Timberland & Timber REITs: Credit Suisse Analysis Lacks Rigor and Logic

23 02 2011

An interesting report landed on our desk a few weeks ago, further reinforcing the sorry state of timberland market analysis available to timber REIT investors. The report, from Credit Suisse, makes assertions based on a careless and faulty application of basic statistics, and demonstrates a rudimentary understanding of forest growth and harvesting over time.

Lead author Chip Dillon looked at, among other things, the relationship between housing starts and log prices.  He states that the evidence “… shows the lack of correlation between US housing starts and saw log prices.”  The supporting exhibit in the Credit Suisse report (below) contradicts this assertion.  It indicates an unmistakable, positive relationship between housing starts and log prices in the US South and North.

Since the report failed to include any quantitative analysis to assess the degree of this relationship, our Forest Economist, Dr. Tim Sydor, decided to run the numbers. Using readily available data (and twenty minutes with an Excel spreadsheet), the results confirm Mr. Dillon’s assertion as faulty: housing starts and log prices, over this time frame in the US, did in fact demonstrate a significant statistical correlation. The table below summarizes the results:

The report generated additional questions from our team and clients.  “Timberland acres are shifting from tobacco farming to timberlands and driving up supplies?”  “Are we really running into a wall of wood from deferred sawtimber harvests?”  Again, we turn to the data and math behind forest growth to make the following observations:

Timberland acreages in the US South, the land of tobacco and cotton farming, remained virtually unchanged between 1977 and 2010. Acres declined ~1% if compared with 1953.

The future inventory of sawtimber (logs for lumber) includes two parts.  First is the currently deferred sawtimber inventory.  Second are today’s small log (pulpwood) trees. Deferring harvest of sawtimber increases future inventories, but a concurrent increase of harvests of pulpwood trees (to replace the loss of residual chip flows from sawmills) effectively decreases future inventories of sawtimber trees.

Since a typical age of harvested sawtimber trees in the US South is ~25+ years, it is useful to look further than four years, the time frame of the Credit Suisse analysis, prior to judging the importance of temporary harvest deferrals. A point of reference: in 1992, the US South produced 13 billion board feet (BBFT) of softwood lumber. By 2000, this increased 28% to 16.7 BBFT. In 2005, it further increased 14% to ~19 BBFT.

Our analysis of the data indicates the forest industry – including timber REITs and timberland investors – “ate” into the inventory for sawtimber inventories on private timberlands in the US South during the housing run up.  In assessing the future performance of timberland assets as housing markets return, we see a more sophisticated picture that varies highly across timber REITs (click here for the summary).


Timber REITs and Timberlands: Wall Street Excitement versus Institutional Indifference

15 02 2011

Last week, I spoke at the Global Real Assets Investment Forum in New York as part of the panel on “Timber in Institutional Portfolios.”  My takeaway from participating in this event:  institutional investors seem bored with timberlands.  They showed more interest in other real asset categories, such as commodities, infrastructure, water and gold.  Why the indifference to our panel?  Talking with investment managers produced three types of answers:

  1. “We already invest in timberlands.”
  2. “We hear pitches from timberland investment managers regularly.”
  3. “We’re looking for higher rates of return.”

In short, audience members already know the asset class.

Interestingly, timberland-owning REITs – which have outperformed Lady Gaga year-to-date – generated few questions.   Regardless the slow housing recovery, the Forisk Timber REIT (FTR) Index of public timber REITs has returned 24.10% year-to-date compared with 5.69% for the S&P 500 (as of February 11, 2011).

Reasons for the relative outperformance of this asset class include:

  • Heightened inflation concerns fueled the rally for asset classes such as Gold and Timber, which are viewed as inflation hedges;
  • Rising demand for timber and lumber in China, resulting from its rapidly growing economy and decreased timber imports from Russia;
  • On the supply side, the impact of the Mountain Pine Beetle infestation on timberlands in Western Canada, particularly in British Columbia, which historically sourced about a third of the lumber for US housing markets.  This turn of events benefits US lumber manufacturers;
  • Due to the housing slump, timber REITs deferred harvest and shifted the harvest mix towards lower priced pulpwood, where prices remained relatively stable (for a detailed study on this topic, click here). By doing so, these companies deferred cash flows while the timber assets continued to grow. So, when housing markets recover, these firms will benefit from increased harvest levels and improved pricing.

While the short-term outlook for timber remains slightly negative to stable, the medium-to-longer term outlook appears opportune, which drives interest in the sector.

Timber REITs: Weyerhaeuser (WY) Above, Potlatch (PCH) Below Expectations for Q4 2010 Earnings

10 02 2011

From the desk of Neena Mishra, Director of Equity Research:

On February 4, 2011, Weyerhaeuser (WY) reported its Q4 2010 results. Net income for the quarter came in at $0.10 per share, a nickel ahead of street consensus.  Timberlands earnings declined $19 million due to lower sales of non-strategic timberlands and higher logging costs.  Western log prices rose 4%, but Southern log prices declined 4% during the quarter. WY continued to defer harvest, while increasing export volumes; its log exports to China increased by 10%. For Q1 2011, the company expects higher earnings from this segment due to higher log prices and seasonally higher volumes.  Wood Products lost $85 million during the quarter, versus a loss of $100 million in Q3 2010, mainly as a result of lower costs. Cellulose Fibers income declined $43 million from the previous quarter due to higher costs and annual maintenance outages. WY expects lower earnings from this segment during Q1 2011, due to a number of scheduled maintenance outages. Real Estate earnings increased $13 million from increased home sale closings and higher margins.

On February 8, 2011, Potlatch (PCH) reported its Q4 2010 net income (excluding special items) at $0.28 per share, below the consensus estimates of $0.33 per share. Forest Resource operating income was $12.8 million, compared with $24.3 million in the previous quarter, due to seasonally lower volumes. Real Estate operating income was $13.6 million compared to $9.8 million in Q3 2010. During the quarter, Potlatch completed a non-strategic timberland sale of ~29,000 acres in Wisconsin and 17,400 acres in Arkansas to RMK Timberland Group for $36.1 million. Wood Products lost $3.4 million in Q4 2010 from $0.6 million in Q3, mainly from a negative $2.9 million mark-to-market adjustment related to its lumber hedges.  While Potlatch does not provide earnings guidance, Management maintains its weak outlook for housing and expects harvest volumes to remain ~4.2 million tons for 2011.

Timber REITs: Plum Creek (PCL) and Rayonier (RYN) Just Beat Q4 2010 Expectations

2 02 2011

From the desk of Neena Mishra, Director of Equity Research:

Both Plum Creek (PCL) and Rayonier (RYN) reported Q4 2010 results in the past week.  Both firms just beat market expectations through off-setting different combinations of higher and lower pricing and volumes across their business segments.

On January 31, 2011, PCL reported Q4 2010 net income at $0.45 per share (excluding special items), a penny ahead of consensus, primarily due to higher-than-expected Real Estate sales.

Northern Resource operating income was lower compared with the prior-year quarter, due to lower volumes and slightly weaker pricing. Prices for sawlogs in the West started recovering later in the quarter, due to rising export demand. PCL expects to export 7% of its Oregon sawlogs in Q1 2011. Southern Resource operating income benefitted from higher sawlog harvest volumes, which offset a 3-4% decline in pricing for pulpwood and sawlogs.

Real Estate operating income was $73 million, up from $44 million for Q4 2009, as the company sold ~115,000 acres of land during the quarter. This included ~69,000 acres from the third phase of its Montana conservation sale. Wood Products reported profits of $3 million as prices for lumber and plywood increased 8% and 6% respectively.

Management expects 2011 earnings to be between $1.25 and $1.45 per share. Timber harvest levels and mix are expected to remain similar to last year.

On January 25, 2011, RYN reported fourth quarter net income (excluding special items) of $0.43 per share, four cents ahead of consensus. The beat can primarily be attributed to better-than-expected results from Performance Fibers.

Timber segment operating income was flat compared with the prior-year period. Eastern Region sales declined from the prior-year period, as higher prices were more than offset by lower volumes. Western Region sales and income improved from prior-year quarter, primarily due to higher prices (resulting mainly from stronger export demand).

Real Estate operating income of $1 million was $4 million lower than Q4 2009, reflecting lower rural sales volumes.  However, Performance Fibers income came in $4 million above the prior-year quarter, reflecting increased prices for both cellulose specialties and absorbent materials, while sales volumes were lower due to the timing of customer orders and production issues.

For 2011, the company expects better timber segment results resulting from continued export demand for sawlogs and strong pulpwood demand in the Southeast. Performance Fibers is expected to continue to benefit from strong demand for cellulose specialties Overall, Management expects the 2011 EPS to be between $2.50 and $2.70 per share.

Wood Bioenergy: Project Count Edges Up; Future of Cellulosic Ethanol Uncertain

1 02 2011

As of January 30, 2011, Wood Bioenergy US counted 445 wood-consuming, announced and operating bioenergy projects in the continental US, up from 441 in December 2010.  In total, these projects – which include wood pellet, wood-to-electricity, and cellulosic ethanol projects – represent potential, incremental wood use of 123.7 million green tons/year by 2021 in the continental US.  Based on Forisk analysis, projects representing only 68.5 million tons/year (55.4%) pass basic viability screening.  (Click here to download the free Wood Bioenergy US summary.)

Recent government decisions have favored cellulosic ethanol. On January 12, 2011, the EPA granted a waiver for E15 (15% ethanol, 85% gasoline blend) for model year 2001-2006 vehicles. The agency granted a waiver for E15 for model year 2007 and newer vehicles on October 13, 2010 and delayed the decision for model year 2001-2006 vehicles until DOE completed testing. The fuel is still restricted for vehicles with a model year 2000 or older.

The USDA selected three cellulosic ethanol projects to receive loan guarantees: Coskata, Enerkem, and INEOS New Planet BioEnergy. Coskata received a letter of intent to receive a $250 million loan guarantee for a 55 million gallon plant in Greene County, Alabama. Enerkem will receive  an $80 million  loan guarantee for its 10 million gallon plant in Pontotoc, Mississippi. INEOS New Planet BioEnergy LLC will receive a $75 million loan guarantee for its 8 million gallon plant in Vero Beach, Florida.

Despite these favorable decisions, uncertainty continues to surround cellulosic ethanol and advanced biofuel projects. For example, Range Fuels has reportedly shut down its cellulosic ethanol facility in Soperton, Georgia after producing one batch of ethanol this year. The plant will work through technical issues and raise additional funds needed to complete construction of additional phases of the commercial-scale facility.  Overall, the slow progress of cellulosic ethanol projects has increased scrutiny from private financiers, necessitating public USDA loan guarantees.