Weyerhaeuser: A Deep Dive Into Valuation

Summary

• Weyerhaeuser is trading at a discount to the value of its assets.
• Land appreciation, along with free cash flow sum to an attractive expected return.
• Opacity of WY to those outside of the forestry industry is leading to significant mispricing and at the moment WY is opportunistically priced.
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I must admit that performing valuation analysis on Weyerhaeuser (NYSE:WY) has been one of the most humbling experiences as an analyst. The timber REITs use a whole different set of accounting unlike any other REIT and even more estranged from the broader market. This makes cash flow analysis tricky and asset value analysis is even more specialized requiring extensive knowledge of the forestry industry. As a man who has never even chopped down a tree, I was woefully ill prepared to know what a 50 foot Douglas fir is worth.

This opacity to those outside of forestry is likely a source of opportunity for those willing to dig in and figure it out. Looking at the way Weyerhaeuser’s market price moves, it is quite clear the market is looking at the wrong things. WY’s market price moves in lock step with lumber futures

Sources: SNL Financial and Tradingeconomics.com

Note the peaks in September, 2020 and May, 2021 for both WY and lumber. As lumber rose from sub $600 to ~$1700 WY grew from ~$23 to ~$41 and as lumber fell from ~$1700 to ~$880, WY fell from ~$41 to ~$34.

While it is true that WY’s near term earnings are heavily impacted by current lumber pricing, the fact that its price moves as much as 20% based on current price of lumber is just wrong.

Given the volatility in WY’s price based on a temporary change to fundamentals, I suspect there is substantial mispricing here. There seems to be a huge knowledge gap with most of the market having no idea how to value timber REITs.

In an attempt to take advantage of this situation, I have dug into every resource I can find to estimate WY’s underlying value. I will attempt 2 different methods of valuing Weyerhaeuser:

1. Earnings based
2. Sum of parts Net Asset Value (NAV)

Earnings based valuation

Given that WY is a REIT, the tendency in earnings valuation would be to use Funds From Operations (FFO) or Adjusted Funds From Operations (AFFO), but timber REITs have atypical line items that make these measures not necessarily applicable. For most REITs there is a substantial depreciation charge which I would typically add back because the buildings didn’t necessarily lose value.

It is not appropriate for a timber REIT to add back depreciation because its assets are land which does not depreciate (in accounting terms), sawmill machinery which absolutely does depreciate (in both real and accounting terms) and timber which gets depleted and replanted.

Thus, to get to a proper earnings number we need to make some adjustments. Below is WY’s historical adjusted EBITDA as well as the Capital IQ consensus estimates for 2021-2023

Source: SNL Financial

So the spike in 2021 is basically analysts accounting for the unusually high lumber prices and is fully supported by WY’s 1Q21 actual results. Lumber prices have fallen a bit since Q1 and are generally expected to return to a more normal level. Thus, I think the 2020 and 2022 numbers are far more realistic as a run rate than the 2021 number.

For our analysis we will start with the 2020 adjusted EBITDA number because that is the most recent actual number from a more normal time period. To get to Adjusted EBITDA from GAAP earnings, WY makes the following adjustments.

Source: 10-K (highlights added by me)

Most of these adjustments are entirely reasonable, but there are 2 that need further adjustment.

Basis of real estate sold should not be added back. That is capital WY invested in the land before it was sold for “higher better use” and since this capital is not recovered (other than through sale price) it would be double accounting to add it back while also recording the gain on sale. Gain on sale is already in the GAAP numbers from which these adjustments are made, so I will not add back the basis of real estate sold.

Depreciation, depletion and amortization is a tricky line item. These are all non-cash items, but they are also real expenses that recur year after year. In particular I do not think it is appropriate to add back the depreciation of machinery or the expense that went into planting the trees that were then cut down to incur this depletion charge.

These expenses are accounted for as capital expenditures and are capitalized onto the balance sheet until they are later removed from the balance sheet through the depreciation, depletion and amortization line. The capex is very much recurring as seen below.

Source: SNL Financial

The recurring level seems to be about $350mm so that is the amount I will remove from adjusted EBITDA in calculating the run rate.

Consensus figures of EV/2021 EBITDA will show Weyerhaeuser at an EV/EBITDA of 7.12X

Source: SNL Financial

7X EBITDA would be a screaming buy, but this figure is obviously distorted by the blockbuster year that 2021 is from lumber prices and further distorted by the add backs that probably shouldn’t be in there.

With my adjustments to a normalized year and removing certain items I calculate the run rate as $2201M minus 141M (cost basis of real estate sold) minus $350mm capex = $1710M

That would be an EV/EBITDA of 17.57X

17.57X is a somewhat high multiple, slightly higher than that of the S&P’s EV/EBITDA, but we should note that as a land play WY has a second source of returns in the form of asset value appreciation. Frankly, land values go up over time and WY does not have to pay anything to makes its land values go up. It just happens through the passage of time. Thus, the total return looks more like the EBITDA Yield plus the asset value appreciation.

This sort of value appreciation as a second component of returns is only shared by a few asset classes such as farmland and gold. For gold, however, there is no cash flow yield so appreciation is its only source of return. Timberland and farmland are really in a unique place as having returns come from the aggregate of cash flow yield and appreciation yield.

In order to estimate the magnitude of appreciation we must first know what WY’s assets are worth today.

NAV Valuation

This slide from WY’s presentation depicts its major assets.

Source: WY

We must note that the 14 million Canadian acres are licensed and not owned. While WY gets a good amount of revenue from these acres, they are not owned assets and therefore will not be included in my NAV calculation.

Similarly, some of the 11 million acres owned in the U.S. are not truly owned as they are long term leased by WY from a separate owner. Like the Canadian licensed acres the leased land generates revenue for WY but since they are not owned they will not be included in the NAV.

The actual number of owned acres is disclosed in the 10-K and shown below.

Source: 10-K

So, what is the value of 9.95 million acres?

Well, there are 2 components to look at here; the value of the standing timber inventory and the value of the raw land itself. As of the end of 2020 WY had standing inventory of 593 million tons. There is a nice breakdown of the types of trees so that we can get a bit more granular in valuing it.

Source: 10-K

As I said at the start, I am far from a forestry expert so let’s value the big bucket categories and just ballpark the smaller buckets.

So, the first item of note is that timber is a regional business due to the heaviness of logs making them prohibitively expensive to transport long distances. As such, pricing can be wildly different depending on location and western logs are worth substantially more than southern logs. TimberMartSouth provides excellent pricing info for the southeast.

WY has 264M tons of southern yellow pine and 85M tons of southern hardwood valued at $24.67 and $29.92 per ton respectively. However, not every ton of standing inventory is of saw timber caliber. WY does not break out their saw timber versus pulpwood mix but peers in the southern region like CatchMark Timber (CTT) have a 50/50 mix of pulpwood and sawtimber so I would anticipate a similar ratio here. Thus, we have the following value of WY’s standing southern inventory.

Type of wood	Tons (Millions)	Value per ton $	Value $ Million
Pine sawtimber	132	24.67	3256
Pine pulpwood	132	8	1056
Hardwood sawtimber	42.5	29.92	1272
Harwood pulp	42.5	7.50	319
Total			5903M

Click to enlarge

In the West, available pricing is quoted in dollars per thousand board feet or $/MBF.

Source: DNR

Douglas firs are worth about $692 per MBF, so how many tons does it take per MBF? Well it turns out it is not a constant conversion because the ratio of weight to MBF is related to the diameter of the trees. Bigger trees have more usable sawtimber per ton with the ratio of tons per MBF roughly tabled below.

DBH stands for Diameter at Breast Height which is considered 4.5 feet from the ground.

Per the 10-K,

“The average age of timber harvested from our Western timberlands in 2020 was 49 years.”

According to this study the average diameter of conifers at age 50 is 13.6 inches If WY harvests at 49 years of age, the average age of standing trees is about 25 years, but because the older trees are bigger, the weighted average age by mass is probably closer to 40 years. As such, we can estimate a DBH of about 12 inches.

Using the table above, that is 9.8 tons of standing inventory per MBF. Thus, WY’s 202 million tons of standing inventory in the west is about 20.6 million MBF. At $692 per MBF that would imply a delivered log value of $14.255B.

Note, however, that what we should be calculating is stumpage value, not delivered value because there are substantial costs associated with harvesting and hauling. Stumpage price tends to be somewhere in the range of 60% of delivered, so I would value the standing western inventory at $8.55B.

The northern region tends to be significantly lower value. I suspect this is due to it getting hit with lumber imports from Canada where timber is heavily subsidized. Thus, timberland on the States bordering Canada tends to be low value. As such, I would value the inventory at closer to $10 per ton all in netting standing northern inventory of roughly $420M.

Putting these together, WY’s standing inventory is worth somewhere around $14.873B.

The reason I walked through each step of this estimate is so you can see that this number is really just a rough ballpark figure. There were assumptions and estimates each step of the way so we should put error bars on this estimate of a few billion on each end.

Land Value

To ascertain land value we can look at some comps.

On June 22^nd_, CatchMark Timber sold its Bandon property in Oregon for $100mm which translates to a price per acre of $5,536. This is fairly typical price for the pacific northwest.

Southern timberland tends to be much lower in value with transactions around the $1800 per acre range.

Potlatch recently sold some Minnesota timberland at $662/acre

Source: SNL Financial

While it seems like a shockingly low per acre value, many other sales in the north are in this same range.

These timberland transactions of course include the standing inventory. So to get to the value of the raw land not including the value of the standing inventory we have to net it out.

Location	# acres (millions)	Value per acre $	Value of land with inventory ($million)	Value of standing inventory ($million)	Value of raw land ($million)
South	6013	$1800	10823	5903	4920
Pacific northwest	2731	$5536	15118	8550	6568
North	1202	$662	796	420	376
Total			26737	14873	11864

Click to enlarge

Why is it important to separate the value of the standing inventory from that of the land?

Well it has to do with asset value appreciation. We cannot apply an appreciation figure to the full land value of $26.737B because the asset value accretion that comes from the standing inventory and the tree growth already shows up in EBITDA. Thus, it would be double accounting.

The number I am trying to get to is the NAV accretion that does not show up in EBITDA. This would be the appreciation of the raw land. Until the land is sold, appreciation is not accounted for and I think the market is overlooking this source of value creation.

Timberland tends to appreciate at a pace just slightly above inflation. While inflation is likely to be in the 3%-4% range for the next couple years, longer run I think most people including the Fed see it somewhere around 2%.

If we apply a 2% annual appreciation to WY’s raw land that is $237M of annual appreciation. That is $0.31 per share annually.

Finishing up the NAV valuation

Beyond the $26.737B of total land value, WY has 35 manufacturing facilities ranging from general sawmills to facilities making specialized wood products such as OSB. These are worth $5.445B at cost and on a book value basis have been depreciated down to $2.013B Source: 10-K

Since WY fully maintains these properties with a couple hundred million in capex each year, I would place the value closer to the cost than to the book value.

Using $5B, it takes total asset value up to $31.737B. With an enterprise value of about $30B, WY seems to be trading at a healthy discount to NAV.

The Buy Thesis

I see Weyerhaeuser as an attractive investment at current price. Timber in general is a strong asset class because the underlying asset is perpetual and harvesting can be deferred until whenever prices are favorable. This makes it able to hibernate during bad times and become explosively profitable during good times.

The present happens to be one of the good times which is why EBITDA is likely to spike to over $4B this year. That said, I put minimal value on the present being a boom time. The aspect that really matters to me is that there will continue to be boom times periodically in the future. WY will fluctuate between producing an okay cash flow and a great cash flow.

At just over 17X stabilized run rate EBITDA I see it as an okay price. The investment proposition gets significantly juicier when the $0.31 of annual asset value accretion are added on top of the EBITDA yield. That makes it an overall strong return which in my eyes is made more attractive by the high quality nature of the company.

This article is getting long so I’ll just briefly mention some of the aspects that contribute to its quality.

WY has an investment grade rating and a rock solid balance sheet.Source: SNL Financial

It is the biggest player in the space and has spent extensively on R&D to have the lowest cost of operations. Their harvesting and silvicultural practices are the gold standard.

Finally, WY is making a big push into the carbon capture market, being the first timber REIT to have a division of the company dedicated to this opportunity. As of right now, carbon offsets are not allowed to compete in carbon allowance markets, but there is a big push to let them in. If that ever happens WY is ready to spring and it could be wildly lucrative.

If nothing comes of it, no problem. WY will just continue in its current steady state. That is my preferred way to invest in disruption – where the failed case is still a solid investment.

We plan to discuss Weyerhaeuser's carbon offset opportunity in greater depth in a future article. I believe it could increase EBITDA by over $400 million annually over the next 10 years by raising the realized price of low value wood by $24 per ton.

Analyst’s Disclosure: I am/we are long WY, CTT. 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.

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