Sino-Forest (TRE.TO – C$19.30, OTC:SNOFF - $18.77) is China’s largest timber company and is uniquely positioned to benefit from continued improvement in China’s economic standard of living. SNOFF grows, harvests, and processes timber domestically and is a major importer of logs. SNOFF offers investors exposure to a Chinese resource that is in short supply and to an industry that is favored by the government. Sino-Forest shares trade on the Toronto exchange using TRE.TO and on the US Pink Sheets using SNOFF.PK.
First it is cement, then it is steel, and then it is wood. This is the progression of raw materials demand as a country moves through economic development – cement for roads and infrastructure, steel for commercial buildings and factory production, and wood for housing and consumer products. It is estimated China has reached the point in economic development when domestic wood demand will grow by a consistent 10% annually. For example, the government has set a short-term target of 4 million new affordable housing units over the next three years to accommodate the anticipated long-term migration of 300 million people from rural to urban areas. Beijing looks favorably on the timber industry to supply the materials for this effort and in Oct 2009 formed the Forest Industry Revitalization Plan 2010-2012. The Plan calls for reduced government taxes on timber land and offer financial incentives for best practices forest management. In addition, the government is looking to privatize its state-run tree farms.
China lacks domestic wood resources. Domestic resources account for approximately half of annual wood demand, with the balance supplied by imports. Imports of hardwoods increased 3-fold from 1996 to 2005, and this trend is expected to continue. About 21% of China’s land resources are dedicated to native forests or plantations versus a global average of 30%. China has about 0.2 hectares (ha) of forest land per capita, or about 0.5 acres, representing about one third of the global average. Demand for wood products is estimated to increase by 50% over the next 5 years and domestic production is expected to fall short of this growth. Imports of wood will continue to make up the difference. 80% of imports historically have come from Russia, with the majority of the balance from Latin America, New Guinea, and others. The Russians have recently imposed substantially higher log export taxes, potentially shifting Chinese imports to other countries, along with increasing domestic pricing.
Wood and wood fiber comes from two sources – native forests and actively managed timber plantations. China has realized the long term benefits of well-managed timberlands and has a very active program of offering long-term leases to timber companies like SNOFF to clear cut native forests and to establish timber plantations under 50-year lease arrangements. Of particular interest is the species replacement when native forests are harvested and converted to plantations. Native forests usually comprise pine and hardwoods while many plantations grow eucalyptus. Eucalyptus trees begin to mature in about 6 years compared to 15 years for pine and a bit longer for other hardwoods. Eucalyptus is best used as a substrate in manufactured wood products and as pulp, but has been used in construction and composite manufacturing.
Sino-Forest is well positioned to benefit from these trends. Management has been on a buying spree for the past several years, adding both logging concessions and plantation acreage. Management spent $1.0 bil in 2009 to acquire leases, and anticipates investing similarly in 2010. SNOFF currently manages over 667,000 ha, or 1.7 million acres, of plantations, with options to purchase leases on an additional 900,000 ha. As SNOFF develops more plantation acreage, the percentage of revenues from these managed assets will increase. Log yields and profit margins are better with plantation operations which should translate into higher earnings going forward. For example, in 2009, plantation facilities generated 138 cubic meters of wood per ha versus 89 cubic meters in 2008. Over time, productivity at some locations could increase to over 200 cubic meters.
The Chinese government is anticipated to begin offering for sale its under-performing State Owned Properties, or state-run tree farms. As the leading private manager of timber assets in China, SNOFF is in prime position to acquire upwards of 20% of the 24 million ha (60 mil acres) of state run farms.
In 2009, Sino-Forest generated $1.2 billion in revenue and earned $1.35 a share. Stock market capitalization is $5.6 bil with 265 mil shares outstanding. 78% of revenue is from timber sales, 20% from importing activities, and 4% from upstream wood manufacturing. SNOFF has $1.1 bil in cash and $950 mil in debt.
SNOFF missed 4th qtr 09 EPS estimates due to higher interest expense and depletion allowance charges. The Street was expecting $0.53 and the company reported $0.48 for the qtr and $1.35 for the full year 2009. This has created some weakness in share prices, providing an acceptable entry point. 2010 anticipated consensus revenues are $1.9 billion ($1.6 bil low to $2.2 bil high) with EPS anticipated consensus of $1.55 ($1.31 low to $1.82 high). 2011 anticipated consensus revenues are $2.4 billion ($2.1 bil low to $3.1 bil high) with EPS anticipated consensus of $2.29 ($1.59 low to $3.08 high).
Investors seeking exposure to the China market should consider SNOFF. Timber assets have been historically a good long-term investment. Growth prospects for Chinese timber companies seem to be better than their US counterparts due to lower current productivity and higher land acquisition opportunities. As the industry utilizes more modern silviculture techniques, yields and profitability will improve. In addition, as the Chinese government exits the timber management business, private companies like SNOFF could aggressively expand acres under long-term management.
My personal 18 to 24 month price target for SNOFF is $28, or a PE of 14 on earnings of $2.00. A great place to start your due diligence is the presentations section of investor relations on the company website. The most recent posting is the 3rd qtr 09, but the year end 09 presentation should be available shortly.
Disclosure: Author is long OTC:SNOFF and has been a shareholder since 2009