Wood Market Realities, Part I: Stumpage Price Paranoia

30 05 2012

This is the first in a two-part series related to the analysis of wood baskets and timber markets for investments in forest industry mills, wood-using bioenergy projects and timberland.

When analyzing timber markets or wood baskets, paranoia regarding stumpage price data may serve you well. Why?  Two reasons.  One, each stumpage price data set – no matter its source, perceived quality, consistency, depth and structure – reflects a (biased) sample that suffers from practical, unavoidable limitations when applied to statistical analysis.  Two, stumpage prices cannot be generalized across markets.  Like timber markets in practice, stumpage prices reflect a snapshot of uniquely local circumstances.  Analyzing timber markets for investment purposes is a localized, situational exercise.

Consider the disparity of historic and forecasted pine sawtimber prices across markets in the US South over time (Table 1).   The wide ranges of prices (High-Low spread) across states in the past translate into broad ranges of estimated prices across states in the future. We have used stumpage price data from dozens of public and private sources, and all have limits.  When applying third-party stumpage price data, we want to know, for example, (1) how well the price series reflects realized changes over time and (2) how well the series reflects price levels over time.  These are two different questions that speak to the coverage, consistency and biases imbedded in the data.

My paranoia related to stumpage price data extends to analysis delivered by stumpage price providers. Whether or not analysis is rigorous and statistically valid, research that relies on one’s own data, when other data sets are readily available for further market testing, is biased and incomplete.  That’s just the way it is, by definition and by practice.

What about stumpage forecasts?  Forecasting helps identify relationships in historical data to infer future conditions.  A forecast tells a story, a view of how the market functions.  Since stumpage forecasts could compound the limitations of stumpage price data, perhaps forecasting is a fool’s errand. However, the mystical status of forecasting discounts the primary importance of prudent analysis, focused objectives, and rigorous implementation.

In theory, building a forecast is straightforward.  Plug into the Matrix and ask the Oracle.  (She’ll bake you some cookies and tell you not to worry about breaking the vase.  Then she will tell you we don’t forecast to make decisions, we forecast to justify decisions already made…..) In practice, it’s a disciplined analytic exercise to test ideas, data and assumptions.  Properly collecting and understanding the strengths and limitations of the data are as important as any aspect.  Without testable, useful, reliable data, quantitative analysis would suffer and, once exposed, wither in a sea of scornful questions.

Forisk will teach “Timber Market Analysis” on August 15th 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


Wood Biofuels, Venture Capital and Skin Moisturizers

18 05 2012

A fundamental mismatch exists between clean energy projects and venture capital funds.  This conclusion, in a Harvard Business School working paper “Venture Capital Investment in the Clean Energy Sector” by Shikhar Ghosh and Ramana Nanda, emphasized investor expectations of extraordinary financial returns from successful projects in order to balance out numerous failed projects.  The problem with energy projects is that they can take decades to succeed, require enormous capital resources and, in the case of liquid biofuels, compete in an efficient commodity market (i.e. oil).  This working paper was published in 2010 and cited by David Rotman in Technology Review.

In 2011, Forisk and the Schiamberg Group published a study – Transportation Fuels from Wood: Investment and Market Implications – that evaluated 36 cellulosic biofuel projects and estimated commercialization timelines for 12 technology approaches in the United States.  Projects producing drop-in fuels appeared to have superior potential for investors and timber markets.   While we found major technical hurdles that would likely disrupt commercialization, we identified promising projects and strategies including, for example, gasification technology (for diesel and/or jet fuel) and catalytic fast pyrolysis.

Now, in 2012, recent announcements reaffirm the relevance and implications of these previous studies:

  • U.S. cellulosic producers will massively miss EPA projections and mandates dictated by the 2007 Renewable Fuel Standard.  As noted by Mike Orcutt in “U.S. Will be Hard-Pressed to Meet its Biofuel Mandate” (May 9, 2012), “Congress [in 2007] vastly overestimated the government’s ability to create a market for cellulosic biofuels.”
  • Biofuel projects continue to retool.  Forisk’s 2011 study emphasized the advantages to investors from firms with flexible end product strategies focused on drop-in fuels and other chemical products.  Amyris, a firm that applies synthetic biology technology to produce alternatives to conventional chemical and petroleum products, announced in their Q1 2012 earnings call that they are getting out of the biofuels business.  Rather, the firm will focus on higher-valued products, such as skin moisturizer.

“Transportation Fuels from Wood” is now available at 60% off the original publication price.  For more information, please click here.

Timber in Turmoil, Part III: Public Timber Liquidity

13 05 2012

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 15th 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

7 05 2012

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

4 05 2012

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.