Patient Investors Get A Crack At Plum Creek Timber

| About: Plum Creek (PCL)
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Timberland investing has become one of the more popular "open secrets" of institutional investing - numerous papers have been published comparing the long-term value and performance of investments in timberland to other asset classes, and timberland has often come out looking quite good. Not surprisingly, that has led to institutional dollars flowing into the asset class, leading to quite a bit of volatility in the price (or value) per acre of this class of real estate.

While investing in timberland itself is not very easy for the average investor, REITs like Plum Creek Timber (NYSE:PCL) offer an appealing alternative. While Plum Creek (and comparables including Weyerhaeuser (NYSE:WY), Rayonier (NYSE:RYN), Deltic (NYSE:DEL), and Potlatch (NASDAQ:PCH)) are not pure plays on timber (many of them produce wood-based products and/or sell off lands for real estate development), they're as close as most investors will find, and the popularity of timber as an asset class has generally kept these shares well-valued.

Financial writers often talk about "waiting for a pullback" before buying a stock, and Plum Creek looks like it's offering just that sort of opportunity. With U.S. housing and real estate on the mend (albeit slowly), more lumber going to China, and new opportunities for wood like fuel pellets, Plum Creek's long-term value looks solid. Even so, the shares are down sharply from the May 2013 high and flat for the year. Assigning an objective fair value to Plum Creek may be like nailing Jell-O to a tree, but I would argue that the shares are worth at least $54 today which, in combination with a nearly 4% dividend yield, makes this a stock worth consideration today.

Why The Decline?

The first question that I think is worth addressing in terms of Plum Creek is why the stock has been weak. I would think that weak lumber prices have played at least some factor in this. Despite the positive buzz about lumber demand from Home Depot (NYSE:HD), Lowe's (NYSE:LOW), and Universal Forest (NASDAQ:UFPI), lumber futures prices have plunged from the 380 to 400 level in the first quarter to below 280 in late June before bouncing back to around 320. Although trying to calculate the value of timberland acreage on the basis of current lumber prices is close to futile, I don't think it's controversial to say that these stocks are still sensitive to lumber prices.

Along similar lines, it's not as though volumes have been at blockbuster levels for Plum Creek. Northern volumes declined 17% yoy in the second quarter (and 29% sequentially), while Southern volumes were down 14% and 5%. Lower prices, lower volumes, lower stock price - it does make a certain amount of sense.

Still A Valuable Collection Of Assets

Though it's not exactly true that timber companies can always "just wait until next year" and see the value of their property increase (there is a point of diminishing returns even with tree growth), it is true that quarter to quarter and year-to-year wobbles tend to even out over time. To that end, I think it's more important to keep a long-term view on Plum Creek's assets.

Plum Creek directly controls just under 6.4 million acres of timberland in the U.S., making it one of the largest such owners in the U.S. (though Weyerhaeuser isn't too far behind). One of the challenging parts to this story is that timberland is just like any other form of real estate in the sense that location makes an enormous difference in the value of a given acre. To that end, Weyerhaeuser's highly productive acreage in the Pacific Northwest (also conveniently located to the major export markets of China and Japan) generate more EBITDA per acre and are worth more than the acreage owned by Plum Creek, Rayonier, Potlach, and Deltic.

But Plum Creek's forests aren't chopped liver. The company has close to half a million acres in the Pacific Northwest, as well as about 3.3 million acres across various states in the southern U.S. The remaining 1.4 million or so are scattered across the Northeast (Maine, Vermont, New Hampshire), the upper Midwest (Michigan and Wisconsin) and the Rockies (Montana). While a lot of the Pacific and Northern wood production ends up going towards lumber and similar products, Southern production is divided between sawlogs (which end up as lumber and related products) and pulpwood - and given that pulpwood prices can run about 50% those of sawlogs, you can see why companies with more Southern/pulpwood exposure tend to produce less EBTIDA per acre.

The wood that comes of Plum Creek's acreage is only a part of the story, though. One of the key sources of value from timberland can be found in converting it away from timberland and to its "highest best use" (NYSEARCA:HBU), which often means clearing the wood and using the land for residential or commercial real estate development. Not only does Plum Creek look to sell its timberland for its HBU value (which can be double or more the value of the land as timberland), it also looks to develop some of that land itself where it can realize even higher prices.

In addition to its timberland and real estate operations, Plum Creek has a modestly-sized manufacturing operation that produces lumber, plywood, and medium density fiberboard. These manufacturing operations are quite modest compared to those of Weyerhaeuser and Rayonier (let alone more focused manufacturers like Louisiana-Pacific (NYSE:LPX) or Boise Cascade (NYSE:BCC), and Plum Creek does not produce the cellulose/performance fibers that these other companies do.

Harvest, Improve, Sell

The Plum Creek investment thesis basically comes down to this question - do you believe that the U.S. housing and real estate markets are going to recover and grow again? If so, lumber demand is going to increase and real estate prices are going to head higher. It's not quite that simple, as demand for wood pellets as a renewable biofuel, demand for wood from China, and demand for timberland as an investment class all factor into the future performance of the shares, but that basic question about the future of the U.S. housing/real estate market is the big one.

Of the 6.4 million acres owned by Plum Creek, the company says it intends to manage about 5.2 million as timberland. I believe this land is worth an overall value of $1,545 per acre, with the Pacific acreage worth as much as $3,250/acre, the Southern acreage worth $1,650/acre, and the Northern acreage worth (on average) $750/acre. I base these numbers both on projections of future lumber prices and EBITDA generation, as well as "comparable sales" that have occurred in the relevant regions. All told, that works out to over $8 billion in value from the timberlands.

Moving along, the company has targeted 600K acres for sale as HBU. While current sales have been around $2,000 per acre, the company has been holding off on the expectation of better prices and most industry watchers believe that prices could rise into the $2,500 to $3,000/acre range. I'm going with $2,250 per acre for my model, with another 75,000 acres of developed property going at $6,000 acre for a total overall average of $2,666/acre or $1.8 billion in value. I'm also looking for additional sales and conservation sales at $1,750/acre to generate about $750 million in value.

I value Plum Creek's manufacturing operations at roughly $350 million based on a mid-cycle EBITDA multiple of 7x, and I likewise include $300 million for various joint ventures of the company. From that total I deduct the company's current net debt of over $2,600 million, as well as various pension and corporate costs. When it's all said and done, I arrive at a sum-of-the-parts valuation of $54 per share.

It's also worth mentioning that Plum Creek trades at a higher EV/EBITDA than peers like Weyerhaeuser and Rayonier. This can be attributed at least in part to the fact that manufacturing operations (which are not shielded from corporate income taxes) are a much larger part of the businesses (and business values) for these two companies. Some of it can also be tied to a long-held positive reputation for Plum Creek. Last and not least, I would remind investors that cyclical businesses often sport eye-popping multiples during the trough/early recovery phases of the cycle, as trailing earnings are depressed.

The Bottom Line

A sum-of-the-parts valuation always involves some element of guesswork, and Plum Creek bears can argue that timberland values have been inflated by institutional investor interest and could/will crash with higher interest rates. Likewise, an argument can be made that the housing/real estate recovery won't be as strong as expected. Those are valid points, though I would argue that recent transactions in the Pacific at over $4,000/acre and in the South at almost $1,600/acre to lend some support to the numbers I used.

Plum Creek isn't a rock-bottom value, but what it is is a well-run company that generally trades at a high valuation now trading at a more reasonable valuation. For investors looking to own a quality play on timberland, this looks like a relatively uncommon opportunity to do so.

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.