Time to Buy Early-Cycle Housing Play Weyerhaeuser?

Yesterday I looked at all of Weyerhaeuser’s (WY) assets except for its most valuable ones – the timberlands. The 5.7 million acres of timberlands that Weyerhaeuser directly owns constitutes the company’s most valuable asset, and changes in tax law notwithstanding, Weyerhaeuser is going to have to take some serious restructuring action if it wants to boost its stock price anytime soon. That leaves two major options: selling the timberlands to a timberland investment management organization [TIMO] or converting into a tax-advantaged REIT structure.

A sale of timberland assets to a TIMO has been seen as plausible by Deutsche Bank contacts as recently as mid-December, despite the possible transaction size. How big would such a deal have to be? Pre-tax, earnings from Weyerhaeuser’s Timberlands segment have averaged $700 million in the last two years – an amount that looks to be approximately in-line with long-term averages when one-time events are excluded. With the style of TIMOs, these earnings should essentially be treated as a perpetuity – and industry returns (the discount for this valuation) seem to be in the range of 4-5%. That suggests a pre-tax value somewhere between $14 billion and $17.5 billion for the timberland assets, however, this excludes the holdings Weyerhaeuser includes under the “corporate and related” heading – namely, the 50% interests the company has in two partnerships that operate plantations in Uruguay. While I can’t find any clear breakout of those in Weyerhaeuser’s financial reports, Note 7 of the 2006 10-K indicates $64 million in operating income from (what I believe to be) those assets. This seems like a reasonable number to progress with, and on a lower discount of 3% to reflect the higher forest growth rates and lower cost of those assets, it suggests another $2.1 billion in value for a combined pre-tax sum of $16.1 billion.

On a $4 billion tax basis and a 35% tax rate, this leaves a potential $4.25 billion tax liability – essentially meaning minimal value creation above present market values. Tax-deferred notes used to make the deal could considerably shrink the tax liability by about $1 billion net. The only remaining piece of the Weyerhaeuser puzzle in this scenario is the wood products business. Earnings are cyclical, so I’ll take this with the same approach as with real estate in yesterday’s example – a P/S multiple. The comparable company I’m using is Louisiana-Pacific (LPX), which has a ten-year average P/S multiple of 0.75. I estimate normalized sales from Wood Products to be around $7 billion, giving a value of $5.25 billion to this division.

For those of you (still) scoring along at home, $5.25 billion from Wood Products in addition to $9.8 billion from other divisions yesterday yields a total value of $15 billion, excluding tax effects, which are difficult to estimate. Adding in the pre-tax value of the timberlands business to a private buyer delineated above gives a combined value of $31 billion, or $94.75/share after deducting substantially all long-term liabilities.

But there is an alternative: for REIT pricing, there are several market comparables: Plum Creek (PCL), Potlatch (PCH), and Rayonier (RYN). Although imperfect, there are a few ways one could hypothetically value Weyerhaeuser’s timberland assets. Consider the following ratios, which show Enterprise Value/Book Value of Timberland Assets:

-Plum Creek: 2.38x
-Rayonier: 3.37x
-Potlatch: 3.571x

Taking the average (3.11x) and multiplying by Weyerhaeuser’s most recent timberland book value ($3.8 billion) implies a value of $11.8 billion – not quite the value to a private buyer, but likely fairly accurate considering the “public discount” given to extremely long-lived assets.
Similarly, a 15x EBITDA multiple to estimated normal earnings from timberlands of $764 million would produce an $11.5 billion valuation, although one could argue that with PCL at 17x trailing/18-19x forward EBITDA, Weyerhaeuser could reasonably go on the top end of that range, thus producing a roughly $15 billion value consistent with the private scenario. It seems that, excluding execution risk and potentially adverse tax consequences, which would need to be carefully managed throughout a restructuring process, a $90+/share value for WY is not a stretch. The large discount the shares currently trade at suggest a public that is wary of the slow pace of change and the high uncertainty (though not necessarily risk) that surround the company. Additionally, economic headwinds will likely depress earnings near-term, and Weyerhaeuser indicated on their most recent conference call that there was no upswing in sight.

This brings me to the original point of this analysis: discussing the various plays on housing as that moves through its cycle. Because it is a late-cycle play, I don’t like Sherwin-Williams (SHW) – although I own wallboard maker USG (USG), a mid-cycle play. Where, then, does an early cycle housing play like Weyerhaeuser fit in? I’m not very enthusiastic about the stock, although I’m adding it to my watch list and would become interested if the price came down into the $50s. Even though lumber demand will presumably see a recovery before, say, wallboard, I have more confidence in the management of USG than Weyerhaeuser when it comes to adjusting to a highly dynamic, cyclical environment. Further, Weyerhaeuser’s packaging unit is a very large operation important to the overall profitability of the firm, and as it is levered to industrial output it will likely face more than a year of slack demand. With all this in mind, I don’t see the point in chasing Weyerhaeuser – if it comes in, it comes in, and a decision can be made at that point. After all, waiting to make a decision about purchasing Weyerhaeuser stock might be poetic justice for a company that has frustrated existing shareholders with its ponderous decision-making in the past.

Disclosure: none