The wait for Plum Creek Timber's (NYSE:PCL) realization of value from its timber assets drags on. These shares bounced up for a little while after my Top Idea write-up in September 2013 ("Patient Investors Get A Crack At Plum Creek Timber"), but declined sharply on the announcement of the acquisition of MeadWestvaco's (MWV) timberland and the concomitant equity offering. Matters were helped little when the company followed that up in January of 2014 with a weak guide for 2014 EPS on lower land sales.
Plum Creek shares have long traded at premiums to Weyerhaeuser (NYSE:WY) and Rayonier (NYSE:RYN) (at least on an EBITDA basis), but investors seem to be tiring of the wait for a sustained recovery in housing construction and demand for sawlogs in the southern U.S. For what small consolation it offers, it doesn't appear that Plum Creek's issues are all company-centric, as Rayonier and Potlatch (NASDAQ:PCH) have declined by similar amounts since September and Weyerhaeuser is also in the red for that period.
I remain bullish on the long-term value of these shares, but I realize that a "be patient, it gets better" call is not the most compelling call to make, particularly with the shares trading around 19x 2014 EBITDA. A clean 2014, with higher harvest volumes and better prices, would be welcome, but patient investors can still find a lot of value in the company's substantial timberland holdings, real estate development potential, and possible biomass energy play.
Paying A Steep Price For MeadWestvaco's Acreage
The market really did not like it when Plum Creek agreed to purchase roughly 500K core acres of timberland from MeadWestvaco, as well as certain surface/subsurface royalty rights and participation in two joint ventures.
The timberland was complementary to Plum Creek's existing holdings in the southern United States, but the cost per acre looked steep at $1,735 when I've valued Plum Creek's existing acreage in the area at $1,650 per acre. I believe at least one detail is important, though - the acreage that Plum Creek acquired came with a high stocking level. While timberland acreage in the South averages around 45 tons per acre, MeadWestvaco's acreage averages above 61 tons per acre. Adjusting for that does not exactly make this deal a bargain, but it makes the price paid seem more reasonable and more likely to generate worthwhile long-term returns for Plum Creek investors.
As for the other components of the deal, Plum Creek paid $65 million for surface and subsurface royalty streams worth $6 million a year. The two joint ventures both concern "highest and best use" (or HBU) real estate opportunities. Plum Creek paid $12.5 million for a 5% stake in the JV1 venture controlling 22K acres and $140 million for a 50% stake in a second JV that involves 87K acres in the Charleston, SC area. I could have frankly done without the non-timber aspects to the deal, but I do not believe these other projects destroy value.
Could Biomass Become Meaningful?
Plum Creek does not have particularly large manufacturing assets relative to Weyerhaeuser or Rayonier and the company is not much of a player in lumber, nor any player at all in cellulose products. What Plum Creek does have, though, is a potentially growing business in supplying pulpwood to make wood pellets. Companies like Drax and Enova are adding pellet capacity, looking to take advantage of growing opportunities in markets like the U.K., where wood pellets are being regarded as a serious option for replacing coal in electricity generation.
Pellets sourced from the U.S. South are about half the cost of those from Europe and demand could help underpin pulpwood pricing for Plum Creek in the coming years. Demand has already grown from around a quarter-million tons in 2006 to 2.7 million tons in 2012, with some estimates above 8 million tons in three years' time. It certainly is not clear or proven yet that Europe will stay committed to this fuel source for the long term, nor that it will offset shrinking demand for paper, but it already seems to be helping pulpwood prices.
Aggregate Diversification A Mixed Blessing
Plum Creek has added other revenue streams to complement its exposure to housing growth in the South. In September, the company acquired a royalty interest in 255M tons of aggregate production from four Vulcan Materials (NYSE:VMC) quarries near Atlanta for $154 million. The deal could boost Plum Creek's EBITDA by $5 million to $15 million a year for 25 years, but the success of this investment will be tied to a recovery in construction activity in the Atlanta area.
I am not all that bullish on this move. The cash-on-cash return of this investment could be strong if housing recovers, and if readers don't believe in a housing recovery in the U.S. South there's not much reason to own the stock anyway. On the other hand, it is the sort of deal that makes me ask why management couldn't find better reinvestment opportunities within its current sphere of operations.
The Bottom Line
The Plum Creek story remains basically the same - as single-family housing construction rebounds in the South, so too should lumber demand and prices for Plum Creek's timber. The company will also leverage that housing recovery to develop and sell more HBU acreage into the real estate market. The bullish argument for Plum Creek rests both on the expectation of higher timber/lumber prices and also increased demand, with management looking to increase its annual harvest by 30% over the next ten years.
Adjusting my NAV calculation for the MeadWestvaco and Vulcan deals, and the dilution of the offering, my NAV moves to $50, roughly 20% above today's price. An EV/EBITDA approach does not indicate much value today (approximately $32 on a 16x multiple), but also highlights how much of the value in this story is predicated on a housing recovery pulling up demand for timber.
Plum Creek's 4% dividend yield offers some downside protection, but what the timberland space really needs is better demand. With significant harvest deferrals over the last five years, it will take a little time for that backlog to get used up and for housing demand to show up in timber values, and there is at least a possibility that the $35 level gets tested again, but patient investors still have a reason to consider these shares for their full-cycle total return potential.
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.