Timber REITs Outpace S&P in 2011 Based on Long and Short-Term Market Factors

7 04 2011

From the desk of Neena Mishra, Director of Equity Research:

The Forisk Timber REIT (FTR) Index of public timberland-owning real estate investment trusts (REITs) continues to outpace the overall market in 2011, returning 23.78% year-to-date compared with 6.19% for the S&P 500 (as of April 6, 2011).

What factors have contributed to the outperformance of the FTR Index over the broader markets?  We highlight one longer-term investment upside and two shorter-term market drivers.

First, market analysts and investors have incorporated the positive upside imbedded in timber REIT timberland assets over the next few years.  During the downturn, timber REITs deferred their forest harvests and changed the harvest mix (away from higher priced sawlogs towards pulpwood). This effectively increased the capacity to harvest more and improve the mix in the future. When the recovery occurs, these REITs will benefit from higher harvest volumes, improved harvest mix and strengthened pricing.  [We proposed this thesis and detailed the volume impact by firm in our January 2011 Technical Note, which specified Weyerhaeuser (WY) as the primary beneficiary.]

Second, China rapidly increased imports of both logs and lumber since last year, which strengthened sawlog prices in the Pacific Northwest. Though Southern sawlog prices remain impacted by weak domestic demand, pulpwood prices continued to benefit from demand for bioenergy (i.e. pellets) and steady demand from the pulp and paper industry. On the supply side, tailwinds from declining merchantable pine volumes in British Columbia due to feasting by the mountain pine beetle continue to affect pricing.

Third, the recent catastrophic events in Japan will increase demand for logs and lumber once rebuilding starts.  Approximately 150,000 buildings were destroyed by the earthquake and tsunami; these will be rebuilt over the next few years. Most rebuilding will use wood as it is more earthquake resistant.  Of the four public timber REITs, WY is best positioned to gain from the rebuilding, due to the coastal location of its Western timberlands, its focus on higher valued-premium sawlogs and its long-standing client relationships in Japan. Japan has been WY’s largest log export market and currently represents about 10% of its total sales and 75% of its export volume.

As a result of the improved outlook for the timber REITs, Moody’s raised Plum Creek’s (PCL) debt rating one notch, to Baa2 from Baa3, with a stable outlook; and affirmed the debt rating for Rayonier (RYN), while raising the outlook to positive from stable.

To receive the free FTR Weekly Summary along with an Excel file with the historical data that can be used for market research and benchmarking, email Neena Mishra, nmishra@forisk.com .