Timber: Another Way To Play The Housing Market Recovery

by: Bennington Investment Ideas

While the U.S. economy continues to recover, housing starts posted a strong November with private home starts at 685,000, well above expectations. A direct way to play the improving economy would be through home construction companies like Toll Brothers Inc. (NYSE:TOL), Lennar Corp. (NYSE:LEN), and KB Homes (NYSE:KBH). However, these stocks have rallied significantly in the last three months with TOL up about 50%, LEN up 47%, and KBH up about 16%. Another approach would be through timber companies, both stocks and REITs, as timber companies are frequently organized. Increases in home construction would increase demand for wood and wood products. This article will focus on a couple companies (all organized as REITs) as well as two broader timber ETFs, Guggenheim Timber ETF (NYSEARCA:CUT) and iShares S&P Global Timber & Forestry Index (NASDAQ:WOOD). Both ETFs have between 100 and 150 million in assets. The companies reviewed for this article are:

Timber Companies and ETFs

Ticker Name Market Capitalization ($B) Recent Price ($) TTM Dividend Yield
WY Weyerhaeuser Company 10.0 18.67 3.2%
PCL Plum Creek Timber Company, Inc. 5.9 36.56 4.6%
PCH Potlatch Corporation 1.3 31.11 4.0%
RYN Rayonier Inc. 5.4 44.63 3.6%
WOOD Guggenheim Timber ETF NA 37.19 2.4%
CUT iShares S&P Global Timber & Forestry Index NA 16.54 2.3%

Source: Data provided by Zacks.com services and Guggenheim funds

These companies offer reasonable dividends, all of which are above the current TTM yield for the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) which is at 2.1%. The ETFs provide more diversification but lower yields and also are much more thinly traded than the stocks.

Timber companies have previously offered low correlations to SPY, but with higher volatilities. However, current calculations show this diversification benefit to be more limited as noted in the following table:

Correlation and Volatility

Ticker 36 Month Correlation 36 Month Volatility Implied Beta
SPY 100.0% 5.2% 1.00
PCH 56.6% 8.2% 0.90
PCL 76.7% 6.9% 1.03
RYN 78.9% 8.0% 1.22
WOOD 88.8% 8.4% 1.44
CUT 88.1% 9.4% 1.60
WY 77.0% 11.2% 1.68
EEM 87.8% 8.0% 1.37
XLB 93.3% 7.7% 1.40

Source: data from Yahoo!Finance and author calculations. EEM is iShares MSCI Emerging Index Fund ETF and XLB is Materials Select Sector SPDR ETF which were included for comparison purposes. Implied Beta is correlation x stock volatility/ market volatility.

The above table shows that timber companies (and ETFs) do not have very low correlations to SPY with the ETFs comparable to broad emerging markets. Furthermore, they do offer slightly lower correlations than broad basic materials ETFs like XLB. However, timber companies are more volatile than the market as a whole and in many cases more volatile than emerging markets, at least as measured by EEM. PCL would probably be the best option for this; however, timber does not appear to be a great way to add income while reducing overall portfolio volatility. The incremental income comes with increased portfolio volatility. There are far better options for improving the income to volatility ratio including high yield corporate bonds and emerging market bonds. However, it is possible that timber companies correlations will decline in the future, but their volatilities have always been high relative to SPY. For example, in 2007, the four timber companies had correlations to SPY of less than 50%.

So in looking at these four timber companies, how should one compare them and decide if any are even suitable for your investment portfolio? The following table shows a build up around Enterprise Value to EBITDA:

EBITDA Valuation ($ Billions)

Ticker Market Capitalization Net Debt Enterprise Value TTM EBITDA EV/EBITDA
WY 10.0 3.5 13.6 1.00 13.6x
PCL 5.9 2.5 8.4 0.38 22.0x
PCH 1.3 0.3 1.5 0.11 13.5x
RYN 5.4 0.3 5.7 0.47 12.2x

Source: Yahoo!Finance, SEC filings

This table shows that three of the four companies have similar valuations. It also shows that RYN has the least leverage among the four and the lowest valuation. RYN also has the lowest forward P/E at 21x while WY is the highest at 42x. However, when one looks at valuation ratios it is also important to consider growth. A higher valuation ratio might be justified if there is higher anticipated growth. Looking at historical dividend growth, RYN shows increases over the last two years from $0.33 per share to a current value of $0.40. PCH just cut its dividend from $0.51 to $0.31. PCL has continued to pay a consistent $0.42 per share per quarter for the last couple years. WY may raise their dividend for the next quarter from its current $0.15 per share. This would also point to RYN for having consistent dividend growth. It should be noted that it is expected to have more modest EPS growth - lower than PCL (~12%) and WY (~42%) based Yahoo!Finance's tabulation of analyst estimates.

From this analysis, I think RYN offers the best overall opportunity. PCL appears to be attractive from an income generation perspective though. It should be noted that this is a very preliminary analysis. Additional research would be required to make any final investment decision. Two top of mind considerations would be to look at the companies on a cash flow valuation basis and then also consider their overall market position - what products do they offer, are any specialty products or is it mainly commodity products, and level of vertical integration.

Disclosure: I am long SPY.

Additional disclosure: Disclaimer: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.

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