Comparing America's 3 Largest Lumber Production Companies

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Includes: PCL, RYN, WY
by: Joseph Cafariello

Summary

The Lumber & Wood Production industry is expected to outperform the S&P broader market significantly this Q3 and Q4, and moderately in 2015 and beyond.

Mean/high targets for the 3 largest U.S. Lumber & Wood Production companies – Weyerhaeuser, Plum Creek Timber and Rayonier - range from 8% to 26% above current prices.

Find out which among Weyerhaeuser, Plum Creek and Rayonier offers the best stock performance and investment value.

* All data are as of the close of Thursday, October 16, 2014.

The Lumber & Wood Production industry may not be the sexiest of markets to invest in, but it is an important one nonetheless given its intimate ties with the housing market.

Ever since the U.S. housing market imploded from 2006-08, the U.S. Federal Reserve has embarked on a plan to reinflate residential property values. How? By slashing interest rates to near zero, the lowest they have been in history. The intent was to stimulate home buying by making it cheaper to get mortgages. And it worked, as noted in the graph below plotting the sales of existing homes.

In it, we can clearly see the inflating of the housing bubble to its peak of more than 7 million home sales annually by late 2005, followed by the bubble's burst down to less than 4 million annual home sales by 2009. But thanks to ultra-low mortgage rates made possible by the Federal Reserve's slashing of the inter-bank borrowing rate, existing home sales picked-up dramatically, reaching 5.5 million units annually by late 2009.

Source: TradingEconomics.com

But existing home sales were not the only segment of the housing market to benefit from the Fed's ultra-low interest rate policy. Once the glut of existing homes (especially those foreclosed upon) was all bought up, interest rates remained at their historical lows, spurring demand for new home construction, as noted in the graph below of housing starts.

After also experiencing a bubble by 2006 and implosion by 2009, new home construction picked up on the power of low interest rates, doubling in volume from 500,000 annual starts in 2009 to near 1 million annual starts by early 2013. Since then, however, new housing starts have plateaued, holding steady near the 1 million per year level.

Source: TradingEconomics.com

This is precisely the same pattern we see in the Lumber & Wood Production industry as noted in the graph below: a strong upward surge from the start of the recovery in early 2009 until early 2013, and a flattening since then. By 2013, anyone who could be enticed by low interest rates had pounced on them by then, leaving just the normal stream of home buying since.

Where the broader S&P 500 index [black] has grown some 177% and the iShares S&P Global Timber & Forestry Index ETF (NASDAQ: WOOD) [blue] has gained 162% since the economic recovery began in early March of 2009, America's three largest Lumber & Wood Production companies - Weyerhaeuser Co. (NYSE: WY) [beige], Plum Creek Timber Co. Inc. (NYSE: PCL) [purple] and Rayonier Inc. (NYSE: RYN) [orange] - have put in a split performance. Where WY has outperformed both the S&P 500 and WOOD with gains of 350%, PCL has underperformed with gains of 65%, while RYN runs par for the course with gains of 180%.

On an annualized basis, where the broader S&P 500 market has averaged 31.70% per year and the timber & forestry index fund, WOOD (of which our three lumber stocks are the largest components), has averaged 29.01% since March of '09, Plum Creek has averaged a mere 11.64%, Rayonier has averaged a comparable 32.24%, while Weyerhaeuser has averaged an outstanding 62.69% per year!

Source: BigCharts.com

Although interest rates will eventually begin rising, as they return to their historical norm near 5 or 6%, the increase should be very gradual over the course of at least 5 years or even longer, as the Federal Reserve does not want to risk a relapse into recession by moving too quickly. Thus, the housing recovery is expected to continue for years to come, albeit at a more moderate and sustainable rate.

As such, the Lumber & Wood Production industry is expected to outperform both its Industrial Goods sector and the S&P broader market as tabled below, where green indicates outperformance while yellow denotes underperformance.

While that growth is expected to remain robust in Q3 and Q4 of this year as interest rates remain ultra-low, such growth will slow down somewhat in 2015 and beyond as interest rates rise. Even so, the industry is still expected to continue outperforming the broader market handily.

Within the Lumber & Wood Production industry, our three highlighted stocks of Weyerhaeuser, Plum Creek and Rayonier seem to have one good year left to beat their industry peers in 2015, after which they are expected to lag behind likely due to their large size; large and medium caps tend to grow much more slowly than their small cap competitors.

Compared to the broader S&P 500 index, our three highlighted stocks' earnings growth will fare a little better than average, again with outperformance in 2015 followed by underperformance beyond.

Even so, many investors prefer the stability of large and medium caps like our three amigos here. Though they may not shoot upward like the small caps, they do not tumble so deeply during periods of volatility, which are expected to increase in frequency as interest rates return to normal levels over the next several years.

Hence, all three of our Lumber & Wood Production giants will continue to hold a place in many portfolios as solid mature companies offering stability, moderate growth, and attractive dividend yields ranging from 3.60% to 4.40%, ranking them among the best on the market. But how do the three compare against one another, and which makes the best investment?

Let's answer that by comparing their company fundamentals using the following format: a) financial comparisons, b) estimates and analyst recommendations, and c) rankings with accompanying data table. As we compare each metric, the best performing company will be shaded green, while the worst performing will be shaded yellow, which will later be tallied for the final ranking.

A) Financial Comparisons

• Market Capitalization: While company size does not necessarily imply an advantage and is thus not ranked, it is important as a denominator against which other financial data will be compared for ranking.

• Growth: Since revenues and expenses can vary greatly from one season to another, growth is measured on a year-over-year quarterly basis, where Q1 of this year is compared to Q1 of the previous year, for example.

In the most recent reported quarter, Plum Creek provided the greatest revenue growth of the three, while Weyerhaeuser provided the greatest earnings growth by far. Rayonier, however, suffered an earnings shrinkage, and by a significant amount.

• Profitability: A company's margins are important in determining how much profit the company generates from its sales. Operating margin indicates the percentage earned after operating costs, such as labor, materials, and overhead. Profit margin indicates the profit left over after operating costs plus all other costs, including debt, interest, taxes and depreciation.

Of our three contestants, Plum Creek and Rayonier operated with the widest margins, while Weyerhaeuser ran with the narrowest.

• Management Effectiveness: Shareholders are keenly interested in management's ability to do more with what has been given to it. Management's effectiveness is measured by the returns generated from the assets under its control, and from the equity invested into the company by shareholders.

In returns on assets and on equity, Rayonier's management team performed best, while the other two teams split the last spots between them.

• Earnings Per Share: Of all the metrics measuring a company's income, earnings per share is probably the most meaningful to shareholders, as this represents the value that the company is adding to each share outstanding. Since the number of shares outstanding varies from company to company, I prefer to convert EPS into a percentage of the current stock price to better determine where an investment could gain the most value.

Of the three companies compared here, Rayonier provides common stock holders with the greatest diluted earnings per share gain as a percentage of its current share price, while Plum Creek provides the least - although all were fairly close.

• Share Price Value: Even if a company outperforms its peers on all the above metrics, investors may still shy away from its stock if its price is already trading too high. This is where the stock price relative to forward earnings and company book value comes under scrutiny, as well as the stock price relative to earnings relative to earnings growth, known as the PEG ratio. Lower ratios indicate the stock price is currently trading at a cheaper price than its peers, and might thus be a bargain.

Among our three combatants, Weyerhaeuser has the cheapest stock price relative to forward earnings, while Rayonier has the cheapest relative to company book value and 5-year PEG. Each company's stock ranks most overvalued in one of the three metrics.

B) Estimates and Analyst Recommendations

Of course, no matter how skilled we perceive ourselves to be at gauging a stock's prospects as an investment, we'd be wise to at least consider what professional analysts and the companies themselves are projecting - including estimated future earnings per share and the growth rate of those earnings, stock price targets, and buy/sell recommendations.

• Earnings Estimates: To properly compare estimated future earnings per share across multiple companies, we would need to convert them into a percentage of their stocks' current prices.

Of our three specimens, Weyerhaeuser offers the best earnings percentages in all four time periods, while Rayonier offers the worst EPS percentage over current stock price.

• Earnings Growth: For long-term investors, this metric is one of the most important to consider, as it denotes the percentage by which earnings are expected to grow or shrink as compared to earnings from corresponding periods a year prior.

For earnings growth, Weyerhaeuser seems poised to outgrow the rest this year, while Plum Creek is seen growing the fastest over the next five years. Rayonier's earnings are expected to shrink this year and over the next five on average.

• Price Targets: Like earnings estimates above, a company's stock price targets must also be converted into a percentage of its current price to properly compare multiple companies.

For their stocks' price targets over the coming 12 months, Weyerhaeuser has the greatest upside price potential, while all three have fairly close mean price targets. Yet Weyerhaeuser is also believed to have the greatest downside risk, likely due to its stellar outperformance in recent years. Rayonier is expected to have the least downside risk, likely due to its already floundering stock performance as of late.

• Buy/Sell Recommendations: After all is said and done, perhaps the one gauge that sums it all up are analyst recommendations. These have been converted into the percentage of analysts recommending each level. However, I factor only the strong buy and buy recommendations into the ranking. Hold, underperform and sell recommendations are not ranked since they are determined after determining the winners of the strong buy and buy categories, and would only be negating those winners of their duly earned titles.

Of our three contenders, Weyerhaeuser is best recommended with 6 strong buy and 3 buy recommendations, representing 40% and 20% of its analysts, followed by Plum Creek with 3 strong buy and 2 buy ratings. Rayonier comes least recommended with no strong buy and no buy recommendations, just 7 holds.

C) Rankings

Having crunched all the numbers and compared all the projections, the time has come to tally up the wins and losses and rank our three competitors against one another.

In the table below, you will find all of the data considered above plus a few others not reviewed. Here is where using a company's market cap as a denominator comes into play, as much of the data in the table has been converted into a percentage of market cap for a fair comparison.

The first and last placed companies are shaded. We then add together each company's finishes to determine its overall ranking, with first place finishes counting as merits while last place finishes counting as demerits.

And the winner is… Weyerhaeuser by a sizable lead, outperforming in 14 metrics while underperforming in 9 for a net score of +5. Rayonier places second, outperforming in 13 metrics and underperforming in 14 for a net score of -1. Crossing the finish line last is Plum Creek, outperforming in 4 metrics and underperforming in 8 for a net score of -4.

While the Lumber & Wood Production industry seems rather blasé, it is expected to outperform the broader S&P 500 market significantly this Q3 and Q4, and moderately in 2015 and beyond, as the Federal Reserve's low interest rate policy continues to fuel housing sales and construction.

Yet within the industry, our three highlighted stocks are seen having one great year left in 2015, in which they are expected to outperform both their industry peers and the broader market significantly.

Afterward, however, the three largest lumber producers in the country are seen lagging behind both their industry and the broader market, with Plum Creek offering the greatest earnings growth potential of the three, while Weyerhaeuser stands first among its peers on the basis of overall company fundamentals compared here.