Weyerhaeuser Goes 3-D With Its Efficient Land Usage

Summary

• WY is focused on efficiency of operations.
• It gets superior margins and now has an additional source of revenue.
• They get to double dip by still using their land for forestry while also leasing it out.
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AlessandroPhoto/iStock via Getty Images

Weyerhaeuser (NYSE:WY) has enjoyed a couple of quarters of insanely high lumber prices which have fueled record profitability, but this has little to do with what makes it a strong long term investment.

Lumber prices will fluctuate but WY’s operational efficiency will consistently set it ahead of the pack. Even amidst the commodity price frenzy WY continues to demonstrate its attention to detail and commitment to operational efficiency. Little optimizations matter far more than it initially appears and they often go un-noticed by the market as they seem small relative to WY’s $28.8B market cap.

Over time, WY’s superior operations should lead to outperformance and it is presently trading at an opportunistic valuation.

Let me begin by digging into the idea that small operating efficiencies can sum to large impacts to the bottom line. I will then follow with data and concrete actions taken by WY that demonstrate their commitment to efficiency.

Large cap companies often get too big for their britches

As companies get larger, small expenditures can start to seem meaningless as their impact on the bottom line becomes a rounding error. However, losing sight of these small expenditures can erode company culture.

• Maybe they stop comparison shopping when purchasing equipment
• Maybe they stop focusing on worker efficiency and high productivity workers start to feel overlooked.
• Perhaps the chain of command gets too crowded with middlemen that might not even be necessary.

Any number of problems like this can occur and they become more prevalent as companies get larger. To get a sense for the scope of such problems we can look at Iron Mountain (IRM) as a case study.

Hundreds of millions of annual savings

As Iron Mountain grew into the world leader in information storage and security its success came with some bloat. Bill Meaney, CEO, recognized this bloat and took to solving it as he launched Project Summit. IRM had a significant amount of redundant middle management, so Project Summit involved a serious trimming down of management along with other efficiency initiatives. Heading into 2022 the estimated savings from the endeavor are $375 million as an annual runrate.

So while each individual unnecessary hire was peanuts for a company IRM’s size, they summed to a huge number. In cutting the fat, IRM found a massive chuck of extra earnings and the efficiency gains are largely responsible for IRM’s outperformance in recent quarters.

SA

Weyerhaeuser’s tight ship is getting tighter

As of the latest quarter WY is #1 or #2 of its peer group in EBITDA margin across each manufacturing segment. It also boasts the highest EBITDA per acre among western timberland.

Its efficiency is already quite good, but still has room for improvement. Through 2025, WY is planning to increase annual margins by $175 million to $250 million as per their presentation:

WY

That would be an additional $0.28 per share of EBITDA at the midpoint. That’s quite a bit and the latest transaction gives me increased confidence that they can do it.

Leasing subterranean ground

Occidental Petroleum (OXY) via its green subsidiary 1PointFive on March 28^th leased 30K acres of land from WY with undisclosed financial terms. The carbon capture industry often does not disclose the financial terms, but I think there is enough information here to determine that it is a clear win for WY.

I understand there are multiple viewpoints on carbon capture and I’m not going to provide my opinion on it because from a WY shareholder perspective it doesn’t really matter which side of the debate you fall on. Airbus (OTCPK:EADSY) is paying OXY for 400,000 tonnes of CO2 removal and OXY is paying WY for the land.

The counterparties are massive, so there is minimal risk of default on the lease and while the financial terms were not disclosed, there is reason to believe the rental payments will be substantial.

Quite simply, the scale of this thing is enormous. Up until now, the worlds largest Direct Air Capture (DAC) facility was owned by Climeworks and according to Bloomberg

“The plant will capture 4,000 tons of CO₂ a year, making it the largest direct-air capture facility in the world.”

This new plant from OXY will have capacity to capture 1 million tons per year making it the largest by orders of magnitude.

Per the Announcement from OXY:

“Construction of the first DAC facility is expected to begin in the second half of 2022 in the Permian Basin. When fully operational, the DAC facility is expected to be the largest in the world, with a one-million-tonne annual CO₂ removal volume capacity”

Let’s convert that into dollar terms.

Note that DAC is one of the most expensive forms of carbon offset/removal because it scores very well in terms of permanence and additionality. Companies looking to improve their ESG will pay up for DAC because it ranks so highly by third party governance organizations.

Airbus has strict standards on what they will count as a carbon offset per their annual report:

“the carbon offsets need to be certified by the Gold Standard (or Verra for certain projects) and the supplier needs to show proof of how each one of the mentioned criteria were met.”

As such DAC commands a premium price per ton.

According to the world resources institute:

“The range of costs for DAC vary between $250 and $600 per tonne.”

So the 400,000 tonnes for Airbus would cost around $100 million to $240 million. My guess would be that it is toward the lower end assuming there are benefits from the scale.

That is just from the Airbus contract. Presumably in building a 1 million ton annual capacity DAC facility OXY intends to provide the service to companies beyond Airbus. At the $250 per ton rate the annual revenue capacity would be $250 million.

Since financial terms were undisclosed, it is unclear how much of this will go to WY as rent although I think it has to be a fairly substantial number as 30,000 acres is a lot of land, the land needs a specific geological formation to be suitable for capture and there has to be extensive data on the geology of the land.

A pure win for WY

The brilliance of this deal for WY is that it is almost 100% margin.

In owning millions of acres of timberland WY owns this.

WY

But what often goes overlooked is that they also own the ground underneath the forest.

The above ground footprint of the OXY facility is negligible and WY will be able to continue their forestry operations on the 30,000 acres per normal.

This means there is little to no interruption of WY’s existing revenue streams and that the rental stream from OXY is additional revenue.

$100 million EBITDA annually

WY has announced plans to form a $100 million annual EBITDA business through green endeavors. This OXY deal is a good start and it is the right way to do it.

For most companies ESG is an expense line, but for WY it is high margin revenues.

Overall valuation

Weyerhaeuser’s core timber and lumber business easily justifies the valuation. In 2021, adjusted EBITDA of $4.09B facilitated a special dividend of $0.50 per share and a second special dividend of $1.45 per share in addition to their normal dividend of $0.17 quarterly. In 2022 WY increased its regular quarterly dividend to $0.18 and is estimated to get another $3.26B of adjusted EBITDA which would likely cause another large special dividend.

At $38.79, the $2.63 of 2021 dividends represents a 6.7% yield. The $3.26B of expected EBITDA represents an EV/EBITDA of 10.46X.

By either metric WY looks quite cheap. Admittedly, EBITDA is likely to drop a bit post 2022 as I think lumber prices will stabilize a bit lower than they have been so perhaps the yield and EV/EBITDA are a bit less attractive than the above numbers.

That said, there are some significant growth engines in the form of the $175-$250 million annual EBITDA savings from opex efficiency initiatives and the $100 million from high profit margin ESG initiatives.

Given the unpredictability of timber and lumber prices as well as those of manufactured wood products, it is difficult to pencil out an exact fair value, but given the range of where lumber prices are likely to go I think WY looks undervalued.

This speculative EBITDA based valuation is backed up by a far more concrete NAV valuation in which WY is trading at 86% of NAV.

The bottom line

I like owning large tracts of land as it is an asset that has historically perpetually increased in value. WY allows me to buy that land at below fair value and it provides a strong revenue stream while we wait for that land to appreciate. WY operates with a superior level of efficiency which I believe will lead to outperformance over peers and over the broader market.

Analyst’s Disclosure: I/we have a beneficial long position in the shares of WY either through stock ownership, options, or other derivatives. 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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Comments

[Elon beat me with jumper cables]

Well it was a good idea, had I caught the article earlier but I think they are coming for all the stocks and owning land might be a good idea in an inflationary environment but it's a cyclical industry that is trading near 52 week highs with a dangerous macro backdrop that I'll take another glance once they are done taking everything out to the woodshed so to speak.

[btdavis1]

Excellent article. This additional cashflow will fit well into ongoing ESG monetization by simply designating forestland to be “avoided conversion” and selling the carbon credits. While it’s roughly at parity now (a ton of US SE stumpage is roughly what a ton of incremental carbon could sell for on the California market), the notion of this being ~$20 (either use) is likely in the rear view mirror for both applications. This creates a positive dilemma for WY and others.

The various carbon value estimates vary but the UN number needed to make a difference is much higher than current North America pricing. BCG uses an upper bound of $135/tonne, for instance, in their paper “Staggering Value of Forests…” noting that it’s “the price necessary to keep global warming below 1.5°C by 2030 according to the Inter- governmental Panel on Climate Change (IPCC).”

The main takeaway I see is timber will be allocated to perpetually standing status (I.e. not cut… ever) for ESG issues. This means the value of the timber that IS cut will be much higher. I see this macro environment serving to stabilize a formally volatile market. We have the price of timber anchored low thanks to BC’s pine beetle epidemic where the bulk of a massive pine area was, essentially though they will dispute it, given away for ~$0.25/ton for over a decade (I was there!). Take that pressure off and we will see some timber/lumber inflation that is, well, the opposite of transitory. Sorry Mr Powell.

web-assets.bcg.com/...

[toomuchgas]

What's the problem with disclosing the terms of the lease? The amount should be posted on the WY and OXY quarterly reports. If it isn't it is fraud and they are withholding important financial information for investors. Time to contact the SEC?

[jarratta]

@toomuchgas Public companies have stringent disclosure requirements. They don't extend to nonmaterial items, which I suspect the OXY/WY lease is. Companies that size have many thousands of leases of various types. Making their terms public would be burdensome and wouldn't be useful to investors, generally speaking.

If this arrangement takes off and starts having a meaningful effect on the bottom line, I'm sure WY will disgorge typical terms.

[toomuchgas]

@jarratta Then why mention it at all if it is a meaningless transaction?

[jarratta]

@toomuchgas It's not meaningful from a reporting standpoint at this time. Way too early to see if this arrangement will become a significant contributor to WY's performance. If it grows, more info will be provided.

[terryongarland]

Great ideas to offset what will become a housing slump. I say this as someone who has been a player in the homebuilding industry. Yes home supply is limited in many venues, but people have to be able to afford the homes they want to buy..and that prospect is diminishing by the day. However , homebuilders have faced increasing rates in the past and can be very aggressive in offsetting slumping demand. Monetizing your assets as WY has done is smart and they appear be readying to counter an economic crunch.

[nystrom]

Would be smart for WY to buy WFG or Interfor. Both those companies trade at less than 3x earnings whereas WY gets a premium of almost 12x earnings.

[btdavis1]

@nystrom I believe the limitation is that of being a timber REIT. The stipulation is that “Through its subsidiaries, a REIT may have assets and en-gage in businesses that are not in real estate (such as forest product manufacturing). However, the securities of such subsidiaries can not be greater than 25% of a REIT‟s asset value.”

To me, the question RYN and WY will need to chew on is… is it worth it? With the solid wood names trading at 2x EBITDA and lumber futures not slowing in any material way, is timber REIT status a crutch that will see others (PE funds etc) scoop up accretive assets that would be WY-synergistic on the cheap?

www.timbertax.org/...

[jarratta]

This is an exceptionally insightful article. Thanks. I particularly like you turning our attention to the DNA that distinguishes truly great companies from also rans. (I was reminded of the Collins' Built To Last theses.) A religious devotion to core values is so important.

I try to be attentive to this. For example, if I thought that AMZN was deviating from its worship of cash flow and was turning its attention to earnings, I'd know it was time to head for the hills.

Every tree is a carbon sink. Much of WY's timber is un-harvestable. None of it can be turned into milled products until it's mature. In the meantime, selling sequestration is the cat's pajamas. You right, its margin is darn near 100%.

[Keypounder52]

Love the special dividends...

[jarratta]

@Keypounder52 The fixed annual divvy coupled with a variable one based on market conditions should be the standard for all commodity businesses.

[arson]

Staying away, as I do not believe the underlying land is below fair value. Yes, it is an 800 pound gorilla and can go crashing through the jungle destroying everything in its path. Its size gives it operational efficiencies and causes it to appear cheap as it devours the rest of the industry it monopolized. In its quest for profit, WY has eaten every decent banana out of the jungles it owns. What's left could be called over-valued micro-bananas. The carbon credit offsets will further mask that the timberlands can not meet the inflated projections. Just because all the other monkeys left are tiny, doesn't make King Kong WY a good investment at a 3-yr high. After a correction I'll jump back into PCH before taking a position in WY again. Also, the time to buy WY is at the bottom of a housing correction, not near the top of a real estate cycle, IMO. I'll take risk where there looks to be greater reward. In regards to crop-land holdings, I'm long ALCO.

[atlantic51]

@arson Fair enough, but the reason the real estate market is so hot is because supply is insufficient to meet demand.

[rado403]

Good article - long time WY owner back when there was a Weyerhauser on the Board- back when they built an amazing- wasteful- brick and mortar headquarters-- interesting quarter and interesting price level- high for recent years-- still purchase more shares?