale of timber) are treated as long-term capital gains and taxed at relatively lower tax rates compared with ordinary dividends.

Weyerhaeuser (WY, which will elect REIT status in its 2010 tax filing) and the three publicly-traded timber REITs – Plum Creek (PCL), Rayonier (RYN) and Potlatch (PCH) – announced the tax treatment of dividends paid in 2010. The following table breaks down the dividends by firm:

For PCL and RYN, 100% of the dividends paid will be treated as capital gains. WY paid a special dividend of $26.46 per share as required for its REIT conversion (see previous post for details).  Of this, $0.46 per share (including the regular quarterly dividend of $0.05 per share) is treated as capital gains, $0.47 per share is attributed to Earnings and Profits of the company prior to March 1, 1913 (treated as a non-taxable distribution) and the remaining $25.53 per share is treated as ordinary income and taxed accordingly. For PCH investors, $0.50 per share (24.5% of the total distribution) will be treated as return of capital, while the balance will be treated as capital gains (related to income from the sale of timber).

For further details on how timber REITs typically fund dividend distributions, please see our earlier blog on this topic.

EPA Exempts Biomass Electricity; Smooths Path for Wood Bioenergy Projects

13 01 2011

From the desk of Amanda Lang, Managing Editor, Wood Bioenergy US:

On January 12, 2011 the EPA announced that it will defer greenhouse-gas permitting requirements for facilities using biomass to make electricity (see “EPA Grants Greenhouse-Gas Rule Exemption”, wsj.com, 1/13/11). During the three-year deferral, the agency will consider third party scientific research to determine a future rulemaking specific to biomass electricity. The agency plans to officially issue the deferral in July 2011. In the meantime, EPA will issue guidance to local air permitting authorities to consider biomass fuel as the best available control technology for greenhouse gas emissions.

Forisk worked with the National Alliance for Forest Owners (NAFO) in December 2010 to research the potential economic impacts of the EPA’s greenhouse gas Tailoring Rule on biomass energy producers. Nationwide the Tailoring Rule captures in the PSD permitting program 87% of the currently operating and announced wood-to-electricity projects and 92% of cogeneration facilities at forest products mills in the continental US.  Prior to EPA’s announcement, the Tailoring Rule put 134 of these projects “at-risk” for cancellation or delays with the following impacts by the year 2021:

  • 5,384 fewer MW of renewable electricity generation in the US;
  • 11,844 to 26,380 fewer renewable energy jobs;
  • $18.0 billion fewer dollars of capital investment in renewable electricity generation; and
  • 53.8 million tons of wood biomass per year removed from the renewable energy marketplace.

The EPA’s decision to defer greenhouse gas permitting requirements for biomass electricity facilities will encourage projects currently in development to move forward. The decision will also shorten expected permitting delays for woody biomass projects that are in or exploring the permitting process. A copy of the Forisk report is available at: http://nafoalliance.org/wp-content/uploads/NAFO-Study-Tailoring-Rule-Economic-Impact-20101214.pdf

Timber REITs: Rayonier (RYN) Looking to Capitalize on Manufacturing Expertise

12 01 2011

On January 7, 2011, Rayonier (RYN) announced the potential conversion of the existing fluff pulp fiber line at its Jesup, Georgia facility to produce cellulose specialties pulps. The company expects to complete its analysis by mid-year, when the board will decide on the project. If approved, the converted line would begin production in 2013 and boost cellulose specialties capacity nearly 40%. The conversion would help the firm capitalize on the surging demand and tight supplies in the broader cellulose specialties market (see “The Touch, the Feel – of Rayon?” at wsj.com on January 6, 2011).

Rayonier’s Performance Fibers segment has a total annual capacity of ~ 740,000 metric tons (MT) for both cellulose specialty fibers and absorbent materials. Cellulose specialties fibers (dissolving pulp) are used in the manufacturing of high value products like filters, LCD screens, pharmaceuticals, food additives, paints, tire cords and sausage casings and thus command premium prices. Absorbent materials, also known as fluff fibers, are mainly used for diapers and hygiene products.

Rayonier has long focused on the higher valued cellulose specialty fibers.  In 2009, Rayonier manufactured 734,000 MT of performance fibers of which 63% were cellulose specialties and 37% were absorbent materials. Rayonier exports 61% of its cellulose specialty fibers production, mostly through multi-year agreements. The firm already extended contracts for over half its volume into 2013 and 2014.

Rayonier’s Jesup facility has three mills, two of which exclusively produce cellulose specialty fibers.  The third, which produces fluff fibers, is being considered for conversion.  During the nine months ending September 30, 2010, Rayonier had total operating income of $225.29 million of which $152.16 million (67.5%) came from the Performance Fibers segment. Strong earnings from this segment helped Rayonier weather the housing downturn more effectively than other timber REIT. During 2010, Rayonier shares appreciated 24.67% and the firm increased its dividend.

Timber REITs Gaining Members, Yet Asset Class Illiteracy Lingers with Misreporting on WY

3 01 2011

Timberland and timber REIT investors continue to wade through erroneous and underreported analysis in financial outlets. For example, a December 31, 2010 article, “Worst Performers in S&P Led by Weyerhaeuser, Dean Foods & H&R Block,” from Barron’s claims Weyerhaeuser (WY) stock lost 56% in 2010, when in fact shareholders earned 16.6% for the year.  That makes two years in a row for Barron’s.  An August 2009 article, “Trouble in the Forest”, on timberlands from Barron’s demonstrated a limited grasp of timberland investment characteristics and mathematics, confusing timber – the growing trees – and timberland, and citing a potential decline in timber prices “of as much as 50%” without detailing assumptions, offering evidence, or providing the most basic analysis of readily available data with which to inform and educate readers and investors as to why these assessments fail rudimentary screening.

What are the facts as they relate to WY?  In connection with its REIT conversion, Weyerhaeuser paid a special dividend of $5.6 billion in September 2010. The dividend value per share was $26.47 (in cash and stock combined). On the ex-dividend date, July 20, 2010, WY’s share price adjusted to reflect this stock dividend (from $41.83 per share as of close of July 19, 2010 to $15.76 as of open on July 20, 2010).  After adjusting the prices for the special dividend, WY actually returned 16.64% to the investors during 2010.

The chart below shows the comparative performance of the three publicly traded timber REITs: Plum Creek (PCL), Rayonier (RYN), Potlatch (PCH); and Weyerhaeuser, which had effectively become a timber REIT and has been added to the FTR Index effective January 3, 2011.

Timber REITs: Weyerhaeuser (WY) Joins FTR Index Effective January 3, 2011

2 01 2011

Weyerhaeuser’s (WY) December 2009 announcement regarding its board’s approval for conversion to a real estate investment trust (REIT) drew attention to the timber REIT sector, its financial performance through the economic cycle and its investment potential moving forward.  We published a Forisk Equity Technical Note in response to questions received from subscribers and clients regarding the conversion of Weyerhaeuser and its inclusion in the FTR (“footer”) Index, the longest continuously published index for the timber REIT sector.  The complete Note is available here: Forisk Equity_Technical Note 201012 Indexing WY.

Questions arose regarding the adding of Weyerhaeuser to the Index because the timing and nature of its REIT conversion differed from all previous cases.  Unlike previous timber REIT conversions, Weyerhaeuser converts retroactively to tax year 2010.  The Technical Note  details our thinking for when to index Weyerhaeuser as a REIT to optimally satisfy investor needs related to benchmarking timber REIT financial performance.

Initiated in 2008, the Forisk Timber REIT (FTR) Index is a market capitalization weighted index of all publicly-traded timberland-owning REITs. The Index which presently includes Plum Creek (PCL), Rayonier (RYN) and Potlatch (PCH), provides a benchmark for a subset of institutional and retail timberland investors, particularly interested in tax efficient REIT structures.

With the payment of the special dividend in September 2010 and announcement of dividend guidance for 2011 in December 2010, Weyerhaeuser effectively completed all steps required for conversion to a REIT.  The company has (1) operated as a REIT, with the ability to satisfy the IRS income and asset tests requirements for REITs, since January 1, 2010 and (2) provided dividend guidance as a REIT for the year 2011. Investors buying shares of Weyerhaeuser today now have better visibility about their investment and tax planning. Though there is no guarantee that the IRS will accept Weyerhaeuser’s REIT qualifications upon electing REIT status on its 2010 tax return in early 2011, we believe that company has established its ability to satisfy the asset and income tests for this year and, barring unforeseen complications, the company’s conversion remains a foregone conclusion. Thus the company is now a REIT from an investor’s perspective.

We therefore include Weyerhaeuser in the FTR Index on the first trading day of the new year on January 3rd, 2011.