Timber
For some time now, Jeremy Grantham has been
listing timber as an undervalued sector. It sounded pretty boring so
I decided to do a little checking, and found that the US timber
industry has been pretty much dead in the water for the last ten
years. Normally this kind of long-term trend would be enough
discourage any further investigation, but there are a couple of
factors that lead me to look a little deeper. Over the past few
years price pressure has lead to industry consolidation, and a great
deal of capacity has been removed from the marketplace, and even
better, timber is a good weak-dollar play.
In the long run, the dollar has to get weaker
and commodity prices are going to continue to inflate. I have no
idea of the short term direction of the dollar or timber prices, but
over a period of ten to fifteen years the above trends seem
inevitable to me. The trade deficit cannot expand forever, and with
three billion people in Asia experiencing a rapid expansion of
personal income, prices of the basic things like oil, gas, wood, and
paper are likely to increase faster than they have for the last
twenty or thirty years
There are a couple of almost pure plays for
timber in the United States: Plum Creek Timber Co. and Rayonier Inc.
Both of these companies have recently converted REITs which gives
them some tax advantages: 1) It eliminates the double taxation of
dividends. 2) As qualified timber REITs, most of the dividend is
considered a return on capital and is taxed at the same rate as long
term gains.
Rayonier owns about 2.1 million acres of timber
land, and has a total market capitalization of $2.0 billion. Plum
Creek is much bigger with 8 million acres of timber land and $5.6
billion in market cap. Much of the land now held by Plum Creek came
with the 2001 reverse merger into The Timber Company. The Timber
Company was the result of the spin off and merger of six
timber-related subsidiaries of Georgia Pacific Corporation.
Weak Dollar
The domestic timber industry has been in a long
period of stagnation and depression. The strong dollar during the
late 1980s and all of the 1990s made Canadian timber cheap to
import, and at the same time made the price of American timber very
expensive in overseas markets.
The impact of the weak dollar was apparent in
this years first quarter at both Rayonier and Plum Creek. Rayonier's revenue was up 10% and their net increased from $2
million in 2003 to $26 million or $.51 per share. Plum Creeks
timber revenue increased by 17% and their net income (helped by $102
million operating profit from the sale of real estate) was $155
million compared to $33 million in the same quarter of last year.
The dollar has recovered a bit since its lows
earlier in the year, and it will be interesting to see how this
affects timber prices and industry profits in the second and third
quarters of this year. But further dollar weakness is probably
necessary if the business is to continue to gain traction.
Grantham's view on timber was quoted in a 2000
article in the Outstanding Investors Digest. He points out that
during all the secular bear markets for equities of the twentieth
century, timber prices have increased.
"(Timber is) one of my favorite asset classes.
We expect it to enjoy huge returns 1910 to the present real
timber prices have compounded at 3% per year. That's greater than
the 1.4% real increase in S&P earnings per share.
Total yield on timber today is—and always has been—about 6%, the yield on stocks is down from 4.5% to around 1.2% today. So you've got a price series that's won and a yield that's hugely higher.
Now, I've looked at the price of timber and the
price of the S&P during this century's three great bear' markets.
Remarkably, when you really, really needed help, timber provided
it."
Emerging Market Timber
Emerging Markets are another area where
projected ten-year returns are substantially in excess of large cap
American and European equities. The problems with emerging markets
are numerous, but they do offer one huge saving grace: they
constantly offer a nice political or economic crisis in which their
equity markets get reduced to rubble. A disciplined investor can
"buy the crisis" and end up with very nice companies with huge
margins of safety.
Aracruz is Brazilian company, and while it is
not big in the lumber business, it produces 31% of the world wide
production of eucalyptus pulp which is used for making high grade
papers. This is an interesting equity for several reasons. First is
the recent political and economic problems which have impacted the
company's earnings and stock price. Second, the Brazilian forestry
industry offers competitive advantages provided by extremely
favorable climatic conditions. Aracruz is about the same size as
Both Plum Creek and Rayonier, with about $1 billion in revenue and
earnings of $136 million.
All three of the companies pay a dividend of
over 4%, and while they are not cheap at current prices, a market
correction might make them tempting, especially considering the
dividends. How secure these dividends are is a good question. Of the
three, Rayonier, has the best cash flow to debt ratio so this may
offer some down side protection.
REITs are required to pay out cash earnings, so
its likely that Plum Creek and Rayonier will increase their dividend
in 2004 and 2005. This is my guess in view of the fact that Rayonier
earned more in the first quarter of 2004 than they did in all of
2003, and Plum Creek earned $.84 for the same quarter compared to
$1.04 in all of 2003.
This is a commodity business so any moat would
have be based on a company being the lowest cost producer. In this
regard, Aracruz may gain because of lower labor costs and cheaper
land prices. On the other hand Rayonier and Plum Creek are REITs so
they do not pay any corporate income tax, whereas Aracruz paid over
$130 million in tax in 2003. Aracruz does its business mainly in
dollars, so all three companies will gain a cost advantage from any
further weakness in the dollar.
| Rayonier | Aracruz | Plum Creek Timber | |
|---|---|---|---|
| Revenue | $1,101,000 | $1,000,000 | $1,196,000 |
| 2003 Income | $50,000 | $136,800 | $192,000 |
| Operating Cash Flow | $208,000 | 276.000 | $369,000 |
| Market Cap | $2,120,000 | $3,160,000 | $5,700,000 |
| Forward PE | 20.8 | 12.1 | 19.7 |
| Acres of Timber | 2.1 Million | 8.0 million | 1.1 million |
| Long Term Debt | $620,000 | $1,077,800 | $1,439,000 |
| Est. 2005 Earnings | $2.01/Share | $4.32/Share | $1.58 |
| First Qtr 2004 | $1.49 | $.46 | $.84 |
| Year 2003 | $1.16 | $1.33 | $1.04 |
| Debt to Cash Flow | 2.95 | 3.90 | 5.96 |