Timber REITs: Sector Meets and Exceeds 3Q 2011 Consensus Earnings; China Demand Softening

31 10 2011

Last week, all four publicly-traded, timberland-owning REITs announced and reviewed their third quarter 2011 results (just in time to catch Game 7 of a heart-thumping World Series between the St. Louis Cardinals and Texas Rangers). All firms met or exceeded consensus expectations, even accounting for special items (see table). During their Earnings Calls, two timber REITs referenced, but did not name, the closure of Georgia-Pacific’s Crossett, Arkansas lumber and plywood facility, which had the capacity to consume close to 1 million tons of pine sawtimber annually. This represents a material loss of demand in a key Southern market, and will influence timber REIT valuation models sensitive to state-level stumpage pricing and wood demand.  Alternately, all firms cited demand from China as a driver of strong log pricing and demand in their Western markets, though Weyerhaeuser noted this demand had softened since the second quarter.

Firm-by-firm highlights include:

  • Weyerhaeuser (WY) reported net earnings of $157 million for the quarter ($0.29 cents per share). Excluding after-tax gains of $91 million from special items, including an $83 million benefit related to foreign tax credits, WY earned $0.12 per share. Timberland earnings declined $50 million in the third quarter compared with the second due to: (1) earnings from dispositions of non-strategic timberlands declined $28 million to $4 million; (2) average prices for Western logs fell from weaker Chinese and domestic markets; (3) prices for Southern logs declined; and (4) silviculture and road costs increased (seasonal). In addition, CEO Dan Fulton echoed two themes we’ve been sharing with clients from our research.  First, WY has outsized exposure to housing across business segments relative to other timber REITs. Two, current housing forecasts often understate the impact of multi-unit homes, which can use 50%+ less wood per housing unit relative to single family dwellings.
  • Plum Creek (PCL) reported Q3 2011 earnings of $50 million ($0.31 per share) versus $32 million, or $0.20 per share in Q3 2010. Northern Resources reported a $7 million operating profit for the quarter, up $2 million for the same period in 2010. Sawlog and pulpwood prices were, respectively, 7% and 8% higher than in Q3 2010.  Southern Resources earned $21 million for the quarter, down $4 million for the same period of 2010. While prices remained stable and slightly up since last quarter, sawlog prices were 15% lower and pulpwood prices were 17% lower than average prices for Q3 2010. PCL sold ~36,000 acres of lands during the quarter and completed the acquisition of 50,000 acres of timberlands in Georgia and Alabama.  Finally, PCL repurchased ~670,000 shares of common stock at an average price of $34.87 per share (closing price as of 10/28/11: $38.47).
  • Rayonier (RYN) reported Q3 net income of $105 million ($0.84 per share). Excluding a $16 million tax benefit related to the 2009 alternative fuel mixture credit (“AFMC”), net income was $0.71 per share. Forest Resources reported Q3 2011 operating income of $11 million, up $2 million, which offset higher logging costs in the Northern region and lower results in the Atlantic and Gulf regions primarily due to forest fire impact and soft grade markets. Performance Fibers reported operating income of $75 million, up $13 million. CEO Lee Thomas noted that RYN increased its 2011 guidance, and that RYN’s 190,000 ton expansion of high purity cellulose specialties capacity at its Jesup mill is “on track” with “approximately 70% of this new volume…already committed.”
  • Potlatch (PCH) posted stronger earnings across business segments this quarter relative to the same period in 2010. Net earnings for Q3 2011 were $25.6 million ($0.63 per share) compared to $18.1 million ($0.45 per share) for Q3 2010.  The Resource segment benefitted from the Northern region’s seasonally strongest quarter. Fee harvest volume for the Northern region tripled since last quarter. Also, Southern fee harvest volume increased 33% in Q3 2011 over Q2 2011 from increased pine plantation thinnings.  Real Estate revenues totaled $14.8 million in Q3 2011 compared to $19.0 million in Q2 2011. Wood Products earning $2.9 million in Q3 2011 versus $2.8 million in Q2 2011.

For those of you not keeping score at home, the Cardinals won….


Woody Biomass as a Forest Product

26 10 2011

What are the wood supply and timber market implications from emerging bioenergy demand?  We just published a white paper on this topic commissioned by the National Alliance of Forest Owners (NAFO).  The research was motivated by concerns about potential impacts of wood bioenergy markets on the established forest products industry, on forest management decisions, and on the environment in the US.

We examined how the current forest industry evolved over time and the impact of new market entrants. Key findings include:

  • From 1999 to 2009, paper and paperboard production declined by 19% as the digital age and falling economy reduced paper consumption. As the paper industry declined, OSB and particleboard plants expanded, which use the same type of raw materials as pulp and paper mills. Increases in wood use by OSB plants in the 2000s partially offset decreased wood use by the pulp and paper sector.
  • Total forest growing stock on timberlands has increased in the United States. Despite timber market expansion for paper and lumber markets in the 1990s and the growth of a new industry (OSB), the forest products industry did not deplete raw material supplies. For example, total forest growth net of removals increased by 101% from 1986–2006 in the South. Softwood growth net of removals on private timberlands in the South increased by 97% from 2006-2009. Recent increases in net growth in the South are due primarily to declining markets for forest products since 2005.
  • There is insufficient evidence to suggest a regional or national shift in pulpwood markets, especially given the modest outlook for the pulp and paper sector for the next 10 years. Given the expected lower levels of wood use by the pulp and paper sector, some portion of the pulpwood supply will likely be available for bioenergy uses, assuming sufficiently robust market prices.

We also analyzed how much woody biomass markets in the South must evolve to affect landowner decisions with respect to harvest rotations. Forecasted pine pulpwood prices in the South in 2016 would have to increase from $11.47 per ton to higher than chip-n-saw prices of $17.09 per ton for landowners to be economically indifferent between a pulpwood-dominated forest and a sawtimber-dominated forest. Across the South, bioenergy demand would have to increase 435% by 2016, from an expected 22 million green tons a year to 120 million green tons per year, for pine pulpwood prices to reach $17.09/ton. Biomass energy wood use will have to be high enough for a sustained period to maintain high pine pulpwood prices to cause a shift in landowner behavior. At the same time, competing higher-valued product prices would have to remain at prices low enough to incent switching from pulpwood to sawtimber rotations. Once established, these prices would have to remain economically feasible for over 23 years to incent multiple pulpwood rotations on the same property. Overall, the analysis suggests that a significant shift from sawtimber to pulpwood rotations in the South is highly improbable. 

To download and read the complete study, click here.

How Do Exchange Rates Affect US Forest Products and Timberland Investments?

20 10 2011

When studying exchange rates and currency markets, I sometimes think of the old joke “the quickest way to double your money is to fold it in half and stick it back in your pocket.”   Currency markets shake more than jello and swing more than Tila Tequila.  Short-term events and market sentiment can drive capital flows into and out of currencies, swamping fundamentals and expected relationships for years.  As such, exchange rates affect forest products trade flows and investments in timberland assets.

It’s funny to think that money “has a price” beyond our labor, but it does.  An exchange rate – which is the price of money in terms of another – and interest rates – which reflect the price of borrowing or loaning money – produce thundering reverberations in the heads of investors and currency traders, far beyond the crack and snap of a tree hitting the ground.  However, exchanges rates affect forest businesses and timberland investors in at least three ways:

  • Exchange rates affect prices.  When the US dollar gets stronger (when we can buy more Canadian dollars or Japanese yen per US$), US exports become relatively more expensive and imports become cheaper.
  • Exchange rates affect investment returns.  If, for example, forest products are imported or exported, or if they compete with forest product imports or exports from other countries, their prices will be affected by exchange rate changes.
  • Exchange rates affect investment activities. When, for example, the US dollar weakens, US timberlands appear relatively cheaper assets to foreign investors.

Previous research into the affects of exchange rates on the US forest products industry indicate that while (1) exchange rate volatility negatively impacts some US exports in the long-term (Sun and Zhang 2003) and some forest products in the short-term (Zhang and Buongiorno 2010), (2) exchange rate levels are more important than exchange rate volatility.  For products such as logs, lumber, pulp and paperboard, a 1% increase in exchange rate variability leads to a 0.3%-0.4% decrease in volume exported in the short-term and a 0.1% export price decrease in short-term.

How do exchange rates affect timberland investment activities?  First, foreign investors continue to increase holdings of US timberlands (Mendell 2009), and investors from Canada and Europe dominate this activity.  While US interest in forest timberlands is minimally affected by exchange rates (Mendell et al; in press with the International Forestry Review), foreign investors cite exchange rates as a critical attraction to investing in the United States.

Forecasting Stumpage Prices and Timberland Investment Performance Requires Local Knowledge of Wood Demand

16 10 2011

Last week, I met with the CEO of one of world’s largest forest management and consulting firms.  We ended up discussing a mutually perplexing question, “why do some timberland investors prioritize macro issues like housing at the expense of understanding market-specific issues such as local wood demand, mill risk and actual forest inventories?”  While housing market forecasters have, once again, delayed expectations of the anticipated home building recovery, Forisk analysis of local timber markets affirms the primacy of micro-market, investment specific factors over regional and national trends.

Shifts in forest supplies and wood demand influence regional timber markets. The extent to which sub-regional markets, such as mill-specific wood baskets or property-specific timber markets, are influenced by regional or macroeconomic changes remains unclear.  Previous analyses by USDA Forest Service and University researchers such as Bob Abt, Fred Cubbage, Tom Holmes, David Newman, Jeff Prestemon, and Runsheng Yin, estimate a price elasticity of demand for softwood stumpage ranging from -0.50 to -0.57 and a price elasticity of supply ranging from 0.29 to 0.50.

This implies that for every 1% change in price, changes in demand or supply will be considerably less than 1%. [This also implies that for every 1% change in demand, price changes would exceed 1%.]

In 2005, Forisk Consulting began collecting mill-specific wood demand data on a quarterly basis throughout the US South.  In 2008, we expanded this coverage to the continental United States.  Today, our team manages an ongoing research program that collects and confirms data on 3,196 announced and operating wood-using forest industry and wood bioenergy mills throughout the US.  We believe this to be the most comprehensive and current tracking of US forest industry health and demand available in the world.

How has this research helped the forest industry and timberland investors?  We have found that local market performances have wide ranges of price-to-demand elasticities and mill risk profiles, beyond those established in regional or national analyses.  The differences across markets are statistically significant and provide a rigorous basis to adjust market-specific discount rates, stumpage price forecasts and expected rates of recovery.

For example, the expected price effect from a demand shock (i.e. a new mill) in a sub-regional market depends heavily on:

  1. Available forest inventories and growing conditions; and
  2. The competitiveness and distribution of wood-using mills in the local market.

Competitive markets with multiple mills can aggravate and prolong the impact of a demand shock on prices.  Alternately, competitive markets provide the best uses of new capital for timber and forest industry investments when benchmarked against ranges of wood baskets and timber markets across multiple performance criteria.

Wood Bioenergy: What is the “Biogenic Carbon Cycle”?

13 10 2011

Earlier this year, the EPA deferred a final decision on how to regulate greenhouse gas (GHG) emissions from wood-using bioenergy facilities.  Why?  EPA wants to study further the research on carbon accounting and the carbon neutrality of biomass.  (While clearly an important topic for additional study, the research posted on CNN this morning about the female orgasm looks more interesting…..I’m just saying).

The idea that forest biomass is carbon neutral when used for energy stems from its natural role in the biogenic carbon cycle.  What’s that?  In the biogenic carbon cycle, plants constantly remove carbon from the atmosphere through photosynthesis and emit carbon into the atmosphere through natural processes, including respiration and decay. In contrast, fossil fuels, such as coal, oil, and natural gas, take millions of years to form and cannot replenish themselves in this same way in short time periods.

When a wood bioenergy plant burns biomass to make electricity, it releases the carbon stored in the biomass into the atmosphere. Proponents of the carbon neutrality of forest biomass and bioenergy argue that the same carbon that was removed from the atmosphere by the tree’s growth is being released as the biomass burns. Because the carbon removed by the living tree is the same as the carbon released by burning the biomass from the tree, forest biomass and bioenergy is said to be “carbon neutral.”

What are the implications?  If, ultimately, the EPA decides that biomass energy is not inherently carbon-neutral, then biomass power could struggle to grow as an energy source. If biomass is not deemed carbon neutral, then perhaps one could question its renewability.  If biomass is no longer considered renewable and cannot be used to meet renewable portfolio standards, then few incentives exist for producers to generate biomass for power.  Regardless, further study of this, can, as a former professor of my Dad’s said, “titillate our lascivious desires creating a symbiosis of emotion.”  Or not.

National Research Council Affirms Results of Forisk Liquid Biofuels Study

7 10 2011

This week, the National Research Council (NRC), which operates as part of the US Academy of Sciences to advise Congress, published a study concluding that the United States will likely fail to satisfy its long-term Renewable Fuel Standards (RFS2) mandate for producing advanced biofuels from trees, grasses and crop waste.  In particular, the study cites the technological challenges of producing “next generation” ethanol.

The NRC research affirms the results of the study Forisk published in May 2011 with the Schiamberg Group which evaluated the wood-based transportation fuel sector in the United States.  While wood pellet and wood-to-electricity projects use established technologies proven at commercial scale, wood biofuel projects continue to face major technological, feedstock and policy challenges.  That said, there is a wide range of technologies and business models in development in the wood transportation fuels sector.

The study – Transportation Fuels from Wood: Investment and Market Implications of Current Projects and Technologies – includes the status of 36 cellulosic biofuel projects and estimated commercialization timelines for 12 technology approaches. While the NRC study addresses policy and sector-wide analysis and implications, the Forisk study emphasizes bioenergy and timberland investor implications by firm and project in the US.  Projects producing drop-in fuels appear to have superior potential for investors.   However, major technical hurdles will likely disrupt commercialization for most technologies under development.

While Forisk’s study finds an 11 year gap on average between estimated technology viability and firm announcements, it highlights promising approaches.   This includes the gasification technology under development by firms like Rentech and ClearFuels for diesel and/or jet fuel. INEOS New Planet, Rappaport Energy and Coskata, and Kior are pursuing innovative approaches using gasification and microbes, and catalytic fast pyrolysis.

For more information, please click here.

Timber REITs Join Sector-wide Decline; Yields Improve (for now….)

6 10 2011

While publicly-traded timberland-owning REITs, and REITs generally, outperformed the S&P 500 over 10-year, 3-year and 1-year benchmarks (see table), the sector took a shellacking during the third quarter of 2011.  The Wall Street Journal profiled the “dethroning” of REITs as investors fled from concerns about the global economy (“Investors check out of real-estate stocks”, October 5, 2011).  Within the REIT space, REITs that manage hotels and industrial space fell 32% and 24% during the quarter.  The timber REIT sector, as measured by the FTR Index, returned -20.84%.

Individually, the four publicly-traded timber REITs yielded varying returns for the quarter:

  • Potlatch (PCH): -10.63%
  • Plum Creek (PCL): -14.38%
  • Rayonier (RYN): -15.55% (split adjusted)
  • Weyerhaeuser (WY): -28.87%

WY drove timber REIT returns as it comprises 44% of the market cap weighted FTR Index.  The drop in share prices proved advantageous to investors shopping for dividend yields as WY approached (and temporarily exceeded) 4%.  Yields for PCH continue to exceed 6%, while PCL and RYN hover between 4 to 5%.  The question becomes the sustainability of dividend levels given the outlook on core revenue generators for these firms.  Our research targets the ability of current cash generators by firm to satisfy cash obligations (i.e. debt service and dividends) in the near and mid-term.

Looking forward, the sector suffers from downward revisions associated with housing demand and construction in the United States, and the associated declining need for softwood lumber manufactured from the pine, Douglas-fir and hemlock trees grown by the timber REITs.  Alternately,  the Performance Fibers and log export businesses have provided timely and opportunistic lifts to revenues.

To receive the free FTR Weekly Summary with detailed historical index data in Excel, please email Brooks Mendell, bmenedell@forisk.com.