Don't Ignore China's Potential Long-Term Shift in Timber Suppliers

Includes: POPE, RYN, SNOFF, WY
by: George Fisher
According to the China Custom Statistics, as reported on ETCN, China’s imports of timber were robust during the first half of 2010 versus last year. Volume pick up 25% and values increased by 60%, driven by a 28% increase in average pricing. And demand keeps rising, with June experiencing the highest monthly volume since 2008 representing a 33% increase y/o/y. However, imports from its biggest supplier, Russia, dropped mildly. So, if the business is growing and the largest supplier is shrinking, who is taking up the slack?

China is the world’s second largest importer of timber and lumber products, right behind the US. For quite a while, the Chinese have depended heavily on imported logs to satisfy a growing domestic demand for pulp and paper, construction lumber and panels, crating, and industrial uses. Demand growth rate estimates are pegged at about 10% annually. While domestic production is expanding through the government-sponsored development of tree farms, or plantations, consumption consistently outstrips availability. Even the utilization of faster growing trees on plantations has not alleviated the need to import 30% to 35% of total domestic needs. Russia had been the major timber supplier until the government imposed a 25% tax on raw logs to encourage more exports of finished products. Volumes subsequently declined 40% from 2007 to 2009.

China has been shopping the world for logs. The major recipients of higher exports have been New Zealand, Africa, British Columbia and the US. Even Peru has seen its exports to China soar, albeit from minuscule levels.

Chinese imports for the first 6 months total 16.6 million cubic meters (cm), valued at $2.9 billion. Annually, that represents a market size of around 35 million cm and $6 billion. Through June, Russia provided 45% of the imports, New Zealand 17%, Africa 8%, US 7%, and others 23%.

In addition to timber logs, Chinese imports of sawn wood, excluding sleepers, adds another 13 million cm valued at $3.4 billion annually. Russia again tops the list of suppliers with a 25% market share, Canada with 17%, followed by Thailand and US each at 13%. Export shipments of sawn wood from British Columbia hit a record in Aug and are expected to grow by an additional 60% by the end of next year.

Increased shipments to China have helped prop up the west coast timber market with stumpage prices increasing to $343/mbf from a bottom of $163/mbf in the second qtr ’09. According to Bob Flynn, Director, International Timber, log exports from the US Pacific Northwest in the first qtr were up 35% from ’09 and up 5% from ’08, and represent one of the few bright spots in the timber industry. China’s share of US Pacific Northwest exports grew to 23% in ’10, up from just 2% in ’08.

In Aug, International Wood Marketing Group recently released a 300-page report, “China Book – Outlook to 2015”, that outlines a consistent opportunity for timber and wood exports to China. According to the report, shipments to China may represent upwards of 20% of the total Canadian lumber production by the end of this year. If projections are correct, by 2015, China’s annual shortfall of logs and lumber might equal the total timber harvest of Canada in 2008 and 2009 combined. More information is found in their press release (here).

Russia has threatened to raise its export tax to 80%, and was scheduled to do so last summer before Finland, another large importer of Russian timber, voiced its concern. It seems obvious the Russian government desires higher export taxes over time to decrease supply. This should create higher demand for US and Canadian suppliers and their timber assets.

During this week’s conference call, the CEO of Rayonier stated that increased Chinese timber exports were partially responsible for the strength in west coast stumpage pricing. This is the second consecutive call in which he has referred to growing Chinese opportunities. Look for increased comments by other timber CEOs during their calls this quarter and next concerning this improvement.

There are some that are not convinced the higher North American export trend is sustainable. Their argument is that the Russians won’t increase taxes and volumes are driven by commodity price alone. As soon as there are less expensive alternatives, Chinese interest will quickly wane. In addition, exports are a small section of US company revenues and the current housing demise is far more important.

US investors have several timber and lumber companies to chose from with exposure to west coast stumpage, both in the US and Canada. The problem is few offer exceptional value at today’s share prices. Many timber companies are structured as a REIT and dividend yields are in the 4.5% range. Most are priced closer to mid-cycle valuations than early-cycle.

However, there may be medium-term structural changes to current North American supply and demand. Substantially higher and long-term demand from China, reduced supply of upwards of 35% of the British Columbia interior harvest by 2018 due to the Mountain Pine Beetle infestation, and slowly recovering US housing and industrial demand. If this trend continues, companies with west coast timber assets and lumber production should do quite well.

Timber investments are dull and usually unexciting, and are more suitable for investors with multiple year horizons.

Since February 2010, I have written previous articles and blogs concerning my personal choices for timber exposure and include:

Far from an exhaustive list, these articles may help to explain each of these companies and offer suggestions for your further research. Some are higher risk, and others are currently fully valued. However, if the structural changes described come to fruition, the impact should be quite positive for the entire industrial sector. This rising tide should lift all boats.

As always, investors should conduct their own due diligence, should develop their own understanding of these potential opportunities, and should determine how it may fit their current financial situation.

Disclosure: Author is long RYN, SNOFF.PK, POPE, TMWEF.PK, WY