Timber Companies Present Strong Buying Opportunity

Includes: PCH, PCL, RYN, TIN, WRK, WY
by: FP Trading Desk

The decline of the U.S. housing market has been bad news for home builders and lumber mills. But for timberland companies, which simply grow the trees, the downturn has not even registered.

Plum Creek Timber Co. Inc. (NYSE:PCL), the largest publicly traded timber real estate investment trust, has seen its shares rise 21% over the past 12 months. That is a great return that looks even better when you consider that softwood lumber prices and U.S. housing starts have been in a tailspin.

In Canada, TimberWest Forest Corp. has been lumped in among income trusts but has shrugged off the concerns of most of its peers since it will not be subjected to the same tax changes within four years. Its units are up 22% over the past 12 months, after cash distributions are factored in.

The reason for these success stories? Mostly, it comes down to a combination of rising investor interest in timberlands and the trend among companies to hive off valuable parts of their land for real estate development.

The rising interest part of the argument relates to the success of pension funds and large endowment funds, mostly in the United States, that have used privately owned timberlands to reduce the volatility of their portfolios.

Timberland, which consists of tree-growing properties rather than things like pulp and paper mills, has a low correlation with the stock market, bond market and commercial real estates, meaning it tends to perform well when these other assets are under pressure. As well, timberland has a wonderful solution to commodity price fluctuations: When the price of lumber is low, timber companies can delay harvesting trees. In the meantime, the trees grow bigger and more valuable -- a delaying tactic that few other industries can use.

Investors are also catching on to the fact that the dividends paid out by some timberland companies can be taxed advantageously under U.S. law, since earnings derived from harvested trees are considered long-term capital gains.

Now, interest is rising to the point where diversified companies such as Weyerhauser Co. (NYSE:WY), Temple-Inland Inc. (NYSE:TIN) and MeadWestvaco Corp. (MWV) are under pressure to spin off their timberland assets into stand-alone companies.

Some timberland companies that are stand-alone entities already -- including Potlatch Corp. (NASDAQ:PCH) and Rayonier Inc. (NYSE:RYN), in addition to TimberWest and Plum Creek -- are beginning to sell parts of their portfolios that are worth more than the timber growing upon them. These properties, known as HBUs, or "higher-and-better-use," can be turned into parks, golf courses or even residential developments.

Moody's Investors Service, which is releasing a report on timber REITs today, says the more prudent companies reinvest the proceeds into their timberlands or pay down debt. This helps them withstand earnings fluctuations when they are watching their trees grow rather than cutting them down.

Need a final reason to get interested in timberland? They are ripe as takeover targets. Longview Fibre Co. shares rose 59% in 2006 before the U.S. company was bought by Canada's Brookfield Asset Management Inc. this year.

Said Moody's: "The generous amounts of capital now looking for a timberland home has no doubt tempted owners of unencumbered timberlands."

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