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Elevator Pitch

Rayonier (NYSE:RYN) is one of the few timber REITs in the industry, and has one of the lowest payout ratios in the industry, which could easily be lifted and in turn drive its dividend yield to over 5%; what's more is the stock is undervalued by as much as 35%.

We believe there are significant value prospects buried in Rayonier. The timber company completed its recent conversion to REIT status and should see upside in the near future thanks to a rebound in housing. The unique timber and pulp combo also provides exposure to various industries, and we see the downside limited given the company's vast asset base.

We believe the opportunity is unique given the current investing environment, one with both income and growth prospects. This is especially intriguing given the current market, where other dividend stocks might be trading richly as investors flock to yield.

Company Description

Rayonier is one of the three major growers and harvesters of trees in the U.S. and is believed to be the seventh-largest private timberland owner in the United States. Its business includes a broad process of (1) harvesting trees from land, (2) converting to wood products and lumber, (3) remaining real estate is developed and sold as residential homes, (4) trimmings from lumber are used for pulp and paper, and the fiber segment.

Its performance fibers segment was 70% of 2012 sales and 80% of operating income, while its timber business is 15% of sales and 10% of operating income. With such a high portion of income from fibers, it might be expected that Rayonier spin off its fibers segment in the near future in order to keep its REIT status. Its end use for fibers includes cigarette filters, textiles, and plastics. Wood products makes and sells specialty lumber, but only makes up 5% of revenues and 2% of operating income.

The REIT does have a wide customer base, across various industries, which adds some insulation to the company's revenues. The timber REIT also has strong customer diversity. Rayonier gets about half of its sales from customers outside the U.S., with China accounting for around 20%, Europe (10%) and Japan (10%).

Competitive Landscape

Industry Outlook. A large part of the timber REITs' success is tied to housing. Thus, a housing recovery is fairly instrumental to the thesis that timber REITs can outperform the general market over the interim. The key driver in the interim for Rayonier will indeed be a boost in the homebuilding industry. There has been recurring weakness in the housing market over the last few years, we believe this has begun to turnaround as of the second half of 2012. The strengthening in the housing market will continue as the job market turns around, which will boost home buyer confidence. Looking at housing permits, September numbers showed a 27% year over year, indicating solid demand for future home building. S&P expects housing starts to be up 20% in 2013. We believe this will be a fundamental driver of demand for timber and a driver of Rayonier's future solid performance. Other notable timber demand-driver will be the rebuilding after the destruction caused by Hurricane Sandy. The backlog in home building is believed to be 2-4 years from Sandy alone.

Competitive Environment. The U.S. timber REIT industry is run by three key companies, Weyerhaeuser (NYSE:WY), Plum Creek Timber (NYSE:PCL), and Rayonier. Rayonier trades on the very low end of the industry when compared to major peers Weyerhaeuser and Plum Creek. Rayonier trades at a P/E of 25x, while Weyerhaeuser is at 42x and Plum Creek 48x. We believe that the discount makes Rayonier an attractive buy, not to mention the company's opportunity to reward shareholders with dividend increases and the possible spinoff of its fiber segment.

The market is niche that there are only three key players and the market is limited based on resources-land. Since most competitors cannot operate on the same scale as the big three timber REITs they have a strong competitive advantage in the industry. The exclusivity includes both access to land and resources, and shipping and supply ability for catering to international markets.

Revenue & EPS Outlook

Rayonier continues to post strong numbers, having beat analysts' earnings expectations for each of the last four quarters. Rayonier also has one of the best balance sheets in the industry, with debt to capital that comes in at 47%, compared to Weyerhaeuser (51%) and Plum Creek (71%).

As well, Rayonier's profitability and return measures is well above its major peers:

Key Financial DataOperating MarginReturn on SalesReturn on InvestmentReturn on Equity
Rayonier25%18%11%20%
Weyerhaeuser8.00%5.50%4.50%9%
Plum Creek24%14.50%5%17%

Its revenues have been very stable the last five years, with sales rising at a compound annual growth rate of 5.0% from 2007 through 2012, and its profitability has been consistent, averaging a net operating profit after-tax (NOPAT) margin of 15.5% over the past ten years

Thesis & Catalyst

The Moat. We believe that Rayonier has significant downside protection inherent in its real estate portfolio. In assuming the worst case, Rayonier still has its robust real estate portfolio. Rayonier owns over 2.1 million acres. Using a conservative value of $1,500 per acre, we place the potential value of Rayonier's land at $3.15 billion. We believe that in the absolute worst case that the company's operations are rendered useless then the REIT could sell off its real estate to provide investors with some cash. With a potential real estate value of $3.15 billion it would provide investors with almost $25. As a result we see the max downside from the current stock price as around 55%.

Dividend Potential. Rayonier's conversion to a REIT took place in the last couple of years, and the company currently has the lowest payout ratio of the three major timber REITs at 43% of FFO, compared to Weyerhaeuser's 58% and Plum Creek's 90%.

Rayonier should, over time, match the REIT leader, Plum Creek's, historical funds from operations payout ratio. The long-run average is around 90%; applying that FFO payout to Rayonier's pro forma FFO and its dividend yield could be 5.2%.

Pro Forma Dividend Payout
Pro Forma FFO Payout90%
Expected Dividends$353
Pro Forma Shares Outstanding123
Dividend Per Share$2.86
Current Share Price$55.00
Pro Forma Dividend Yield5.21%

Valuation

Sum of the Parts. If Rayonier decided to divest its fiber segment, or if the earnings generated from the segment threaten its REIT status, the value for that segment could be something along the lines of:

2013E
Fibers Segment Income$ 6
Average P/E (Eastman, DuPont, Dow, FMC)16.5
Fiber Segment Value ($ in millions)$ 99

Since the fiber segment is valued at $8.13 of value (above), what about the other segments? Putting an 8.5 times EBITDA multiple (which is an industry average conglomerate multiple) the wood, timber and real estate operations are worth $58.40 per share:

2013E
Timber, Wood Products, Real Estate EBITDA$ 845
Historical EDITDA Multiple8.5
Timber, Wood Products, Real Estate Operations Value$ 7,183

This puts the SOTP valuation at $66.50, making the stock undervalued by almost 20%.

Relative Value. Assuming earnings grow at just over 10% annually for the next three years the earnings and FFO should shape up as follows:

Per Share2015E2014E2013E
Funds From Operations$3.86$3.66$3.31

Using the 2013 FFO and the historical average of bellwether REIT Plum Creek's P/FFO multiple of 25x, the stock would be valued around $82.75, potential upside of 50%.

DCF on FFO. Using the pro forma funds from operations, the fair value of Rayonier as around $73.74, or 34% upside:

DCF Valuation2015E2014E2013E
Funds From Operations$ 475$ 450$ 407
Terminal Value$ 9,990
Present Value$ 8,307$ 386$ 377
Intrinsic Value$ 73.74

Multiples based valuation. Applying the 2012 EBITDA estimate, yields the following:

REIT SectorUS REIT UniverseValuation
EBITDA Implied Cap Rate5.9%$ 14,627
Per Share Value $ 118.92

The valuation for the EBITDA implied cap rate multiple method shows as much as 115% upside for the stock.

What to do? Rayonier appears to be under-valued and an interesting play on housing. The REIT may also boost its dividend in the interim, making it a growth and income play.

Equal weightings on all methods used above leads to an overall intrinsic value of $85.48, upside of almost 55% upside.

Final ValuationValuationWeightingWeighted Value
Sum of the Parts$ 66.5025%$ 16.63
Relative Value$ 82.7525%$ 20.69
DCF - FOO$ 73.7425%$ 18.44
Multiples$ 118.9225%$ 29.73
Per Share Value$ 85.48
Source: Why Buy This Undervalued Timber REIT?