Forest Finance: Analyst’s Creed

27 12 2012

You are an Analyst, a warrior shrouded in mystery and feared for your ruthlessness with Excel. Your actions can throw Investment Committee meetings into chaos, and your existence will shape forest management during this pivotal moment in history.

[Inspired by the Assassin’s Creed]

Forest finance is the language of managing forest resources as investments.  It addresses three questions.  First, the investment decision considers, “How do we screen and value timberland acquisitions or forest management decisions?”  Second, the financing decision asks, “How do we pay for this investment?”  Third, the exit or sale decision asks, “How and when is the appropriate time – during good markets or bad – to harvest timber or sell the property to maximize profits?”

Investment objectives matter.  Analysts use finance to compare projects and identify those that satisfy the predetermined criteria of clients or managers.  This facilitates the investment decision by screening out those that we can set aside, and those that we should consider further.  For example, a preliminary screen may include geography, deal size, information quality, and basic financial metrics. If the potential investment satisfies the initial screen, then managers can allocate the human and financial resources required to investigate further.

As forest analysts, we make investment recommendations.  It is our responsibility to be transparent and truthful in our assumptions and analysis, and practical and clear in communicating recommendations and ideas.  My PhD advisor at the University of Georgia, Dr. Mike Clutter, reinforced the importance of having an integrated feel of finance with forestry when evaluating timber-related investment decisions. For me, this means forestry and investment professionals must be able to:

  • Identify and communicate key financial issues for a given forestry or timberland investment;
  • Differentiate and explain the pros and cons of alternate approaches to financial analysis; and
  • Analyze and value timber and timberland investments and alternatives.

As analysts and researchers, how can we better support our firms and clients?  Over time, I have found few methods as effective for increasing analytic rigor and reducing errors as repeated application of financial tools in a range of forestry-related cases to highlight the range of unique questions and attributes associated with timberland assets….

Click here to learn about and register for “Applied Forest Finance” on February 7th in Atlanta, Georgia.  The course details necessary skills and common errors associated with the financial and risk analysis of timberland and other forestry-related investments. Registration includes copies of our “Forest Finance Simplified” handbook that distills key forest finance themes and questions into a question-and-answer format for those who want an accessible reference to key concepts but lack the time and inclination for “deep study”…… 


“Limits to Growth” for Wood Pellet Production in the U.S.

20 12 2012

This post summarizes research from the December 2012 edition of Wood Bioenergy US (WBUS).

In 1972, the Club of Rome commissioned The Limits to Growth, a book which explored the interaction between exponential growth and limited resources. The book concluded that the world would reach its limit within the next 100 years, resulting in a massive population decline and industrial capability.  While criticized upon publication, key elements of the research – such as those associated with population growth and CO2 levels – held up, reinforcing historic relationships between resources and growing populations.  However, the research may have understated the role played by prices and markets in allocating resources.  Lessons from this research apply when evaluating the development of wood bioenergy markets.  While market forces and policy decisions struggle to coexist, the actual growth of bioenergy relative to available resources can be understood.  Wood bioenergy projects must successfully navigate logistic challenges and access to wood raw materials.

Forisk explored this theme by addressing three questions:

  1. Which wood bioenergy subsector in the U.S. demonstrates the fastest growth?
  2. Why?
  3. What “limits to growth” do we observe in this subsector, if any, looking forward?

Of the nine regional and technological subsectors evaluated, wood pellet project development in the South leads the United States.  Of current pellet project announcements, 86% of total production by 2022 would be exported to European markets.  However, the ability of U.S. firms and exporters to successfully produce wood pellets is limited by factors associated with port access and the economics of pulpwood markets. The WBUS feature article includes spatial analysis of announced projects relative to deep-water ports and state-by-state data for the South of expected pulpwood use by export-oriented pellet projects relative to forest industry pulp mills, OSB facilities and operating bioenergy plants.

20121220 WBUS_pellets

WBUS Market Update:  As of December 14, 2012, WBUS counts 455 announced and operating wood bioenergy projects in the U.S. with total, potential wood use of 129.4 million tons per year by 2022.  Based on Forisk analysis, 298 projects representing potential wood use of 78.4 million tons per year pass basic viability screening.  To download the free WBUS summary, click here.

Timber REITs and the “Dividend Tax” Cliff, Part II

4 12 2012

Part I of Timber REITs and the “Dividend Tax” Cliff summarized, in words, the implications to shareholders of publicly-traded timberland-owning REITs if the current dividend tax rate expires on December 31, 2012.  This post quantifies the implications and puts into context the impact of changing tax rates on timber REIT shareholders relative to shareholders of non-timber REITS or other dividend-paying stocks in the United States.  The bottom line: timber REIT equities retain a tax-advantaged status in a post-tax cliff environment.

Let’s compare the dividend yields of the four public timber REITs – Potlatch (PCH); Plum Creek (PCL); Rayonier (RYN); and Weyerhaeuser (WY) – under different assumed tax scenarios:

  • No Taxes:  our “fantasy” and “frictionless plane” scenario.
  • Current Post Tax: reflects the present code that taxes dividends at 15%.
  • Post “Cliff”:  represents a return to pre-2003 rates, which treats timber REIT dividends as (mostly) capital gains and taxes them at the pre-2003 capital gains rate of 20%.
  • Non-Timber REIT:  captures a return to taxing dividends at the marginal ordinary income tax rate.  Our scenario focuses on shareholders in the 35% ordinary income tax bracket.

Table 1 summarizes how the impact on dividend yields, while negative in all scenarios, slices results to a greater degree for non-timber REITs.

Table 1

20121204 Table 1

What would you need to receive in dividends from your timber REIT investments to generate the same dividend yield “pre” versus “post” change in the tax code, if it occurs?  Table 2 summarizes this result relative to non-timber REIT shares.

Table 2

20121204 Table 2

While dividend yields do not tell the whole story, they do provide a starting point for comparing alternate investments.  At a minimum, stocks that emphasize dividends compete with risk-free rates offered by U.S. Treasuries (currently 1.63% pre-tax for 10 years).  Other factors to consider include:

  • Total expected returns:  investors reasonably expect a risk “premium” for holding stocks over bonds, and this premium supports expectations of total returns which sum dividends and appreciation.
  • Effective tax rates:  actual tax rates vary significantly across investors.  Institutions such as mutual funds and pension funds hold approximately two-thirds of public equities in the U.S.  And many individuals attracted to dividend-paying stocks pay lower ordinary income tax rates.

In the end, regardless the valuation math and legislative decisions, timber REITs, in the world of dividend-paying stocks, feature an attractive tax profile for potential investors.

Click here to learn about and register for “Applied Forest Finance” on February 7th in Atlanta, Georgia.  The course details necessary skills and common errors associated with the financial and risk analysis of timberland and other forestry-related investments.