The Wait At Plum Creek Timber Stretches On

| About: Plum Creek (PCL)
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Summary

Plum Creek guides down expectations on a reduced harvest and higher basis for land sales.

Private timberland transactions continue to indicate that Plum Creek shares are undervalued, but the Southern sawlog market appears oversupplied in the near term as demand has yet to really recover.

A long-term NAV estimate suggests fair value in the high $40s, but the "hurry up and wait" nature of the story makes it harder to remain patient.

The housing recovery thesis has fractured this year, with some housing/construction names doing relatively well and others faring pretty poorly. For the timber companies (Weyerhaeuser (NYSE:WY), Rayonier (NYSE:RYN), Potlatch (NASDAQ:PCH), and Plum Creek (NYSE:PCL)), it hasn't been a great time as sawlog prices have yet to really recover and opportunities to sell land to real estate developers are still relatively limited. While it may be true that patience on Plum Creek will pay off and that management is making a good decision by reducing harvest levels over the near term, it's not going to encourage most investors to reconsider the shares today.

Results Were Okay...

Plum Creek didn't have a terrible second quarter relative to published analyst expectations. Revenue rose 17%, with 30% growth in the Southern operations and 45% growth from Real Estate, but a 5% decline in Manufacturing and an 8% decline in Northern operations.

In the Southern business, Plum Creek shipped 27% more tonnage in sawlogs and saw a 5% yoy improvement in price. Pulpwood volume was up 28% and prices jumped 9%. In the Northern operations, sawlog volume declined 14% on a 5% price increase, while pulpwood volume increased almost 19% on a 2% price decline. To give some sense of scale, Plum Creek produced more than three times as many tons of sawlogs in the Southern operations (and almost nine times for pulpwood), but realized prices were about one-quarter of what they were in the Northern operations. All told, timber revenue was up 17% from last year, but down about 11% sequentially.

Real estate operations remain limited by soft demand for property acreage, particularly in the rural South. In the manufacturing operations, Plum Creek was able to increase lumber volume by 8% and realize a 9% improvement in realized prices, but a facility fire reduced fiberboard production (down 9%), plywood production was down double-digits and prices were up just 1% for plywood and fiberboard.

Profits do continue to improve. Adjusted EBITDA rose 35% and operating income rose 29%, lifting operating margin by about two points. The Southern operations and Real Estate both saw significant year over year increases, while Northern and Manufacturing profits were both down significantly (but are smaller contributors overall).

But The Guidance? Not So Much

Although wood prices recently showed the first signs of real momentum this year, Plum Creek management guided expectations lower. With demand for sawlogs in the South still pretty uninspiring, Plum Creek is reducing its harvest guidance. This is disappointing in the short term, but it's also supposed to be one of the positive features of this REIT as an investment - when prices are weak the company can reduce its harvest levels and its assets continue to grow, allowing the company to get a better price in the future.

In the short term, though, this delay does not help the company's cash flow profile. What's more, management guided to lower profits from the real estate operations as the company sells acreage with a higher basis. While this is a non-cash impact, it still doesn't help the optics around earnings. On a more positive note, I'd point out that Plum Creek realized good prices for HBU sales of land acquired in the Mead Westvaco (MWV) deal - $2,750/acre in transactions that occurred after the quarter end.

Still Waiting For The Recovery

The story for the publicly-traded timber companies remains what it has been for some time - a frustrating wait for housing construction activity to drive increased sawlog demand and better prices. Recent reported sales transactions continue to suggest upside to valuation for Plum Creek (as well as Rayonier and Weyerhaeuser), but Plum Creek's overweight exposure to the South (versus the Pacific Northwest) continues to weigh on valuation and sentiment. It also doesn't help matters that smaller operations in the South continue to sell volume into a weak market (likely to meet their own capital/cash flow needs).

Although lumber product prices are recovering, that is not going to help Plum Creek as much as others, as the company's manufacturing operations are relatively small. As mentioned before, Plum Creek also is seeing near-term pressure on its real estate sales from an oversupplied land development market in the South.

Value Yet To Be Realized

Plum Creek has seen some significant harvest deferrals over the past few years and sawlog prices are still about a third below what most industry watchers think will be the long-term normal. As the market improves, Plum Creek should have the opportunity to sell significantly higher amounts of timber at better prices.

I've adjusted my NAV estimate down a bit to reflect the lower near-term prospects and still believe that these shares can trade into the high $40s. That said, the shares do not look so cheap on the basis of cash flow or EBITDA today - that's not so surprising given that the company is just starting to come out of a prolonged depressed cycle, but the market can be inconsistent with respect to whether it prioritizes long-term or short-term valuation metrics.

The Bottom Line

Preaching patience on a stock like Plum Creek gets old after a while. A better than average dividend has taken some of the sting out of the company's market-lagging performance, but this continues to be a frustrating wait for better housing activity and better land prices. I do still expect the underlying market to improve for Plum Creek, but it is up to readers to answer for themselves whether they are prepared to wait it out.

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