After the subprime mortgage crisis, it is natural for investors to be wary about Weyerhaeuser (WY). While the company has a strong brand and will continue to grow into the long term, the foreseeable future is viewed by many as, fittingly, bleak. The forest products company depends largely on the U.S. housing market and foreclosures could very well be on the rise. At the same time, would-be homeowners remain hesitant about low interest rates over an extended period of time and poor credit. In addition, log prices are trending in the lower end until at least the first quarter of 2012. Weyerhaeuser, appropriately acknowledging the challenging backdrop, is currently taking the necessary steps to build value in the long term through exposure in faster growing segments. I would recommend holding out until fears over a double dip clear.
From a multiples perspective, it can be argued that Weyerhaeuser is cheap only on a peer basis. It trades at a respective 21.4x and 37.5x past and forward earnings; competitor Universal Forest Products (UFPI) trades at a respective 85.9x and 25.5x past and forward earnings. As Weyerhaeuser is the strongest company in its field and has flexible fundamentals, it is a bit odd that its multiples are at a discount to competitors. This could be possibly due to the speculative nature of the high beta industry. Whatever it may be, Weyerhaeuser does not meet the traditional definition of an undervalued stock by the PE metric. Even still, the stock may be attractive to income investors with its 3.55% dividend yield, 209 basis points higher than UFP's. Over the last five years, almost three-quarters of shareholder value has been lost and net debt currently stands at 38.9% of market value. The Street currently rates shares of WY a "hold".
At the third-quarter earnings call, Weyerhaeuser's CEO, Dan Fulton, gave a cautious outlook on the business environment:
First, let me talk about housing. Three of our 4 businesses, Timberlands, Wood Products and Real Estate, are impacted in varying degrees by current conditions in the U.S. housing market, which I described in this morning's release as languishing. As we entered 2011, our planning assumption was that U.S. single-family housing starts would total 525,000 for the year, which would have been a modest increase over 2010 construction levels. As we sit here today in late October, we currently estimate that we'll end the year at a level of about 425,000, approximately 20% below that planning assumption.
Long-term demographics continue to be compelling, but prospective homebuyers today exhibit little sense of urgency. This is a result of a lack of consumer confidence, continued high unemployment rates, concern about potential downward price risk related to an overhang of foreclosed homes and a desire to maintain employment mobility.
It should be viewed as a positive the way management is able to analyze its business very genuinely. This results in a less volatile market and improved confidence. With that said, it is difficult to not be critical about the housing environment. Years of pushing for home ownership have artificially inflated values and now that the bubble has burst, questions over the viability of ownership linger. Weyerhaeuser owns more than 6.4M acres worth of land primarily in the South and Pacific Northwest - and the demand for housing is currently not where one may have hoped. Even emerging markets, like in China, are concerns and do not provide an ideal hedge. Canada, on the other hand, is surprisingly on the rise with 185K starts thus far in 2011. Japan too is a bright spot, as rebuilding begins following tsunamis.
In the third quarter, timberlands fell to $62M, down $50M. This loss was offset by strong growth in cellulose fibers, which serves as a bit of a catalyst over the next few quarters. Wood products additionally beat expectations, but pulps were given low guidance.
Consensus estimates for EPS are that it will decline by 45.8% to $0.26 in 2011 and then increase by 73.1% and 95.6% in the following two years. Of the 12 revisions, 5 have gone up. Assuming a 35x multiple - slightly aggressive, but below peers - and a bullish $0.50 2012 EPS estimate yields a rough intrinsic value of $17.50. That implies a 3.6% margin of safety - not an undervalued investment, in my view. Weyerhaeuser is still a strong brand and the penetration abroad will be beneficial in the long term. Consequentially, investors may consider shorting other timber companies and going long WY as a bet on the relative outperformance of the market leader. A much safer bet - and the one I recommend - would be entirely holding out in this industry until concerns over a double dip come to a close.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.