Pope Resources: A Diamond In The Rough

| About: Pope Resources (POPE)

Before starting this article, I want to disclose that I worked for Pope Resources (NASDAQ:POPE) for the last ten years of my career until I retired at the end of December 2010. For eight of those years, I was the Director of Timberland Operations. Since then, I have not been privy to any insider information. All of the data in this article can be found on POPE's web-site and on many financial websites such a Schwab, Google or Yahoo.

POPE can trace its origins back to 1849, when two men from Maine, Andrew Pope and Frederic Talbot, moved to San Francisco with plans to enter the lumber business. In 1985, due to the hostile takeover atmosphere in the timber industry, which I mentioned in my first article, "Understanding Investments in Timber REITs", Pope and Talbot spun off their remaining land holdings and formed Pope Resources, a master limited partnership, MLP. The descendants of the original Pope and Talbot families each control 50% of the general partnership of the company, and own about 22% of the company units. Outside directors and management control another 7% of the units. That makes inside ownership almost 30% of the company. Another 20% is owned by institutions and high net worth individuals. The remaining 50% is owned by retail investors. The MLP structure is very tax efficient, that is, in most years, POPE issues a K1 that generally shows a tax loss. It is a little more work for your tax accountant, but generally worth the extra time and expense. POPE has three main businesses, Fee Timberlands, Real Estate, and the Timberland Investment Management Organization business [TIMO].

Fee Timber

POPE is as close as you can get to a pure timber play without owning timberland outright. Most timber REITs also own some manufacturing capabilities. POPE's lands are located in the Pacific Northwest [PNW] with no exposure to other timber growing regions of the country. This is not bad, however, since the PNW has some of the most valuable timberlands in the country, and access to the Asian export log market. The fee timberlands consist of about 114,000 acres in western Washington. These are some of the most productive timberland acres in the US. Major species are Douglas-fir, Western Hemlock and True Firs, Red Alder, and Red Cedar. Over the years, POPE has been quite good at playing the log markets and has an efficient land management organization. The sustainable harvest from POPE's fee timberlands is about 44 million board feet (mmbf) per year.

Real Estate

POPE's real estate segment owns about 2,800 acres west of Seattle on the Olympic Peninsula. Their most valuable real estate property is a commercial and residential development in Gig Harbor, Washington, near Tacoma. They also own residential developments near Kingston Washington, and the historic town of Port Gamble. Because of POPE's small size, and the anti-growth atmosphere in Washington state, most of POPE's real estate ventures take between five and ten years to mature. In the interim periods, POPE has to subsidize its real estate business and spends a good deal of capital on development and speculation. I think POPE would be better off doing some minimal entitlement work and then be a seller of land rather than a developer. Like I've said before, that's just my opinion, I could be wrong.

TIMO business

POPE's TIMO business is composed of two Timber Funds that own about 61,000 acres in Washington and Oregon. A third timber fund is due to close sometime in 2012 at around $150 million dollars. POPE owns a 20% interest in its first two timber funds and will own 5% of the new fund. The third fund should allow POPE to add about 60,000 more acres to its timber fund portfolio. Because of GAAP accounting rules, POPE has to consolidate its TIMO business with their other businesses even though it only owns 20% of the TIMO acres. This makes POPE's financial statements a little confusing and misleading if you're not aware of this. The TIMO business, for those not familiar with it, consists of raising capital from private investors, pension funds, and the like, and forming a fund that invests in direct ownership of timberlands. The funds usually have a life of about ten years. The land is managed during this investment period, spinning off what cash it can, and is then sold at the end of the fund's life. POPE collects an annual asset management fee from the timber funds of 0.9% of the original purchase price. In addition, POPE collects a management fee for the actual on the ground management of the properties, as well as its 20% of any income from the funds.

All in all POPE is a very well run company with quality assets and talented managers. POPE has one major flaw, their size. POPE has a market cap of about $200 million and is very narrowly traded. Their average volume is less than 5,000 units per day. Because of their real estate business and concentration in one timber market, the PNW, its revenues and earning can be quite variable from year to year. In addition, their administrative overhead for compliance is high due to its small size. POPE's main source of growth is its TIMO business. They have been creating a new timber fund about every two to three years. The only other way I see for POPE to grow would be some kind of merger or acquisition with other small private landowners but that seems unlikely. On the other hand, POPE would be an ideal acquisition candidate by either a Timber REIT or one of the larger TIMOs.

Let's examine why I think this may be a good idea. The table below places a value on the timberland assets of POPE, Plum Creek (NYSE:PCL), and Potlatch (NASDAQ:PCH). I'm using my estimated regional average timberland prices. However, through first-hand knowledge, I know POPE's lands are above average, so the values below should be considered conservative. This shows PCL's timberlands to worth about $8 billion, PCH's about 1.2 billion, and POPE's about $318 million, or $49.65, $31.16, and $72.16 per share respectively

Timberland Acres and Estimated Values

Region

(000) Acres

(000) Acres

(000) Acres

$ million

$ million

$ million

Avg. $/Acre

Plum Creek

Potlatch

Pope

Plum Creek

Potlatch

Pope

Southeast

$ 1,500

3,368

406

$5,052

$609

Pacific Northwest

$ 2,500

492

0

127

$1,230

$318

Inland West

$ 625

899

812

$562

$ 508

Northeast

$ 625

1,110

0

$694

Lake States

$ 625

770

223

$481

$139

Total

6,639

1,441

127

$8,019

$1,256

$318

Average $/Acre

$1,208

$872

$2,500

$/share

$49.65

$31.16

$72.16

Click to enlarge

Using conservative estimates for other non-timberland assets yields an additional $7.58, $16.14, and $8.64 per share for PCL, PCH, and POPE respectively.

Non-Timberland Assets

$ million

$ million

$ million

Plum Creek

Potlatch

Pope

Real Estate

$924

$150

$ 28

Timber Fund

$10

Mills

$300

$500

Total

$1,224

$650

$38

$/share

$7.58

$16.14

$8.64

Click to enlarge

If we now combine these and subtract debt, we get asset value based share prices of $39.40, $38.62, and $72.39 per share for PCL, PCH, and POPE respectively.

Asset Value Share Prices

$ million

$ million

$ million

Plum Creek

Potlatch

Pope

Asset Value

$9,243

$1,906

$356

$/share

$57.23

$47.30

$80.80

Debt

$2,880

$350

$ 37

$/share

$17.83

$8.68

$ 8.41

Asset Value less Debt

$6,363

$1,556

$ 319

$/ share

$39.40

$38.62

$ 72.39

Click to enlarge

Now let's compare the asset value based share prices to what the market has set over the past 52 weeks. PCL has been in the range of 16% undervalued to 7% overvalued. I'd say that PCL has been fairly priced. PCH has been between 3% and 27% undervalued. I'd say that at the present time, PCH is being punished for cutting its dividend. POPE has been between 25% and 48% undervalued by the market. Add to this the fact that POPE has just recently come to its 52 week high and has never spent much time over $45 per share. As I said, POPE's assets are above average for the PNW so a price above $75.00 per share would not be unreasonable. I know that stock prices are more a reflection of earnings than assets, however, when there is a large disconnect, arbitrage comes into play.

Comparisons

$ million

$ million

$ million

Plum Creek

Potlatch

Pope

Shares

161.5

40.3

4.4

52 week low

$33.02

$28.01

$38.00

Market Cap

$5,333

$1,129

$167

Over/Under Valued

-16%

-27%

-48%

52 week high

$42.10

$37.3

$54.00

Market Cap

$6,799

$1,503

$238

Over/Under Valued

7%

-3%

-25%

Click to enlarge

So, is POPE a diamond in the rough? Do I really think that a well-managed company with quality assets and talented managers should be acquired or sold? I do believe that because of POPE's small size and low trading volume, the market has never valued POPE anywhere near what their assets are really worth. You can see that the market has valued PCL and PCH more fairly. Add to this the fact that quality timberlands are in high demand by TIMOs and timber REITs. In the end, I'm not advocating for or against this idea, but I would like to start a discussion and hear your comments.

Disclosure: I am long (POPE), (PCL), (PCH).