Basic Materials and Chemicals Sector Ideas

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Rayonier, Plum Creek Timber -- >>> A Fine Time for Timber



By CHRISTOPHER C. WILLIAMS
8-25-12
Barrons


http://online.barrons.com/article/SB50001424053111904881404577601231399336716.html?ru=yahoo&mod=yahoobarrons#articleTabs_article%3D1




A recovery in housing could boost Weyerhaeuser's sales and earnings, and unlock the value of its high-quality timberland and real-estate assets. A REIT with rising payouts.

Money doesn't grow on trees, but a recovery in America's depressed housing market could produce lots of it for timber giant Weyerhaeuser .

Suddenly, signs of a nascent pickup in housing are everywhere, from rising building permits and housing starts to improved sentiment among builders. Add higher lumber prices to the list, along with a powerful liftoff in the shares of home builders such as Toll Brothers (ticker: TOL) and PulteGroup (PHM).

Weyerhaeuser owns some of the best timberland in the U.S., in the Pacific Northwest and the South. The Mount St. Helens Tree Farm is in Washington.

Weyerhaeuser's stock (WY) has been no slouch, either. It shot up 50% in the past year, to a 52-week high of $24.62, and the rally could be in the early innings. The shares, which topped $85 in 2007, look rich at 29 times next year's expected earnings of 85 cents a share, but the P/E ratio is misleading, as it is based on trough earnings.

Headquartered in Federal Way, Wash., Weyerhaeuser is best viewed as an asset play, and its assets are sorely undervalued. The company owns six million acres of timberland, including some of the best properties in the U.S., chiefly old-growth forests in the Pacific Northwest and the South. It also makes wood products and cellulose fibers—Weyerhaeuser is one of the biggest producers of absorbent pulp used in diapers and feminine-hygiene products—and operates a real-estate development company. Some analysts and investors calculate its net asset value at more than $30 a share, or about 30% above the current stock price.

"Weyerhaeuser is a terrific asset play," says Todd Lowenstein of HighMark Capital Management, which owns shares. "You are buying attractive timber and other housing assets that are under-earning and have been mispriced at the bottom of the cycle, for around 70 cents on the dollar."

Moreover, as a timber real-estate investment trust, Weyerhaeser pays a 60-cent dividend and yields 2.4%, with the promise of higher payouts to come. Converting the company to REIT status in 2010 was one of management's savviest financial moves, as earnings from REIT timber harvests are taxed at 15% instead of the 35% tax rate applied to C-corporations. Weyerhaeuser is one of four publicly traded timber REITs, a group that also includes Plum Creek Timber (PCL), Rayonier (RYN), and Potlatch (PCH).

REITs are required to distribute at least 90% of their taxable income to shareholders, and Weyerhaeuser intends to pay out 75% of its funds available for distribution in dividends. Anthony Pettinari, an analyst at Citi Research, thinks the company can raise its dividend 50% by 2014. "The long-term potential to increase the dividend is unmatched in the sector," he wrote in a July 9 report to clients, in which he upgraded his Weyerhaeuser rating to Buy from Neutral.

Although 84% of Weyerhaeuser's revenue is tied to housing, the company is more diversified than its closest rival, Seattle-based Plum Creek. In the second quarter, all four of its operating units turned a profit for the first time in six years, and most improved sequentially from the first quarter, suggesting that Weyerhaeuser is building momentum as housing turns, and could meet analysts' estimates for a double-digit increase in earnings this year, to 38 cents a share.

Close.No one expects Weyerhaeuser to earn, any time soon, the $5.43 a share it reported back in 2004. But Heather McPherson, an associate portfolio manager of T. Rowe Price Mid-Cap Value Fund, says that in a normalized housing market, with housing starts above one million units, the company could net closer to $1.75 a share. Baltimore-based T. Rowe Price Associates is Weyerhaeuser's second-largest institutional investor, behind Capital World Investors, with 36 million, or almost 7% of the outstanding shares.

THE MAJOR RISK FOR WEYERHAEUSER is that the housing recovery stalls. Indeed, some housing skeptics cite a "shadow inventory" of foreclosed homes waiting to come on the market that will keep prices depressed. But Weyerhaeuser officials think the foundation is being laid for a multiyear recovery. "The housing market has bottomed," says Chief Financial Officer Patricia Bedient. "We are seeing signs of a recovery, although it's not V-shaped" in nature.

Citi sees annual housing starts ramping up to one million units by 2014 from an estimated 730,000 this year, although that is below an annual rate of 1.44 million units before the crash. Recent data have been encouraging, with the Commerce Department reporting that building permits rose in July to the highest level in four years, and the National Association of Home Builders citing an uptick in its index of builders' sentiment. Housing starts slipped last month from June's level, to a 746,000 annualized rate, but are up 20% from 2011.

Pettinari sees lumber prices rising further, too, noting his channel checks have revealed that dealers haven't built adequate inventories to meet housing-construction demand. The annualized average price for lumber, he says, could increase to $315 per thousand board feet in 2013 from $300 this year and $272 in 2011.

Driven by higher lumber prices and a double-digit uptick in wood products, Weyerhaeuser could earn 42 cents this year and 95 cents in 2013, Pettinari calculates. He expects revenue to jump to $7.3 billion next year from an estimated $6.7 billion this year.

A HOUSING RECOVERY could help close the gap between Weyerhaeuser's net asset value and its current share price. Peter Shawn, a portfolio manager and director of research at New York-based Tocqueville Asset Management, owner of two million Weyerhaeuser shares, figures Weyerhaeuser could be worth between $28 and $31 a share.

He calculates the company's timberland assets at between $13 billion and $14 billion, based on recent transactions that valued timberland at $2,000 to $2,200 an acre, equal to a 5% yield. Timberland sales generated 23% of the latest quarter's $1.8 billion of revenue, and 47% of its $164 million in earnings from operations.

Shawn estimates that the wood-products business, including non-U.S. timberlands, is worth $2.1 billion, on the assumption that it would trade for six times normalized earnings before interest, taxes, depreciation, and amortization of $350 million. The segment contributes 44% of revenue.

The cellulose-fibers segment, at 26% of revenue, is worth $2 billion, he says, with real estate valued at between $2 billion and $2.5 billion, or 1.2 to 1.6 times book value, a sharp discount to other home builders' price-to-book multiples. Weyerhaeuser Real Estate Company, or Wreco, builds mostly single-family homes and residential lots.

All told, Shawn pegs Weyerhaeuser's net asset value at $16.4 billion, above its current market value of $13 billion. Subtracting corporate expenses of $300 million and net debt of $3.6 billion, and dividing the result by 540 million shares outstanding would yield the aforementioned per-share value of $28 to $31.

GROWING AND HARVESTING timber is a relatively stable business that generates substantial cash. In part, this has made timberland a favorite holding in recent years of endowments, pension funds, and other institutional investors. But many of Weyerhaeuser's end markets are cyclical, and the company has ridden numerous economic cycles in its 112 years. Sales and profits both fell sharply amid the latest downturn in housing.

The Bottom Line

Converting Weyerhaeuser to a real-estate investment trust was a savvy management move. The REIT yields less than competitors, but its dividend could rise by 50%.

After an earlier acquisition spree, Weyerhaeuser sold or otherwise divested underperforming assets, to gain efficiencies and sharpen its focus. The company spun out its fine-papers business in a deal with Canada's Domtar (UFS) in 2006, and later sold its packaging business to International Paper (IP) for $6 billion.

Management, led by company veteran Daniel Fulton, has tried to cut costs, and aims to slice total debt to $3.9 billion by the end of next year, from $4.5 billion now. The company reported cash of $861 million as of June 30.

After the pruning and trimming, Weyerhaeuser is tied even more closely to housing. But that could be a good thing now.


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