Rayonier Inc. (NYSE:RYN)
Analyst Day Conference Call
September 22, 2011 8:30 am ET
Lee M. Thomas – Chairman and Chief Executive Officer
Paul G. Boynton – President and Chief Operating Officer
N. Lynn Wilson – Vice President, U.S. Forest Resources
Charles Margiotta – Senior Vice President, Real Estate President, TerraPointe Services
Hans E. Vanden Noort – Senior Vice President and Chief Financial Officer
Jack M. Kriesel – Senior Vice President, Performance Fibers
Lee M. Thomas
So good morning again, it would be worthy appreciate you being here for Rayonier’s Investor Day and welcome to the Jesup Operation. I think, I had I talked a little bit last night, the focus today is really our plans for the future. I think a lot of you’re familiar with our performance over the past number of years. We want to talk to you about our performance over the next few years and our projections, and what it means in terms of cash flows, particularly our EBITDA goals for the next five years.
No, I think a routine for Rayonier here has been all about execution and discipline around execution. And so as we look to the future, I think you’ll see a lot of that built into our plans going forward as well. It’s been a lot going on here, particularly over the course of the last year as we’ve looked at both growth opportunities for us and we want to cover those with you. I want to talk about some of our latest acquisitions in our timber business, but we think that means for us going forward, how we think the markets are going to look for timber.
We also want talk to you about our Performance Fibers business in some detail. And we want to talk to you about our latest expansion plans, and adjust. When we finish this presentation, you’re going to have an opportunity to take a tour, so you will get a direct understanding I think from some of our folks here, open R&D as well as out in the mill and out in the place.
So with that, what I'm going to do is turn it over to Paul, and Paul is going to talk some about our strategy going forward and then we’re really going to spend most of our time with our business unit leaders, giving you a much better understanding of each one of the businesses and where we think we are and where we are going over the next several years. So, Paul?
Paul G. Boynton
Thanks Lee. Hey, good morning, everyone, I'm just going to take a few minutes and review our strategy, but first before I do that, let me introduce all of our presenters here this morning. I will start off with our business leaders and if you guys don’t mind standing on (inaudible) Lynn Wilson, our Vice President of U.S. Forest Resources; Charlie Margiotta, Senior Vice President of our Real Estate Group; and Jack Kriesel, Senior Vice President of Performance Fibers.
So we are going to start off with Lynn, Charlie and Jack talking through the strategy for the businesses and we’re going to wrap that up on a financial summary with our CFO, Hans Vanden Noort, concluding. And then Lee will come up again and wrap everything up for you at the end of our presentation. So that’s kind of the flow of what we’re going to do this morning.
I’d like to remind you that in this presentation we will include forward-looking statements made pursuant to the Safe Harbor provision of Federal Securities law. Our Form 10-K file with the SEC lists, some of the factors, which may cause actual results to differ materially from the forward-looking statements we may make. They are also referenced on page 2 of your presentation material.
Okay, now let me just start with a review of our strategy. In the very simplest of forms, our strategy is to invest in Timberland and Performance Fibers growth, very simple, it’s invest in Timberland, invest in Performance Fibers growth and make sure we’re continuing to push forward shareholder value.
Now when we say we’re going to invest in our Timberland, when I say we’re going to invest in our Timberland, I am talking about really the combination of portfolio of our two businesses. And when I talk about that, if you think about our Timberlands as a portfolio, we’re going to just simply costly go out and look for quality timberlands to bring in to that portfolio. So we’re looking around, looking for what we say upgrades our existing portfolio by bringing it in at the same time divesting part of the portfolio, which is less optimal. While there is either a location that’s optimal or perhaps on a quality of site index, if there are optimal, but moving that out of the portfolio. And then what we have on balance is really our strategic timberland, and we will have Lynn come up and talk about our methods, our way of increasing future value with that property.
On the real estate side, we actually have a very comprehensive land classification system. And we categorize all of our properties by greatest potential for market value, where there is transactions from a real estate sale for our roll sales, whether it’s guiding value creation for conservation fields or positioning the property from entitlement to industrial, the commercial or residential sales value. And Charlie will talk through the details of this strategy.
And in Performance Fibers, we’ve developed a strategy to maintain our leadership position in cellulose specialties and high purity cellulose. What we do better than anybody else in the industry is create and isolate a high purity cellulose fiber and we do that consistently day in and day out.
And so our challenge in this Group and our strategy is to continue to add value to our customers and at the same time, create a wedge between, a technology wedge, between Rayonier and its competition. Also important in this strategy is the continuing invest in capital for reliability and for low cost improvement to help maintain our position in the long term, which again is very important for our customers and low cost position out there as well.
Jack is going to highlight what is this market segment is all about, Cellulose Specialty segment is all about. He’s going to talk about what makes Rayonier different from our competition and he’s going to expand on how we plan to grow our position here with our recently announced expansion.
So we’re going to walk through each of those three businesses with Lynn, with Charlie, with Jack, and we’re going to talk about our strategy in each of these areas and how we’re creating value for our shareholders. And again, quite simply, it’s a very focused strategy based on strong execution and disciplined growth in Timberland and Performance Fibers.
With that let me turn it over to Lynn Wilson to talk about Forest Resources.
N. Lynn Wilson
Thank you, Paul, and good morning. It’s my privilege to be here today and I’m going to continue on with the theme of EBITDA growth and really focusing on four drivers for our U.S. Forest Resources Timberland acquisitions and our current portfolio. We focusing on volume, mix, price and our acquisition strategies which Charlie Margiotta will share with you.
I would like to start with familiarizing you with our U.S. Forest Resources Timberland and our New Zealand operation. If you look on the map, we have a 26% position in the joint venture and 317,000 acres in New Zealand and Rayonier is the managing partner. For our U.S. Forest Resources, I would like to start with the Atlantic Region. In the Atlantic Region, we have 1.1 million acres in Georgia and Florida.
Moving on to our Gulf States Region, which is where all of our most recent acquisitions are located, we now have 746,000 acres located in Louisiana, Alabama, Mississippi, Oklahoma, Texas, and Arkansas, with a very small parcel in Tennessee in addition. So the recent 50,000 acres in July and in the most recent announcement of the 250,000 acres are all located in those Gulf States regions.
If you look at our Northern Region, we have 128,000 acres of high value hardwood located in New York. And then moving on to our premier timberlands in Washington State, we have 398,000 acres in the Olympic Peninsula, which I’m going to dive into a little bit deeper in the later slides.
I’d like to emphasize this diversification that you see here in this map, which helps us with both geographic end market regions, so as the economy and markets change, we can really implement a very strong business.
Going to our EBITDA growth drivers for Forest Resources, those primary drivers are volume, mix, price and timberlands acquisitions. So I would like to start with volume. The Asian demands in Rayonier’s position in the Pacific Northwest is allowing us to ramp up and respond, we’re uniquely positioned with that acres that we have there. In addition we have differed volume over the past few years in the Pacific Northwest and now we are able to respond over the next five years and really capture that export opportunity. Also to our advanced silvicultural practices are increasing the available volume on our southeast Timberlands with significant investment in ongoing capital, and I will speak to that as well.
As we take a look at mix, we’ve improved our southeast sawlog mix because we’ve differed over time a significant volume which is now stored and we can capture and bring that – we have the ability to bring that to market. We also have to our silvicultural, practices we are improving our mix significantly over time.
When you look at price, as one of the major drivers, we feel there are several areas that are going to really bring our pricing over the next five years. Housing recovery will be one, the British Columbia mountain pine beetle will come in the outer years will support pricing, in addition to the housing recovery as well as that ongoing export demand.
And as for as Timberland acquisitions, this is one of the areas where we get both additional volumes and we get additional operational flexibility. With that said we think that really is important to think about and it will be a reinforcement – tour later today is execution, we have a very strong business strategy that’s in place and it’s ongoing that the team is really focused on executing on all of these drivers.
I would like to start off with China’s demand for softwood driving the higher imports into their country. We have conviction now after doing significant internal and external due diligence within our team that this is a long-term play that is not a blip on the screen. As you take a look at the graph on your left, it shows that China's softwood log and lumber deficit is expected to grow by 10% per year or going from 2010 to 2015 the demand is going to be up over 110 million cubes.
With that the domestic supply that China has internal to their country does not have the ability to respond both because of depleted resources and because of ongoing pressure from conservation and agricultural uses of land. So we see that the total gap will be 2015, 60 million cubes and this data comes from RISI and several other sources.
If you move over to the right, we see that the China softwood log and lumber imports by region will over time move to three significant runners. We see that China will be using logs and lumber from Canada, New Zealand and U.S. and that’s where the growth will occur.
We know that Russia has a very large resource that’s transportation advantage and is sitting there very close to China, but we see that the infrastructure, the social challenges and the way that things have transitioned over the past few years that that gap will remain and they will be unable to respond.
So what does that mean for Rayonier’s business? Rayonier in the Pacific Northwest our ownership is strategically located with export opportunities. I’d like you to notice where our ownership is, we have 398,000 acres in the Olympic Peninsula all within proximity of five different ports, which we are currently shipping out of today.
Those are the things that just really put us in a position to take advantage day-in and day-out and so both domestic markets and our export markets are lifting up those prices, which you’ve seen in our financial performance. Not only does this mean that we have higher export markets, but the domestic sawmills are in a position to continue to compete if they are going to run their mill.
So to date what we’ve seen is that we’ve had this operational move with in our team, last year we ended the year at 17% export; this year we’re going to end the year at 33% to 35% total export of our log volume that we have harvested.
One other thing I’d just like to really emphasize is that we’ve made a move to also position ourselves for the next five years by continued investment in road infrastructure; we have a very large capital investment and it takes one to two years between the permitting process in the challenging topography to have roads in place and we see that those proximities at port and the availability of volume that is already roaded is the key driver for our success in the Pacific Northwest.
One of the things that we have done overtime, if you look at the chart between 2008, 2009, one of the things that Rayonier did was dispersed all log volumes because of the weakened and soft domestic markets. So we have the ability right now with our standing inventory to move up to that 1.8 million tons to 2 million tons volume over the next five years.
So this year we will be at 1.5 million tons; next year, we’re moving up to 1.8 million tons, but we have the ability during this planned period on an annual basis to harvest between 1.8 million and 2 million tons. This increased harvest adds if you move up to 1.9 million tons as an additional adjusted EBITDA of $18 million a year annually at 2011 pricing. Well, I think I just like to stress a bit what’s going on in the Pacific Northwest is independent of what's going on in our other log markets and is a very unique position for us to have.
I’d like to move on to silviculture. One of the things that I’d like to emphasize here is that when we add additional inputs into the forests, we can improve both the volume per acre that we're growing and the mix, so improving the sawlog mix. So right now our forests, if you look at the left our site index on average is 68. And if you take a look at site index as a measure that is at age 25 in our southern forests, we expect those trees be on average 68 feet tall. So what site index allows us to do is compare our forest across the south.
So what our goal is to move the site index from 68 on average now to a site index on average of 73 and move the whole forest up to the inputs that we put in. So with that one of the things that we're able to achieve is an additional 20% more volume over that rotation of which is approximately 33 tons per acre or an increased revenue of $660 per acre at 2011 pricing.
How do we do that? The inputs that we use are Stand Establishment, so when we’re planting those trees we have already either chemically or mechanically site prep those. We plough the fields and better them or we’ve used chemicals to clear the blush, we’re putting in better genetics and better seedlings. We’re also fertilizing it in key times, which is a very large investment so early Juvenile fertilizers within those first seven years of planting and mid-rotation or just after that first seeding we’re adding in on certain soils, a second fertilizer depending on the financial return that we calculate at the time. As well as ongoing competition control, which means that out there evaluating our site on a very site specific basis and if so [weeds] in the competition come back, so we’re adding an additional herbicide treatment.
First thing that we really struck with our (inaudible), he’s really spend a lot of time with our foresters and our silviculture team is to make sure that we are doing the financial return on investment and calculating those the net present value and the IRR of all of those treatments, because you can actually overcapitalize and we see that the balance of that net present value and the focus on the return to our shareholders.
I’d like to spend a little bit more time on advanced genetics, I called it out on the last slide and it’s something that really sets Rayonier apart in that and I’ve been really impressed with over this past year is that we have a very large large-scale and effective controlled breeding program. So the seeds that we’re putting out and the seedlings we’re putting now, which should be emphasize again this afternoon are better than open pollination or standard seed across the industry.
The other thing that we have is the ability to site-specific seedlings out there on the site. So we are actually taking a known female and a known male and creating a genetically improved seedling out in the field in a plantation called the seed vouchers. So as you take a look in 2011, we will have planted 30% of our new plantations with improved seeds. By 2012-2013 we will be up to 35% and we have now in place with our new seed orchids and ones coming online. By 2014, we will actually be planting 60% of our loblolly pine will be coming from this improved genetically advanced seed source.
Moving on, I’d like to really talk about the way that we are looking at mix. We have over the past few years deferred saw log harvest. So we’ve been at 80% in 2009 and 2010 with our pulpwood harvest, leaving our saw logs in the force and deferring that. I call it storage on the stump. And one of the things that we have is as we move forward, we have the ability to respond to the markets as they come back and move our saw log harvest back to that 50% level. So on an ongoing basis we will see that improvement through mix will bring us annually an additional $6 million. So if you think about in 10% increment, for every 10% there’s a mix changes we are generating an additional $3 million EBITDA annually.
The other things that I’d also like to focus on is that, on the slide I’ve showed you that we’re moving to 70% saw log mix, but on an ongoing basis, what we will be doing is having stemming every year. So not only we have these mature forest, but we’ll also every year have a certain percentage of stemming and so that 50% or higher saw log mix is obtainable.
Moving on to price improvement, we see two categories. We have a structural demand and then we have a Canadian timber supply impacts. So if you look at the structural demand, one of the things that we see is that as housing rebounds from the current record lows, price will be supported. In addition, the increased biomass facilities across our ownership footprint is really supporting our pricing, and we are really focused on this, and log and lumber export, as I’ve already summarized.
When you think about increased biomass facilities, I’d like to give you an example. We have had over 400 announcements of biomass consuming facilities and very small percentages are actually in production. So our team is primarily focused on those three to four that are within our footprint that have the financials and business ability to continue on. And we one right now in Georgia, called Georgia Biomass, and we are delivering to that facility now and just that one announcement and start-up of that now with 1.5 million tons annually that they will consume; crisis in the region was lifted up by 10%. So it's really a major impact. We have had an announcement in Gainesville, Georgia, so we see that will be moving forward with the utility, which is within our footprint as well as in Alabama, the previous Dixie Pellet facility is now going to be started up under another name.
So we’re very pleased with that, the results are something that we’re being very targeted and not looking at all 400 facilities, we’re looking at the three to five that are going to directly impact out business.
As we move on to Canadian timber supply and the impacts from the mountain pine beetle, we see that the diminished ability of the British Columbia to respond when U.S. housing recovery happens in 2015, 2016 that that would add additional support to pricing in that outer term of our planning period. And in addition, Eastern Canada had very aggressive high harvest levels over the past few years and so not only the softwood lumber agreement terms, but also they’re bringing down in Eastern Canada, particularly Quebec and Ontario, bringing down the annual allowable cut. It will not allow Canadians to respond at the next U.S. housing recovery as they have historically.
So I’d like to get a little bit deeper into how we view the demand/supply dynamics and how they drive our saw log prices. So here this is focused on our Southeast pine saw logs and there are several pieces of data here. We have the historic U.S. housing starts on your left, as well as the historic pricing that has come from timber market itself. And on the right you have Rayonier’s projected outlook as well as Rayonier’s viewpoint of housing.
We are planning by 2015, 2016 to return to $1.2 million housing starts. So we are taking a conservative position. And one of the things that we see is that we expect pricing to return by 2016 to about $40 per ton level and really coming from three different drivers in our viewpoint, housing recovery, the effect of the mountain pine beetle and British Colombia’s inability to respond, as well as Asian demand.
So one of the things, if you take a look at this chart, if you add an additional $10 per ton on it, then you sell logs during the planned period, as that is listed up, that will add an additional $20 million to our EBITDA.
Now that I’ve covered volume, price and mix, I’m going to hand it over to Charlie Margiotta, so that he can review our recent acquisitions and our strategies.
Thanks, Lynn. I’m sure every timberland organization has got their own criteria for buying timberland, so I’m going to go over ours. Firstly, strategic fit, what does that mean? We’re particularly interested in the southeast and targeted regions in the southeast. We continue to monitor the northwest and what that means, as Lynn pointed out, we’ve got a long history in export log business; several years ago we made an acquisition in the northwest; we continue to look, but I would say we have little more emphasis on the southeast.
We look for competitive end markets. So we do a lot of analysis on existing demand and one of the things we put a lot of time into is trying to predict and project the health of an existing market, the pulp market, the saw log market, we recently saw a shutdown of a firewood in the northwest, that’s pretty important to us.
We also try to project future demand, and again as Lynn pointed out, biomass has discussed a great deal and again, trying to project their demands overtime, so the competitive market for us and the competitive markets for our products is pretty important.
Size, if it’s a bolt-on acquisition in an existing area, we really don’t have a size criteria, but in a new area like in Louisiana, we don’t have a strict rule, but I’d say somewhere around 50,000 acres, particularly in the south is what we need to enter a new area.
Site, obviously we want average to better than average site. If we’re going to make an acquisition, we’d like it to increase our overall average, and the other thing is site implies, generally implies softwood. We wouldn’t rule out hardwood, but we’re generally more interested in softwood plantations, conifer plantations, either in the southeast or the northwest.
Obviously we’re interested in HBU potential. One of the things we find overtime is that land sales certainly bridges a more difficult timber time. Non-timber income is important, but obviously at the end of the day we need to exceed our timberland capital on any acquisition.
I want to go over two specific acquisitions that we made and the result, I thought you may find this interesting, it’s great to talk about projected returns, but here we have two acquisitions we made in the last five to seven years.
The Alabama acquisition, on your left 83,000 acres purchased about 7 years ago. Let me back up for a second, in Timberland acquisitions there is two components to return, cash flow, which comes from multiple sources three, four, five, six, seven different sources of cash flow. We got to do it more well, but returns on timber, returns on non-timber income, land sale. The second is the appreciation or depreciation of the asset value including in that biological growth. Typically you do get appreciation over time, we still get appreciation over time, it can be somewhat cyclical. So there is two components to return.
And the Alabama purchase – acquisition in ’04 to today we believe we got a 10% nominal return. 7% return on the day-to-day operations, timber and non-timber and 3% return biological growth and appreciation. We got a very appreciating asset in Alabama. So between ’04 and today, we feel like we’ve got 10% nominal. And the Alabama purchase was one, really one large contiguous log.
The Oklahoma and Texas purchase in ’06 are very different assets, multiple parcels spread over two to three states. And in this case we believe we got an 8.5% nominal returns, but in this case not as much appreciation, 6% from day-to-day cash flow. We’ve got a pretty aggressive land sales program over there that’s generated 2 plus percent returns.
Now I would like to talk about the acquisition we announced on Friday predicted to close in the fourth quarter, we had a lot of questions last night about it, so I’m going to go over it here. 250,000 acres, I am going to really explain what drove us to make this acquisition. Why we think this is so attractive for our company.
Firstly, 250,000 acres often in the south you get some portion of you acquisition are leased acres, frankly less attractive and in this case of the 250,000 only 10,000 acres are leased acres and those are in Alabama. The pure strategic fit, our goal with that on the map the next chart – but this is an area that we’ve targeted to increase our ownership because of three reasons; existing demand, for timber and timber products projected demand and land sale opportunities.
Land opportunity in this case, to negotiate with the seller. Having been in this business for a long time, I’d always rather negotiate and bid, when this stumpage, I didn’t want to bid on one of our stumpage sales as competitive as it is, I’d rather negotiate any day. And so we had an opportunity to negotiate, which again is much preferred.
There are no significant supply contracts on this property, there are few small contracts, but no significant supply contracts that fits perfectly with our stumpage model of selling stumpage, varying our sales along with market demand, we really select, we can optimize the value. It’s very high quality, average to better than average, it’s high quality to our existing ownership in the south. It was relatively young timber, I will point out that the, what we call the rayon purchase in Louisiana, which we just made was relatively old timber. But this fit really well; the age cost has fit really well into what we just acquired three or four months ago. I talked about strong end markets, and really good HBU potential you’re seeing on the map.
Here is the location. Let me just go over this with you; the blue is Rayonier existing ownership, this is Western Alabama, and East Texas and East Oklahoma and the two edges. The blue is existing ownership, the red is the – what we call the rayon purchase which we made about three months ago, close about three months ago, and it’s currently operating. And the green is the Joshua/Oklahoma property that we announced on Friday.
A couple of things I’ll point out, these are targeted areas for growth for us, it’s the way I think about it is. We have East Texas property, obviously we’ve had Alabama, Georgia property. We’re really trying to close in the center and the Gulf States, I think that’s really important. And also the scattered nature of the ownership fits our business model better than great, big, large contiguous blocks. Those scattered parts will create a lot of land sale opportunities.
I’m going to turn it back to Lynn; Lynn is in charge of executing these acquisitions.
N. Lynn Wilson
So now we get to the exciting time, we actually have as we add these acquisitions, we have significant progress this year and thanks to Charlie and several key people within the acquisitions team, we had a lot of success. And with this additional investment of $425 million, our 3,000 acres is really a great opportunity, and while it has increased our ownership in acres it’s really all about the additional operational flexibility as well as the additional funds and EBITDA that it will add. So if you think about the 1.5 million tons that we are going to harvest by 2015, this forest just to re-emphasize is relatively young, so one other thing that we have in these first two years is it, when age cause distribution that allows us to ramp up that harvest. By 2016, we have a lot of volume coming on board. So one of the things that we’re working on right now is to make sure that we’re prepared for that 2015, 2016 ramp up.
As I said before, it’s our job and my team to make sure that we’re focused on execution, and on these timberlands, we are already, we’re preparing to in Q4 to be in place and operating those timberlands, harvesting, finishing the planting season in December and January, and have all those pieces in place.
We are already in full swing on the Louisiana timberlands that we purchased a few months ago, and right now we are harvesting, delivering to our customers there as well as moving staff into Louisiana. So we’re very pleased with the way that’s integrated, and that focus on integration and that focus on execution is really the strong suite of Rayonier’s operational team.
That incremental EBITDA from the additional 1.5 million tons is $40 million annually by 2016. So how does this all roll up, here are the numbers. So we have, I’ll summarize for you the four key drivers around our EBITDA growth. I’d like to stack it all out for you.
In 2011, as we’ve previously indicated, we’re going to end this year, $110 million EBITDA, and that’s substantially up from last year. Our near-term focus, when you look at 2012 and 2013, we expect to have the ability to move that to about $130 million, $140 million EBITDA with two near-term focuses. One is on those early acquisitions done, and on the Washington opportunity, because we see that, that’s immediate. We’re executing it, as we seek right now, but we see the ability to move up to that 1.8 million ton mark next year or 300,000 tons more than we harvested this year.
In the longer-term we have each of these things that we’ve discussed earlier. We have the additional sawlog mix, we have the additional volumes that’s coming from the Pacific Northwest, and we have the capability to move up on not only our acquisitions, but additional sawlog in the south as the U.S. and domestic sawlog markets come up. So as you move to that $200 million EBITDA category, you can see that we’ve added each one of those layers.
So in summary, we have four pillars of growth in our business in U.S. forest resources. And I have the opportunity now to entertain a few questions or Charlie on the acquisitions, if you have any?
Could you just talk about cost of capital, how you calculated given that you’ve got EBITDA or cash return as well as appreciating asset where you’re not actually earning and how you factor the two or blend the two to come up with an appropriate hurdle rates?
N. Lynn Wilson
Okay. Paul, if you want to speak to that?
Paul G. Boynton
Sure, overall we looked at our cost of capital in the timber segment, roughly 7.5% to 8%. And so as we look at these acquisitions, we’ll look at the various sources of cash flow as Lynn and Charlie mentioned. But over time, we’ll either get the cash flow on an ongoing basis or else when we monetize it. But when we do our modeling, we typically are going out over two locations, and so we are going out 50 plus years, just to make a little bit different from some of the [timbers] for example as they do their modelling?
N. Lynn Wilson
Yes. Could we wait for the mic so the other audience could hear?
Yes. Maybe this is specific, but is it fair to say, if you look at the two acquisitions, I think you paid a little over or about 400 million for the two.
N. Lynn Wilson
And you expect to get a $440 million EBITDA return, so that, I guess on a EBITDA basis that’s 10% and then you take off a little bit to get to the 7.5% to 8% or I guess cash cost, sorry the non-cash cost?
Paul G. Boynton
Well, you certainly I have some basis coming back to you, but you also have some capital that you're going to have to be putting into these forests as well.
Yeah. And when do you get to the 40s I guess by 2014?
N. Lynn Wilson
Yes. Well in that period of 2014 to 2016, because what we're saying is that, we need to give you a (inaudible) to respond to get all of that $200 million.
Got you, got you. And then I guess the second quick question is on the biological growth price appreciation, is that the right way I guess to look at that is, obviously the price appreciation, whatever the market is doing. But on a biological growth that I guess assumes that you’re in effect undercutting, and I guess that number returns negative, if you are over cutting over the entire acreage, is that the way to look at it?
N. Lynn Wilson
Well, the way that I look at it from a true, just strictly biological standpoint is that, growth rate has change over time. So by those imputes we are actually increasing the IRR by 16%, but the growth rate early in the lifecycle of plantation is anywhere between 12% and 16%. And then as it move up into that new location, it’s 7% and at the peak when it’s just adding volumes, but not growing quite as fast as by adding values, you are down at the 2% to 4% rate in the southern pine. So that is over the lifecycle. And then when you harvest, you’re going back down to zero, but we look at it over two rotations so that you get that average over time, so we could have growth rate.
And that’s great info. So over those two cycles what is that average annual improvement that you are getting from silviculture?
N. Lynn Wilson
If you look at individual treatments that vary somewhere between 10% and 12%, but over the life cycle where we expect 7% to 9% actual growth depreciation over that full cycle, but individual treatments.
If you think also about it, you get two kinds of growth, you get biological growth, you get cylindrical growth of the tree, and then we get what we call ingrowth, which is a tree moving from one class to another class, (inaudible) timber and that’s growth also, so you can get growth and value just specifically if the tree is bigger. And secondly the tree is more valuable because it’s gotten bigger. So we pick up that and that is very age class driven. So that amount to several percent of value increase just through silviculture within breeding product.
Just to end on this, you gave a great chart here that shows the 20% goal to increase the tonnage per acre from where it was in the past. So is that what’s going to take place maybe over one or two generations lets say you harvest some acre after your 1980 and it is a 20 year rotation, would you expect the number of tones when you harvest it in 2020 to be 20% more or 40% more?
N. Lynn Wilson
That’s actually more near term effect because when you have started 6 to 7 years ago planting has dramatically improved and so in the next three to four years when you get those first spinning what I call that new forest, if you planted a seedling today 10 years from now you are going to – or 9 or 10 years from now you are going to get that first spinning. So its not, you can get the advantage much sooner than the full rotation 25 years because you are getting that first spinning sooner. So what might have happened at 12, 13, 14, 15 years old, we are now spending a lot of these new stands at age of 9 and 10, but the first spin and then getting that volume we capture sooner and getting those trees out there and growing. I think there was another question over here, thank you.
Yeah. Just a couple of quick items. I just want to make sure that the 7.5% to 8% cost of capital that Paul has referenced at, I’m assuming that the nominal number. And then secondarily what kind of actual (inaudible) but would it be fair to assume that these acquisitions would have been undertaken absent all the excess cash you guys have on your books?
Paul G. Boynton
The answer to the first question, yes, it’s a nominal return. And the second answer is that we’ve been we had a fair amount of cash on the balance sheet for quite a while and so we’ve looked at a number of acquisitions over the last two years, done some small ones. But we really have these stringent criteria that Charlie mentioned and went through quite frankly a number of things we looked at didn't meet those criteria. So we didn't pull the trigger. So we just thought to split all of our criteria and we’ve had a good value.
Thanks. Just a quick question. Is there any risk as you ramp up to use of one set of genetic seedlings that the homogeneity of species is a problem?
N. Lynn Wilson
What we've done is we’ve actually selected several families and we have several classes and one of the things that we're doing is picking certain resistance to rest for certain regions and certain growth characteristics for other regions. So we actually right now have eight to 10 classes that we're using, so to your point there is always a risk whenever you have the same age class. But I would say that as much about having the same species, but not the same family.
So I think the other piece is that when you think about across the landscape, we don't have all of these trees planted side-by-side, it’s almost – if you think about a very large area of photograph that they are scattered across the ownership in much more geographic and landscape diversity. So we feel pretty confident, but we also track it through University of Georgia and NC State for the three cooperatives and we rely on them to keep us on track to that genetic diversity question.
Can you talk about the housing that I keep hearing the reference of recovery in housing et cetera, are you guys fighting a little bit of the 18 demographic story in what potentially could be a recovery in housing or is it just a projection of recovery? And then is there something unique about the target markets that you’re graphing in that make sure estimates or expectations for a recovery in housing to be a little bit different than maybe a national view?
I would say that it's not a specific demographic that we’re trying to target. It's a good bit of work, but looking at projections outside done by a lot of us the national forecasters, but it's also kind of dig and down into it ourselves and I think over the last couple of years we've been a little more conservative in our views of what we think housing recovery is going to be than some of the national trend. And I think that's kind of where we still are. So that’s why we are saying probably 2016 or so before we really think will get above that million starts.
Paul G. Boynton
Moving to the next question just in the middle.
Just a couple of belated question, can you talk about sort of what type of pricing assumptions you think that Nassau are also out there bidding for timberland and in term to TIMOs? Whether there’s swamp in price over the last four or five years that led them to change their long-term kind of trend price assumption, in other words, whether they’ve had to bring that down at all?
And then could you also just talk about what you think the dynamics would be with the TIMOs over the next kind of three to five years, because really if you look, Rayonier early on was buying from people like Smurfit, Smurfit-Stone and really now a lot of these transaction seem to be with institutional timber owners. I’m just particularly curious a lot of the TIMOs seem to be nearing may be the end of an investment cycle. So I’m just wondering whether there may actually be more timber getting the market?
N. Lynn Wilson
Yeah, I think Charlie would be the most, he is deeper in that, and then I’ll have other follow-on with the comment on agriculture.
First question we always just hope to answer is, you know, because we try to…
Ended up closely beyond that?
We try to analyze every deal and then compare it, particularly if we were interested and compare it to how we got to the number and try to understand why we were lower. Our sense is that the TIMOs maybe somewhat more aggressive on price projections and maybe somewhat lower discount rates than we use. Where we think we have an edge is, where we have maybe a land, a real aggressive land sale components and where we can introduce a lot of productivity improvement through what Lynn described. But again that’s really difficult to know what they're using, they don’t send us their model, so which would be very helpful.
And the second one, report that at Portland, last few days is that there is still fair amount of capital looking for a home is very difficult to verify that. But our sense is that there is still a reasonable amount of institutional capital stake in timberland.
Paul G. Boynton
But the other point I think, Mark is that clearly, the ownership of industrial timberland has changed over the course of last 10 years as you well know. And so in fact there aren’t anymore Smurfits and IPs and Georgia-Pacific timberland, it’s own by the leads and the TIMOs largely. And so, I think as you see tribes come on the market, that through the sellers are going to be and that's also who the buyers are going to be.
We did expect to see more timberland come to the market, and I’d always speculated that the, a lot of the institutional owners are somewhat happy to have their parts in a interest starting note right now and not have to – not place it somewhere else. So we're not seeing substantial amount of timberland come to the market.
N. Lynn Wilson
Okay. I believe we have time for one more question.
Hi, two quick ones. On the biomass opportunity, is that really in your mind, pulpwood opportunity is and material that you normally would not take out of the words that you can think you can monetize? And then also can you just talk a little bit currently what you are seeing on the spot markets, seem to slow a bit over the summer, is that picking up?
N. Lynn Wilson
Okay. Thanks. First question is that, it’s really, in our case, it’s been a biomass. It’s been a pulpwood opportunity. So this facility at Georgia biomass itself is going after the same specification log as the pulpwood customers in the region. So it’s going to the same, I think that could have gone to any other regional pulp mill. So it’s a Southern Pine back pulpwood draw that 1.5 million tons is 100% solid wood, not waste on top of (inaudible) and that seems to be the trend that we’re seeing in the most recent announcements.
And your second question we’ve seen the announcements and the news and just like everybody else there is a slowdown in what the Chinese exports in particular on the China Port. The advantage that we have within Rayonier is that we have a New Zealand team; we have also team members in China. And they have this pipeline in a long history of exporting directly and they have really shared with us all of their market information and yes, there is short-term question on the port and the unloading ability. But we see that underlying GDP growth and those housing starts and the economy is still driving forward. So we’re still receiving orders, we’re still seeing our first quarter pricing in place, and we’re still moving our scheduled volume. We have continued to monitor those same reports. And we see that that backup in the port has to do with a very short-term issue that they’re having there.
If I can quantify too, just on that, again, an example of land use of the Georgia biomass, it is a tenant facility. So pulpwood, all the trees are important in their production process. If you look at some of the others that maybe coming on again from Florida facility is going to do a power generation, we would believe that it’d be more of the rims and other waster wood, it would be a bigger component to that facility. Just to understand the distinction there.
N. Lynn Wilson
One more quick question.
How much flexibility do you have to change your harvesting pace? In a given year if demand surprises on the upside or the downside?
N. Lynn Wilson
Across the south, we have extreme operational flexibility and we can move within two to three weeks, we can ramp up quickly because of our land base and eroded nature of it and our proximity to the markets.
In the North West, just to reemphasize, if we have the roads in place, which takes one to two years, we can move in place three to four weeks at a minimum, four weeks because of the permitting and the regulations and it’s a little bit different climate in the Pacific Northwest, but we do have that flexibility. It should take a little bit longer for resin in the Pacific Northwest.
And Diane, one of the things that does help, and Rayonier may be a little bit unique in this way, we have a real nice combination I think of a stumpage model and a deliver wood model. The deliver wood going to a specific customer, a specific location, stumpage, we're actually making a transaction out there with the 12-month cut to that customer and they have ability.
So we can move very quickly because we got a stumpage component. It allows us to quickly get out there, seize an opportunity if we see a spike in prices we go and grab that spike. So and just will allow Lynn to comment, but lot of flexibility on that and both [course] to be able to go ahead and move on stumpage volume.
Paul G. Boynton
And I would emphasize, in the Northwest that the execution of purchase has always been to try to maintain good solid roading and invest in those roads, so in fact, we can take advantage of changes when they come about in the marketplace. And it also allows, when we go out with a stumpage sale for that buyer to have the ability to move in quickly or to hold back during that twelve-month period of time to determine when they want a cut.
N. Lynn Wilson
And a transition now to the real estate section with Charlie.
Thank you, Lynn. Start at the top, the mission of the real estate business within Rayonier is really twofold. One is to add value to Raynoier’s existing timberlands, and other through a variety of ways that we do that. And second is to support the timberland acquisition program through a variety of ways, obviously to try to identify land sales opportunities. But also, since we’re doing a lot of selling, we have a lot of contract and transactional experience. So we try to help the acquisition program as much as we can. So that’s a twofold mission.
The way we think about value creation in Rayonier’s real estate business is capturing alternative uses. So moving from a timberland use to another use creates value. Rayonier is really fortunate. We made a lot of these acquisitions, but our past managers made a great deal of the acquisitions also, and we did find out a reasonable amount of our land is in the path to grow, I’ll go over that. It’s a very fortunate position to be as a company.
Here is a depiction of the various types of lands we have from a real estate, land sales perspective. As you could see, the majority of the property is strategic or core timberlands, but we also have a fair amount of other property that we believe that has much greater use and value than timberland.
We serve basically at three markets; rural HBU market, a development market, and then I think of it as a market, but we have non-strategic timberland properties. The rural market, which generates about 15,000 to 20,000 acres of sales a year that was on our existing land base is really the backbone of our business. Buyers in that market include adjacent landowners, other landowners, people looking for recreational use, conservation which has been a fairly big part of our program over five, six, seven years, particularly in Florida, recently several transactions in Georgia, and in the State of Washington, which were really good, and even other industrial players.
We restock that as you can see from the Joshua, Oklahoma, and Rayonier acquisitions. So we restocked that rural program through acquisitions. Development, which I’ll talk about, obviously is struggling a bit now with the housing market, but our focus now is to entitle and position those properties to monetize them when the market returns. The buzzword there for us is to be patient, not try to push those properties into a market at prices that aren’t acceptable. And I’ll talk a bit about what we’re doing on the development side, particularly on industrial and commercial.
And then non-strategic, Lynn and I get together, we look at our maps, we look at our property and we determine if any of those don’t really fit and frankly (inaudible). And in those cases, we take them to market and we have a straight price that’s well above our cost of capital, we can beat it, we will sell it and if we can’t we’ll hold it. A very disciplined approach. I’ll leave you with this, Rayonier is not a developer, we don’t invest strategic capital in the real estate business, our goal is to add value.
Here is I think a really interesting example of, admittedly one of our more successful acquisitions from a land sales perspective and I believe from a timber perspective also, we call this the Gibbs acquisition, it was acquired in 2007 about 55,000 acres, 90 miles Northeast Houston, we acquired this from a TIMO. The grey is the existing footprint, and the brown are the land sales that we transacted since we bought it. We’ve had 27 transactions since 2007, and we’ve achieved 45% margin, all of this point out that most of those property we sold, 90% of the timber is the harvested [office].
So we’ve generated cash flow from the property through timber operations. You’ll have the few scattered trees, and the rest of that we’ve taken to market. And so as you can see, the sales are quite scattered. The really positive point here is, there’s a substantial amount of land sales yet to go. And I can’t predict in 10 years how much more brown will be on that chart, but I would say there would be a lot more browns.
So we have a ongoing list of (inaudible) in an extremely high return project both from a timber perspective and a land sales perspective.
Many of you’ve seen this map before, it’s our coastal corridor ownership. We have 200,000 acres, let me just define as we define coastal corridors. For us is 20 miles from Atlantic Ocean, and along the I-95 corridor either on the east side or the west side of I-95. We obviously have a lot of land just west of that 20 mile, that arbitrary 20 mile line, but that’s how we define our coastal corridors is between Savannah and Daytona.
Again very fortunate to have this property. Along that 200,000 acres about seven, eight years ago, we identified three areas that we thought have the greatest upside potential for development in the company for residential, industrial and commercial development. One property or group of properties in Bryan County, Georgia which is just west of Savannah, another large property that you will be on this afternoon on your tour is Nassau County property 24,000 acres, six miles along the St. Marys river, 8 miles along I-95. We’ve identified that for a long term potential development, not that we would invest capital, but we’ll be able to monetize it overtime.
And then in Flagler County, that has been property annexed into the city of Palm Coast, a 6,000 acre property. These are identified a number of years ago, and we began an entitlement process, which I’ll explain in a few minutes.
We’ve in 2005, 2006, we embarked on a process of entitling these properties; frankly in Georgia that’s not so difficult; and in Florida historically it’s been extremely difficult and challenging, and we’ve been working away at entitlements. Entitlements are basically giving you the relevant rights, the right to develop the properties. You have a whole long list of conditions to that development, but certainly having those development rights are worth a lot more than not having them. We can debate the added value, but in Florida historically it’s been a great deal of added value.
We have been working away at these entitlements and I really say due to a variety of factors including a political change in Florida, we had a lot of success, we’re on the brink of getting entitlements in Florida, in the last year we went over the goal line and we now have nearly 39,000 acres of entitled properties. I will say that we will continually look at other opportunities, but for now most of our entitlement efforts are done. There could be a few other special cases, but now our strategy and our tactics are to execute. I’d say again a lot of it is for residential, but we have a substantial amount of industrial and commercial entitlements.
So here, I believe this is the first time we’ve done this, is an attempted evaluation of the Coastal Corridor properties. Of the nearly 40,000 Coastal Corridor properties that are in some form of entitlement, as you can see we have industrial and commercial and then residential units, we are valuing those 39,000 acres as I’d say $5,000 an acre plus and this is the present value. And we’re valuing the remaining 161,000 acres, un-entitled acres along the Coastal Corridor; in those acres, those areas are generally the areas we have been selling over the last 10 years at $3,500 an acre plus present value. So our estimate of the value of our Coastal Corridor acres; remember a lot of rural HBU acres don’t come out of the Coastal Corridor, but on that map of those blue properties, we believe it’s somewhere around $75 million.
So to wrap up, I think Lynn mentioned that we have an ongoing land classification project. So we embarked several years ago on classifying every acre of our land into a number of buckets, for timberland, Rural HBU, development, conservation, and that process is an ongoing process because things do change and we also through that process on every acquisition.
Our sense of our projection of earnings and EBITDA frankly is relatively flat for the next several years, somewhere where we are in 2011, in the $60 million to $65 million a year range. We believe we’ll have a steady rural program that based on acquisitions – I'm sorry, [timberland is] in place today, plus acquisitions, but no projections for future acquisitions in the 15,000 to 20,000 acres a year.
We believe we have a relatively low level of non-strategic sales. A lot of that programs behind us. However, we continue to find properties that frankly other people are willing to pay a lot more for. And so we’ll take some of that to market, but a much lower level than the past. And on development, I think again the key word is to be patient. We’re going to position the properties for sale, but I would think that patience is more important than trying to push those properties into a market.
We do think we'll start to see some improvement in commercial and in particular industrial, but really believe large Greenfield residential will take some time. We do see small development sales, particularly here in Georgia every quarter and we report those on our quarterly report. But again, I think we will have to be patient. And projecting loan housing will be back is difficult. We believe its several years off. We believe Florida Georgia Coast as a high demand area, we’re well positioned, but it will be several years.
Paul G. Boynton
With that, we’re going to open it up to questions and maybe just walk around with a microphone.
Thanks for the color, Charlie. Just quick question on the land you just purchased. Have you attempted to go through the stratification process yet for the 250,000 acres that you acquired in the floor space plus the 50,000 acres. I’m assuming from the rest that's actually one of the things. Second question would be, from the (inaudible) over your time horizon, you're seeing real contributions for the 15.000 or 20,000 acres and relatively low levels in non-strategic sales. So that would imply that the land that you currently purchased really fits more in the rural conservation areas than in the non-strategic.
Unidentified Company Representative
Sure. Okay, thanks. First one, on every acquisition, one of the challenges with acquisitions are you don't have a lot of time. And so what we always do and we've done in this case is, we do those through the property and determine what we think is core and what we think are potential land sales. And we put those into our pro forma and into our valuation.
If we do acquire it, we will go back and more methodically go through the property and do a more methodic land classification process. We do have a really good sense of the HBU, rural land sales opportunities, but we will go back through it, if we acquire it and really methodically go through property by property, big stack to maps, and a lot of debate and then ultimately classify the property.
On the acquisitions, yes, we will quote a number, but particularly the Joshua ownership, if you recall, the scattered nature of those properties, the locations in Mississippi and Louisiana, we are pretty optimistic about future land sales potentially, rural land sales potentially.
Thank you. On slide 32 where you talked about the net present value, could you tell us back when there was more activity I guess back in ‘05, ’06, what is sort of a good guess to users, at least at that point you were able to sell residential lots more, because obviously you’re selling it undeveloped to some level of entitlement, just to give us an idea?
Lee M. Thomas
Maybe change the question a little, then I’ll try the log question. In call it the more peak of the market, we were selling unentitled 500 to 3,000 acres unentitled properties being bought for potential conversion to residential development. This is unentitled in the $4000 to $7000 an acre. So we had several sales that I recall in the $6000 to $7000 an acre and now we are quoting those numbers on that part at $3,500 an acre, so that's the compression in the market.
I hope we see it get back to the $6000, $7000, $8000 an acre range. There is a property in Canadian County that’s for sale, that's being publicly – they’re trying to sell 15,000 acre property that was acquired at $5,000 an acre and it’s not being sold at timberland. So there has been some compression. The positive thing is we continue to have on our property, we continue to have sales not multi-thousand acre sales, but smaller sales at those price points.
And I guess the second question is, I mean intuitively it seems like if you – if I went to I guess Nassau County, Florida, in fact today it was about how this wood last. But I would have imagine, I want to say even in this environment I mean 7,000 per acres for a lot, sounds fantastic.
Paul G. Boynton
It's a big difference between (inaudible) selling for.
And I know you’re not in the development gain, but the question is that where you can capture there seems to be a lot of value creation.
The quick multiplier I use to get from timberland value to a develop lot is about five. So it fits $5,000 to $7,000, so fits $5,000. And in Florida, because of 100% you don't – you may get one unit per acre or two units per acre. But its $50,000 per acre price, it will be $25,000 to $40,000 for the lot as a quick multiplier. Does that make sense?
Hans E. Vanden Noort
And to add that Chip it just obviously doesn't fit our risk profile because to get to that multiple, we’re talking about curbs and streets and gutters and things that Rayonier just doesn’t going to do. And quite honestly, this downturn the market really underscores I think our direction never – rather we didn’t do those things. So others were willing to take that kind of risk on and particularly as usually a private enterprise and this on a public and so it just doesn’t fit our reserve profile.
So where we were willing to take the risk was once through the entitlement, because if you sell unentitled, there is entitlement risk. And we saw we could get entitlements without a lot of capital because we have the expertise and we were – we have lived in that county for 80 years and if we could take the entitlement risk off the table, we could create value, but not put much capital at risk and let’s – let the developer put the capital at risk.
And when you say $4,000 to $7,000 that is excluding the same entitles that (inaudible)?
No, those are unentitled.
So if you got them entitled, how much of that multiplier can you capture to get to…?
If you look at chart, we said at least $1,500 an acre, I suspect it’s more in taking that entitlement risk off the table, particularly in Florida.
Paul G. Boynton
We got time for one more question?
Charlie, can you give us any sense of what you think you actually pay for kind of the underlying ground? And the reason I asked, how to think about that Texas example you gave us, where you said, we’ve sold this for $2,700 an acre, but we take a most of the timber on...
And so I'm wondering if you paid on enough $1,300 or $1,500 an acre, presumably most of what you paid for was the standing inventory of Timberland land, not the underlying tort. So if you already harvested cash from it, you will face this – seems to be quite a bit low.
It sounds like the margin we generated – yeah, it’s probably not as low as you think, but most of it is what – we do if it specifically identify a parcel, we might have a little higher basis in that, but you’re directionally correct. We have pretty attractive basis on our lands even recently acquired. Is that on?
Yeah, that's exactly – so I think an example you had about 45%. We almost doubled it, so basically that was just land value that was left there.
Paul G. Boynton
Thanks, Charlie. I just want to underscore as Charlie walks up, he mentioned several times about patience and that’s really key to how we look at this whole part of our business, it’s patience. And keep in mind in your modelling as we think, well there’s going to be kind of low level of development sales in the foreseeable future. We’re still actively managing all these properties for timberland. So even though we're not moving down that path on development, we could be patience and still – and it’s still on Lynn’s team to manage it and optimize the cash flow of that property. So keep that in mind in your process.
Okay. With that, we’re going to turn over to Jack Kriesel for Performance Fibers.
Jack M. Kriesel
Okay, thanks, Paul, and good morning again. What I'm going to focus on today, as Paul already stated earlier, is that we want to talk more about what the CS market is, why is Rayonier the leader in this demanding market, and then I'll give you an update on where we are out with our CSE or Cellulose Specialties Expansion project?
And I know a number of you have been here before, we’re going to try to make this as fresh as possible, give you some new information. So hopefully at the end of this what you leave with is that you look at the Performance Fibers business as having a very strong earnings potential going forward, similar to what we've been doing here in the last few years. So that's the objective.
And before we dive into those things, let me ground everyone as to what our Performance Fibers business is today. And we produce roughly about 740,000 tons of pulp, the bulk of which about 70% of that is what we call our Cellulose Specialties or our CS pulp. And then the balance about 30% is Absorbent Material pulp. This is produced at two different facilities, our Fernandina facility is a – what we call a sulphite mill that uses a low pH type cooking liquor, it is a 100% cellulose specialty mill. And then our Jesup mill here, that’s where you guys are at today, it has three production lines, two of which is our CS and one is an Absorbent Material, and then in fact Absorbent Material line, that's the one that we're converting to produce the new CSE capacity.
When you look at what our strategy has been and continues to be, really what Performance Fibers is all about is making sure that the product that we deliver is the highest purity and the support that we provide is superior in the marketplace on a consistent day-in and day-out basis. That's the overall objective in the CS market and what I’ll show you here as we go forward is more the reasons why we think we’re the leaders and believe we’re the leaders in this.
I think most of you have seen this pyramid depicting the overall market pulp industry, roughly about 54 million, 55 million tons of product. And the bulk of which is this commodity market pulp, which we don’t participate in, and that is 44 million tons. Above that we’ve got roughly 5 million tons of fluff, and as I mentioned we do participate a little bit in that on our C Mill, the third line here at Jesup.
But what we really want to focus on is these top two parts of the pyramid, kind of better known out there in the industry as dissolving pulp. The bulk of that section though is made up of commodity viscose and we link, actually commodity nitration pulps within that.
The segment that Performance Fibers focuses on is that top part of the pyramid, roughly 1.4 million tons of cellular specialty products. And that’s about 2.5% of this total pyramid. Off to the right, that's where those products are depicted. I'm not going to get into the specifics here. We’ll cover that as we go into the conversation here.
So let me explain a little bit over the next few slides here as to what makes the CS production unique from a technical and production perspective. I guess the best way to explain this is for me to first explain the supply chain that we’re talking about. Starting at the end, you’ve got these end products as shown here on the table, very highly demanding consumer-oriented products, whether it’s going into the automotive, the electronics the food and pharma type applications. Within themselves, those products are very demanding.
When you look at the supply chain to get there, you’re starting with a CS sales specialty pulp mill. Well, our purpose is to liberate that cellulose fiber. We then sell that cellulose fiber to really, chemical companies. They then convert that cellulose fiber into another intermediate product, sell it to another manufacturer who either creates the final product or even sells it to another final producer to get to the end product.
So it’s a very highly value-add supply chain as you walk through this, and because of that it’s very important that we start with a very peer product. It’s important that a CS supplier understands the customer base, knows a lot about wood chemistry, able to produce things that the customer wants. It’s a market that requires a lot of capital, not only in our process, but throughout the supply chain. If you look at the capital investment for a pulp mill, it’s quite a bit different if you’re making paper pulp or if you’re making viscose pulp or you’re making CS pulp, it gets much more expensive as you go up in that purity level.
From the street we all look the same, as a pulp mill. Everyone kind of well have another pulp mill, but it’s quite different when you start looking inside. These customers want a real consistent and secured supply, because of its value added nature, they cannot have people coming in and out of the market, they need to be able to rely on a supplier that is consistent and dedicated to the market.
And it’s a relatively small group of chemical companies that we actually sell into. If you look at the top 10 CS chemical companies that we sell to, they make up roughly about 1 million of that 1.4 million ton market. So roughly 70% of the market involves 10 CS customers, all of which, that whole supply chain as a very strong financial. In short, what we are doing is selling a chemical; we are a chemical company ourselves, to another chemical company.
So these next two slides I want to talk a little bit more about why is this so technically demanding. I think this will help describe that. What this is showing, if you picture this as a log and what I want to do is kind of walk you through how do you get down to the final output of say specialty type product. So as these logs come in, let’s say you got a 100 ton log, that’d be a real big log, but if you got a 100 tons log coming in, 50% of that is water. So immediately in the process you take out that water, you get down to a dry basis, and so now you are 50 tons left.
Of that 50 tons, these percentages as you see here, cellulose, the pure sales, the stuff that we are after makes up 43% to 45% of percent of that, it depends upon the CC that you are going after, that’s why these ranges in these percentages. Everything else from a CS standpoint is containment, and the hemicellulose, these are shorter chain fibers, 27% to 30%, the ligament is the glue that holds the fibers together gives the tree the rigidity about 20% to 28% and then extractors that small green arrow coming out 1% to 5% and it may seem like a small thing, but it’s very critical to our customers. The 1% to 5% of the extractors can make or break a chemical customer because these are the things that if a tree is rotting in water, it turns the water brown it’s the resins that turn it brown. Well, it’s that same material that can turn plastics brown or something else in that product. So it’s very important you get that out.
So what we have done is we’ve taken that 50 tons of dry fiber and the output for the Cellulose Specialties is 17 tons. So we’ve removed 33 tons of contaminant to get to our product. If you are making a viscose product, less purity, less demanding, not as much capital required in the process, it takes – you get about 20 tons out. And if you are making fluff for paper, that’s about 25 tons.
Now that doesn’t seem like a lot of difference than it is and that’s where depicted in the bottom there that exponential curve gives you an idea. The bottom part of this chart here is the purity as measured by alpha going all the way from 85 alpha all the way up to 98, which is very pure cellulose and they going up is the degree of difficulty. So it’s much more difficult to produce a CS pulp than it is to produce a viscose pulp or a fluff pulp.
Okay. This next slide, we will talk a little bit more about the chemistry from a physical standpoint that we are trying to get to. Obviously, you got this, we saw the wood, a slice of wood here, in this picture you can see very easily the growth rings. The white part of these growth rings is the fast growing spring summerwood, the dark part of those rings that’s the winter or the fall winter when the tree basically shuts down and the cells are very tight.
If you take a slice that even thinner and you put it in under a scanning electron microscope that’s what you see in this next picture. And you can more clearly see the spring and summerwood with the white cells and then all of a sudden the tree shuts down, it gets real dense and then as it goes on through the year it starts getting wider and wider.
So what we are doing if you look at that from a vertical standpoint is we are separating each one of those fibers and that’s after it right there, if we are separating a softwood fiber it has a length of about 3 millimeters. If we are separating a hardwood its roughly about 1 millimeter. And this in itself is a huge difference to our customer whether we are using a softwood or a hardwood, what kind of species we are using, it’s basically different.
After we get done with our process, the bottom left hand corner is kind of shows the slur of these fibers. So these are random fibers taken from pulp sheet that’s what it looks like. So again what we are ultimately getting down to is the cellulose polymer chain that’s what is depicted here with all the chemistry. And in the bracket, those are glucose, it’s a glucose polymer in there, and why is this important? What’s going on here is there is a whole serious of chain there. And what we control is, how long that chain is and that’s again very important to the costumer. Each customer wants a certain length of a chain depending upon whether they are making a blue light screen or whether they are making something to put in an Aspirin tablet to make sure to integrate that to right way.
So our customers, in addition to wanting a specific length of this chain, they want to make sure it’s pure, if there is any sorts of impurities in this – it add problem to their process. And what they do there is they take to cellulose chain they add chemicals, you know what these chemicals do is, they will grab on to these OH groups called hydroxyl groups and add a low chemical there and that’s what gives – gives it all the different characteristic for the customers, so each customers adding a little different chemical and again it’s very important as it grew. So that’s kind of chemistry less than no test at the end of this period.
We’ll go on. So what this chart does just kind of puts us all together and if you look at CS attribute, customer processing thing and the end user attributes, I’m not going into a lot of details here but the part in the CS attributes is the box of all the characteristic that a customer is looking for, these are the technical – the specifics what they say, we want a specific cellulose type that if you call that old chemistry chain there, we can change that a little bit by doing stuff in our process that will change the cellulose type, whether it’s an IV, the intrinsic viscosity, how long that chain may get again.
What kind of impurity levels are left under that Hemicellulose did we get it all? All of this sort of thing has an impact on our customers, the stuff in the box above versus chemical usage and yield that’s common to all these customers. So that’s why I put it in a box. Everyone, if we don’t supply exactly what they want it impacts their yield to chemical usages. But just to take out a couple of examples, if you are going on the Casing, Sausage Casings and I know those of you on phone can’t see this but this is an example of a Sausage Casings here. And if we supply a pulp that has some impurities in it, it can make the sausage casing, when the processor is jamming meat in it, we think its meat. Putting meat into this and I would say hundred feet a minute and then they’re cooking it and there is as weak spot, it explodes, that’s not a good thing. So, some of the characteristics around.
Another example here is and we talked about it a lot over the past visits about plugged spinerettes and let me show you this example, what happens. And I'm going to pass these around also. Two spinerettes, essentially what’s in the left hand picture there. And what I want you to do when you get it, look up at the light and you can see how small those holes are, you have to look real closely.
And what our customers do, they dissolve the pulp and now they are forcing that solution through these spinerettes and the middle picture shows you the holes. And this isn’t just some random designed holes, it’s very important that it’s designed as it is because they want that fiber that comes out of there to have a certain shape. And that’s very important when we put together a cigarette filter at the right drag on it. So that is consistent.
You can imagine, if there is a particle in one of these corners of that into that hole, it changes the shape of that filament then it will change the overall performance of that cigarette. And again it seems in a relative trivial from a laymen standpoint who cares but to a smoker that really makes a big difference. And then after the right, this again kind of graphically show you how smaller the holes are, the large fiber is a human hair and that small fiber is the size of that filament that comes out one of those spinerettes. So it’s very small and that’s again why we have to have such a pure product. All right, that’s a technical reasons why CS is so demanding overall.
So let’s switch gears and talk a little bit about from the market dynamics. Overall, the supply and the demand is kind of going in opposite direction. The supply for CS, excuse me, the demand for CS is roughly 3% to 4% per year. And you may take that on that 1.4 million tons it’s 45,000 tons of yield. That’s been very consistent over the years that’s what we see going forward, it is roughly about 45,000 tons of growth per year. That’s being fueled primarily by the Asian demand for filter cigarettes. It’s also being fueled by new applications, the LCD screen usages, a lot of new food and pharma type applications.
On the supply side, there’s been people who have exited these market. As I mentioned, this is a very capital-intensive market. If we do not keep up with that investment, it can become overwhelming and you just can’t continue to produce it.
So back in 2004, we had a number of people started to get out of the business. IP Natchez is a very large player, very good competitor, but this just not a fun business to be in anymore. Warehouse at Cosmopolis shut down its facility; the former Port Alice mill Neucel shutdown. It’s restarted. When it restarted originally, it was kind of focused on CS. Now the largest Chinese viscose manufacturer bought it, Fulida, so their focus now is back on to viscose.
Offsetting some of this is the Sateri mill in Brazil that started up a couple of years ago. And I’ll talk more about them here in a minute, but the technical challenge is that I just discussed, really has kept a lot of people out of this market. In the last 20-plus years Sateri has been the only one that has attempted to come into the CS market.
This graph here just kind of shows you more graphically how the closures and the most recent start-ups this year, how it’s impacted the overall supply from a supply standpoint. Again, people have left; very few people have come in.
The following slide, really just a couple of points here, it shows all of the producers in the CS market segment. Two things that kind of jump out here, one is that Rayonier is the largest supplier. Rayonier is the most focused in this business. Right now we do have some absorbent material, but soon we’ll be 100% focused in the CS market segment.
The other thing to see, that again a lot of these other players are significantly smaller. Many of them are involved in more of the commodity dissolving pulps, the viscose, the nitration, that’s kind of what’s depicted off to the right, and even some of them are heavily involved in the paper pulps. The likes of Sappi and Tembec have a lot of activity in paper pulps. So the point here again is, our focus is on the CS business much more than anyone else.
So now let’s jump into what differentiates us from the others, why we believe we have a leg up and why we’ve been the leader in this business for so many years. And it really comes down to, and I’ll cover this a little more over the next few slides, but it comes down to, one, our knowledge of the overall business, our proprietary knowledge that we’ve gained over the years working not only from our internal work, but working with our customers, the leadership position we have in the R&D, and you’ll have a chance to see a lot of this activity, and our ability to be able to produce exactly what the customer wants, the relationships we talked about working with these customers for many, many years.
So let’s take a look at the slide here. And this is kind of what we want to talk about more is, what is the secret sauce, what is the Rayonier recipe that makes us so unique? And really there isn’t a secret recipe; there are hundreds of secret recipes, and it’s specific again to every single product we make that’s unique to a specific customer.
And the best way to describe this is to walk through an example, but let me first explain one of the things that we have that others do not have. We have the ability to process both hardwood and softwood. Here at the Jesup mill, we can process both of those in the Kraft process. We have a sulfite mill in Fernandina Beach using softwood.
We have a lot of abilities to essentially mould our product again to our customers just from the start in our processing capabilities that others don’t have. So let’s take an example. Let’s say a customer comes to us and says, hey, we want to make engine filtration medium. So we know from our experience, and we know from the knowledge of their process, we got to start off with softwood. And we know that it’s not just any softwood. It has to be specific parts of a softwood tree that is going to make that engine filtration medium work.
We know that we can’t make it at Fernandina in the sulfite process, we got to make it here in Jesup using the Kraft process, so we set that up here. Then it’s a matter of setting up our bleaching sequences, the use of chlorine, the hydrogen peroxide, chlorine dioxide. At specific temperatures and pressures, we know what we need to do and modify that cellulose chain so that the customer, when they get it, it performs just like they need it to.
An important step for the filter medium process is a step called mercerization. And what take place there, again, if you'd go back and picture that cellulose chain, what takes place as we change the structure of that cellulose chain, and what they call the cellulose 1 to cellulose 2, and it kind of disoriented a little bit and what happened is, it creates a much different stiffer and a curly fiber, which then gives a much better ability to use it as a porosity type application.
Now, if we did that same thing by accident and send it to an acetate customer, it would be a disaster because if it becomes unreactive in the cellulose 2 form, you better keep it in the cellulose 1 form. Again, just trying to emphasize the importance of understanding the customers and understanding the process of what it takes to get there.
Kind of building on that same point, we’ve been doing business with these customers for many, many years. When you look at the CS customers, most of them are well over 50 years, we have one customer that’s pushing up here, 80 years of working together. And I mean, in a technical field, you get to know each other extremely well, so we know our customers, we know what they want, we know how to work with them. They have shared information back and forth with us, they can trust us, we don’t share anything else out with other customers, what they share with us is confidential.
We have the ability to essentially duplicate a lot of the processes out in our lab. So when they say, hey tweak this, tweak that, we then set it up in the lab, run a process and make sure it works. We can also do that with our own processes, we have pilot plans, and again we’ll see that in the overall tour. So we have a very good R&D facility and technical support.
When you take this equation to the next step, the end use product, all of this makes a big difference, all of the things we’ve talked about, it’s not just price of our pulp, it’s all of what we’ve brought to the table that enables us to add value to the overall equation.
Now, I just use a couple of examples here, we’ve talked a lot about, even last night, we talked about LCD applications. I mean if we take LCD, our customers came to us and said, hey, we want to be able to use wood pulp to produce a film or the LCD screen type application. So we work closely with our customers, and our customers’ customer who develop this product and now we’re the only supplier, wood pulp supplier into this LCD market.
Hence that type of activity again that we’re able to bring to the table. One more example here, if you look at Fernandina, Fernandina has a great capability of being able to supply a wide range of those viscosities that we talked about. And that’s very important in the ethers market. Again, it depends on whether you’re making an ether for a shampoo or an ether for a paint or an ether for some pharmaceutical. That wide range of viscosity makes a big difference.
Our pulp from Fernandina also creates an ether that has a very small particle size. So when you’re pouring that syrup on your pancakes, you don’t taste any particle, you can’t feel any of the particles in them because they are so small, and the Fernandina process enables that to happen.
These next few slides kind of wraps it up, comparing why is Rayonier the leader, why is CS so much different. And we use it to compare against the viscose pulp again. It’s very important that people understand that CS is different than viscose pulp. And I want to point out here that we’re not [deriding] the viscose pulp manufacturers, because it’s a good business for a number of people. It’s just not Rayonier’s business.
And we focus on CS, and we just want to make sure that you understand the separation. All of these things basically we have talked about, but it comes down to really how demanding the product is, whether it’s specifically the product, the competitive landscape, or the overall market. That’s what differentiates us between the CS and the commodity viscose market.
All of this flows to this next graph where you start looking at the pricing between the two, the blue line being the CS pricing historically from about over a five-year period, the green line being commodity viscose. It’s pretty obvious what jumps out at you, cyclicality of the commodity viscose business. The other thing that jumps out is that you see the steps on an annual basis for CS. Every year, we adjust our pricing working with our customers, and this is very important that we have annual pricing and we have long term contracts with our CS customers.
But just to highlight a point here, you can do the math, but if you look at from Q1 2009 out to Q1 2011 that’s almost a $2000 a ton swing in commodity viscose. So it’s a very volatile type market. It recently has dropped off, but we have seen a change again, where Q4 prices have started to go back up.
We have orders in China that are now up over $1,500 a ton. So the bottom line there is, are all these things rolled back in. And if you look back from a earnings performance standpoint, that’s you can see that all these efforts that Rayonier has really reflected in the strong earnings from a historical standpoint.
Okay. I'm going to shift gears now and going to the CSE, to do the Cellulose Specialties Expansion, and give you an update on that. All of what I said, the 45,000 tons a year of growth our customers are asking us to kind of belly up to the buy and really, hey you guys have got to produce this product because we need your products.
About a year or so back we undertook an exercise, say how should we expand. And we literally scrubbed every pulp mill in the world, looked at it and said, does this make sense for us to drop there and acquire this pulp mill converted and make CS pulp there. At the end, they made sense for us to convert material lines here. And that takes it from into this roughly about $300 million project, we go from 260,000 tons of raw materials products down to 190,000 tons of CS product.
Back to the yields, it’s a much lower yielding pulp, so you’re going to produce less tons over the same production line. Again, it’s very important that you understand this will be pulp. We’re not pushing this product in the middle, and I will show you a product into the market. And I will show you that here in a minute, we’re continually turning down requests from our customers for incremental demand not only from our customers, but people that we haven’t done business with. And we said, we’d love to sell you some pulp or we just do not have the product, so we said, we got to expand.
Obviously, we won’t be doing this if it wasn’t strategically attractive for us. What this enables us to do is to excess our pulp business, a non-core business. This is despite the fact that we actually pioneered and developed that pulp in conjunction with a major end user in the marketplace. So we actually did that unlike our goal we claim to (inaudible) we actually did this. But it had also enabled us again to go out and expand our market share and also diversify into a wider range of the CS market.
We won’t be doing it, if it wasn’t financially attractive. We can see the numbers there, and it’s also a strong cash generator. I’ll show you a little bit more on that here in a second.
When you undertake a project like this, a $300 million project you say, we have a lot of risk, and what we started out with is, we wanted to make sure we minimize the risk of this project. So what we did initially is that we are going to duplicate our B mill hardwood line. That is known within the industry as being the best hardwood pulp in the world. So our customers want that pulp, they like it. So we setup this expansion, this conversion to essentially duplicate that B mill hardwood line.
One other thing we have done is that, through this next 18 months, two years, we said we’re going to start up these pieces of equipment in a stagger type basis, bring them online as quickly as we can, at least get them to a point where we can test them before we put the switch, and we say we want to start producing this.
So we’ve got a number of projects really by March of 2013, 15 or the 20 major pieces of this project will be in place. The plan is for, by to be complete by mid-2013. At that point in time, we are going to start qualifying the pulp again, because our customers are familiar with this type of pulp off the B mill, we think the qualification time will be minimal, three to six months for most of the products.
If you look at it from a milestone, 2011, what we’ve doing? We’ve getting the permits, we’ve been securing our general contractor and really just starting to get the site prep going. And again you will some of this on the tour. Most of the effort is taking place in 2012. About $200 million of work we’re going to be spending in that period of time. That’s when most of these equipments going to be going in. And again, in 2013, we plan to start a facility up in May, June time frame.
This gives you an aerial view and just to kind of orient you, we are in that white building on the left hand side, that’s where we’re sitting today, you know where that big parking lot is. So it’s an aerial view of the Jesup operation. All the little annotated boxes are areas that we are putting in projects to be able to produce this CSE expansion.
And just to point out a couple of these, and again you will see this on the tour, but one of the big ones is, we’re going to be adding a lot more chip storage capacities. So in the upper right hand corner, there is a lot of activity, there that will be going on, also if you look in the heart of the mill, you can see what are all the main pieces of equipment. But this just gives you an aerial view of what we’re doing, it’s not just building one building, it’s a number of series of projects.
So again to quantify it from a growth standpoint, where is this growth coming from? What gives us the confidence that it’s going to be there? If you look at the acetate market today, roughly 680,000 tons, overall this market is going to grow 1.5% to 2%, it’s been fueled again by the cigarette usage in Asia, primarily and the growth in the LCD screens. So roughly about 75,000 ton increase by 2016.
You can see in the ethers segment, 545,000, we don’t have a very big slice of that pie right now. And that’s purposefully because what’s in that smaller pie is the highest purity part of the ethers product, there is more of that out there, and our intention is to see if it fits as we go forward this CSE expansion. That small food and pharma section is actually growing at 5% to 7%, but well over 10% growth rate, the exact section that is really growing.
And then, John on the high-strength viscose is especially high value, the biggest growth there is really the sausage casing that, I passed around that casing material. A lot of growth in that area, 4% to 5%; overall growth for sausage casing. All total, we’re looking roughly 330,000 tons of just market growth from 2010 to 2016.
So let’s get to one of the important slides here, you can build it, but you’re going to sell it? And that, I’m very pleased to share with you that as of this point in time, we have over 100,000 tons of CS commitments, that’s the high value add we’ve been talking about; customers have agreed to sign up the long-term contracts well into our startup as to 2013 and commit to incremental volume with us.
We also have gained commitments from a couple of large viscose, commodity viscose manufactures of 30,000 tons. This volume will be used when we startup the facility initially. So we’re going to be using a little bit of viscose as we qualify others, but we expect to have that phased out in a couple of years.
So total commitments today, about $130,000 or $190,000 roughly 70%. We’re currently in the process of negotiating an additional 60,000 tons with customers, and some of it’s very close to being completed, some of it we haven’t even started with various customers. So it is a, we feel very confident that this early in the game, we have this much of a commitment.
So to help you guys in your models, what we did is say, well we need to build some sort of performance here and to tell you, it’s kind of what kind of value add we might have. What this slide shows you is, that off to the left, that’s kind of what we depict is our current cost bar. That’s what we do today, with the mix of AM and CS. If we were to say for pro forma where we are converted today to 100% CS, what kind of cost would we have?
Well, the cash cost goes up about a $125 a time, driven largely by lower volume, and as we’ve discussed just the overall difference in cost of manufacturing. Let’s take this now to more of an EBITDA perspective, again on the left hand side that’s what we’re projecting for this year, if we use our current mix, $350 million of EBITDA. So let’s say we would convert it today, we use those cost figures in our sale with our current sales price that under pro forma model using today’s prices, 2011 prices, not any increase in pricing, the EBITDA jumps up to $407 million. So over a $50 million improvement using today. I mean obviously as we build our model and this project we’re expecting price increases as we go forward.
So this I think hopefully gives you an idea, the value of this business and that going forward that we believe that past earnings are going to continue in that extent. So questions?
Lee M. Thomas
Thanks Jack. We’ll open it up for questions and Dave will come around with microphone indeed.
Yeah two questions, first it looks like from the commitments you’ve gotten compared to what I think I’ve heard kind of Lee talked about a few months ago, also may be those commitments have come in a little faster and a little bit stronger than you expected, is that correct?
I think we didn’t want to get overly optimistic initially, but they’ve been strong. People have said we want to line ourselves up with Rayonier and we don’t want to hassle with the nuances of the market, we know that Rayonier delivers.
The other question I want to ask is probably a little bit tougher for you to answer, but it’s really to try to help us understand how the pricing is going to work in this business, because I think everybody was really kind of taken aback that the size of the increase you got this last year in CS was probably four times the inflation rate. So if you can just give us some sense that might help us as we try to shape a view going forward, what do we need to watch to understand sort of where pricing moves?
Jack M. Kriesel
Well, I’ll make a couple of comments and maybe Hans or Paul want to jump in here. But you could take that slope and say, maybe the slope is the right one, that’s an 8% to 9% slope and then they do a range on that, not to say that that’s what the change in price is going to be, but we believe that because of the limited entrance that there is going to be continued strong demand, so if you watch that always in this market in the long-term, that’s going to help give you guidance as to how healthy this market is.
Paul G. Boynton
I’d only add, Mark, I think when Jack works with customers and negotiates price on an annual basis, he’s really trying to project our cost and their cost increases every year, some built in like labor, some we’re trying to project commodity price increases for the inputs we have would, particularly chemicals that we use and so we’re looking at cost.
We’re also looking at the overall marketplace in terms of supply and demand. I mean, that drives an awful lot of what we think pricing is all about, but finally we’re also looking at our customers and the health of our customers’ profitability. How well are they doing, and so that’s why I call it a negotiation. We’re entering into a discussion with them about what we think the price should be taken into account our cost, taken into account supply and demand.
Now, I think last year we were able to achieve a significant price increase, the year before we had very little price increase. So I think you have to look at it overtime, it’s not just every year the same thing. We have to take those into account each year when we negotiate price.
Yeah, a quick question. Can you give us a breakdown on the typical fiber feedstock, soft versus hard, and does it vary by customer?
Paul G. Boynton
It’s a good question. It does vary quite a bit. For example, we in the cigarette feedstock, we do not only sell products from our Fernandina mill, which is sulphite softwood, but we also sell from the Jesup mill, which is hardwood. I think it depends on the customer, how their process is set up and we’re able to use more of a sulfate type process easier than a kraft or vice versa, it all depends on whether they’re making plastics or cigarette filters type thing, so it does vary.
Some processes do not lend itself to making a good acetate for cigarette filters. For example if we try to use softwood and the kraft process here to make an acetate for a cigarette filter. It’s not as good. We can do it, but our customer has given a feedback that just not as good a product as your mixed hardwoods.
Paul G. Boynton
And just to build on that a little bit, just to keep in mind to clarify some of our acetate customers taking many different grades of acetate product from Rayonier’s, not only we’re just making, we’re not making one for all customers by any means and even at any particular customer, we may make several different products just for acetate, just for them for different applications. And Jack has already did on plastics or even if it doesn’t to filter type of cigarette, there maybe different attributes needed and we can manipulate our process to manipulate the fiber in such an application.
Do you want to take more shares on the ether market, I had a couple of questions, can you just explain to me, why is it that food products, the food products are growing more than 10% annually. What is changing in the way we make food that’s making a better market. And then how are you going to supply this growth?
Jack M. Kriesel
Well, I don’t know if I can answer the first question as to what’s changed, it’s more our customers profit that we may not see all that familiar with. And they kind of have a saying in that ethers market. They say, well, if you look good on supermarket everything you pick up has a 0.5% of ethers in it.
And the aspect of using a natural resource into making these properties desirable, it continues to grow. New applications are discovered every day, new foods type thing. And of use the examples of aspirin tablets, how fast it’s dissolving your stomach versus how fast it slides down your throat. All of these things make a difference and new applications are discovered every day, I’m sorry the second question…
Jack M. Kriesel
Okay, yes. The supply question that will be – the ethers will largely be supplied out from Fernandina and the plan will be for us to as the CSE comes on line, is that we will shift some of our volume from Fernandina up to Jesup and provide more volume opportunity at Fernandina to expand that.
Having said that, there are some forms of ethers called Micro Crystalline Cellulose that has made here in Jesup and is very desirable, it’s a hardwood type application. So that market will continue to grow.
And how does the ether pricing compared to the CS pricing?
From a pulp perspective, it’s very close. It’s very little difference between the two in terms of price – our sales price.
Just a couple on – on slide 35 when you talked about the announced expansions, you had questions more of the side Sateri and Cosmopolis. And do you have any kind of guess just to how much of their addition, I guess, a total about 525,000. Do you think maybe in three or four years could be aimed at your market is it something where they may completely flop because they don’t qualify or could it be more meaningful than – could it be half of what they bring on?
Well, let me talk about the Cosmo mill first, and again this is speaking from public knowledge nothing that I have that’s I’m sharing that’s I shouldn’t be sharing. But our feeling about this the Cosmo mill is that one that is producing now totaling into the viscose margin. We’ve heard that they’re knocking on some of the acetate doors but you’ve got to remember we’re going back to this consistency of supply, it’s so important to our customers that they can’t come in and out. And the intent of the Boris Group, Cosmo, I don’t know what it is but – typically they don’t hold on things too long various institutions that they would likely sell the facility. That uncertainty really is a barrier for a number of folks to line up with them.
The Sateri mill they announced a number of years back that they were going to get into this market and what we saw from a historical standpoint that when the commodity viscose market took off, their focus was primarily in the commodity viscose market. The ability for them to produce a product that goes into the CS market, I’m sure they are finding this not as easy as what they thought.
Let me give you an example of that specifically the Cyclo Mill South Africa, I remember 25 years ago hearing they are going to be in this market in the big way. And now at this stage 25 years latter it’s still a best 50 maybe a 100,000 tons into this market. And we’ve also heard that their interest has shifted more to viscose. So it’s tough.
It’s other mills like Sateri, would that be acetate or ethers primarily?
Unidentified Company Representative
Primarily, what we’ve heard they'd be going into is acetate.
And then one more quick one, on slide 62, and this is very helpful by the way. On the pro forma numbers, the cash cost, would that assume to be flat as well? Well, obviously wouldn't be for each product, but for the CS products?
Unidentified Company Representative
It's just as if we had run 2011, that same chemical cost, the same wood cost, yes.
Okay. And I guess the last question I want to take is, the EBITDA, using those assumptions is up $52 million. I guess with the incremental depreciation, you would see the EBITDA as maybe 25 to 30.
Unidentified Company Representative
We would expect about another $15 million a year of depreciation. $300 million on average over 20 years would be a pretty good guess at this point.
Unidentified Company Representative
And Chip I think to your first question about the customers' to a large extent are speaking to the issue of who is going to in the market and who is not going to be in the market with the kind of commitments we’re getting for 2015, 2016 and beyond. I mean, to Mark’s point, I think we’ve been very pleased with the customers who have come and said, we want to go ahead and sign up for a contract with you for that volume you are going to bring on. I mean I think that is a loud statement on behalf of customers of how they do our supply in the marketplace and the dedication we have to this market.
Yeah, I had a question with respect to the loss of volume as you moved from fluff to CS. I understand that the yields are different, but if you could bring in more wood, could you just make the previous volume or are there limitations due to digesters or water permits.
Unidentified Company Representative
The answer to that question is, in this process we are adding incremental digesters. I believe it’s just 8 total digesters that we’re adding. Where the limitation comes in, and that comes in with most of the pulp mills and CS-type mills is in your evaporation, your recovery of capacity, because you have certain limits from an environmental perspective, also your recovery burners are set up to only burn at certain amount. So that’s where your major limitation is.
And to replace a recovery boiler is extremely expensive. So that's kind of, you could go up (inaudible). We could add more digesters, but we may not be able to use them because you are up against your solid contents and your liquor and know how much you can burn.
Unidentified Company Representative
Time for one more question, anybody here?
Hans E. Vanden Noort
Okay, first let's start off with just the recap and we've touched on some of this already, strategic capital allocation. And so, we’ve talked about the two main areas today, number one, Timberland acquisitions we’ve been looking for quite a while. Did a few million last year, but year-to-date, $433 million and we touched on all the criteria. I think we've been quite disciplined going through that using the criteria that Charlie went through. The second area that we’re investing for growth, in the Performance Fibers business, and it's clearly going to be the focus for us for the next year-and-a-half to go ahead and go through this.
But just a note. This idea of converting (inaudible) quite been around for 10 years here. So it's been under a lot of study, a lot of scrutiny and the [finance] just came into play here recently after we went through the worldwide kind of search that Jack mentioned to really go ahead with this. So we’ve been pretty focus and pretty disciplined on our capital over time, but we realize we need to continue to invest to grow our EBITDA.
The third area that we're really focused on, under the Return to Shareholders is the dividend, and six of the last seven years, we paid dividend increases. We recognize it's a very important part of our total value propositions. Lee mentioned the 12.5% total shareholder return. When we look back at that, just about half of that is coming via the form of a dividend. So we want to continue a prudent growth, we need that prudent growth to be able to keep increased the dividends and make that dividend growth reliable and predictable.
Changing now just a little bit to cash and balance sheet expectations here, and first of all, just want to go through and give you a little update on how we think the ending balance sheet's going to look. So with the acquisition of the Joshua and Oklahoma Timberlands, we're going to use cash on hand, we're going to be assuming a note from the seller and they will be using some revolver debt initially.
So you can see that at year end we expect our net debt to increase just under $400 million to about $775 million. Over the next two years then, as we go through the CSE completion, we expect our net debt to increase roughly $100 to $125 million. You see the bulk of that spending is in 2012, around $200 million.
Basically, when you look at the chart on the next page, it still does leave us in a quite a manageable debt situation, and certainly you'd give us the flexibility and give us room for some opportunities that may come up. So when you look at a couple of the metrics that we look at, and we have discussed with the rating agencies, on the top left where we show our debt-to-EBITDA metric. And here you can see, we’re about 1.6 times right now through the completion of the CSE project, we expect that to flux up to 1.7 to 1.9 times. If you look at on the right graph, that’s kind of the EBITDA coverage ratio, relatively higher than the last couple of years, 9.8 to 10 times. We expect that’s going to drop through the period to maybe 8 times still quite high coverage, and still quite secure.
And overall, when we then look at some of our debt maturities, we got $93 million coming due at the end of this year, which we’ll just use available cash, and then we have $300 million of converts a year from now, we look at different ways to refinance that, that’s up at the TRS.
Likely towards the end of this year after we close the Joshua acquisition, we’ll look to term out some of the debt at the REIT, and so we’ll be looking possibly going out for 10 year or we have a very strong bank group, and perhaps looking at a term loan. But we have a lot of flexibility there, one thing that’s really core to our overall strategy and our principle is, not to ever put our investment grade rating at risk.
So as we go through these projects, and we’ve gone through the forecast and look at what we think we can do, we always believe we’re going to see metrics well inside those requirements to maintain the investment grade ratings.
Just the last pull up there, liquidity wise we just increased our revolver to $450 million, just to give us an additional flexibility over the next fiver years. So we have extremely strong bank group over 20 banks in, and in fact some new banks came in as we increased debt from $300 million to $450 million.
So when you put it all together, and you put the various elements that Lynn and Jack has talked, and you can see why we’re pretty excited about the what the future holds for us. We believe by executing well on the timber aspects that Lynn mentioned, again some improvement in the markets, and executing on the Performance Fibers, conversion plan here that four to five years out we can be running at $750 million to $800 million EBITDA. And so, we’re pretty excited about the opportunities there.
Well, obviously you’ll need some help in the market on the timber side. Everybody has their own idea about when the housing market will recover. But we think we have a lot of the pieces in place to go ahead and execute on this and really continue to grow the business pretty prudently and at relatively low risk.
So with that let’s open for questions. Paul?
Thanks. Lot of great slides today. By this you’ve had asked about the REIT asset test over the next few years and then is there any sort of circumstances where it spin off of the Performance Fibers would make sense or (inaudible) something that got through your mind?
Yeah, as far as the REIT asset test as we go through our projections we’ve looked out which we believe currently we run it every quarter and we still have some headroom there. And as we’ve looked out over the next couple of years, based on our projections and how we see the market shaping up, we thought we were still in pretty good shape on the asset test there.
As far as the separation of PF, I’d say over the past, we really liked the structure we’ve had. We’ve had the strong TRS; we’ve had the ability to have the debt with TRS. We think it’s been a great advantage to us through this whole built-in gain period which runs through 2013. So at this point, we think this is core and we like – we’ve had a lot of operating flexibility to just with the strength of Performance Fibers as some of the soft timber markets have declined, we haven’t been forced to put timber out in very weak markets. We haven’t been forced to sell off our core timberland. And so for us we got really had a lot of the strengths to the overall the non PF of the side of the business as well.
Okay, great thanks.
A quick one, you mentioned pro forma benefits of the CSE of 150 or 200 and in slide 62 – 52, is that because you’re assuming better pricing?
Yes, on one slide, it was just pro forma for ’11 so exactly we’re looking out the 2014 2015 time range as we give this type of offerings or what we think of the PF business can be.
Hans E. Vanden Noort
I think just to add to that it’s not just pricing, it’s cost management as well. So we’re investing on an ongoing basis in how to do we manage and reduce cost in our operations.
That’s great. And then real quickly the new gap that the revolver is that at the TRS level, or that stay at the TRS?
Hans E. Vanden Noort
Some of this is going to be at the REIT as we execute on this stock purchase but basically both the TRS and REIT have access to the revolver.
All right, I’ll turn it over to Lee. Thank you.
Lee M. Thomas
Okay, we’ve covered a lot. I hope we’ve given you a lot of information to think about some of which is the new information. As I’ve said before if you look over the last five years, we followed a pretty consistent strategy. I think, it has resulted in good operating cash flows, good shareholder value. If you look at the next five years, you’re going to see that strategy again, focus strategy, it includes growth, but it also includes a lot of discipline around the execution. It includes acquiring timberland, which we are in the middle of doing more of today then we'd done recently. A lot of our effort will be on integrating those timberlands, getting kind of value that Lynn talked about out of those timberlands.
We’ll continue to look in the marketplace, and if we see opportunities, we will acquire additional timberland to add to our portfolio. It also is going to include the kind of CS strategy that Jack talked about, particularly bringing on this new capacity and integrating it into our overall CS business. That’s going to require a lot of focus over the course of the next several years.
It will meet a lot of the demand that our customers have been asking for, give us the ability to diversify our product mix more, give us the ability to continue to grow cash flows in the business. And at the same time we also are going to continue to analyze our land base, make sure as far as our land is concerned, where we see HBU value, we want to take advantage of that with an aggressive, good, solid, rural land sales program.
And not built into some of those numbers was any upside from a recovery of the real estate market. Basically what you saw in those EBITDA numbers was continuing that EBITDA number in the 60 to $65 million a year range that Charlie talked about, potentially out in 2015 and 2016 if the market has recovered as we hope it would, we will begin to see more monetization, particularly of some of those entitled properties. That’s not built into some of the numbers you saw.
So if you look at over the last number of years, as I've told you before, 12.5% total shareholder return on annual basis, but half of that came from dividend. 28% improvement in dividends over time. As you know, we announced a significant dividend increase last month. Dividends are a very important aspect of our strategy, very important to our shareholders and will continue to be a very important of our strategy going forward.
Well if we look at our outlook we see opportunity for accelerating our EBITDA growth from this diverse set of businesses. And I think to the question that was asked, we do see
the fact that we have had all three businesses, the fact that they complement each other, particularly in the overall structure we’ve got for the company, has given us significant operating flexibility and is a real advantage we've had.
We also had worked hard to build a broad geographic base for our business. You heard about what we are doing in terms of exports along the log market, what that means to us. You also notice, we sell across the globe as far as Performance Fibers, and this year about 50% of our sales are outside the United States. We sell into 40 countries around the world. We maintain a conservative balance sheet, going forward we will have a conservative balance sheet. Low debt levels, ample liquidity, investment grade always, those are key elements of our strategy and have been for the years, and as I’ve said, an attractive and growing dividend over time.
So what are some of the targets that we have, well if you look on the sales side for the last five years we’ve grown revenue at 4% a year, compounded annual growth rate, we’re projecting the next five years at 6% a year. If you look at EBITDA over the last five years, 6% per year compounded annual growth rate. We are projecting anywhere from 8% to 10% per year for the next five years, and you’ve seen the elements of how we feel we get there as we’ve gone through each one of these businesses.
So that concludes the review of the businesses, review of where we think we are today, and what we think future holds of. So ask me what final questions you’ve got if any before we begin our tour.
Terrific, so with that we’re going to take a 10 minute break; and I want to thank everybody for one thing several of us will be leaving you at this point, if we can go work on that EBITDA number I just put out. But we really appreciate the fact that you gained, the fact that you’ve spend a day with us, a great opportunity for us, you to get to know us better, as to get to know some of your questions and your answers. So thanks a lot, let’s take a break.
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