Shiver Me Timbers: Investing In Timber For Dividends

Includes: PCL, RYN, WY
by: Activist Stocks

With homebuilding stocks on a tear over the past twelve months, what are some other industries that could be big benefactors from the surge in housing? One industry I find intriguing is in the specialty REIT space, specifically the timer REITs. The big three timber REITs - Rayonier (NYSE:RYN), Plum Creek Timber (NYSE:PCL) and Weyerhaeuser Company (WY) - all have there respective exposure to the core timber and housing market, but the inner-workings of each company makes them solid investments in their own right. They all also pay dividend yields in excess of 2.5%.

Plum Creek Timber is one of the largest owners of private timberland in the U.S. and pays the highest dividend yield of the three at 3.3%. The company produces lumber and plywood at various wood products manufacturing facilities in the Northwest. The fact that Plum Creek is such a large operator helps the company capitalize on large economies of scale and provides operational flexibility.

Plum also has a couple of key initiatives. Back in early 2013 the REIT entered a 10-year agreement with UK-based Drax to supply up to 770,000 tons of wood fiber. The company also entered in a deal with Vulcan Materials (VMC) where it will receive royalty payments from the production and sale of crushed stone mined from the quarries for the next 25 years located on certain properties owned by Plum Creek.

One of the long-term catalysts for the company should be the unlocking of the inherent value held in its land holdings, and we expect real estate to become a rising source of earnings in coming years. The company plans to develop some 75,000 acres of land over the next 15 years. Although the price for timber is expected to be up this year thanks to rising demand from a recovering housing market, Plum Creek does not plan to increase its production this year.

Weyerhaeuser is one of the leading U.S. forest product companies with operations focused in Southern California, Nevada, Washington, Texas, Maryland and Virginia, and paying a 2.5% dividend yield. Much like the other timber REITs, Weyerhaeuser grows and harvests trees, builds homes, and manufactures forest products worldwide, primarily for use as lumber, pulp and paper, and other wood and building products.

Unlike Rayonier, which gets the majority of its revenue from its fiber segment, Weyerhaeuser's top segment is wood products, generating over 40% of revenues. Its cellulose fibers segment accounts for over 25% of revenues, timberlands around 15% and real estate 15%.

For the first quarter, Weyerhaeuser posted EPS results of $0.26, compared to $0.08 for the prior-year quarter, and blowing past consensus of $0.22. Sales are expected to be up 20% in 2013, and another 15% to 20% in 2014. Weyerhaeuser has been divesting assets to focus on its timber, wood products, real estate and fiber businesses. During 4Q 2012, the company disposed its non-strategic land in San Diego for $65 million in earnings.

Rayonier pays a 2.9% dividend yield. Rayonier's key segment is performance fibers segment, making up 70% of 2012 total sales and 80% of operating income. This segment manufactures high-performance cellulose fibers and absorbent fluff pulp. Meanwhile, its timber business accounts for 15% of revenues, which buys and manages timberland.

Upcoming revenue growth should be driven by the conversion of capacity to higher value cellulose specialties from fluff pulp. The price of cellulose specialties, used in cigarette filters and textiles, are expected to increase 2% to 3% this year.

For 1Q, Rayonier posted EPS of $0.65, versus $0.41 for the same period last year, and long-term profitability should come from a stable performance fibers segment. One of the big catalysts for the company should be value extraction from its land in the Southeast. Hedge fund manager Alex Klabin of Senator Investment Group believes Rayonier's fair value is somewhere between $60 and $75, per his comments at last year's Invest For Kids Conference. Klabin values Rayonier's Southeastern focused timber properties at around $4 billion and believes the REIT operations should trade at 9 to 11 times EBITDA.

Other notable positives for Rayonier include its ability to up its dividend payout. The company's conversion to a REIT took place over the last couple years, and the REIT currently has the lowest payout ratio of the three major timber REITs. Rayonier should, over time, match the REIT leader, Plum Creek, in its historical funds from operations payout ratio. The long-run average is around 90%, and applying that FFO payout to Rayonier's pro forma FFO yields a possible dividend yield of 4.7%.

Hedge fund trade

Going into 2013, there were only 11 hedge funds long Rayonier, which was a 21% decrease from the previous quarter. Jean-Marie Eveillard's First Eagle Investment Management had the largest position, worth $197.6 million position (check out First Eagle's high yielders).

Meanwhile, Plum Creek had 13 hedge funds long the stock. This includes, once again, First Eagle, with the largest position, a $351 million position making up 1.2% of its 13F portfolio (see how other hedge funds are trading Plum Creek).

Weyerhaeuser had the most hedge fund interest of the three timber REITs, with 28 hedge funds long the stock, a 17% increase from the third quarter. Once again First Eagle is the top hedge fund owner, with a $522 million position in Weyerhaeuser and making up 1.9% of its 13F portfolio. The second largest stake is held by Third Avenue Management, with a $162 million position (check out Third Avenues top stocks).

The market

In the end, the homebuilders are solid investments for playing the housing "re-boom." However, the timber REITs are an under-rated play on the industry that are currently being under-appreciated. Housing starts were up 7% sequentially in March, with full year 2012 housing starts up 27.5% year over year.

S&P expects full year 2013 housing starts to be up 34.6%. The other tailwinds for these REITs include higher prices and demand for wood products, increased home closings and prices, and reduced costs in specialty pulps. What's more is that they all pay a solid dividend yield.

Bottom line

So if you had to pick one timber REIT, which one would it be? Outlined below is how the dividend yields stack up and their payout ratios.

Plum Creek Rayonier Weyerhaeuser
Dividend yield 3.3% 2.5% 2.9%
Dividend payout 118% 19% 16.5%
5-year dividend growth 1% -4% 5.7%

From a valuation perspective, Rayonier trades on the cheap side of its peers.

Plum Creek Rayonier Weyerhaeuser
Forward P/E 31 21 22
Price to operating cash flow 38 18.6 15.5
PEG ratio 2.5 7.2 2.6

What's more is that Rayonier trades cheap, but it has the best returns in the industry.

Plum Creek Rayonier Weyerhaeuser
Return on equity 18.9% 11.6% 22.8%
Return on assets 5.3% 3.9% 10.8%

If there was one of the best ways to play the housing rebound it would appear to be Rayonier. The stock has a solid 2.9% dividend yield and is the cheapest of the timber REITs. It also has large exposure to the high-growth high-margin fibers industry.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.