Weyerhaeuser Company: More Than Just REIT Structuring Priced Into Valuation?

Weyerhaeuser Company (WY) announced results on Friday, 4th May and their performance was quite disappointing. WY missed analyst estimates by a wide margin. The company reported 20c in earnings as against 31c estimate.

WY continued to feel the impact of the weak real estate market as wood products and real estate business segments substantially underperformed analyst expectations. The poor performance of these and the paper and pulp segment were slightly compensated by in the timberland and container boards division. Given this poor performance, and the weakness in the real estate market, it is probably impossible to have an optimistic outlook for the next quarter. The consensus estimate of 18 analysts for 2007 prior to the announcement of Q1 results was $2.31.

With such underperformance, I would expect estimates to be substantially lowered and my guess would be to somewhere within $2.10-2.20 range. If that be the estimate, the stock can be regarded as trading around 37x FY07 earnings. Purely on P/E multiples, this stock is definitely overvalued.

However, the stock gained over 5.7% following the earnings release and traded up an additional half a percent in post market trading. One reason could be the potential to convert into a REIT – the same reason that has been driving up the stock for several months now. Along with its earnings WY announced that it was considering strategic options for its container board and packaging division.

This is yet another indication that the company is on the same REIT path as Rayonier (RYN) and Potlatch (PCH). As REITs these companies are required to distribute 90% of their income to their shareholders and are not subject to federal income tax on the REIT income that they distribute to their shareholders. REITs are definitely the most tax efficient way to hold timberland assets. However, I am not convinced that alone is the reason. Even if we were to build in the REIT tax benefits, the valuation does not seem extraordinarily attractive.

The most recent REIT conversion story probably began with the letter that Franklin Mutual Advisers, a 7.6% shareholder in WY, wrote on 14th December 2006, requesting the company to consider steps to unlock value (the stock closed at $65 on the previous day). Franklin Mutual was looking at a possible enhancement in value of $24 a share. The following is an extract from this letter which can be found in 13D filing with SEC, where Franklin Mutual justifies the need for change in structure.

..According to a recent report from one major Wall Street analyst, by 2010 the current structure, as opposed to a REIT structure, would destroy an incremental $24 per share of shareholder value, or nearly 35% of today’s equity value…

This suggests a crude price target of $89, provided the company was performing per expectations. Citigroup has an eventual target of $100 (when the conversion to REIT is completed). None of these are exciting by themselves. A continuation of the rally from here necessarily requires something more. I suspect this extra something is the expectation of an eventual private equity buyout at a premium. In February, Brookfield Asset Management agreed to acquire Longview Fibre (a timber REIT) in a deal worth $2.15 billion valuing Longview’s 588,000 Acres at a price of over $3000 an acre. WY has over 5.7 million acres of timberland. If this were the story driving the market, the rally could continue substantially longer.

WY 1-yr chart

Disclosure: none