Weyerhaeuser (NYSE:WY) is a good example of a stock where it can be challenging to nail down the fair value. Cash flow doesn't necessarily account for the underlying value of the timberland and can miss the cyclicality of the housing cycles, but sum-of-the-parts net asset valuations can require a lot of work to find reasonable inputs/comparables for timberland valuation. Be that as it may, I think Weyerhaeuser offers decent value today on the strength of its extensive timberland assets and the improvements the company has made not only toward streamlining and focusing the business, but also in improving operating margins in the manufacturing operations.
It's been a while since I've updated my coverage on this company, but I think $30 to $35 a share is a reasonable (albeit wide) range for Weyerhaeuser shares, with $35 as the "sweet spot" on the basis of my sum-of-the-parts valuation. A trade war with Canada over lumber is a looming issue, but one that shouldn't hurt Weyerhaeuser, and I like the company's leverage to increasing housing activity albeit with some caution on what would be a potential oversupply of lumber into the market in the coming years.
Can The U.S. And Canada Play Nice?
A standstill agreement subsequent to the expiration of a long-standing Softwood Lumber Agreement (or SLA) between the U.S. and Canada recently expired, and it's not really clear what's going to happen next. The U.S. Lumber Coalition is threatening to move forward with trade cases against Canadian lumber companies like West Fraser (OTCPK:WFTBF), Canfor (OTCPK:CFPZF), and Interfor (OTC:IFSPF), arguing that the Canadian government charges unfairly low stumping fees for logging on public lands and that this constitutes a roughly 15% to 20% subsidy for Canadian lumber exporters (or that was the claim about a decade ago; I don't know what the current subsidy claim would be).
Although the U.S. previously tried to impose duties against Canadian lumber, Canada claimed these were violations of trade agreements and won. The two nations subsequently agreed to the SLA, which capped Canadian exports to the U.S. at 34% of the market. In recent years, the weak U.S. housing market and stronger demand in Asia (Japan and China) had driven Canadian exports down into the 20%'s as a percentage of the market, but production has increased considerably with the U.S. housing recovery (and slumping Asian demand) and Canadian producers went back up to the cap earlier this year.
I really have no idea what happens now. It would seem that agreements like NAFTA would limit would the U.S. can do with tariffs, but neither political party in the U.S. is singing the praises of free trade these days. Were Canadian lumber to be further restricted from the market, it should be a net positive for Weyerhaeuser and its roughly 13 million acres of U.S. timberland. That said, it wouldn't necessarily be a total disaster for companies like West Fraser and Interfor, as both have increased their capacity in the U.S. (to around 40% and 66%, respectively, versus 28% for Canfor).
Will Housing Cause A Logjam To Break?
One of the frustrating parts of following Weyerhaeuser in recent years (not to mention Plum Creek, Pope Resources (NASDAQ:POPE), and Rayonier (NYSE:RYN) has been the lackluster market for sawlogs, as housing activity remained stubbornly weak.
Well, housing has certainly gotten better, with single-family starts up around 8% through August. But with that, many timberland owners that had been sitting on their holdings and waiting for higher prices are now moving forward with harvests. That has led to weaker realizations, with Weyerhaeuser's realizations in the West declining from $104 in Q1'15 to $98 recently, while realizations in the South are down slightly.
I don't think we're going to see a flood of sawlogs hitting the market, but increased supply is nevertheless a threat. That's good news for a company like Louisiana-Pacific (NYSE:LPX), that buys logs from timber producers to run its OSB, siding, and engineered wood product mills, but it's a challenge for Weyerhaeuser given that Timberlands supply around half of quarterly EBITDA. Weyerhaeuser has done a lot to improve the profitability of its timberland operations, and the profitability certainly stands out next to companies like Pope and Rayonier, but there's only so much you can do with more efficient seedling management and harvesting practices if oversupply pushes prices down.
Refocused Around High-Quality Wood Operations
Weyerhaeuser recently sold its cellulose and liquid packaging board operations (to International Paper (NYSE:IP) and Nippon Paper, respectively) and managed to do so for a pre-tax total that was right in line with sum-of-the-parts valuation for the operations (around $2.5 billion gross). With that move, Weyerhaeuser is now keenly focused on its timber and wood product operations, both of which I believe are high-quality businesses.
Weyerhaeuser isn't the largest player in lumber, OSB, plywood or engineered wood products (though it is the largest in I-joists, part of EWP), but it is one of the most profitable operators. For almost two years now, Weyerhaeuser has maintained a healthy EBITDA margin lead over Canfor, West Fraser, and Interfor in lumber, and has managed to keep pace with Norbord (NYSE:OSB) in OSB with a margin of over 23% in the last quarter (LPX is closing the gap too). Likewise in EWP, where Weyerhaeuser is significantly ahead of Boise Cascade (NYSE:BCC) and LPX.
Integrating Plum Creek's timberlands in the southern U.S. certainly won't hurt wood product margins, but they don't explain why Weyerhaeuser is already so good. For that you have to look at past efforts made to drive "operational excellence" by increasing productivity, improving production reliability, and upgrading the portfolio/product mix. Unlike a lot of players that focus on dubious economies of scale (obtained by expensive greenfield expansions), Weyerhaeuser is less interested in being the biggest and more interested in being the best operator of what it has - Weyerhaeuser is a number three or number four player by market share, but industry-leading margins leave it nothing to apologize for.
Given that capacity additions have been very restrained, particularly in OSB and EWP, the prospects are looking good for high single-digit to low double-digit price growth again in 2017, provided that housing starts continue to grow. That should support even further margin leverage, as the company's cost structure is pretty well optimized now.
I know a lot of investors like to think that you can just buy and forget timberland companies, and I suppose maybe that's true if your outlook is truly long term. I'd note, though, that there's a lot of cyclicality in the meantime as demand for wood products and sawlogs is very much driven by housing starts and that is a cyclical driver.
Between the expanded acreage post-Plum Creek and the opportunities to run these operations more efficiently, my per-share value for Weyerhaeuser's timberlands moves to about $35/share, with another $4/share or so from opportunities to sell land into the real estate market and over $5/share in value from the wood products businesses. Adjusting for asset sales, pension, net debt, and other factors, I get a sum-of-the-parts valuation of just under $35 today. A 12x multiple to my "full cycle" estimate for Weyerhaeuser's EBITDA gives me a value closer to $30, while discounted cash flow comes in around $31. I'd note that my bullish DCF scenario produces a higher target of $38, and I think that's about as high as I can go given current conditions.
The Bottom Line
With a dividend yield near 4%, a buyback program in place, a very strong commitment to operating efficiency and value maximization, it's hard for me not to like Weyerhaeuser. A lot of housing/building material stocks have enjoyed good runs already, and Weyerhaeuser isn't dirt-cheap, but it's a worthwhile stock for investors who can be patient and/or who believe the upturn in housing construction can stretch on a while longer.
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