US Treasuries, Private Timberlands and Timber REIT Investment Returns

27 12 2011

Executive Summaryall timberland investment vehicles exceed US Treasury benchmarks over long time frames; timber REIT dividend distributions enhance yields to help offset short term share price volatility.

U.S. Treasuries remain a common benchmark for private timberland investments.  Why?  Relative safety and low risk over long time frames.  However, U.S. Treasuries, thanks to a robust secondary market, are more liquid than private timberlands, making them convenient benchmarks for publicly-traded timber REITs.  Over time, how have timberland investment vehicles performed against U.S. Treasury 10-year notes?  First, let’s take a (BRIEF) moment to revisit the world of bonds and government debt.

US Treasury Refresher

Treasury yields refer to the total amount of money you earn on U.S. Treasury bills (less than 1 year terms), notes (2 to 10 year terms) or bonds (longer than 10 year terms) sold by the U.S. Treasury Department to pay for the U.S. debt.  Remember:  Treasury yields fall when demand increases for Treasuries, which investors view as safe investments.  As with timberlands, when prices go up, expected returns on capital invested go down. Treasury yields change daily because few investors hold them to term.  Rather, investors resell them on the open market.

One reason we care about Treasury yields is because when they increase, so do interest rates on fixed-rate mortgages. This increases the cost of buying homes and decreases the demand, and prices, of those homes, which can slow the economy.  This coincides with a second reason why timberland investors take such a strong interest in Treasuries:  they affect the costs of building and buying homes, which influence the supply and demand of forest products such as lumber, OSB and plywood.

Usually, Treasuries with longer time frames have higher yields.  Why?  Because investors require higher rates of return for locking up their capital for longer periods.  The figure shows the “yield curve” as of December 22, 2011.

Yields remain abnormally low due to economic uncertainty. Investors accept these low returns in exchange for safety.   When shorter-term yields exceed longer-term yields to produce an “inverted yield curve,” it reflects near-term concerns of potential recessions.  Inverted Treasury yields occurred in April 2000, prior to the 2001 recession, and in January 2006, prior to the most recent recession.

US Treasuries versus Timberlands and Timber REITs

On an annualized basis and year-to-date, how have timberland investment yields benchmarked to 10-year US Treasuries?  For the ten year period from 2001 through 2010, both private (less liquid timberlands) and public (more volatile timber REIT stocks) investment vehicles outperformed US Treasuries (see table).

Year-to-date, shorter term market volatility has punished equities and private timberland markets reflect the cresting of timberland prices over the past three years.   Still, for those holding public timber REITs, the positive cash flow associated with quarterly dividend distributions offset share price declines, as reflected in the FTR Total Returns Index.

Wood Bioenergy: Fun House Mirrors and Fact Checking Cellulosic Ethanol

21 12 2011

This month I met with the Lt. Governor of a state with a substantive forest industry.  The discussion centered on ways to support forest owners, wood markets and job creating projects.  Then the conversation turned to the potential of wood-based liquid biofuels – such as cellulosic ethanol – and the Lt. Governor turned to me and asked, “Mr. Researcher, what would YOU do?”

After accepting the fact that we weren’t actually on a first name basis, I replied, “I would make it easy for users of wood to operate in your state without betting on any specific technology.”

The Lt. Governor liked the first half of the answer, but not the second half.  The fear of “missing out” on a “wood biofuels boon” has distorted policymaker views of wood market realities.  The sexy, explosive potential of reorienting US transportation fuels to rely on renewable “just-add-sun-and-water” raw materials has made fact-based discussions about the sector akin to strolling through a carnival fun house.

I remember, as a twelve-year old, looking from mirror to mirror at a county fair.  Tall and thin in this mirror; short and stumpy in that mirror.  We use mirrors both to show us what we want to see, and what we don’t.  And when we see what we don’t want, we either change our view, or change mirrors.

When it comes to liquid biofuels and cellulosic ethanol, multiple mirrors continue to reflect a consistent set of facts.  Our team has three years of research, a comprehensive US liquid biofuels study and ongoing market evidence that cellulosic ethanol faces the thorniest of practical challenges in an increasingly difficult context.  So, what are the facts?

  • No cellulosic ethanol facilities operate at commercial scale.  Wood Bioenergy US tracks every announced and operating wood-using bioenergy project in the continental United States.  As of December 7, 2011, this represented 456 projects.  Of these, 39 are liquid fuel projects.  How many are operating at commercial scale?  Zero.
  • Cellulosic ethanol faces unsolved technology hurdles.  The lack of wood biofuels projects is consistent with the results of our study “Transportation Fuels from Wood: Investment and Market Implications of Current Projects and Technologies.”  For 36 cellulosic biofuel projects, we estimated an 11 year lag between when the projects expect to operate and when our technology analysis indicates the technology could overcome hurdles and be viable at commercial scale.
  • Government subsidies and EPA mandates failed.  The Wall Street Journal (“The Cellulosic Ethanol Debacle,” 12/14/11) recently detailed the failure of subsidies and mandates to spur progress and, by implication, facilitate deceit and unrealistic projections.

Finally, the context for these projects has become increasing stark.  In a US market environment where gasoline use has been declining this year and where supplies of natural gas have been increasing, the political urgency and investment potential of these projects dissipate.

Timber REITs: PCH Dividend and Harvest Reductions Demonstrate Prudent Asset Management

7 12 2011

Years ago, I held shares in Crown Pacific Partners, a timberland-owning firm headquartered in Portland, Oregon.  During market declines in the late 1990s, the firm subsidized its shareholder distributions through borrowing and cash generated from non-organic business activities.  In other words, the firm ate its seed corn.  Crown Pacific filed for bankruptcy in 2003.

My shareholding experience with Crown Pacific influences my research to this day; it provided valuable lessons on the available (and unavailable) levers for cash generation and risk mitigation with timberland investment vehicles.  From this point of view, Potlatch’s (PCH) recent announcement to reduce dividends and harvest levels reflect sound, investment-strengthening decisions to protect long-term shareholder interests.  Decisions by the PCH Board and senior management (1) place long-term asset values and maximization over short-term yields and (2) embrace the realities of  knowable, quantifiable impacts on wood markets relative to speculative forecasts of key demand drivers.

PCH actions reinforced key messages we shared with clients in 2011 based on our equity research:

Equity markets appear to have embraced the PCH 39% reduction in its yield.  While share volume spiked on the day of the announcement, PCH’s share price declined 2.2% after two days of “post announcement” trading.  This left its dividend yield at 4.1%, in line with the other public timberland-owning REITs (see table).  According to the FTR Index, the timber REIT sector now has a 4.0% dividend yield.

Which Forest Industry Firms Use the Most Wood in the United States?

2 12 2011

The “80/20 rule” – also called the “Pareto principle” for Italian economist Vilfredo Pareto – posits that approximately 80% of your results or effects derive from 20% of the causes.   Look around and examples materialize.  80% of your revenue comes from 20% of your clients.  20% of your job will take up 80% of your time.  80% of the time your newborn cries at night occurs due to 20% of the potential reasons.  Pareto made the original observation in 1906 when he noticed that 20% of Italy’s population owned 80% of the land.

This management rule of thumb provides a means for quickly assessing profitability, risk, control and capacity in a business or an industry (which helps prioritize work). In the forest products and timber industries, we see examples of this rule in our research associated with timberland ownership, end product market share, and factors driving prices, especially at the local level.  However, nationally, industries may reflect more or less concentration.  Let’s consider the use of wood in the United States.

In 2005, Forisk Consulting began collecting mill-specific wood demand and capacity data in the 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. [One product that we provide to clients from this research is a mill database that supports shapefiles for analyzing wood baskets and timberland investments, and making maps for spatial analysis.]

In a given year in the US, approximately 2,300 forest industry firms consume ~500 million green tons of wood.  Which firms use the most?   The accompanying table includes the top 10 US companies based on potential wood use.  The list includes wood use at full capacity for mills labeled as open in our database as of July 2011.  Full capacity for the industry currently sits just short of 600 million green tons.

The top 10 comprise ~241 million tons per year of capacity (actual wood use represents 70-90% of this, depending on products produced and time period).  The top 10, which represent less than 1% of the firms, account for ~40% of the wood using capacity.   The top 10% of the firms (~230 firms), account for ~85% of the wood using capacity in the US forest products industry.