Forest Finance: “Drive-By” Timberland Valuations

3 02 2013

Want a simple method for valuing stocks and income earning real estate or timberland?  Consider the Dividend Discount Model by dividing next year’s income, assuming it will be earned annually in perpetuity, by a constant discount rate or cost of equity.

20130203 Forest Finance figure 1

For example, assume that Forisk stock pays $1.00 per share annually in perpetuity.  How much would you be willing to pay per share if you required a 10% rate of return?  According to the Dividend Discount Model, you would pay $10 per share.

20130203 Forest Finance figure 2

If we think about this model with forestry investments in mind, assume a timberland ownership generates $100 of net income per acre per year.  Applying a 6% discount rate in the Dividend Discount Model ($100/6%) gives a valuation of $1,667 per acre.  For those of us in timber, we can see that this approach gets us “in the ballpark” and provides a simple approach for “drive-by” valuations…..

Click here to 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 forestry-related investments. Registration includes copies of our “Forest Finance Simplified” handbook.


ForiskForecast for Stumpage Prices: What Do We Expect?

9 04 2012

In 2011 for the second consecutive year, Forisk’s localized pine sawtimber forecast hit within 4% of actual on average at the state-level.  South-wide, Forisk’s regional pine sawtimber average of $26.57 per ton exceeded Timber Mart-South’s actual price of $23.97 for 2011 by 4.7%.  The just published 2012 ForiskForecast takes on 11 states in the US South and Oregon’s and Washington’s Douglas-fir and hemlock markets in the Pacific Northwest.

Our research develops three economic and forest industry scenarios.  The baseline and “low growth” forecasts expect more of the same, with relatively flat to negative pricing in 2012 for pine sawtimber, with modest strengthening in 2014 as housing returns.  Higher sawtimber prices require more than simply increased housing starts; prices require a suitable balance of forest industry capacity to lumber demand and production, with sawmills exceeding 85% utilization for six to twelve months to “reset the floor.”  Pine pulpwood markets vary across the US South, as those states with concentrated pulp mills and “viable” bioenergy projects – as specified in Wood Bioenergy US – show strong pulpwood stumpage markets.

Meanwhile, other market activities provide opportunities to supplement needed demand, including active export markets and the expansion of the Panama Canal.  Forisk developed a “high growth” scenario that accounts for both strong economic and housing market growth, and potential increased log export activity from the US South by state.  This scenario expects pine sawtimber strengthening in 2012-2013, with prices in 2014 $2.86 per ton higher than the baseline forecast.

To learn more about the 2012 ForiskForecast, click here.

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.

US Forest Growth Far Exceeds US Wood Demand

28 09 2011

The 1970 movie “Sometimes a Great Notion”, based on the novel by Ken Kesey, centers on an independent logger in Wakonda, Oregon, and a battle between the local logging union and a lumber conglomerate.  The patriarch of the logging family, played by Henry Fonda, says to his rebellious, long-haired, youngest son, played by Michael Sarrazin, “where did you get all that hair?”  And the son replies, “it grows.”

Trees grow, too.  All of the time.  Regardless market conditions.  And in the United States, we are REALLY good at growing trees and managing for volume.  In fact, total growing stock – forest inventory – from all forest owners and species increased 51% from 24.6 billion tons in 1953 to 37.3 billion tons in 2007. Despite increases in wood use from all forest products sectors over this time period (pulp and paper and wood products), especially in the 1990s through 2005, the overall volume in the forest in the United States has increased.

In addition, this growth has far exceeded forest harvesting and removal activity, which proxies wood demand in the United States.  While forest growth net of removals has been positive, it has varied by region over time. The West had the lowest net growth in 1976 of 7.6 million tons. Net growth in the West increased over time as forest industry activity in the region weakened. The South had the lowest net growth in 1996 of 21.1 million tons

Thoughts from 2011 UGA Timberland Investment Conference

30 03 2011

From the desk of Dr. Tim Sydor, Forest Economist:

The 2011 Timberland Investment Conference, hosted last week by the University of Georgia’s (UGA) Center for Forest Business at Lake Oconee, attracted over 350 participants from all aspects of the timberland investment spectrum. Here are my thoughts on select topics covered at the Conference:

The condition of housing markets in the US captured everyone’s attention on the first day.  Rightly so.  As the final use for numerous timber products, housing explicitly drives wood demand and prices for lumber and logs. I noted in particular two points from presentations by Harvard’s Joint Center for Housing Studies, the Federal Reserve Bank of Dallas and the Terry College of Business at UGA.  First, the panel estimated an “overhang” of 3 to 3.5 million housing units. This overbuilt inventory includes foreclosed and soon-to-be foreclosed homes, which could dampen any market recovery. Two, there exists an “overhang” of unrealized demand for housing on the order of 2 to 2.5 million units (also known as pent-up demand) stemming from delayed housing formation due to the recent recession and poor job markets.

Optimistic and pessimistic assessments in the forest industry use these points selectively to support conclusions of why a housing recovery is or is not on the horizon. From my view, the estimates of both “overhangs” are sufficiently close to each other to indicate that modest economic growth and activity is all that is needed for stronger employment and the clearing of excess inventory over the next few years.  Also, this same view would discourage any policy that slows the resolution of unhealthy and, where necessary, underwater mortgages.

Export markets to China of logs and lumber shined as one of the bright spots in the industry outlook. Log exports increased 600% since 2008 (wow!). Dr. Jack Lutz put this into context, noting that the associated volume was equivalent to the annual use at a single large sawmill. Hardly a game changer.  However, as an economist, I always look to the margin and found the activity encouraging.

What spurred recent Chinese demand?  Presentations shared multiple theses.  One, the Chinese Government increased plans from building 3 million affordable housing units in 2010 to 10 million units per year until 2015. Two, Chinese log importers felt compelled to react to uncertainty associated with Russian log export taxes (which have been in effect at the same 15 Euro/cubic meter since April 2008).

For me, it remains important to keep this development in perspective. Log exports are increasing to the country (China) where government expenditures keep demand growing for housing. These exports, to some degree, substitute for logs from another country (Russia) whose government chose to curb log exports to support its own lumber industry.  Net result?  The US, in the short term, increased its role as a Chinese source for wood raw materials.