Specialty REITs For The Housing Recovery With Inflation Protection

Includes: CUT, PCL, RYN, WY
by: Greg Group

With positive signs that the housing market is starting to recover and the possibility of higher inflation in the coming years, income investors should take a look at REITs specializing in timber. Demand for timber is directly related to the underlying demand for pulp and paper products, lumber, panels, and other wood products. As a REIT, these companies are required to payout 90% of earnings as dividends. The increase in demand for timber will lead to increased profits and dividend payouts in the coming years. I believe the next few years will be very bullish for lumber and timber prices. With strong US and Asian demand pushing up prices, stocks such as Weyerhaeuser (NYSE:WY), Rayonier (NYSE:RYN), and Plum Creek Timber (NYSE:PCL) will be big winners. An alternative to purchasing individual stocks in this sector is buying shares of the Guggenheim Timber ETF (NYSEARCA:CUT). Here is a discussion of each timber stock.

Weyerhaeuser, one of the world's largest integrated forest products companies, is primarily engaged in growing and harvesting timber; the production, distribution and sale of wood and paper products, and real estate development. Through its timberlands segment (16% of 2011 sales), WY manages 20.5 million acres of forestland through company-owned or leased property in eight states and Canada. It owns 5.8 million acres of these lands. This division grows and harvests trees for use as lumber, other wood and building products, and pulp and paper. It also exports logs to other countries, mostly in Asia, and sells mineral and oil and gas rights on its lands. The wood products business (39%) produces and sell softwood and hardwood lumber, plywood and veneer, composite panels, oriented strand board, and engineered lumber. About 70% of these products are used in new residential construction for floor and roof joists, structural framing, sheathing, and subflooring. Other lumber products are used in furniture, cabinets, decking, and pallets.

Analysts project WY sales rising 5%-7% from continuing operations in 2012. Residential construction is expected to show a modest recovery in 2012 with a 17% increase in housing starts, although activity is expected to remain well below historical averages. This should lead to somewhat higher prices for lumber and panels on average in 2012. Moreover, log sales to Asia are likely to rise due to increased construction activity in that region. The dividend discount metric assumes a $0.60 payout in 2012, a required rate of return of 7.0%, and constant dividend growth of 4%, and values the shares at $20. WY is up 19% year to date which is highest among the Timber REITs in 2012. WY has a dividend yield of 2.74%.

Plum Creek Timber Co., a real estate investment trust (REIT), is the largest private timberland owner in the United States, with 6.6 million acres of timberlands in 19 states. In addition, the trust operates several wood products manufacturing facilities and is actively involved in land purchases and sales. The company conducts operations through four business segments: the timber operation accounted for 49% of 2011 revenues, real estate (26%), manufacturing (23%), and other (2%). The Northern Resources portion of the timber segment encompasses 3.2 million acres of timberlands, in Maine, Michigan, Montana, New Hampshire, Oregon, Vermont, Washington, West Virginia and Wisconsin. The Southern Resources portion of the timber segment consists of 3.4 million acres of timberlands in Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, North Carolina, Oklahoma, South Carolina and Texas.

Analysts expect sales to increase 5%-7% in 2012, following a nearly 2% decline in 2011. With the increase in housing starts in 2012, PCL will benefit from modestly higher demand and prices for sawlogs. Timber harvest levels should also get a boost from an acquisition, and pulpwood prices are expected to remain relatively high. PCL has significant value in its land holdings, and we expect real estate to become a rising source of earnings in coming years. It plans to develop 100,000 acres of land over the next 15 years, and we estimate that these properties can be sold at high margin levels. The dividend discount model, which assumes a $1.68 payout in 2012, a required rate of return of 8.0%, and constant dividend growth of 4.0%, indicates that PCL has an intrinsic value of $42. PCL is up 14.5% year to date compared to 13% for the SPY. PCL has a dividend yield of 4.05% which pays $0.42 per quarter.

Rayonier Inc. is a real estate investment trust that produces and markets timber, specialty fibers and wood products. It owns, leases or manages 2.5 million acres of timberland in the U.S., New Zealand and Australia. Rayonier is pursuing various strategies aimed at providing relatively consistent and moderately growing earnings and cash flow streams. A primary focus is to increase the size and quality of its timberland holdings through cash-accretive timberlands acquisitions while selling timberland that no longer meets the company's strategic or financial return requirements.

Analysts project sales increasing 8%-10% in 2012, following growth of 13% in 2011. Prices for cellulose specialties (used in cigarette filters, textiles, and plastics) are expected to increase significantly, due to strong demand for these products. Western timber harvests are forecasted to increase on strong demand for lumber in China. Rayonier's financial performance has been moderately better than its timber producing peers over the past five years, in our opinion. Its revenues have been very stable overall in that time frame, with sales rising at a compound annual growth rate of 5.0% from 2007 through 2011. While its earnings have shown a moderate level of variability over the period, it has been consistently profitable. RYN's average net operating profit after-tax (NOPAT) margin of 14.4% over the past ten years was modestly above the 13.3% average for its peer group. Moreover, in terms of asset utilization, Rayonier has outperformed the timber group with an average return on invested capital (ROIC) of 10.8% over the past ten years, compared to 7.8% for its peers. The dividend discount model, which assumes a payout in 2012 of $1.60, a required rate of return of 9.0%, and constant dividend growth of 5.5%, indicates that the stock has an intrinsic value of $46. RYN has been flat year to date with no return in 2012. RY has a current dividend yield of 3.60% as its dividend was increased 11% in mid-2011.

Guggenheim Timber ETF seeks to track the price performance of the underlying holdings in the Clear Global Timber Index. The fund will invest at least 90% of its total assets in common stock, American depositary receipts (ADRs) and global depositary receipts (GDRs) that comprise the index and depositary receipts representing common stocks included in the index. CUT is trading at $19 with a distribution yield of 2.05%. CUT has a year to date market return of 12.5%. Based on assessments for cost factors such as expense ratio and Price to NAV lead to an Underweight ranking. CUT's Top Ten holdings were 48.3% of total assets. CUT has total assets of $126.6 million. The Total Market Capitalization of CUT's holdings is $127.3 million.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.