Sino-Forest (SNOFF.PK) is the leading timber company in China, offering investors unique exposure to a domestically-sourced, Chinese basic commodity that is in short supply, and will be for the foreseeable future.
Long-term, Chinese wood fiber demand is expected to grow by 10% annually and the current domestic production shortfall is approx 40%. This gap is met through imports of wood fiber, logs, and finished lumber. Over the next several years, domestic wood fiber production will increase, but not sufficiently to meaningfully fill the gap. In volumes, there is currently a 100 million cubic meters (cm) shortfall that is anticipated to grow to 150 million cm in four years.
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.
Sino-Forest is well positioned to take advantage of this trend by being a major wood plantation operator and a large foreign timber owner with holdings, for instance in New Zealand. In addition, SNOFF owns wood manufacturing plants and is an important importer.
In an effort to gain World Trade Organization (WTO) approval, Russia is considering reducing its 25% export tax to 15% on logs to Europe; it may take longer for the same tax rate to apply to China. Even at this lower rate, domestic Chinese plantations, especially those with improved silviculture practices and higher yields, still maintain a cost advantage.
Background information on SNOFF is here.
The Chinese government is moving ahead with its privatization of State Owned Plantations and SNOFF management has the opportunity to double its plantation acreage from two million acres to over four million within 5 years. To assist in generating higher domestic fiber production, plantation investments receive beneficial tax treatment. As the largest and most successful timber company in China, SNOFF is expected to continue with this growth initiative.
Along with timberland harvest is the ability to switch species. Chinese wood plantations usually grow Eucalyptus trees which 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.
Increasing yields per hectare is one of management’s goals. Over time, improved silviculture practices will increase productivity and is magnified by the relatively high turnover between harvests. Improved productivity should add to margin expansion over the next few years. The goal is to generate sustainable harvests with increasing fiber yields and steady cash flows.
Sino-Forest has a market capitalization of $5.4 billion, carries net debt of $460 million, and has 235 million shares outstanding. Earnings should be announced over the next few weeks, and 2010 eps is estimated at $1.59. Estimates for 2011 are around $1.85 and for 2012 are around $2.20. Earnings estimates have been slowly reduced over the past few months due to the potential for a slowdown in incremental growth of the Chinese economy. EBITA is expected to climb from $1.2 billion to $1.8 billion by 2013.
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 low 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 acreage under long-term management. At a reasonable 14 PE, 2012 estimates of $2.20 a share in earnings should bring a stock price of $31, or about 30% above its current share price.
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: I am long SNOFF.PK. Author has been a shareholder since 2009
