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

27 07 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.


Who are the Top Owners and Managers of Timberland in the US?

15 07 2011

According to Forisk tracking of timberland ownership, 58 firms currently own or manage in excess of 100,000 acres of timberlands in the United States.  These firms feature the following descriptive statistics:

  • As a group, they own/manage 57.6 million acres of US timberlands.
  • On average, they own/manage 993,000 acres of US timberlands.
  • The median ownership is 473,000 acres.
  • Assuming a conservative average per acre value of $1,500, each firm owns or manages on average $1.49 billion in timberland assets.
The top 20 timberland owners as of 2011 are listed below:

How Do Timberland Investment Managers (TIMOs) Make Money?

20 06 2011

“How do timberland investment managers make money?”  The question itself, asked by an analyst working for an institutional investor, was straightforward enough.  However, it was the third time in the past week our team had received a call with such a question.  Since “reading tea leaves” in our research business often involves better understanding the questions and concerns on the minds of those in the marketplace, I’m taking this as an opportunity to review the general business model of timberland investment management organizations (TIMOs).

TIMOs are asset managers.  They generate income through transaction fees, management fees (which grow with their assets under management) and performance fees.   That said, fees and fee structures vary widely across TIMOs.  In part, variance in investment strategies and fee structures help match the investment objectives and risk tolerances of different investors with appropriate timberland investment managers. 

Specific fees earned by TIMOs may include:

  • Placement fees based on the purchase price of the timberland investment properties: 
  • Management fees as a percentage of asset value (after purchases and dispositions); 
  • Management fees as a percentage of appraised market values of the timberland assets over time; and 
  • Performance fees (overage) that provide profit-sharing above a pre-specified hurdle rate.  Hurdle rates may be stated in real (without inflation) or nominal (with inflation) terms.  

An example of an overage arrangement would be where the TIMO receives a carried interest in the fund if returns exceed a stated hurdle rate.  For example, with a hurdle rate of 6%, the fund might receive 20-25% of the returns above this hurdle, called the overage.  This overage would remain in the fund and grow with the investment, giving the fund managers an “interest” in the fund that can compound over time.

Total annual fees paid to TIMOs are expected to approach, but not exceed, one percent of the assets under management in the timberland portfolio.  In the past, some TIMOs reported publicly their estimated fees.  For example, for the fiscal year ending 2002, The Campbell Group indicated average management fees at the property level of 96 basis points (0.96%). Hancock Timber Resource Group used 95 basis points (0.95%) to approximate management fees in publicly available timberland investment analyses.  Over time, annual fees have consistently ranged between 85 basis points (0.85%) and 100 basis points (1.00%), with other structures based on services provided or weighting more or less to performance.

TIMOs can generate the bulk of their income at liquidation, upon the sale of the timberlands, so the appraised values/appreciation estimates carry great importance to all stakeholders.  As such, the appraisal process and asset valuations remain ongoing concerns with timberland investors because of the potential for conflicts of interest.  Fee structures that pay-off towards the end of the investment period moderate these concerns as TIMO managers collect performance fees following the actual liquidation of the fund.  At that point, the market dictates the total returns associated with the properties.

A useful exercise in our equity research has been comparing the relative per-acre administrative loads of TIMOs and publicly-traded timberland-owning REITs.  At the end of the day, the earnings potential of timberland assets varies more by location than by ownership structure, assuming structures of comparable tax efficiency.

Timber REITs: Weyerhaeuser Timber Segment Positioned to Outperform South-wide Average

16 05 2011

Two-thirds of the nearly 6.2 million acres that Weyerhaeuser (WY) owns and leases in the United States are located in the South.  Our Equity Research team matched WY’s timberland acres to Forisk’s state-by-state forecast of stumpage prices and wood demand to assess the revenue growth potential for the next five years from WY’s timber operations in the US South.

Forisk forecasts state-specific pine sawtimber and pulpwood prices in the South for eleven states.  These forecasts use statistical models that establish relationships between stumpage prices and the state-specific demand for timber relative to other states.  These relationships allow each state to individually “express” its price relationship to changes in, for example, sawtimber demand (driven primarily by the housing markets) over time.

According to our models, the top five states in the US South in terms of demand growth for 2011 are Mississippi, Louisiana, Alabama, Tennessee and Arkansas. Approximately three million acres, or 74% of WY’s southern timberlands, are located in four out of five of these high growth markets.  Since these markets are expected to outperform the other Southern states with respect to demand growth, this positions WY’s timber business to outperform the South-wide average assuming any strengthening in housing and lumber markets.

During the housing downturn, WY deferred its harvest substantially and plans to increase harvest by approximately 10% this year and 70% from the current levels over the next 10 years.

Public Timber REITs Report Mixed Results in First Quarter of 2011

1 05 2011

Between April 25th and April 29th, all four public timberland-owning REITs reported their Q1 2011 financial performance.  Three of the four firms reported earnings per share below Wall Street consensus expectations:

Overall, results continue to reflect the US housing downturn and, on a firm-by-firm basis, special items and substantive performance by non-timber business segments.  Neena Mishra, Director of Equity Research, further summarizes results by firm:

On April 29, Weyerhaeuser (WY) reported Q1 2011 net earnings at $99 million or $0.18 per diluted share. Excluding the after-tax gain on the sale of non-strategic timberlands, we arrive at operating earnings of $3 million or $0.00 per share, compared with a $0.15 per share consensus estimate. Timberland earnings grew $33 million with higher log export demand in the West. While Japan remains WY’s largest export market (70% of export volume); China’s share of WY’s exports rose from 7% to 24% over the past year.  Wood Products’ loss shrunk from $85 million in Q4 2010 to $36 million, but Cellulose Fibers reported lower earnings due to higher costs and lower productivity. Real Estate lost $1 million, versus earnings of $33 million last quarter, as single-family home sales declined 40%.

On April 25, Plum Creek (PCL) reported Q1 2011 earnings at $0.23 per share, one cent short of consensus estimates. Northern Resources reported a $7 million profit, $3 million higher than last quarter, driven by higher sawlog prices in the Northwest, and seasonally higher hardwood harvest volumes in the Northeast. Southern Resources reported operating profits of $19 million, down $9 million from Q4, due to lower harvest volumes and sawlog prices. Real Estate earned $38 million and Manufacturing earned $4 million. WY expects harvest volumes of 15 to 16 million tons in 2011. Management maintained earnings expectation for FY 2011 at $1.25 to $1.45 per share.

On April 26, Rayonier (RYN) reported Q1 2011 net income at $58 million, or $0.70 per share, 12 cents ahead of consensus estimates, primarily driven by strong global demand in Performance Fibers. Resource operating income of $11 million was $3 million higher than the prior year quarter as softwood prices in the North and New Zealand increased due to strong Asian demand. Northern softwood log prices rose 45% from the prior year period, more than offsetting lower sales in the Atlantic.  Real Estate operating income of $7 million was $10 million lower, mainly due to reduced non-strategic timberland sales. Performance Fibers operating income of $76 million was $31 million higher due to increased volumes and prices. RYN now expects FY 2011 earnings at $2.85 to $3.10 per share, up from $2.50 to $2.70 per share. Harvest volumes are expected to increase about 33% in the North, while Atlantic and Gulf Region volumes are expected to remain flat, over the next 10-year period.

Potlatch (PCH) also reported its Q1 2011 results on April 26. Earnings came in at $7.7 million, or $0.19 per diluted share. Excluding special items, we arrive at operating earnings of $ 0.28 per share, two cents short of the consensus. Northern Resource reported improved log volumes and pricing by 12% and 16%, respectively; while pulpwood volumes declined 14%, pricing rose 4%. Southern Resource log volumes and pricing improved 4% and 1%, respectively, while pulpwood volumes were up 4% year-over-year, prices were down 10%. Real Estate reported revenues of $1 million and Wood Products had an operating income of $2.9 million. RYN maintained its harvest outlook of 4.2 million tons for FY 2011.

Looking forward, recently released housing data points to weaker market conditions than previously expected. Higher fuel prices will also impact results this year. Increased Chinese demand for wood continues to be a big story: though relatively small based on volumes, it has led to rising log prices in the West for both export and domestic logs. Increased demand for logs and wood products from Japan are expected in due course. We remain positive on the longer term prospects for these firms, as once housing markets return these companies will benefit from increased harvest volumes and improved mix.

Timber Forecast: Sawtimber Prices Expected to Recover in 2012-2013; Pulpwood Driven by Bioenergy and OSB

9 03 2011

Our team at Forisk just released its 2011 timber (stumpage) forecast for pine sawtimber and pulpwood for the US South and by state.  Overall, we show increasing demand for wood raw materials and higher pine stumpage prices for forest owners and investors beginning late this year.  Sawtimber prices for the US South strengthen 4.6% into 2012 and 5.5% into 2013 as lumber production increases with housing starts. Alternately, pine pulpwood – the lower valued raw material used for pulp, OSB and bioenergy – gains 1.4% and 2.7% into 2012 and 2013 South-wide, with high variance across the 11 states covered in our models.  This point is central to our analysis of timber markets and stumpage prices going forward: the ForiskFORECAST emphasizes the limits of regional or national forecasts for timber, and the critical importance of assessing timber prices locally.

In 2011, states such as Georgia, Louisiana and Mississippi show sawtimber prices exceeding $30/ton, and Florida and Louisiana surpassing $11/ton for pine pulpwood.  Prices change annually across and between states in the 10-year forecast as local mills adjust to end-market demands.

In 2010, the benefit to forecast users of this bottom-up approach was evident.  “In 2010, Forisk’s sawtimber forecast was within 4% of actual prices, and within 1% for key end-use markets such as paper and paperboard,” said Dr. Tim Sydor, our Forest Economist.  “The key is understanding and updating the local, state-specific relationship – the elasticity – between wood demand and prices.”

For more information, visit www.foriskstore.com and click “Stumpage Price Forecasts.”

In addition, two short courses on May 11th – “Applied Forest Finance” and “Forecasting Timber Prices” – teach techniques for evaluating forest investment decisions and pricing in local wood markets. To learn more about these Atlanta-based courses, click here.

Timberland & Timber REITs: Credit Suisse Analysis Lacks Rigor and Logic

23 02 2011

An interesting report landed on our desk a few weeks ago, further reinforcing the sorry state of timberland market analysis available to timber REIT investors. The report, from Credit Suisse, makes assertions based on a careless and faulty application of basic statistics, and demonstrates a rudimentary understanding of forest growth and harvesting over time.

Lead author Chip Dillon looked at, among other things, the relationship between housing starts and log prices.  He states that the evidence “… shows the lack of correlation between US housing starts and saw log prices.”  The supporting exhibit in the Credit Suisse report (below) contradicts this assertion.  It indicates an unmistakable, positive relationship between housing starts and log prices in the US South and North.

Since the report failed to include any quantitative analysis to assess the degree of this relationship, our Forest Economist, Dr. Tim Sydor, decided to run the numbers. Using readily available data (and twenty minutes with an Excel spreadsheet), the results confirm Mr. Dillon’s assertion as faulty: housing starts and log prices, over this time frame in the US, did in fact demonstrate a significant statistical correlation. The table below summarizes the results:

The report generated additional questions from our team and clients.  “Timberland acres are shifting from tobacco farming to timberlands and driving up supplies?”  “Are we really running into a wall of wood from deferred sawtimber harvests?”  Again, we turn to the data and math behind forest growth to make the following observations:

Timberland acreages in the US South, the land of tobacco and cotton farming, remained virtually unchanged between 1977 and 2010. Acres declined ~1% if compared with 1953.

The future inventory of sawtimber (logs for lumber) includes two parts.  First is the currently deferred sawtimber inventory.  Second are today’s small log (pulpwood) trees. Deferring harvest of sawtimber increases future inventories, but a concurrent increase of harvests of pulpwood trees (to replace the loss of residual chip flows from sawmills) effectively decreases future inventories of sawtimber trees.

Since a typical age of harvested sawtimber trees in the US South is ~25+ years, it is useful to look further than four years, the time frame of the Credit Suisse analysis, prior to judging the importance of temporary harvest deferrals. A point of reference: in 1992, the US South produced 13 billion board feet (BBFT) of softwood lumber. By 2000, this increased 28% to 16.7 BBFT. In 2005, it further increased 14% to ~19 BBFT.

Our analysis of the data indicates the forest industry – including timber REITs and timberland investors – “ate” into the inventory for sawtimber inventories on private timberlands in the US South during the housing run up.  In assessing the future performance of timberland assets as housing markets return, we see a more sophisticated picture that varies highly across timber REITs (click here for the summary).