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As the U.S. housing market has been recovering from the 2008 - 2009 recessionary lows this has provided many investment opportunities. One company that is situated in an industry poised to capitalize on the U.S. housing recovery is Plum Creek Timber Company (NYSE:PCL).

Plum Creek is one of the largest landowners in the nation and the most geographically diverse, with approximately 6.4 million acres in major timber producing regions of the United States.

The company produces lumber, plywood and medium density fiberboard (MDF) in the company's wood products manufacturing facilities in the Northwest. Plum Creek also operates a real estate development business which is a taxable REIT subsidiary.

The map below lists the states where Plum Creek currently has properties. The company currently has approximately 6.4 million acres of timberlands in 19 states.

(click to enlarge)

Map sourced from (company website)

Over the past 5 years lumber prices have been weak. These weak prices were caused by the recent recession. As there has been limited need for lumber and lumber products over the past few years, there has been a limited need for Plum Creeks products. Because of the limited need for Plum Creeks products the company's fundamentals over the past three years have remained stagnant.

Using the fundamental analysis below, I will analyze the past three performances of the company. I will look at Plum Creek's past profitability, debt and capital, and operating efficiency. Based on this information, we will be able to see how the recession and the limited need for lumber and lumber products has effected the company fundamentals.

All numbers sourced from PlumCreeks Website and Morningstar.

Profitability

Profitability is a class of financial metrics used to assess a business's ability to generate earnings compared with expenses and other relevant costs incurred during a specific period of time. In this section, we will look at four tests of profitability. They are: net income, operating cash flow, return on assets, and quality of earnings. From these four metrics, we will establish if the company is making money and gauge the quality of the reported profits.

  • Net income 2010 = $213 million
  • Net income 2011 = $193 million.
  • Net income 2012 = $203 million.

Over the past three years Plum Creek's net profits have decreased from $213 million in 2010 to $203 million in 2012. This illustrates an decrease of 4.69%.

  • Operating income 2010 = $297 million.
  • Operating income 2011 = $275 million.
  • Operating income 2012 = $281 million.

Operating income is the cash generated from the operations of a company, generally defined as revenue less all operating expenses, but calculated through a series of adjustments to net income.

Like the net income Plum Creek's operating income has also decreased. Over the past three years, the company's operating income has decreased from $297 million to $281 million.

ROA - Return On Assets = Net Income/Total Assets

ROA is an indicator of how profitable a company is relative to its total assets. ROA gives an idea as to how efficient management is at using its assets to generate earnings. Calculated by dividing a company's net income by its total assets, ROA is displayed as a percentage. Sometimes this is referred to as "return on investment."

  • Net income growth

    • Net income 2010 = $213 million
    • Net income 2011 = $193 million.
    • Net income 2012 = $203 million.
  • Total asset growth

    • Total assets 2010 = $4.251 billion.
    • Total assets 2011 = $4.259 billion.
    • Total assets 2012 = $4.384 billion.
  • ROA - Return on assets

    • Return on assets 2010 = 5.01%
    • Return on assets 2011 = 4.53%.
    • Return on assets 2012 = 4.63%.

Over the past three years, Plum Creek's ROA has decreased from 5.01% in 2010 to 4.63% in 2012. This indicates that the company is making less money on its assets than it did in 2010.

Quality Of Earnings

Quality of Earnings is the amount of earnings attributable to higher sales or lower costs rather than artificial profits created by accounting anomalies such as inflation of inventory. To ensure there are no artificial profits being processed, the operating cash flow must exceed the net income.

2010

  • Operating income 2010 = $297 million.
  • Net income 2010 = $213 million

2011

  • Operating income 2011 = $275 million.
  • Net income 2011 = $193 million.

2012

  • Operating income 2012 = $281 million.
  • Net income 2012 = $203 million.

Over the past three years, the operating income has been higher than the net income. This indicates that Plum Creek is not artificially creating profits by accounting anomalies such as inflation of inventory.

Debt And Capital

The Debt and Capital section establishes if the company is sinking into debt or digging its way out. It will also determine if the company is growing organically or raising cash by selling off stock.

Total Liabilities To Total Assets, Or TL/A ratio

TL/A ratio is a metric used to measure a company's financial risk by determining how much of the company's assets have been financed by debt.

  • Total assets

    • Total assets 2010 = $4.251 billion.
    • Total assets 2011 = $4.259 billion.
    • Total assets 2012 = $4.384 billion.
    • Equals and increase of $133 million
  • Total liabilities

    • Total liabilities 2010 = $2.877 billion.
    • Total liabilities 2011 = $2.996 billion.
    • Total liabilities 2012 = $3.161 billion.
    • Equals an increase of $284 million

Over the past three years, Plum Creek has increased its total liabilities more than its total assets. This indicates that the company has been financing its assets through debt. Over the past three years, the company's total assets have increased by $133 million, while the total liabilities have increased by $284 million.

Working Capital

Working Capital is a general and quick measure of liquidity of a firm. It represents the margin of safety or cushion available to the creditors. It is an index of the firm's financial stability. It is also an index of technical solvency and an index of the strength of working capital.

Current Ratio = Current assets / Current liabilities

  • Current assets

    • Current assets 2010 = $410 million
    • Current assets 2011 = $454 million
    • Current assets 2012 = $508 million
  • Current liabilities

    • Current liabilities 2010 = $375 million
    • Current liabilities 2011 = $815 million.
    • Current liabilities 2012 = $472 million
  • Current ratio 2010 = 1.09
  • Current ratio 2011 = 0.56.
  • Current ratio 2012 = 1.08.

Over the past three years, Plum Creek's current ratio has remained relatively the same. It was calculated at 1.09 in 2010 and 1.08 in 2012. As the ratio is above 1, this indicates that the company would be able to pay off its obligations if they came due at this point. This indicates financial strength.

Common Shares Outstanding

  • 2010 shares outstanding = 162 million.
  • 2011 shares outstanding = 163 million.
  • 2012 shares outstanding = 171 million.

Over the past three years, the number of company shares has increased. The amount of common shares has increased from 162 million in 2010 to 171 million in 2012. This signifies a 5.55% increase over the past three years.

Operating Efficiency

Operating Efficiency is a market condition that exists when participants can execute transactions and receive services at a price that equates fairly to the actual costs required to provide them. An operationally efficient market allows investors to make transactions that move the market further toward the overall goal of prudent capital allocation without being chiseled down by excessive frictional costs, which would reduce the risk/reward profile of the transaction.

Gross Margin: Gross Income/Sales

The Gross Profit Margin is a measurement of a company's manufacturing and distribution efficiency during the production process. The gross profit tells an investor the percentage of revenue/sales left after subtracting the cost of goods sold. A company that boasts a higher gross profit margin than its competitors and industry is more efficient. Investors tend to pay more for businesses that have higher efficiency ratings than their competitors, as these businesses should be able to make a decent profit as long as overhead costs are controlled (overhead refers to rent, utilities, etc.).

  • Gross margin 2010 = $366 million / $1.190 billion = 30.76%.
  • Gross margin 2011 = $365 million / $1.167 billion = 31.28%.
  • Gross margin 2012 = $378 million / $1.339 billion = 28.23%.

Over the past three years, Plum Creek's gross margin has decreased. The ratio has decreased from 30.76% in 2010 to 28.23% in 2012. As the margin has decreased, this indicates that Plum Creek has been less efficient.

Asset Turnover

The formula for the asset turnover ratio evaluates how well a company is utilizing its assets to produce revenue. The numerator of the asset turnover ratio formula shows revenue found on a company's income statement and the denominator shows total assets, which are found on a company's balance sheet. Total assets should be averaged over the period of time that is being evaluated.

  • Revenue growth

    • Revenue 2010 = $1.190 billion.
    • Revenue 2011 = $1.167 billion.
    • Revenue 2012 = $1.339 billion
    • Equals an increase of 12.52%.
  • Total Asset growth

    • Total assets 2010 = $4.251 billion.
    • Total assets 2011 = $4.259 billion.
    • Total assets 2012 = $4.384 billion.
    • Equals and increase of 3.13%.

As the revenue growth has increased by 12.52% while the assets have increased by 3.13%, this indicates that the company has been generating more money from its assets than it did in 2010.

Based on the analysis above, Plum Creek is showing that most of the company's fundamentals have remained relatively flat or decreased slightly over the past three years. The company has shown strength in it asset turnover ratio, but the rest of the ratios have remained stagnant. This was due in part because the need for lumber and lumber products has remained quite low. This low demand has been reflected in the company's fundamentals as indicated above. Looking forward to the next five years, leading indicators such as U.S. housing starts are showing that this fundamentally stagnant time for housing, lumber and Plum Creek is changing.

As the U.S. housing recovery progresses, Plum Creek will benefit from rising lumber prices. In an article published by ForestIndustry.com they state "it is now forecast that lumber and panel prices will move to new highs in 2013 and record highs for lumber in 2014." The same article predicts that over the next five years there will be a strong growth in U.S. housing starts, which will create "wood products prices to soar."

This sentiment is supported by woodmarkets.com. In a recently published article they predict that "new residential lumber demand will triple from 2009 to 2017." The article predicts that over the next few years the U.S. housing recovery will head back towards 1.5 million housing starts. As increased demand outweighs the supply for lumber in upcoming years, this could begin to strain the demand on the housing sector and create upward pricing pressure for lumber and lumber related materials.

There are many factors believed to be driving the U.S. housing market recovery. Some of these factors are improving consumer confidence, low interest rates and affordable prices. Also adding to the recovery is the supply of available homes for sale remains in some areas of the U.S. is relatively low. These factors have contributed to the average price of homes rising nearly 10 percent in January 2013, compared with 12 months earlier. According to an article posted by Time Magazine this is "the biggest increase in nearly seven years."

In a recent article issued by the financial post Samantha McLemore of Legg Mason Capital Management Opportunity Trust states: "We still think we are in the early innings of a prolonged recovery in housing and the economy." This sentiment is reiterated by JPMorgan (NYSE:JPM) as they predict "U.S. home price gaining 7% in 2013 and predicts more than 14% increase through 2015". Bank of America (NYSE:BAC) increased their estimates for housing in 2013 by stating "values will jump 8% this year" which is up from a prior estimate of 4.7%.

Chart sourced by (Finviz)

Based on the information and charts listed above you can see a correlation between the company's fundamentals, the price of lumber and the company's stock price. As you can see by the charts above, lumber and PCL have recently broken through their resistance levels. Over the next few months we should see the company fundamentals do the same.

As the U.S housing recovery continues to progress, companies like Plum Creek who are in the lumber industry will benefit. As the need for new buildings and spending increases on upgrading and repairing peoples current homes, Plum Creek is a company well situated well to capitalize on this trend.

Source: Plum Creek: Look For Strong Gains Over The Next Few Years