Timber Stocks Should Outperform in an Inflationary Market (PCL, RYN)

The market seems to have embraced the old axiom "sell in May and go away." But the fact remains that its a great time for finding valuable gems in these rough times.

Lets start with a Trivia question: Name an investment class that has beaten the stock market consistently over the long term? Here's a hint: The Harvard and Yale endowments invest hundreds of millions of dollars in this investment. The answer is timber.

So is timber really that good of an investment? And if so, how can you and I own the asset without the hassles of cutting down trees and hauling lumber to the yard?

First, timber is an asset class that has beaten the stock market consistently. From 1973-2002, managed timber returned roughly 15% annually as an investment, while stocks returned about 11%. Timber, like most commodities, is uncorrelated to stocks. Trees don't know about the rising oil prices or interest rate hikes. Even more important in today's rising inflationary environment, the price of timber has consistently beaten inflation. We should think of a timber investment as a good inflation hedge. According to legendary investor Jeremy Grantham, over the last century timber prices have risen at 3.3% above the rate of inflation. Add 5% a year in income, and you've got a timber investment asset that has returned double digits, competing with stocks over the long run.

Large endowments and funds have the luxury of owning timberlands or holding options on the timber output on acres of forests. Large corporations like International Paper (IP) and Wayerhauser (WY) own timberlands that they use as raw materials in paper manufacture and sell timber in the open market, but there are two companies that stand out in this area Plum Creek Timber and Rayonier.

Plum Creek Timber (PCL) ($34) is a Real Estate Investment Trust [REIT] and the largest private landowner in the United States. They have about eight million acres of timberland under management. The company produces lumber, plywood and fiberboard at ten facilities in the Northwest. It has a $6.5B market cap and pays a dividend of 4.5%. Currently PCL has set an aggressive $400M share buyback plan and as a REIT, enjoys all the favorable tax advantages.

An even more attractive company on a fundamental and technical basis is Rayonier (RYN) ($36.8), also a REIT and a slightly smaller one at that. RYN has about 2.4M acres of timberland in the United States, Australia and New Zealand. It also has the added benefit of a diversified a performance fiber unit, these fibers are used in tires, rayon yarns, paints, ink and even diapers. RYN had a great run this year hitting $47.50 but is down almost 20% at $36.85 and yields a attractive 5%.

On a technical basis, both stocks have broken down (blame the housing slowdown) and are likely to go down south even further. The reasons for this are as follows:

- Timber is a key material in housing construction.
- These companies have sold land at high prices for housing development in the past.
- The resolution of the US-Canadian timber dispute is making Canadian timber competitive again.

However, bearishness aside, it may be a good time to watch these two. Ultimately, both of these companies are long term keepers for the following reasons:

- They are high income yielding companies.
- They own a tangible asset in timber.
- They are a proven inflation hedge, as I already explained earlier.

I think an attractive entry point may be at the stocks' 52 week lows: $33.60 for PCL and $34 for RYN. These should be good, sound buys if you're willing to hold on to them for 5 years or longer.

PCL-RYN 1-yr comparison chart: