By David Sterman
We surely live in uncertain times. The market continues its impressive multi-year rebound in hopes of an ever-firming economy, yet there are still enough headwinds in place that might bring the rally to a halt. In effect, we have no clear read on whether the broader market has already seen its highs for the year, or whether we're about to see further strong gains in the next 11 months.
Although we're still in this broader market haze, there's greater clarity on a pair of sectors that are surely poised for good news this year: real estate and energy. The housing market has clearly turned a corner and looks poised for a multi-year upturn, while heavy investments in new technologies are bringing fresh life to oil and gas fields.
Very few companies can say they have a foot in the door of both of these sectors. But one company was spun off as a standalone entity during the past decade to precisely play that angle: Forestar Group (FOR).
This company has actually been around for nearly 60 years, though in its first half-century, it was known as Lumberman's Group. It was a sleepy business, mostly focused on growing trees to provide lumber for the country's furniture makers and home builders. Lumberman's was eventually acquired by Temple-Inland (which is now owned by International Paper (IP), and was spun off in late 2007 at $24 a share. And then the bottom fell out of the housing and real estate markets, and this stock eventually fell into the single-digits.
Shares are now on the mend, recently moving back up into the upper teens, thanks to signs that the company's development strategies are springing back to life.
Forestar is now pursuing nearly two dozen real estate development projects, with plans to launch 50 or more new projects once the real estate market really gets going. (And if you've read Carla Pasternak's articles recently, then you probably know it's only a matter of time before we see that happening.)
Forestar's real estate approach is simple and direct. The company intends to only build on properties that are near good school districts, have strong employment growth and can be priced low enough to attract first and second-time home buyers. This is precisely the demographic that has been forced into renting during the past five years while the housing market tanked. The company has found that it generates a 100% to 200% return on every property it's developed and sold. The proceeds from sold developments have gone toward further real estate acquisitions.
Oil, Gas And Minerals
But buried under all of the land that the company owns is a hidden gem many investors may not have noticed.
Forestar's real estate holdings are right in the heart of oil country. There are now more than 900 wells in operation on the company's properties. Forestar traditionally sought to simply capture oil and gas royalties and let other firms tackle the challenges of energy exploration.
But management realized it was wiser to gain more control of the profits that these oil wells could generate, so in September 2012, Forestar acquired Credo Petroleum for $146 million in cash. That gave the company badly needed industry know-how, and since it is also now an energy-exploration firm, the company will be able to place a more precise value on its energy holdings.
"Both Forestar and Credo have seen their respective production (and reserves) increase substantially since 2010," note analysts at D.A. Davidson. Forestar produced less than 200,000 barrels of oil in 2011, but this figure may approach 700,000 barrels this year. Roughly 75% of Forestar's energy output is tied to oil, and around 25% comes from natural gas.
Finally, Forestar's land sits on top of a number of water aquifers, especially in Texas, which has become increasingly parched over time. "One thing is clear, owning water in Texas could be quite lucrative, considering its status as the fastest growing state in the union, plagued by drought and competing for water with adjacent states," add Davidson's analysts.
Risks to Consider: With exposure to the housing and energy sectors, this is an economically sensitive stock, so any slowdown in the U.S. economy would deal a clear setback to this stock.
As a real estate and energy developer, this is a hard company to measure against near-term sales and profit metrics.
But for the record, Forestar's net income is likely to more than double this year to between $22 and $24 million, and rise another 50% in 2014 toward the $35 million mark. This means shares trade for nearly 20 times projected 2014 profits.
Instead, it's important to look at this stock as an asset play. The company trades for roughly 1.4 times tangible book value, but many of its assets are carried at cost, not reflecting the long-term earnings they can generate. This could make a stock like Forestar an interesting option to consider for inflation protection at the very least, with the possibility for significant upside as well.