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Abstract:

TimberWest Forest Corp. (OTC:TMWEF, TWF.UN) owns 809,973 acres of highly productive timberland on Vancouver Island in Canada and currently trades at an implied valuation of approximately $1,015/acre versus comparable timberland trading comps of ~$1,750 and transaction comps of ~$2,550/acre. After the burst of the United States housing bubble, TWF nearly declared bankruptcy as it struggled with inefficient sawmills and a bloated cost structure; as a result, the company has sold/closed its outdated mills and made deep labor cuts.

While still highly leveraged and completing a long-term restructuring program, we view TimberWest’s increasing log sales over the last 12 months, especially via exports to Japan, Korea, & China, and firming lumber pricing since 2Q09, as signs of continued financial improvement. Also, unlike most of its United States Timber-REIT peers, TWF does not have any exposure to the low-value Southern Pine timber, which is mainly used as pulp for paper manufacturing, and thus has more leverage to the recovery in lumber markets.

We are reiterating our Speculative Buy rating for investors with a long-term time horizon and the ability to handle potential short-term volatility.

Recent News:

On 02/11/11, TimberWest announced its FY10 results; total EBITDA for FY10 was $21.4mm, a $28.7mm improvement over the FY09 EBITDA of ($7.3)mm. Sales volumes of timber increased ~70% to 3.0mm m^3, while production costs per m^3 of timber sold decreased 11% due to more efficient capacity utilization.

Also, TWF announced a deal to acquire 7,678 hectares of private timberland located adjacent to the company’s existing private timberlands on southern Vancouver Island from Western Forest Products Inc. for $21.9 million. Western Forest Products has been experiencing even greater financial distress than TWF and does not have any other timberlands in the area, so it appears TWF is taking advantage of forced seller and will be able to capture some operational synergies.

TimberWest Key Investment Considerations:

  • Strategic location on the British Columbia coast allows for access to premium priced Pacific Rim log markets (exports to Japan, Korea, & China have significant increase in the last 12-months
  • 809,973 acres of private timberlands of predominately higher value Douglas Fir that have been efficiently harvested and intensively managed since the 1950’s to mitigate potential pest and fire risks
  • Majority of restructuring and capital improvement costs already incurred
  • Couverdon Real Estate division will capture higher-and-better land use value
  • Highly-levered balance sheet, but it appears the company will have adequate liquidity to refinance its $230mm Revolving Credit Facility at attractive pricing in FY11 prior to maturity on 01/11/12

Business Overview:

  • largest publicly traded landowner in Canada and owns >10% of Vancouver Island and >40% of the SE Quadrant
  • Coastal climate limits risk of Mountain Pine Beetle infestation, which is ravaging interior B.C. timberland and causing a short-term surge in lumber production as infected areas are being heavily harvested to prevent further spread of the beetle
  • 56,000 (~7% of total) acres of spectacularly beautiful coastal and mountain landholdings with significant higher-and-better real estate development opportunities
  • In FY10, TWF sold 2,959 acres of higher-and-better land for an average of $4,390 per acre; in FY09, average price per acre of higher-and-better land was $10,344, but only 242 acres were traded
  • Additional opportunities to monetize landholdings include:
  1. Carbon offset payments for conservation of selected old-growth tree stands
  2. Sub-surface mineral, aggregate, and energy rights
  3. Alternative energy site leases for hydro, biomass and wind production
  4. Conservation easements

Key Potential Risks:

  • TWF’s FY10 Asian log sales were >50% of total revenue, up significant from less than 10% in FY08. If this level of Asian demand is not sustainable, TWF revenue could decline significantly.
  • Timberlands in Eastern Russia (Siberia) have a similar species mix to Vancouver Island and benefit from lower harvest and transport costs for Asian consumers relative to North American production. In 2008, Russia enacted steep tariffs on lumber exports in an attempt to crack down on illegal logging. If Russia revises its lumber tariffs, TWF logs will be significantly more expensive relative to Russian production for Asian customers
  • North American lumber prices are highly sensitive to new home construction. If the United States housing market continues to remain soft and new construction remains below the sustainable level of 1.6-1.7mm new homes, TWF free cash flow generation will remain constrained at current levels.

Stapled Units Overview:

TWF has an unique equity instrument referred to as Stapled Units, were each Stapled Unit consists of one common share and approximately $8.98 face amount of the 2-12% Series A Subordinate Notes. These components are "stapled" together as a single unit and trade together on the Toronto Stock Exchange; components cannot be transferred except with each other as part of a Stapled Unit. This unique structure is a result of the company’s historical structure as a Canadian Income Trust and then its severe liquidity crisis in 2007-2010.

At this time, TWF continues to conserve cash by making in-kind (i.e. issuing additional Stapled Units) interest payments on the Series A Subordinate Notes. Please note, for U.S. domiciled individual investors, up to 25% of each Stapled Unit distribution is withheld for Canadian taxes, but the rate of withholding tax can be reduced to 15% (equivalent to the U.S. dividend tax rate), provided that the non-resident holder qualifies for the benefits of the U.S. Tax Convention.

Valuation:

First, TWF’s current implied valuation of $1,028 per acre represents an approximate 40% discount to comparable publicly traded peers with a mean implied valuation of ~$1,750/acre. The trading valuations presented below are as of the close on 02/14/11.

Second, TWF’s valuation of $1,015 per acre represents an approximate 60% discount to comparable timberland transaction comps with a mean implied valuation of ~$2,550 acre. The timberland transaction comps below include transactions valued at greater than $100mm that occured within the last 10 years.

click to enlarge

Summary:

We believe TWF currently trades at a significant discount to its intrinsic value and presents a compelling deep-value opportunity. We are reiterating our Speculative Buy rating for investors with a long-term time horizon and the ability to handle potential short-term volatility.

Source: TimberWest Forest: An Attractive Deep-Value Opportunity