Eric Boughton_

Plum Creek Timber Saws off Excess Supply, Grows Profits

A "$900MM liquidity base ready for the tapping", eh? Where have I heard that before? Oh, yeah, from a bunch of over-leveraged financial firms. ("We have plenty of liquidity," Mozilo said. "We're in very good shape." -9/7/07)

But, of course, since PCL is not a "financial" firm, we shouldn't worry that its $2.73 bln in long-term debt is 5.9 times its FY08 EBITDA, and 6.5 times its FY08 operating cash flow, right? Nor should we worry that PCL generates the vast majority of its "operating" earnings merely by selling land. For example, in the first quarter, PCL made $29 mln in operating profit on selling timber, LOST $13 mln in operating profit on their manufacturing businesses, and made $173 mln operating profit on selling land. That's 92% of operating profit from a completely non-recurring area! The "selling timber" profit didn't even come close to covering the quarter's $38 mln interest expense!

Given these facts, we should probably not worry about whether PCL’s profits are sustainable over the long term, right? I mean, they can continually find land which is worth a lot more than they paid for it, right? Land markets are probably grossly inefficient, and PCL execs are the smartest operators in the world, right? The fact that the majority of PCL's land was purchased in the last 5 years doesn't matter, does it?

For those thinking of PCL as a REIT, consider also that there is a major difference between the earnings reported by other REITs, and PCL. Other REITs depreciate their property (buildings), usually on 30-year schedules. Since buildings don't really depreciate that quickly (unless they are constructed poorly), and in fact can be expected to appreciate slowly as long as they are maintained, other REITs' reported EPS is arguably understated. Not so with PCL: it depreciates NONE of its land, and so its EPS is certainly not understated. This makes PCL's 29 multiple on 2010 earnings just as ridiculous as it sounds.

In a nutshell, each and every year, PCL is making less and less money (and losing money some quarters) from what I would consider its “core” businesses: a) cutting down trees and selling them to saw mills, and b) manufacturing high quality lumber products. Each year, it is desperately attempting to make up for this by selling off its best quality, highest value timberland to real estate developers. When doing so, it is cherry-picking the land it owns at the lowest cost, in order to maximize reported earnings! Eventually, there will be nothing left in this “bag of tricks": the value of PCL's forest land will be judged on its own ability to generate sustainable cash flows. Unless lumber prices once again rise to their bubble levels of early 2004 (or PCL gets lucky and finds "greater fools", like university endowment funds, to buy its land at silly prices), equity holders of PCL are likely to be unhappy with the value of their stock when that happens.