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  • TimberWest Forest Products: Back from the Abyss?  5 comments
    Feb 17, 2010 12:06 PM
    TimberWest Forest Products (TWF_U.TO - C$5.10; TMWEF.PK - $4.88) is a small cap timber company located in British Columbia, Canada.  It is the largest owner of private timberland in western Canada with 796,000 acres, mainly in and around Vancouver and it is estimated TWF owns approximately 11% of the island of Vancouver.  Of this acreage, approx 134,000 acres are designated as higher use and, over time, should be for sale as development land.  The company estimates it could provide upwards of 25% of the real estate needed for Vancouver Island’s future economic development.  The vast majority of TWF’s harvestable timber is higher quality Douglas Fir.  

    Timber companies usually derive the majority of revenues from the logging of timber, augmented by the sale of land that is worth more for development than for growing timber. As demand for lumber and export logs severely declined in 2008 and 2009, timber harvests industry wide were delayed to match. While a unique character of timber as an asset is its ability to increase in value as it grows and delaying harvest usually improves long-term asset values, it is necessary to log sufficient volume to generate positive operating cash flow.  

    Unfortunately, this has not the case for TimberWest.  The recession has not been nice to TWF, and has created financial stress and a weaker balance sheet. Both log demand and pricing collapsed during the past 2 years.  Annual revenues for the past several years are listed below (C$ millions):

    2006
           2007       2008       2009E

    345         318         164         144
     
    2010 and 2011 revenues, cash flow, and operating profit/loss have a wide range of estimates, based on the perceived strength of a recovery in both US and Asian lumber markets.  TWF exports logs to Asia, with China surpassing Japan as the largest opportunity.  2010 revenue estimates range from C$160 million to C$240 million, with EBITA ranging from breakeven to $0.40 per share.

    TimberWest has a different share structure that provides an interesting twist for shareholders.  Investors purchase “stapled units” which consists of one long-term note and one share of common stock.  The note has a par value of C$8.96 and pre-2009 paid C$1.08 (12%) in interest annually. The market for the stapled unit historically traded in the C$10 - C$14 range. 

    In response to crushingly lower operating financials and a possible debt covenant violation, management needed to restructure its debt, relieving pressure on cash flow.  In early 2009, TWF re-negotiated the terms of the note component of the stapled units and issued C$150 million of new 5-yr 9% convertible debentures (convertible to stapled units at a conversion price of C$3.50), with much of the proceeds going to repay bank debt.    The stapled unit notes now pay a variable interest rate set by the company that can range from 2% to 12%, with the option to accrue payments up to 18 months.  Currently, the yield is set at 2% and payments are being accrued. 

    In addition, the yield on both the stapled units and the debentures can be satisfied with a payment-in-kind (PIK) by issuing more units or debentures. While dilutive to current unit holders when PIK is used (up to 3.8 million shares a yr or about 3.1% dilution), the capital generated from the issuance of the debentures and reduced interest payments on the stapled unit notes  has allowed the company to stay afloat. Recently, TWF’s banks waived their EBITA loan covenants for 2010 and 2011.  While still strapped for cash on the books, TimberWest appears to have sufficient breathing room to survive until business returns to a more normal level.

    So why should I be interested in a timber company that is on shaky financial ground during one of the worst markets for wood demand, especially when there are other timber investments available with companies that have solid financials?  The answer is fairly simple – the market price (C$ 5.10) is currently a deep discount to the underlying value of TWF assets.  The value of the timber land and developable real estate is estimated at between C$7.50 and C$10.00 per stapled unit.   In addition, the units are currently trading at a little more than half the par value of the notes.  Since stapled unit and debenture investors now control the majority of outstanding debt rather than banks, hopefully financial pressures will be a little less testy, as demonstrated by the recent covenants waivers. 
     
    If the US housing market begins to improve, and the Asian export market recovers, TimberWest should regain its financial footing, albeit with higher debt and more dilution than pre-recession.  As the economic recovery plays out over the next few years, timber harvest volumes should increase sufficiently to generate consistantly positive cash flow once again. Increasing real estate sales should add to timber cash flow, although 50% of real estate proceeds over C$50 million annually are swept for bank debt repayment.   Increased cash flow should also generate higher cash distributions, although probably not returning to previous levels.  Cash yields on today’s invested capital could be substantial at the peak of the next business cycle.

    Over the past few months, lumber prices have been rising due to slightly higher demand and lack of supply.  With lumber mill closures and log harvest cut-backs, there is little inventory in the pipeline.  While this strength is not anticipated to last, it is a very welcomed “green shoot” worth noting.

    TimberWest has a stock capitalization of C$572 million, with 77 million stapled units outstanding.  Including bank debt, debentures, and stapled unit notes, total long term debt is C$710 million.  Liquidity includes C$90 million available from their C$250 million bank credit line.   

    TimberWest is a high risk opportunity relying on a timely return to improved revenues and cash flow from stronger end-user markets.   If successful, TWF could provide both acceptable capital gains and an intriguing cash yield on invested capital.  For example, the current C$0.18 interest payment, or 2% yield on the C$8.96 stapled unit note that is being accrued, will represent a 3.5% yield on today’s invested capital when paid.   As the company returns to profitability, the variable rate interest payments should increase, with the potential to double, or more. 

    Patience will be required with this mid- to late-cycle turnaround.  My personal 24 month price target is a stapled unit price of C$8.50 ($8.00) and a yield on today’s invested capital of 3.5% to 7.0%. At the peak of the next business cycle, TWF could trade over C$10 and generate an annual cash yield on invested capital in the double digits.  TimberWest is not for the faint of heart, for the fast money trader, nor for those who are not bullish on timber and real estate in Vancouver, BC.   A great place to start your due diligence is the investor presentations section at the company website, www.timberwest.com.        



    Disclosure: Long TMWEF.PK and was a shareholder from 2004 to 2007, re-instituted position in 2009
    Themes: timber
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Comments (5)
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  • gdehuff
    , contributor
    Comments (325) | Send Message
     
    Is there anything unusual about the Vancouver housing market that would minimize the turnaround time for the local housing market?
    31 Oct 2010, 03:38 PM Reply Like
  • George Fisher
    , contributor
    Comments (1442) | Send Message
     
    Author’s reply » g,

     

    Thanks for your comment:

     

    Excerpt from The Vancouver Sun:

     

    Vancouver is one of five metropolitan areas in Canada that recorded sharp year-over-year increases in housing starts in August, according to figures released Tuesday by the Conference Board of Canada.

     

    Vancouver was fifth [out of 27],” economist Jane McIntyre, who wrote the Conference Board report, said in an interview. “And we expect more improvement in the next year in Vancouver."

     

    “Basically, when the recession hit in 2008-09, housing starts took a big hit in Vancouver,” McIntyre said. “But interest rates have remained low, there was the recovery of the economy in general, and the Olympics happened. There were a lot of things that drove the market back up. And that increased demand for housing in the region.”
    3 Nov 2010, 11:19 AM Reply Like
  • gdehuff
    , contributor
    Comments (325) | Send Message
     
    Based on your comment above (last paragraph) is it fair to say that the Vanouver, BC housing market is overbuilt to some degree?
    3 Nov 2010, 04:12 PM Reply Like
  • George Fisher
    , contributor
    Comments (1442) | Send Message
     
    Author’s reply » gd,

     

    My read is it was bad in '08-'09, but has recovered from these lows, unlike the US market.

     

    My gut feeling is the majority of timber sold is not used locally, but rather is fed to sawmills that service the entire country, the US markets and more importantly, exports. A thriving local housing market will positively impact land sales more than timber sales, imho.

     

    Hope this helps
    3 Nov 2010, 04:33 PM Reply Like
  • gdehuff
    , contributor
    Comments (325) | Send Message
     
    Yes, thank you. Based on what you've said TW is no different than any other heavy to timber company. There is time to wait for some dips to pick up these stocks at a lower point. I think this link was in the comments to one of your other posts = www.businessinsider.co...
    4 Nov 2010, 06:04 PM Reply Like
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