Rayonier: Conservative, Consistent Income With Growth Opportunities

| About: Rayonier Inc. (RYN)

Rayonier (NYSE:RYN) is a mid-cap timber and fiber manufacturing company structured as a Real Estate Investment Trust (REIT) that should provide long-term investors with stable income, dividend growth, and mid- to late-cycle capital gains potential. While most timber stocks have had quite a run (really, what hasn’t) and seem to be fully valued at current prices, RYN is overlooked by many as one of the premier forest products companies.

Rayonier is a high-tech, industrial specialty wood fiber manufacturer disguised as a timber REIT.

Rayonier is headquartered in Jacksonville, Florida and was founded in 1926. In 1968, it was acquired by ITT and operated as the subsidiary ITT Rayonier, only to be spun-off in 1994 as a separate company again. In 2004, RYN converted from a corporation to a REIT. RYN has grown into the 5th largest private timber holder in the US with 2.2 million acres owned, managed or leased, and a 26% interest in an additional 400,000 acres in New Zealand.

Rayonier is operationally divided into three segments, the first two are pretty self-explanatory – Timber and Real Estate.

RYN grows and harvests timber for use by pulp, paper, lumber, and other wood product manufacturers in the U.S. and Asia. RYN’s timber is located in the Southeast, Upstate New York and on the Olympic Peninsula of Washington. About 200,000 acres are classified as “higher and better use” (HBU). Most of the acreage is located in the Coastal Corridor from Savannah, Georgia to Daytona Beach, Florida, running from I-95 to the ocean. Over time, this valuable asset will be sold and developed.

These two segments are pretty common within the timber industry and most timber companies prosper from combining a continual revenue stream of timber harvests with one-time HBU land sales.

The third segment of Rayonier’s business is the jewel most overlooked by potential investors – Performance Fibers. RYN has been a leader in developing high value wood fiber based materials used in products such as cigarette filters, impact resistant plastics, paint, and food products.

From the company website:

Rayonier's Performance Fibers group is one of the world's leading manufacturers of high purity, high-performance Specialty Cellulose Fibers. Customers in nearly 40 countries depend on our quality and technical expertise, and our ability to meet their exacting technical and manufacturing specifications, for a wide variety of products ranging from LCD screens to pharmaceuticals. Rayonier also is a significant producer of Absorbent Materials Fibers, used by our customers to make disposable diapers, incontinence pads and other absorbent products.

Rayonier is #1 in the production of Acetate used in cigarette filters, textiles, and plastics; one of the top 3 producers of Ethers used in pharmaceuticals and plastics; one of the top 2 producers of High Strength Viscose used in Rayon Cord and food casings. It is estimated that RYN supplies 33% of the global specialty cellulose market, with some of their niche products commanding a 60% market share. RYN has an 80-year history of manufacturing these products and many clients are on multiple year contracts. 62% of Performance Fiber segment revenue is generated overseas, and it is very unusual for a US timber company to have such large exposure to international markets.

Rayonier does not offer commodity pulp used in familiar paper production, such as newsprint or linerboard. This differentiation, along with RYN’s market leading position in these specialty products, is lost on investors just looking at the typical timber and HBU operations.

Rayonier has a market capitalization of $3.9 billion, 80 million shares outstanding, of which 73% are owned by institutions. RYN carries $700 mil in debt and had $75 mil in cash as of 12/09. Annual dividends are $2.00, for a 4.2% current yield. RYN is a component in the S&P Mid-Cap 400.

As with most forest products companies, 2009 was not nice to the bottom line. Revenues declined by 8% to $1.17 billion, and earnings declined 19% to $1.50. Rayonier did much better than most, due to aggressive land sales during the real estate slump and consistent growth from the Performance Fibers group. Performance Fibers EBITDA grew by 20%, but the gain was offset by weakness in Timber and Real Estate segments.

2009 adjusted non-GAAP EBITDA and Revenues broken down by segment:

Performance Fibers - $242 million EBITDA and $839 million Revenues
HBU - $88 million EBITDA and $101 million Revenues
Timber - $77 million EBITDA and $159 million Revenues

Going forward, Rayonier consensus EPS estimates are for $1.82 this year and $2.10 next, with optimistic estimates upwards of $2.05 and $2.40 respectively. The outlook for specialty fibers continues to look good and the free-fall of housing and real estate markets seem to be stabilizing. However, the North Florida market, which is a large part of RYN’s HBU holdings, may take a bit longer to regain its footing. As the next business cycle unfolds, RYN should once again see growth from all its segments.

According to management, the current $2.00 dividend won’t be raised this year, but dividend growth is a strategic priority. Based on expanding earnings potential of 5% to 7% annually in 2012 and beyond, investors should be rewarded by the return of the steady 4% annual dividend growth experienced in the four years before the recession.

Rayonier stock value has regained its Dec 2007 price of $49 after falling with the general market demise and currently seems fully valued, as exemplified by the current yield of 4.2% being below the 5-yr average of 5.0%.

Offsetting this is the conservative nature of management and over the next 2 to 3 years any earnings surprises should be to the upside. The timber REIT structure is advantageous as distributions are considered as capital gains and a return of capital. For example, in 2009, the $2.00 distribution was reported as $0.46 for return of capital and $1.54 for capital gains.

In addition, there may be a structural change developing in the global timber market. Historically, China imports about half its log demand and 80% of imports come from Eastern Russia. However, over the past 3 years, the cost of Russian logs has tripled due to restrictive export duties and higher transportation costs as the timber resources move farther from the border. With depressed timber prices in Western Canada, it may be cheaper to ship logs from Canada to China than from Russia. Over the next few years, there could be a major shift in the international trade flows of logs, positively impacting North American timber companies, especially those with West Coast assets. The implication for RYN could be higher demand for its Western US timber at potentially higher market prices. For more information on the China timber industry, see my article dated 3/29/10.

For investors seeking a conservative, stable income with growth opportunities, Rayonier should be on your review list. While capital gains potential is muted with a personal 24 month target of $53 to $55, based on optimistic EPS upgrades, medium- to long-term overall annual returns including distributions should be in the 10% range. Any minor pull backs that would increase current yield could make a nice long-term entry point. Rayonier could be a great candidate for a synthetic dividend reinvestment program at a broker. Your due diligence should include reviewing SEC filings and the latest investor presentation as of Feb 2010.

Disclosure: Long RYN and have been a shareholder since 2003