Potlatch Corporation (PCH) CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.24.13 | About: Potlatch Corporation (PCH)

Potlatch Corporation (NASDAQ:PCH)

Q2 2013 Earnings Conference Call

July 24, 2013, 12:00 PM ET

Executives

Eric Cremers - President, Chief Operating Officer and Chief Financial Officer

Michael Covey - Chairman and Chief Executive Officer

Analysts

Michael Roxland - Bank of America Merrill Lynch

Gail Glazerman - UBS

Chip Dillon - Vertical Research

Mark Weintraub - Buckingham Research

Steve Chercover - D. A. Davidson

Collin Mings - Raymond James & Associates

Operator

At this time, I would like to welcome everyone to the Potlatch's second quarter 2013 earnings conference call; featuring Eric Cremers, President, Chief Operating Officer and Chief Financial Officer; and Michael Covey, Chairman and Chief Executive Officer for Potlatch Corporation. (Operator Instructions) I would now like to turn the call over to Mr. Eric Cremers for opening remarks. Sir, you may proceed.

Eric Cremers

Well, thank you, and good morning. Welcome to Potlatch's investor teleconference, covering our second quarter 2013 earnings. Before we begin, let me remind you that this call may contain forward-looking statements with regard to our business and operations. Please review the warning statements in our press release, on the presentation slides, and in our filings with the SEC concerning the risks associated with these forward-looking statements.

Also, please note that segment information as well as a reconciliation of non-GAAP measures can be found on our website www.potlatchcorp.com as part of the webcast for this call.

I would now like to turn the call over to Mike Covey, our Chairman and CEO, who will make some introductory remarks, and then I will review our second quarter results in more detail. Mike?

Michael Covey

Thanks, Eric. Good morning. We are pleased to report another quarter of strong results. Earnings in our Wood Products business were excellent, buoyed by peak lumber prices at the end of the first quarter that continued into early April.

Our Resource operations also performed very well, as favorable logging conditions in Idaho led to increased production in what is typically a seasonally challenging quarter. Results from our Real Estate segment were also solid, and we are encouraged by the strong demand exhibited for our real estate properties, particularly HBU and rural recreational lands.

And we completed the quarter with excellent results, lumber prices softened as we moved through the quarter, after reaching recent highs in March and April. In particular, lumber prices fell in May and June due to a variety of factors. As field inventories now appear to have fallen back in line with more normalized levels, lumber prices have begun trending upward again, albeit at a much more measured pace than seen in the first half of the year.

We anticipate market conditions to gradually improve, as we move through the back half of the year, especially given the Canadian lumber exports to the U.S. will face a 10% duty starting in August. In addition, lower prices have now attracted China to the North American lumber market once again.

Mortgage rates moved higher during the quarter, along with an increase in treasury rates. While this increase in mortgage rates has prompted fears of a slowdown in the housing market recovery, affordability remains at very high levels. Given the gradually improving labor market, we still foresee a continued improvement for housing and along with it lumber demand.

We remain optimistic for the outlook for the remainder of 2013 as well as the longer-term, as underlying market fundamentals remain very positive. That's not to suggest that we won't experience volatility along the way. Historically, lumber prices have been volatile during abrupt supply and demand changes and that is precisely what the industry is experiencing right now.

Nonetheless, our strategy remains consistent with what we laid on at the beginning of the year. And we're positioned solidly for the continued recovery of the forest products industry.

Now, I would like to turn the call back over to Eric, to discuss the quarterly results, followed by detailed questions from you.

Eric Cremers

Thanks, Mike. On Page 3 of the slides accompanying this call, you'll find our reported 2013 second quarter net income of $19.2 million or $0.47 per diluted share. These results compare to $15.5 million of net income or $0.38 per diluted share last quarter and $5.1 million of net income or $0.13 per diluted share in last year's second quarter.

Please note that results for both Q1 and Q2 of 2013, include non-cash environmental remediation charges, associated with EPA proceedings regarding the cleanup of one of our properties in Northern Idaho. As shown, the charge in the second quarter totaled $1.75 million and the first quarter charge was $750,000.

Excluding the environmental remediation charges from our results, our second quarter 2013 net income would have been $20.2 million or $0.50 per diluted share and our first quarter 2013's net income would have been $15.9 million or $0.39 per diluted share.

Now, I'd like to move on to reviewing the results of our operating segments for the quarter. Page 4 displays operating income and margin trends for our Resource segment. For the quarter, operating income was $14.5 million compared to $15.5 million last quarter and $6.7 million in Q2 2012.

The $1 million decline over consecutive quarters of 2013 is related to seasonally lower harvest production. The increase compared to last year's second quarter is attributable to increased harvest volumes as well as overall price improvement in both operating regions.

Page 5 covers harvest volumes and pricing for our northern region. Sawlog prices increased significantly during the quarter, showing an increase of 19% compared to last quarter and 28% from Q2 of 2012.

The price improvements are primarily based on lumber price increases experienced during the first quarter of 2013, as roughly 65% of our sawlog harvest volume in the region is indexed to lumber prices, with one and a three-month lag depending upon the specific contract.

Sawlog volumes dropped 34% compared to Q1, as a result of typical seasonality, but increased 19% compared to the second quarter of 2012, as favorable weather in the spring of 2013 allowed for greater harvest activity than originally anticipated.

Northern region pulpwood prices increased 3% over the prior quarter and declined 11% over Q2 2012. Despite the slight pricing improvement over the last quarter, the market remains saturated with excess pulpwood volume, which we expect will persist throughout the year. In light of the circumstances, we have chosen to minimize northern region pulpwood production, evidenced by the substantial decline in our pulpwood harvest volume.

Moving on to our southern region, Page 6 reviews our harvest volume and pricing trends. Sawlog prices rose 5% over the prior quarter, largely related to the sales mix containing a greater proportion of higher valued hardwood sawlogs as well as a slight price increase in pine sawlogs, prompted by unfavorable weather conditions during the quarter.

Sawlog pricing increased 4% compared to Q2 2012, based upon improved hardwood sawlog pricing, and again the increase in pine sawlog prices due to unfavorable weather conditions for the quarter. Sawlog harvest volumes increased 5% from Q1 2013 and 17% from Q2 2012, attributable to incremental harvest volume from our two timberland acquisitions made in late 2012, as well as firm hardwood sawlog demand in the region.

Pulpwood pricing was relatively flat compared to the prior quarter and increased 6% compared to Q2 2012, as adverse weather conditions during Q2 2013 pushed market prices higher. Pulpwood harvest volumes were relatively flat between the consecutive quarters of 2013, but increased 10% from Q2 2012, due to an increase in thinning activities in order to capture more attractive pricing during the second quarter of 2013.

Turning to Page 7, which reviews the revenue results of our Real Estate segment. Revenues totaled $5.8 million for the quarter on 65 transactions, our highest quarterly transaction count in this segment's history. Over the past few years, the second quarter has been particularly strong for sales of HBU and rural recreational land tracks in the 40 acre to 80 acre range, and this year was no different.

Page 8 displays operating income and margin trends for our real estate business. Quarterly operating income was $4.1 million compared to $3.1 million last quarter and $6.7 million in Q2 of 2012. Real estate acres sold, broken down by product type are shown on Page 9.

We continue to experience robust demand for our rural recreational and HBU properties, as indicated by our high transaction count for the quarter. And anticipate that demand will only increase, as the general economy and consumer confidence continue to improve. In regard to pricing trends, which are depicted on Page 10, markets are firm and our prices in each product category remain strong.

Page 11 highlights our Wood Products segment operating income and margin trends. Wood Products posted impressive results for another consecutive quarter, with $19.7 million in operating income compared to $18.9 million in the first quarter and $11.7 million in Q2 of 2012. The lumber prices have since receded. High lumber prices in April coupled with long order files at the end of the first quarter, enabled the division to deliver its highest quarterly operating income in almost a decade.

Price and volume trends are shown on Page 12. Our average lumber sales price rose 3% compared to the first quarter and 21% from the second quarter of last year. Shipments declined over the prior periods, down 1% from the prior quarter and 7% from Q2 2012.

The decline in shipments during the quarter was a result of a variety of factors, including planned downtime for the installation of a capital project at one of mills and overall weaker demand. Field inventories have since retreated and are currently at more normal levels, resulting in a more favorable demand environment.

Returning to Page 3, total corporate administration costs, excluding net cash interest expense, were $7.7 million in Q2 compared to $11.1 million in Q1 and $9.2 million in Q2 of 2012. Corporate expenses were reduced compared to both prior periods, primarily due to non-cash mark-to-market adjustments related to our deferred compensation plans that had a positive $1.2 million impact on our P&L for the quarter.

Net cash interest expense was $5.3 million for the quarter as compared to $5.8 million in both prior periods. The $0.5 million reduction in cash interest expense is primarily related to the early retirement of $27.7 million of debt issuances completed during the first quarter of 2013. And finally, as was previously mentioned, in the second quarter we incurred a $1.75 million environmental remediation charge.

Our balance sheet remains solid, as our operations continue to generate strong earnings. During the quarter, we retired a $9 million debt issuance in advance of its 2014 maturity date with cash on hand, yet still ended the quarter with nearly $51 million in cash in short-term investments.

The strength of our balance sheet was made further evident this past April, when our corporate credit and senior unsecured ratings were upgraded by Standard & Poor's to BB+ from BB, with a stable outlook; and our debt rating was upgraded Moody's to investment grade Baa3 with a stable outlook, as we mentioned on our last earnings call.

I'd now like to make a few comments regarding our outlook for the remainder of 2013. For our Resource operations, our plan remains to harvest approximately 3.8 million tons for the year. Southern pine sawlog pricing thus far in 2013 has been consistent with our initial outlook for flat pricing. At this time, we do not foresee any meaningful changes in our local market that would instigate a correction to the supply and demand imbalance, and therefore expect prices to remain subdued for the balance of the year.

However, the outlook for sawlog pricing in the northern region is generally positive, but pricing is likely to fall back a bit from the heights realized during the second quarter. We anticipate log prices will settle somewhere between Q1 and Q2 prices for the remainder of the year.

In regard to our Wood Products segment, given the price declines that occurred over the final weeks of the second quarter, we believe we've already seen the best lumber prices for the year. However, our expectation is for prices to steadily improve throughout the final two quarters of 2013, from the price bottoms experienced in late June and to end the year approximately 5% to 10% ahead of our 2012 yearend prices.

In addition, we expect our quarterly shipments to achieve higher levels in both the third and fourth quarters compared to the first two quarters of 2013. Based on these factors, we anticipate our Wood Products division will continue to be a strong earnings contributor throughout the rest of the year.

Turning to our Real Estate business, based on the strong demand experienced during the first half of 2013, we expect to sell slightly more than our initial 18,000 acre to 20,000 acre plan for the year. Our outlook on pricing remains consistent with an average price per acre of approximately $1,400 per acre, and we expect basis to be approximately 20% to 25% of revenues in Q3 and Q4.

To conclude, our results through the first half of 2013 have exceeded the expectations that we had at the beginning of the year. We look forward to continued progress in each of our operational segments, as forest product markets continue to advance.

That concludes our prepared remarks. Operator, I would now like to open up the call to Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Michael Roxland with Bank of America Merrill Lynch.

Michael Roxland - Bank of America Merrill Lynch

Going back to 1Q '13, in your earnings call, you mentioned that you expected northern sawlog prices to be up 11% in 2Q. Were they actually out wind up increasing about 20%? What changed relative to your expectations?

Eric Cremers

Well, I think lumber pricing had a bigger run than we would have expected. And I think cedar pricing may have contributed as a greater percent of product mix than we had anticipated.

Michael Roxland - Bank of America Merrill Lynch

And when looking at your lumber price for the quarter and compared to the benchmark, the Random Lengths pricing, there's an obvious difference. And you think you saw lumber price, as you mentioned Eric, increased 3% sequentially, while the Random Lengths benchmark declined around 8% sequentially. And what accounts for that difference? I mean do you have any lumber contracts that operate on a lag basis and how should we first start to see your lumber prices decelerate beginning 3Q?

Eric Cremers

Well, you will see our lumber prices decelerate in the third quarter. And we expect them to drop consistent with about the same dollar amount that the composite is expected to drop. If you look at where wood markets in RISI and FEA have got prices for the third quarter, the net drop will roughly be in line with what they are expected to see. So I don't think there is anything different happening in our business than what's happening in the composite overall.

Michael Roxland - Bank of America Merrill Lynch

And what accounts for the different spend in 2Q, in terms of you are able to increase prices 3% sequentially. Random Lengths, the benchmark was down 8% sequentially.

Michael Covey

I think it probably has more to do with the length of our order file at the end of the quarter than anything, Mike. We extended out the order files, so we got that benefit in April and maybe a bit in the May. If you at Random Lengths it's a spot in time, day-to-day without the effect of an order file in it.

Eric Cremers

And if you go back to where we ended the quarter, our order file was probably six weeks out into the future. So where Random Lengths is, what today's prices at, we were selling six weeks forward. So in that markets we'll tend to do really well.

Michael Roxland - Bank of America Merrill Lynch

In that pricing, so you're selling six weeks forward, you're walking in that price for a long period of time, as what comes down to?

Eric Cremers

When markets are really good, we'll tend to have really strong order files, when demand is really strong. So we'll sell-out production reasonably far out into the future.

Michael Roxland - Bank of America Merrill Lynch

And just one last question, I'll turn it over. Over the last several weeks, we've heard about mills taking downtime, in light of the weaker pricing. The pricing obviously has turned a corner right now. You're starting to see, I think price was actually about $25 per thousand board feet. A part of that, as you mentioned, was that the inventory channel has cleared, but mills are also, I hope, are taking downtime. Have you started to see the reversal in terms of, given the pricing has now turned a corner, have you seen anything in terms of capacity restarts or did that gives you reason for concern now that pricing is improving?

Eric Cremers

No, I don't think so, Michael. I mean in fact with that Canadian duty, the export tax kicking in August, I think that's going to help things even more. We've seen prices move up right in line with the composite index, and I think our outlook is generally pretty favorable, as housing starts continue to move forward. If you look at the data that was out this morning, new home inventories are down to 3.9 months of supply. So demand is clearly there for new houses and that drives demand for lumber.

Operator

Your next question comes from the line of Gail Glazerman with UBS.

Gail Glazerman - UBS

I guess, picking up on one of my questions, can you give us a sense of where your current lumber price is versus your second quarter average?

Eric Cremers

Yes, Gail, so one way to think of pricing, I like to compare it to the composite. So we report out our lumber prices on a GAAP basis, which includes shipping. If you strip out shipping, which is roughly $40 per thousand, we've already shipped in July about one-third of our volume at about $320 per thousand. And roughly where we're shipping at is about $350 per thousand.

So we think in the third quarter, we're going to roughly finish the quarter with an average FOB price, which is comparable to composite around $340. And if you add back shipping that would be another roughly $40 to it. So our reported price will be roughly $380.

Gail Glazerman - UBS

And in terms of your log contracts, what lumber price did they follow? Would it be something more current with the contractual lag that you have in that relationship or would it be kind of felt as what you're booking at that time?

Eric Cremers

We won't get into the specifics of what the contracts, how the mechanics work. But they're based on lumber prices reported in this region of the country. And they're based on a variety of dimensions and include the negative impact of residual prices, and it lags roughly one to three months. It's a complicated formula, so it's very hard to just explain over a simple call like this. But that's generally how it works.

Gail Glazerman - UBS

So the lag is one to three months. So it's not like you'd be taking an extra six weeks on to that relative to what you're saying kind of for your actual lumber realization?

Eric Cremers

Right.

Gail Glazerman - UBS

And just, I mean, taking it back, you kind of hinted that with reference, as inventories. But can you guys give some maybe color on what you think happen to lumber market in the quarter, what drove them down and what is going to drive kind of more specifically the recovery that you're looking for in the back half?

Eric Cremers

Well, yes, I think you got to go back to the start of the year, Gail. I mean people were pretty excited about housing starts and dealer inventories were relatively low. And so dealers wanted to build strong inventories and advance the building season. They did that and that drove up prices quite a bit early in the year.

And all of a sudden bad weather hits a lot of key building regions in the country, building slowed and dealers decided they had too much inventory, on a monthly supply basis inventories are relatively high. And so they stopped buying and the Chinese stopped buying as well. And then the Canadians started redirecting their lumber away from China to the U.S., right when Canada was having weak housing starts.

So you had incremental supply coming to the U.S., you had weak demand from China, you had dealers here not wanting to buy, because they have full inventories, and so the exact opposite reversed late in the quarter. And that pushed prices down materially, because that opposite happened. And then I think what happened is, as housing starts continue to improve and the Chinese have come back to the market, we've seen prices start to work their back up again.

But I guess what gives me optimism is that tax is going to hit Canadian exports here in the month of August. And you would think the Canadians would be trying to push wood into the U.S. this month in advance of that tax, and yet pricing is still strong. So I am optimistic about the outlook for pricing for the remainder of the year.

Gail Glazerman - UBS

You mentioned weather impact those in Idaho as well as the south, have those at this point normalized or are harvest conditions still low that drenched in the south?

Eric Cremers

No. They have both normalized. We've had good weather here in Idaho and the weather that hit the south in the second quarter has passed.

Gail Glazerman - UBS

And then just last question kind of touched on a little, Mike. There has been some downtime announcements that may, at least from what I've seen, those announcements have all been in the last. So I'm wondering, if you can talk about one; housing, if you can see rise and kind of stuff on the coast played into the log recovery and the trends that you're seeing in Idaho?

And two, just generally speaking what dimensions are you seeing in the south? Did you see customer's kind of hunker down or are you seeing customers coming back to the market, just given the dynamic of reasonable lumber prices improving demand and so quiet attractive log prices?

Michael Covey

Well, a couple of comments. Maybe the south first, the log prices in the south are still stagnant with really no catalyst on the horizon that I can see that's going to cause them to change over the next couple of quarters. But the operating businesses, the lumber business is very good. And we are seeing mills add capacity. West Fraser announced they're going to start mill in North Florida, South Alabama, the McDavid sawmill is one example, which I think is a $100 million board fee.

There are examples like that that are happening around the south, which gives me optimism with these terrific margins in the lumber business in the south will eventually exert pressure on the log market, but we still think that's going to take time. So that's been consistent with our belief all year. So I think things are progressing in the south, not as fast as we'd like, but they are progressing.

And I think in the west, we have to, while there was some downtime taken, I think probably partly due to very high log costs in the west coast, falling lumber market. The holiday, July 4, holiday fell in the middle of the week. I think all of those prompted downtime. And I don't expect that we're going to see that kind of downtime announcement continue through the summer, I think things are moderated a bit.

Gail Glazerman - UBS

I mean, I guess what I was getting up there was western log prices again were very, very strong and it seems like it was something to dig in affordability issue. And I'm just wondering if that's started and continue to crack, do you think that would impact Idaho at all or do you think it's been operating kind of on it's own fundamentals at this point separately?

Michael Covey

I don't think that there is a bleed over to Idaho directly. I mean, certainly at some level they are connected, but I think the correction in the west coast won't weaken our Idaho business.

Operator

Your next question comes from the line of Chip Dillon with Vertical Research.

Chip Dillon - Vertical Research

When you look at the real estate sales pace, you mentioned that it might be a little greater than the 18,000 to 20,000 acres you were looking at for the year. I guess, the couple of questions. One is, do you feel, maybe tempted is the wrong, but maybe you might want to hold off a bit, just because or as you look at '14 and your plans for that, because it seems like the markets are coming back. And you might be able to get better pricing. And I guess secondly, more through this year, how do you feel the mix will be between the third and fourth quarter? How will that sort of split look as your best guess right now?

Eric Cremers

I don't know that there is big advantage pushing real estate transactions out from this year to next year to try to capture better pricing. The pricing plans that we're talking about are relatively small. And if you got a buyer today willing to pay a significant premiums to what the underlying timberland market value is, we're going to take advantage of that disconnect, so we'll take a money and run.

With regard to the mix or the outlook, in the third quarters it's going to be split roughly the de minimis non-strategic timberland sales, but the third quarter we split more or less half and half with the HBU and rural real estate. And then in the fourth quarter, which is going to be the biggest and lumpiest quarter, that will be split more like 75% rural, 25% HBU. But we got a couple of projects underway that we think we're going to hit potentially in the fourth quarter, which could drive relatively high real estate acre sales.

Chip Dillon - Vertical Research

But again, just to make sure, but again the mix will be half and half in the third and much more role oriented in the fourth. But the much bigger numbers in the fourth as well?

Eric Cremers

Right.

Chip Dillon - Vertical Research

And in terms of, I know its early days, but you might have addressed this. But as you look at 2014, and recognizing you've under harvested for some years, what is your look at 2014, in terms of possible harvest levels? And could there be a range there based on what might restart? And are you getting any feeling that there could be one or more major customers beyond the ones you mentioned that could restart next year?

Michael Covey

Well, we will start our planning cycle for 2014 later this quarter. And we'll provide some guidance on 2014, as we approach the Q1 earnings call, but not until then.

Operator

Your next question comes from the line of Mark Weintraub with Buckingham Research.

Mark Weintraub - Buckingham Research

That 380 number, Eric, you gave on lumber, I just want to make sure that, is that comparable to the 423, I believe that was reported in the second quarter?

Eric Cremers

Yes. That's correct.

Mark Weintraub - Buckingham Research

And then, obviously your earnings have increased nicely, your cash was increase slightly, number of your competitors have moved on the dividend. Can you update us on kind of the philosophy on the dividend as to when you would contemplate and what metrics you would be looking at as to potentially moving higher on the dividend?

Michael Covey

Well, just a couple of benchmarks, just some framework around your question. Now, we ended Q2 with $50 million in cash after retiring $37 million in debt year-to-date. We felt that that redemption was the best piece of our cash rather than our dividend increase earlier in the year. Net bad debt had an interest rate of somewhere north of 7%. So we felt like that was most the prudent move that we could make.

We continue to focus on other uses of capital allocation, debt redemption, I spoke to, capital expenditures. We've invested about as aggressively in our mills as we plan to this year. With the capital program and acquisitions we continue to seek those, although the acquisition market has been not very robust this year.

So on an FAD basis, in 2012, our FAD was a $1.30 a share versus a $1.24 dividend payout. This year, our FAD year-to-date is $37 million and we paid out $25 million in the dividend. Our expectation throughout the year is to have higher FAD in 2013 than 2012. So I think it's a fair question of one; that we got to spend time with our board on this fall as how do we return value to shareholders and certainly increasing the dividend is one of the options on the table.

Mark Weintraub - Buckingham Research

And is there a percentage of FAD overtime that you would anticipate the dividend to equal or is there some framework quantitative that you can give to us?

Michael Covey

We haven't set one that I'm going to share publicly right now. But I think there are some of our competitors who have done that. I think it's probably been helpful and we'll try to put some goalpost around kind of how we think about that.

Eric Cremers

One of the things we faced, Mark, with setting at a certain rate of FAD that we generate is that part of our FAD is from wood products, which can be a pretty volatile segment and challenging to predict. So it makes it harder for us to give guidance, but we won't spend time on that.

Operator

Your next question comes from the line Steve Chercover with D. A. Davidson.

Steve Chercover - D. A. Davidson

It sounds like in response to Chips question the second half real estate sales would be bigger deals than what I guess were quiet small transactions in Q2. But do those 65 transactions in nature kind of indicate that the shape of things to come in terms of your actual retail sales?

Eric Cremers

Steve, I'm not sure I understand your question exactly. I don't know that we'll see more transactions going forward. I think you will see a couple of bigger transactions maybe in the third and fourth quarter, not big ones like we're talking about a couple of years ago, where we had large non-strategic timberland sales. But you could see modestly higher acre counts on average in the third and fourth quarter.

Michael Covey

I think the takeaway from the higher transaction count in Q2 than any other quarter we've had in a long time. Typically, its 30 to 40 transactions and then last quarter it was 60. So I just think it's an indication that there is more people out kicking tires and more people pulling the trigger on transactions. And it's just an overall sign that the health in this market, the activity and it's increasing.

Steve Chercover - D. A. Davidson

And then you had a comment with respect to the data suggesting that new home inventories continue to fall. And yet the June starts and permit applications were pretty underwhelming. So do want to take a stab at discussing to disconnect there or do you think that we're going to see a surge in the second half on the housing front?

Eric Cremers

Steve, I think a lot of that volatility that you saw in last month, to-date it was driven by multifamily. And multifamily starts and permits are historically a lot more volatile than single-family. And we're pleased to see single-family continue to march higher as the amount of wood disused by single-family is obviously a lot more than disused by multifamily.

But we haven't seen anything that would suggest that housing starts aren't going to continue to advance. In fact, I just read something a couple of days ago that have starts anticipated and this is eight different economies forecasting, starts to be up 25% to 30% next year versus this year. So I haven't seen anything that suggests that starts are going to materially slow down.

Michael Covey

I think we're focused, Steve. We said at the start of the year, we expected about 1 million starts this year, it was slightly less. And I think, there is going to be monthly operations, we are on track for that. And we think next year is going to be 2 million or more. And I think that's kind of where we're focused on.

Steve Chercover - D. A. Davidson

Not to put words in your mouth, but you are not particularly concerned that higher rates are going to choke things off?

Michael Covey

Not yet.

Eric Cremers

Our affordability is still very, very high.

Operator

Your next question comes from the line of Collin Mings with Raymond James & Associates.

Collin Mings - Raymond James & Associates

Lot of my questions have already been answered. But I just want to circle back to again how that 65% of the volume in the north is indexed to lumber. And if you guys, I don't know if there is a way to think about maybe how important the prior month's pricing in lumber is relative to what it was three months ago. Just trying to get a feel for how that pricing mechanism works?

Eric Cremers

It's a tough question that to answer, Collin. But it's based upon lumber indexes that are published here in the Inland Northwest region. One contract is pegged what happened in the prior months and the other contracts is pegged what happened in the prior quarter. And it's based upon a variety of different dimensions and different species. And it will fluctuate based upon the log pricing, it will fluctuate depending on what happens to those lumber prices and that's about all I can say about it.

Collin Mings - Raymond James & Associates

So I mean there is really no way to think about order of magnitude if the prior months lumber price is more important than what it was in the prior quarter as far as just on a kind of a weighted average basis if you will?

Eric Cremers

No.

Collin Mings - Raymond James & Associates

And then you guys made the comment, just as far as the acquisition environment not being very robust, how much of that is just you guys not seeing opportunities in the wood basket that you guys are looking at versus deals just not penciling?

Michael Covey

Some of both, but if you look at the big picture, so far this year, a less than 1 million acres of timberland has changed hands. That includes the Brookfield Weyerhaeuser deal, which is almost 700,000 acres. There hasn't been a yearly transaction count in terms of acres that low since 2000.

So now if the Midwest property sells this year that could change that number, but there is not that much on the market. And not a lot has changed hands. It's still very competitive. We have competed on a number of transactions and been unsuccessful this year. And I think that points to the fact that investors that are putting this money to work are looking for returns that are still I think in this 5% to 6% discount rate range and that's very tough to compete against.

Collin Mings - Raymond James & Associates

You just maybe remind us the bite size as far as deals that you're targeting?

Michael Covey

Well, what's been for sale has been in the kind of $50 million to $200 million range. And certainly, we think that's a size class, it's of great interest to us.

Operator

At this time there are no additional questions, I will turn it back over to management.

Michael Covey

Thank you. We'll look forward to speak with everyone at the end of the third quarter. That concludes our call.

Operator

Thank you. That concludes today's conference call. You may now disconnect.

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