Timber REITs: Dividend Yields and the Dallas Mavericks

Rayonier’s (RYN) announced ten percent dividend increase reminded me of the well-traveled quote from investor and Dallas Mavericks owner Mark Cuban on stocks and dividends:

I believe non dividend stocks aren’t much more than baseball cards. They are worth what you can convince someone to pay for it.

The quote speaks to the importance of considering ‘total return’, which accounts for both (cash) income and (capital) appreciation, when valuing investments.  For timberland-owning REITs, this includes (1) quarterly dividends and (2) changes in stock prices for a given time frame.  For direct timberland investments, this includes (1) income generated from, in part, timber sales and other forest management activities as well as (2) appreciation of the land and standing forest.

Last week, NCREIF announced year-to-date (through Q2 2012) total returns for private US timberlands of 0.97%.  This total return number includes 1.54% from income and -0.57% from appreciation.  Alternately, publicly-traded timber REITs, as measured by the Forisk Timber REIT (FTR) Index, generated year-to-date total returns (through July 27, 2012) of 19.93%.  As of July 27, 2012, the four timber REITs provided the following dividend yields:

• Plum Creek (PCL): 4.15%
• Potlatch (PCH): 3.69%
• Rayonier (RYN): 3.50%
• Weyerhaeuser (WY): 2.54%

However, timberlands-versus-timber REITs is not an acorn-to-acorn comparison. For multi-year investors, direct ownership of timberlands continue to provide superior capital preservation and diversification, while public REITs offer superior liquidity and total returns with more risk.  While timber REITs attract attention from dividend-seeking investors, the figure below highlights the advantages and disadvantages of focusing solely on dividend yields (income) when investing in equities.  Equity values can and will dive with the overall market (see 2008-2009) while long-term investors gained through buy-and-hold-and-dividend reinvestment strategies.

Reminder: Early registration for “Timber Market Analysis” ends August 1^st.  This one day course will be taught August 15^th in Atlanta. Click here for more information

Timber REIT Returns Pass S&P 500 YTD

Just over two months into 2012, the public timber REIT sector pulled ahead of the S&P 500.  According to the Forisk Timber REIT (FTR) Index, timberland owning REITs returned 9.84% YTD relative to 9.01% for the S&P 500.  Weyerhaeuser (WY) and Plum Creek (PCL) led the sector’s surge, with 15% and 10% ten-week price appreciations respectively since the New Year (see table).

Timberland-owning REITs comprise 5.91% of the market capitalization of all public REITs.

For FTR Index methodology, click here.  For detailed, historical FTR Index data in Excel, contact Brooks Mendell, bmendell@forisk.com.

The Tax Man and Timber REITs

Nobel Prize-winning physicist Albert Einstein once said, “the hardest thing in the world to understand is the income tax.”  On the other hand, actor Wesley Snipes reportedly said, “taxes are only complicated if you pay them.”  (Actually, that might have been Wesley’s cellmate while they served time for tax evasion.)  Lucky for investors in timberland-owning REITs, the Tax Man’s bite hurts less than for other REITs and dividend-paying stocks that are subject to ordinary income tax rates.

Most timber REIT distributions (related to income from the sale of timber) are treated as long-term capital gains and taxed at relatively lower 15% tax rates compared with ordinary dividends.  Recently, all four public timber REITs announced the tax treatment of dividends paid in 2011:

For Plum Creek (PCL), Rayonier (RYN) and Weyerhaeuser (WY), 100% of the dividends paid in 2011 will be treated as capital gains. For Potlatch (PCH) investors, $1.01188 per share (54.955878% of the total distribution) will be treated as return of capital, while the balance will be treated as capital gains.

Click here to learn more and register for “Applied Forest Finance” on February 9th in Atlanta, Georgia.

2011 Timber REIT Results: Led by RYN, Sector Outpaces S&P 500

In 2011, timberland-owning REITs, as a sector, outperformed the S&P 500.  As measured by the Forisk Timber REIT (FTR) Index, publicly-traded timber REITs returned 5.69% versus 0.00% for the S&P (see tables).  The FTR Total Returns Index, which accounts for dividend distributions, earned 9.62% in 2011.

While the timber REIT sector performed well, individual firm performance varied.  Not including distributions, Rayonier (RYN) alone generated positive, stand-alone returns of 27.47%, which accounts for a mid-year 3-for-2 stock split.  The other three timber REITs generated negative returns of 1 to 4 percent.  The primary distinction between RYN and its timber REIT brethren is the relative size, magnitude and profitability in 2011 of its specialty performance fibers division.

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

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:

• Analysts have “over forecasted” stumpage prices.  The pine grade stumpage markets in the South face measurable pressure for 2+ years.
• Georgia-Pacific’s decision to close its Crossett, AR facility moved the needle.
• Among the timber REITs, PCH is one of the two most directly exposed to US housing numbers.  Our January 2011 research detailed this relationship.  CEO Mike Covey has been explicit regarding PCH dependence on US housing numbers, and how it affected Board discussions related to the dividend.

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.

Do Timber REITs Lead or Ride the Coattails of Investor Interest in Real Estate Markets?

Last week, the Wall Street Journal reported on the rush of investors buying into publicly-traded real estate investment trusts (“Real-estate investors target neighborhood that is looking up,” Wall Street Journal, 11/15/11).  According to Citigroup Global Markets, investors, year-to-date, invested 18% more capital into publicly-traded REITs than in all of 2010, and 400% more than in 2009.  Holy groupthink, Batman!

This stampeding herd of buyers returning to public real estate markets reminds me of the African proverb “you can’t run and scratch your foot at the same time.”  As a reluctant runner, I welcome an excuse to pause and scratch a puzzling itch or three.  First, why the interest in REITs generally?  Second, how does this look within the context of the overall market?  Third, how do timberland-owning REITs score during this investment cycle?

REIT investments satisfy the hunt for yields.  With capital looking for “relative” safety and valuing a return to fundamentals, public REITs attract investors eyeballing the steady cash flows and requirement to distribute earnings quarterly.  Within the REIT sector, certain sub-sectors have outperformed the broader REIT market.  According to NAREIT, total 2011 returns on apartment buildings and self-storage properties averaged ~10% and ~22%, respectively, through the first week of November.  Nice.

However, a closer look at the numbers indicates the article made a mountain out of a molehill.  Overall, REITs appear to be tracking the market.  REITs YTD through November 18^th returned -2.25% versus -3.34% for the S&P 500 versus….-2.69% for public timber REITs according to the Forisk Timber REIT (FTR) Index.  While real estate often satisfies objectives to diversify portfolios, this has proven more difficult in the context of a European debt crisis, failing efforts to balance U.S. budgets, and lagging demand for homes and construction.

What about timberland investments?  Year-to-day through Q3, according to NCREIF, equity investments in timberlands returned 1.06% and -0.35% in the third quarter.  For reference, with dividends included, public timber REITs as measured by the FTR Total Returns Index generated 0.63%.

The FTR Index includes Plum Creek (PCL), Rayonier (RYN), Potlatch (PCH) and Weyerhaeuser (WY). As of 11/18/11, publicly-traded timber REITs comprise 4.99% of total public REIT capitalization.

Timber REITs: Sector Meets and Exceeds 3Q 2011 Consensus Earnings; China Demand Softening

Last week, all four publicly-traded, timberland-owning REITs announced and reviewed their third quarter 2011 results (just in time to catch Game 7 of a heart-thumping World Series between the St. Louis Cardinals and Texas Rangers). All firms met or exceeded consensus expectations, even accounting for special items (see table). During their Earnings Calls, two timber REITs referenced, but did not name, the closure of Georgia-Pacific’s Crossett, Arkansas lumber and plywood facility, which had the capacity to consume close to 1 million tons of pine sawtimber annually. This represents a material loss of demand in a key Southern market, and will influence timber REIT valuation models sensitive to state-level stumpage pricing and wood demand.  Alternately, all firms cited demand from China as a driver of strong log pricing and demand in their Western markets, though Weyerhaeuser noted this demand had softened since the second quarter.

Firm-by-firm highlights include:

• Weyerhaeuser (WY) reported net earnings of $157 million for the quarter ($0.29 cents per share). Excluding after-tax gains of $91 million from special items, including an $83 million benefit related to foreign tax credits, WY earned $0.12 per share. Timberland earnings declined $50 million in the third quarter compared with the second due to: (1) earnings from dispositions of non-strategic timberlands declined $28 million to $4 million; (2) average prices for Western logs fell from weaker Chinese and domestic markets; (3) prices for Southern logs declined; and (4) silviculture and road costs increased (seasonal). In addition, CEO Dan Fulton echoed two themes we’ve been sharing with clients from our research.  First, WY has outsized exposure to housing across business segments relative to other timber REITs. Two, current housing forecasts often understate the impact of multi-unit homes, which can use 50%+ less wood per housing unit relative to single family dwellings.
• Plum Creek (PCL) reported Q3 2011 earnings of $50 million ($0.31 per share) versus $32 million, or $0.20 per share in Q3 2010. Northern Resources reported a $7 million operating profit for the quarter, up $2 million for the same period in 2010. Sawlog and pulpwood prices were, respectively, 7% and 8% higher than in Q3 2010.  Southern Resources earned $21 million for the quarter, down $4 million for the same period of 2010. While prices remained stable and slightly up since last quarter, sawlog prices were 15% lower and pulpwood prices were 17% lower than average prices for Q3 2010. PCL sold ~36,000 acres of lands during the quarter and completed the acquisition of 50,000 acres of timberlands in Georgia and Alabama.  Finally, PCL repurchased ~670,000 shares of common stock at an average price of $34.87 per share (closing price as of 10/28/11: $38.47).
• Rayonier (RYN) reported Q3 net income of $105 million ($0.84 per share). Excluding a $16 million tax benefit related to the 2009 alternative fuel mixture credit (“AFMC”), net income was $0.71 per share. Forest Resources reported Q3 2011 operating income of $11 million, up $2 million, which offset higher logging costs in the Northern region and lower results in the Atlantic and Gulf regions primarily due to forest fire impact and soft grade markets. Performance Fibers reported operating income of $75 million, up $13 million. CEO Lee Thomas noted that RYN increased its 2011 guidance, and that RYN’s 190,000 ton expansion of high purity cellulose specialties capacity at its Jesup mill is “on track” with “approximately 70% of this new volume…already committed.”
• Potlatch (PCH) posted stronger earnings across business segments this quarter relative to the same period in 2010. Net earnings for Q3 2011 were $25.6 million ($0.63 per share) compared to $18.1 million ($0.45 per share) for Q3 2010.  The Resource segment benefitted from the Northern region’s seasonally strongest quarter. Fee harvest volume for the Northern region tripled since last quarter. Also, Southern fee harvest volume increased 33% in Q3 2011 over Q2 2011 from increased pine plantation thinnings.  Real Estate revenues totaled $14.8 million in Q3 2011 compared to $19.0 million in Q2 2011. Wood Products earning $2.9 million in Q3 2011 versus $2.8 million in Q2 2011.
  

For those of you not keeping score at home, the Cardinals won….

How Creditworthy are the Public Timber REITs? A Rating Agency Update

Last week, Fitch Ratings raised its outlook on Weyerhaeuser (WY) from “negative” to “stable” and affirmed its rating at “BB+”.  Fitch justified the action primarily on WY’s Pulp business and core Timberland operations, though the rating agency recognized that the company’s financial performance continues to suffer from depressed housing markets via its Wood Products and Real Estate businesses.  Given the Fitch action, we take this as an opportunity to revisit the current ratings across the firms we track in the timber REIT space.

The table summarizes current ratings for the publicly-traded timberland-owning REITs by the three major credit rating agencies: Standard & Poor’s (S&P), Moody’s and Fitch. The rating agencies do not make recommendations about buying or selling securities; rather their ratings are intended to provide independent, objective and informed opinions about the credit worthiness of each company.

In rating long-term debt, the agencies use alphanumeric letter grades, starting from “AAA” (extreme strong capacity to meet financial commitments) and ending at “D” (has been a payment default). Each letter grade has three notches and S&P uses + and – as modifiers. “BBB” and above are considered “Investment” grades and “BB” and below are considered “Speculative” grades. Ratings are subject to revision and the agencies update their outlook on a continuing basis. A “Positive” outlook indicates that the rating may be raised and a “Negative” outlook indicates that the rating may be lowered, while “Stable” indicates a neutral outlook.

Timber REITs: Sector Up and Down in 2011; Still Outperforms S&P

Risk management is back in vogue.  S&P’s downgrading of US sovereign debt last Friday to AA+ from AAA sparked sell-offs across world markets.  Yesterday (Monday August 8, 2011) scored Wall Street its worst day in over two-and-a-half years.  Meanwhile, how have timberland-owning REITs fared?  The good news: better than the overall market.  The bad news: it’s been a roller coaster ride there this year as well.

Year-to-date, following S&P’s downgrade on Friday August 5, 2011, the Forisk Timber REIT (FTR) Index of public timber REITs returned -0.28% versus -4.63% for the S&P 500 Index.  This is consistent with history.  While the S&P outperformed the FTR Index in 2010 (12.78% versus 8.39%), the FTR outperformed the S&P over three, five and ten-year investment periods leading up to 2011.  In other words, timber REITs performed well for buy-and-hold investors.

This year, timber REITs have bounced around.  The sector’s market cap increased nearly $5 billion in the first quarter (21.1%), and retreated 6.6% in the second quarter (see figure).  The market swoons of July and early August brought the sector, as a group, back to where we started for 2011.

To learn more about timber REIT assets, strategies and valuations, participate in the “Investing in Timber REITs” workshop on August 23rd in Atlanta.

Timber REITs: Land Sales Offset Weak Log Markets for PCL and PCH in 2Q 2011

Second quarter 2011 results reported by Plum Creek (PCL) and Potlatch (PCH) the past two days indicated continued weakness in those segments affected by housing markets (timber harvesting and wood products manufacturing).  Both firms somewhat offset lower timber harvesting cash flows with higher sales of timberlands. While sawlog pricing in the West still benefits from strong export demand (primarily China), sawlog prices in the South remained under pressure due to dry weather and weak demand.  (Dry weather provides optimal log harvesting conditions and, therefore, increases potential supplies in the down market.) Southern pulpwood prices also weakened due to weather related reasons.

PCL reported its 2Q 2011 earnings at $44 million or $0.27 per diluted share, two cents short of the consensus estimate. Operating income from Northern Resources remained unchanged year-over-year at $3 million, while Southern Resources’ operating income came in at $15 million, down from $24 million a year ago. Due to weak pricing, the company further reduced its sawlog harvest in the South by ~100,000 tons.  Real Estate reported operating income of $50 million, up from $26 million in 2Q 2010, from large conservation sales in Florida, Arkansas and Louisiana. Manufacturing income was $5 million, compared with $8 million (excluding one-time gains) in the prior year quarter.  Management lowered its guidance for 2011 operating income to $1.15­­–$1.30 per share, reflecting lower harvest levels and weaker Southern sawlog prices. The company will complete its previously announced acquisition of 50,000 acres of timberland during 3Q 2011.

PCH reported net earnings of $8.4 million or $0.21 per diluted share, in-line with consensus estimates. Resource segment operating income was $7.5 million, down from $15 million in 2Q 2010. Harvest levels were down both in the Northern and Southern regions. Real Estate operating income was $11 million, as the company sold ~12,000 acres of non-strategic land and ~2,000 acres of rural land. Wood Products income was $2.8 million, down from $6.0 million in 2Q 2010.