Timber: Shake the Money Tree

The dust hasn’t yet cleared on the collapse of America’s construction industry, but the fallout is there for everyone to see. Residential construction sites have ground to a halt in the cities as cranes are drawn down and labourers laid off. In suburbia, new-builds have been abandoned as first-time buyers are cut off from credit.

And now, out in the country, it’s the turn of the timber companies. Wood has been piling up at lumber mills across America as prices plunge below the cost of production. American lumber consumption is expected to drop from 64 billion board feet in 2006 to 43 billion board feet this year. That’s equal to the total output of the top 20 US lumber producers last year.

For some US timber groups though, the sight of lumber stacked high in the mill isn’t a total disaster. Companies who own the timber forests, such as Plum Creek (NYSE:PCL) and Rayoneir (NYSE:RYN) , will fare better than the paper and saw mills who chop the timber up. Soaring input prices – from gas and chemicals to distribution costs – are eroding profit margins in the timber production industry. But if the raw timber isn’t fetching a good price, the likes of Plum Creek can always just leave it to grow on the stump – their high-quality tracts of forest will hold their value until demand picks up again.

But while America’s timber trees will probably be left to stand for the next two to three years, Chinese forests are being chainsawed as fast as they’re planted. With Beijing still preparing for the Olympic games and Chinese furniture exports thriving, China is crying out for timber. Until recently, China had far less forest (roughly 18%) covering its land than other countries. But harvesting trees has been contentious in China ever since the Yangtze burst its banks in 1998, killing more than 3,000 people and costing the economy some $24bn. 

With rapid deforestation seen as a major cause of the disaster (forest cover helps absorb rainfall, so its absence means more rain to swell waterways), Beijing imposed restrictions on harvesting timber and has thrown its weight behind creating man-made plantations. In the meantime, China has relied on imports to make up for shortage of timber. Imports to China increased tenfold from $53bn in 1990 to $561bn in 2004, with the bulk in recent years coming from Russia. But just as the Kremlin is happy to use its energy reserves to hold economies to ransom, it is squeezing its timber customers as well. Russian export taxes on timber rose to €15 per cubic meter on 1 April and are expected to balloon to €50 next year.

Still, while the taxes are creating misery for Chinese wood-buyers, says Richard Kelertas of Dundee Securities, they represent opportunity for the firms growing trees in the country. With severe winter storms knocking over a tenth of China’s forests earlier this year, log prices should rise 5%-7% a year over the next half-decade, says Kelertas. But as fans of timber, we would encourage you to look even further ahead than that. If there’s ever been an asset that’s perfect for investors to buy and hold, it’s timber. As Jeremy Grantham says, timber is the only low-risk, high-return asset in existence, returning an average of 6.5% a year over the last 100 years and rising in three out of the four market collapses of the 20th century.

The best stock to buy is below.

The best play on timber

With huge tracts of timberland spread across America, Plum Creek (NYSE:PCL) and Rayoneir (NYSE:RYN) are ideally placed to wait out the downturn in US building. As we¹ve noted before, these real estate investment trusts have performed very strongly in recent years, while paying out handsome dividends. But with forward p/es of 32 and 20.5 respectively, there are cheaper ways to buy into timber.

First among these is Sino-Forest (SNOFF.PK). With more than 312,000 hectares of timberland across ten Chinese provinces, Sino-Forest is one of the biggest forest owners in the country. Sino-Forest has been growing strongly ever since it went public, delivering average annual growth in earnings per share of 21%.

Unlike other forest owners in China, Sino's pine forests were left largely undamaged by the snowstorms at the turn of the year. Sino reported a 26% rise in profits for the first quarter. With little debt on its books, there is plenty of scope for increasing its forestry holdings. Sino-Forest is valued on a forward p/e of 16, but with a PEG ratio of 0.8, the continuing growth of earnings comes cheap. Dundee Securities analyst Richard Kelertas maintains a 12-month target price of C$31.50 ­ the stock currently trades around C$19.

Disclosure: none

Comments

[stockmarket...:]

Weyerhaueser (WY) is another large holder of timberlands. An article in Barron's estimated WY's timber assets alone were worth $59 a share. The stock has fallen since then.

online.barrons.com/art...

2008 Jun 15 04:19 PM

[User 120461:]

Well, how about the fact that timber from Russia (Siberia) is much cheaper alternative then buying timber from the US? Can u say- the price of oil and shipping makes this Chinese demand for US timber weak?

2008 Jun 15 07:02 PM

[Al Rob:]

You forgot one thing we can do with timber that may increase its value some day. We can burn it to produce heat and energy.

2008 Jun 15 10:05 PM

[OJO Zafado:]

CUT, NLR and LSO seem to make up the triumvirate of grossly under valued commodities that have significantly lagged behind the other commodity classes. The CUT seems to be the most likely to provide great returns. As far as China goes the SNOFF is a great play. The VCP in Brazil is also a worthy BRIC investment. The best of the Forest products companies are the Canadian and not the US companies named in the article. Our neighbors to the north continue to enjoy the permanent unfair trade advantage to the US. The Canadian government views the timber industry as a vital one to it's economy. They provide both direct and indirect subsidies to the industry to help it through these intermittently difficult markets. A nice little gem is ATBUF, 40% owned by BAM . Brookfield's CEO Bruce Flatt is reguarded by some as the Warren Buffet of Canada as far as I-D ing undervalued assets and scooping them up. ATBUF is in the process of converting to a REIT that will preserve the tax advantage of their dividend payouts. You vcan expect a 40% total return in it over the next 2 years as it moves to $14. While dragging along at the bottom of the barrel and with some cash flow problems to cope with the TWTUF may be a great play on NOT the China Olympics but the 2008 Winter games that will commence within 18 months of the close of the Bejing events. Operating for the most part on Vancouver Island it is involved in Real Estate development as well as timber production and milling. They have closed or sold or dumped some mills and are trying to get lean. Pays a great dividend which is actually a interest payment on the bond portion of the "stapled unit" share structure. It's proximity to major ports of Seattle and Vancouver make it ideally suited to take advantage of the growing export markets. They should benefit the most from Gov't handouts. Hey, it's not our tax money! Perhaps the most promising is CFPUF. Canfor is a very large Income trust with a very generous yield. They are a major player in the OSB market and are continuing to improve their exports. Benjamin may have been seduced by "plastics", but today that one word could be "pallets". The lowly wood shipping pallet is the foundation of world commerce. Add to that the increasing world consumption of computer and toilet paper and you have a very nice play outside of construction for timber products. The pulp industry while not doing so well here in the USA due to high energy costs continues to see increasing world demand. As another poster also noted even the wood "waste" that is left after the production of OSB can now be used in the production of "wood pellets" for home heating. So that leads to the issue of the increasing likely hood that we are going to see some increases in Americans dying from Heat Exhaustion, Hypothermia and it's consequential carbon monoxide poisionings. NLR is an obvious solution. As the price of corn heads for +$10 a bushel the slaughter of breeding stock in the hog, dairy and steer markets must increase and drive down meat prices. Until.... Got LSO?

2008 Jun 17 05:49 AM

[d_teller:]

Great notes OJO - I love securities that pay me to hold their risk.

2008 Jun 17 05:31 PM