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As a recent retiree with 35 years in the timber industry, I have a strong interest in Timber REITS. I recently wrote an article explaining the history of Timber REITS and some of the factors that differentiate timber REITS from each other. This article offers an analysis of the biggest and probably best-known Timber REIT, Plum Creek Timber (PCL). Other Timber REITS include Potlatch (PCH), Rayonier (RYN), and Weyerhaeuser (WY). Pope Resources (POPE), an MLP, could also be added to this group.

I'll say right now that I'm not an accountant or financial analyst, nor do I play one on TV. However, I have been involved extensively in the managing, buying, and selling of millions of acres of timberland. My background is more in the operations end of the timber business. I understand this very well and will do my analysis from that perspective. Also, because I am a dividend growth investor, I'll be focused on the safety of Plum Creeks' dividend, which is $0.42 per quarter or about 4.1%. The data in this article comes from Plum Creeks' 2011 10K, Plum Creeks' website, the Charles Schwab website, and Google Finance.

Plum Creek owns 6.6 million acres of timberland in 19 states. The company generates income from these timberlands through the sale of logs, oil and gas leases, recreational leases, mineral extraction, real estate, and other miscellaneous uses. In addition, Plum Creek has a wholly owned taxable subsidiary that owns and operates two lumber mills, two plywood mills, two MDF mills, and two re-manufacturing mills. All of the mills are in Montana and Idaho.

The timberlands are divided into a Northern Region and a Southern Region. The Northern Region stretches from Maine to Oregon and includes the Lake States as well as the Inland West. The Southern Region encompasses all of the Southern states from Virginia through Texas. The Northern Region is actually composed of four very different geographic areas. All differ as to timber species, topography and markets. The Southern Region is more uniform as to species, topography and markets, although differences do exist. In the Southeast, Southern Pine trees can be grown from seedlings to harvest in 20 to 30 years; in the Pacific Northwest, this can be done in 35 to 45 years for Douglas-fir and Western Hemlock. In the Northeast and Lake States various hardwoods as well as pines, firs, and spruce take 45 to 70 years to mature, and in the Inland West Douglas-fir, larch, pines and spruce take 70 to 90 years. Although the two most important timber growing regions are the Southeast and the Pacific Northwest, the geographic diversity of Plum Creeks' ownership that includes all of the timber-growing regions in the country should be seen as a net positive.

Of the 6.6 million acres, Plum Creek has identified 900,000 acres as having HBU (higher and better use) values. Seven hundred thousand (700,000) of these acres are identified as having recreational value, 100,000 acres as having conservation value, and 100,000 acres as having development potential over the next 15 to 20 years. This seems reasonable as a percentage of the total acres owned. I would estimate that recreation and conservation acres should be worth 1.5 to 2 times timberland value and development land 5 to 10 times timberland value. In addition, 300,000 acres have been identified as non-strategic timberlands and will most likely be sold over the next few years. All told this represents about 18% of Plum Creeks' ownership.

In 2011, Plum Creek had a net income of $193 million, or $1.19 per share. Dividends were $272 million, or $1.68 per share. For dividend investors this may look alarming; however, timber companies have large non-cash expenses on their income statement for depletion, depreciation, and the book value of lands sold. If you look at the cash flows you see that $374 million or $2.30 per share in cash was generated when these non-cash expenses are added back in. Dividends accounted for 72% of cash flow from operations. This may still seem high until you take into account that 2011 was a year when timber harvest levels were down about 22% from 2007 levels due to low demand and low timber prices. Earnings were down 32% from 2007 and cash flow was down 28% from 2007. Real estate sales were also down. I would expect dividends to be safe as things should only improve over the next few years as the housing and real estate markets recover.

Of more concern to some is the amount of debt Plum Creek carries. At the end of 2011, Plum Creek had $2,773 million in debt. The debt-to-equity ratio is 2.2, debt to free cash flow is 1,718, and the coverage ratio is 2.4. (These numbers are from Google Finance.) That being said, Plum Creek had no trouble covering its debt obligations and paying dividends in 2011, a down year for the timber and real estate business as a whole. In fact, in addition to paying the dividend and servicing debt, Plum Creek spent $101 million on new timberland acquisitions in 2011. As the housing and real estate markets improve over the next few years, Plum Creek earnings and cash flow should improve and the company should have no trouble servicing or retiring some debt. Another source of funds to cover debt could be a large asset sale from the above-mentioned non-strategic timberlands.

Another way to look at this -- and I may lose some of you financial types here -- is that the $2,773 million in debt only represents about 36% of my estimate on the market value of Plum Creeks' timberland assets, or 31% of my estimate of the company's total assets. Using the acres by region from Plum Creeks' website, and my estimate of average timberland values by region, we get a timberland asset value of $7.7 billion. Add in another $924 million for the real estate value added and $300 million for the mills and you get a value of $8.9 billion for Plum Creeks' assets. These are my "best guess" estimates of asset value. I'm pretty comfortable with my timberland values; in fact, they may be conservative. I have somewhat less confidence in my real estate and mill values, although I do believe they are in the ballpark and only represent around 15% of the total value.

Region

Acres (000)

$/Acre

Total (billion)

Southeast

3,368

$ 1,500

$ 5,052

Pacific Northwest

492

$ 2,500

$ 1,230

Inland West

899

$ 500

$ 450

Northeast

1,110

$ 500

$ 555

Lake States

770

$ 500

$ 385

Total

6,639

$ 1,156

$ 7,672

Real Estate (net of Timberland value)

900

$ 1,027

$ 924

Mills

$ 300

TOTAL

$ 1,340

$ 8,896

My past experience says that timberland properties can safely carry debt in the 30% to 50% range of asset values. Plum Creeks' 36% seems safe by these standards. My take on this is that although the debt is high, it is also manageable.

Twenty-eight percent (28%) of the $2,773 million debt is $783 million owed to a joint venture formed by Plum Creek and the Campbell Group, a TIMO (Timberland Investment Management Organization) in 2008. This took a bit of creative financing to allow Plum Creek to get around some restrictive REIT rules pertaining to land sales. The joint venture allowed Campbell Group to place $783 million in a timberland investment and Plum Creek to sell 454,000 acres of timberland without really selling it. Plum Creek contributed the 454,000 acres to the joint venture and the Campbell Group contributed $783 million, $1,725 per acre. The joint venture then loaned Plum Creek the $783 million on a 10-year note. Plum Creek pays only interest annually with the principle dues in 10 years.

Plum Creek has a $705 million preferred interest in the joint venture as well as a 9% common interest. Here is where my lack of a financial background may fail me, but I believe the way it works is that Plum Creek receives payments from the joint venture for its share of the venture that just about covers the interest payments. Somewhere around 2015 to 2020, the joint venture will sell the property and Plum Creek's share of the proceeds will cover most or all of the $783 million note. So, the $783 note is not really debt as it will self-extinguish. That is, the net result is that Plum Creek will not need to use any current cash flow or new debt to pay off the loan to the joint venture. It looks just as if Plum Creek sold the land to Campbell Group in 2008. As Dennis Miller, a favorite comedian and commentator of mine, often says, "Of course, that's just my opinion. I could be wrong." I would appreciate any comments correcting me if this is the case.

So my bottom line is that Plum Creek Timber is a good investment for those interested in investing in timberlands and because of the 4.1% dividend, which is taxed as capital gains. As the housing and real estate markets improve, Plum Creek's cash flow should greatly improve and some debt could be paid down, dividends increased, or both. Full recovery of the housing market is still probably two to three years out.

Source: A Layman's Analysis Of Plum Creek Timber