3/14/2012 | By Clay Risher
Hockey legend Wayne Gretzky once said, "I don't skate to where the hockey puck is, rather, I skate to where I think it's going to be." If the Great One applied that same philosophy to investing today, he might take a long look at timber REITs. While lumber prices and the housing market remain slumped, timber REITs appear positioned for sustainable, long-term growth.
Billionaire John Paulson has taken that route with his eponymous hedge fund. His largest investment in high-dividend stocks for 2011 turned out to be $366 million in shares of timber REIT Weyerhaeuser Co. (NYSE:WY).
Timberland as a distinct asset class has been around since the early 1980s, but timber REITs started with the conversion of Plum Creek Timber Company, Inc. (NYSE: PCL) in 1999. Thirteen years later, the sector continues to grow and evolve.
Individual Results May Vary
Timber REITs currently account for just over 5 percent of total listed REIT equity market capitalization, according to data from Forisk Timber, a timber REIT analysis firm. The group's Forisk Timber REIT Index (FTR) tracks the performance of the four publicly traded timber REITs, including, Weyerhaeuser, Plum Creek, Rayonier Inc. (NYSE: RYN) and Potlatch Corporation (Nasdaq: PCH).
"While the Timber REIT sector performed well, individual stock performance certainly varied," says Brooks Mendel, president at Forisk Timber. Although Potlatch, Plum Creek and Weyerhaeuser generated negative returns of 1 percent to 4 percent in 2011, Rayonier ended up as a standout. Not including distributions, Rayonier generated positive, stand-alone returns of 27.47 percent. The gain also reflects a mid-year three-for-two stock split.
Rick Holley, Plum Creek's CEO, summarized the outlook on timber in general and how he believes his company will perform going forward. "From an investor's perspective, you should start to see improvement in the sector overall in 2012 and beyond." Of all the Timber REITs, Plum Creek has probably been most affected by the housing downturn as 40 percent of all its lumber is generally apportioned to housing.
Holley adds, "as we start to see housing improve, timber will be a good investment going forward. And specifically for Plum Creek, housing demand will equate to higher cash flows and earnings over time as the market recovers."
In addition to the four listed companies, Wells Timber REIT, Anderson-Tully and Forest Capital are leading non-listed timber REITs. Data provided by Forisk suggest that the timber REIT sector has outperformed many other asset classes in annualized returns over the last 10 years, including the U.S. Treasury 10-year note, the S&P 500 and the FTSE NAREIT All REITs Index. In 2011 alone, timber REITs returned 5.69 percent, versus total returns of 2.11 percent for the S&P 500 and 7.28 percent for the FTSE NAREIT All REITs Index.
Most timber REITs maintain some diversification within their business. For instance, Potlatch operates three business segments – resource, wood products and real estate. The resource segment, which CEO Mike Covey says is the primary driver of the company's cash flows, harvests timber on 1.45 million acres of timberland, selling saw logs and pulpwood to the forest products industry. The wood products segment operates five manufacturing facilities and produces lumber and plywood. Potlatch's real estate segment takes a small portion of timberland acreage and sells it as raw land. Generally, the properties are sold as rural recreational real estate or development land.
With the housing market depressed, Potlatch recently decided to lower its harvest level to 3.5 million tons in order to preserve resources and take advantage of better markets in the future. The company's resource segment cash flows remain temporarily depressed, but most analysts covering timber believe housing has now bottomed and is beginning to recover. "When we see increased demand and pricing for our saw logs, we'll increase our harvests and, ultimately, we expect to increase our dividend," Covey says.
Steve Chercover, a timber REIT analyst at D.A. Davidson Company, provides a granular view of the timber REIT industry overall by shedding light on the specific performance of the sector and the four publicly traded timber REITs he follows.
When Weyerhaeuser converted to timber REIT status in 2011, many observers predicted a mass migration in which more corporations with timber interests in their businesses would see the benefits of becoming a timber REIT as a viable strategy to expand their business, improve the bottom line and attract a new shareholder base.
However, Chercover says that although the timber REIT sector is performing well, he does not see more conversions on the horizon. "It is unlikely that you will see future conversions a la Weyerhaeuser, because most integrated forest products companies made the conversions earlier, or monetized their land to capture the value that was not reflected in their share price," Chercover says.
According to Chercover, Weyerhaeuser was the last holdout. Its delay in becoming a bona fide timber REIT was primarily due to the significant operating assets that were not REIT eligible. Weyerhaeuser's sale of its white paper business in 2007 and the sale of its containerboard business to International Paper in 2008 allowed the company to convert fully to a REIT, according to Chercover.
While challenging market conditions remain, Chercover is bullish on most of the publicly traded timber REITs. Currently he has a "buy" rating on Weyerhaeuser, Plum Creek and Rayonier. He also has a "neutral rating" on Potlatch at present. He does caution that none of the Timber REITs are "particularly compelling from a short-term trading perspective at this juncture."
Longer term, Chercover estimates that "all four public timber REITs will be beneficiaries of a recovery in domestic housing, due to increased demand for timber, particularly Weyerhaeuser." (Weyerhaeuser has a development business and a significant building materials business as well.) Conversely, "Rayonier has a modest lumber business, but significant development potential in eastern Georgia and Florida," Chercover says.
"Rayonier has been the best performing timber REIT since the housing slump started," Chercover adds. "The company has raised its dividend twice, due to the strong financial contribution from its performance fibers division."
Chercover also believes that if the general economy and residential markets continue to recover at their current pace, then Rayonier should continue to be the timber REIT with the most solid financials and potential for dividend growth.
Weyerhaeuser CEO Dan Fulton offers up a measured perspective on his company's outlook: "Uncertainty about the housing recovery is still high, but the good news is that the Fed is now clearly engaged on the issue that housing must play a critical role in any recovery of our national economy."
Weyerhaeuser is taking a guardedly optimistic approach in 2012, planning on a modest 6 percent increase in housing starts this year. "Given our experience in 2011, we are planning cautiously, but we'll be prepared to flex up if necessary," Fulton says.
Seeing the Forest Through the Trees
After bottoming out in 2008 and 2009, a series of economic factors continue to work against timber REITs. Lumber demand in housing starts remains depressed. Also, the use of conventional paper is decreasing due to digital publishing. With the reduced demand, timber prices are at an all-time low.
Conversely, timber companies are allowing their trees to grow, which will leave these companies with older trees that generally yield higher-priced wood when they ultimately go to market. Timber REIT pricing has also historically outperformed inflation. "If the Fed were to engage in another round of 'quantitative easing' and inflation became a front-burner concern again, I expect timber REITs would get a lift due to the asset class' historical role as a store of value or inflation hedge," Chercover says.
This supports a growing consensus on Wall Street that, with conservative investment strategies like U.S. Treasuries drying up, prescient investors like Paulson and others are looking to timber REITs and their accompanying long-term dividends as a great inflation hedge and a viable alternative asset class that can outperform long-term treasuries right now.