A Hard Asset to Buy for This Market

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Stock market pundit and noted permabear Jeremy Grantham has called it his favorite long-term investment and has revealed that in the past, up to 20% of his personal portfolio may have been invested in the stuff.

 Grantham's investment firm, Grantham, Mayo, & Van Otterloo (GMO), also expects it to outperform all other asset classes over the next seven years, projecting a real return of 6%. According to Grantham, this asset is known to be a great inflation hedge and it's countercyclical, having retained its value during both the Great Depression and the 1970s. Best of all, it tends to have a low correlation with other asset classes, which makes it a great portfolio diversifier.

At this point, I'm sure you're expecting some sort of diatribe about the commodity investment du jour, gold, but what I'm talking about is a completely different type of hard asset: timberland.

The great thing about timberland is that if it is properly managed, it increases in value yearly as the trees grow, and you only have to harvest the wood if the price is right, unlike other commodity crops that spoil. In fact, as trees grow bigger, they actually start to increase in value at a faster clip because larger logs can be sawed for premium lumber products, rather than lower-priced wood pulp. Additionally, with timberland there is the option to strategically sell sections of the land for development when the housing market recovers and possibly capture a much higher value for the land than if it were sold as timberland.

As an individual investor, it's difficult to get direct exposure to timberland unless you have a bankroll big enough to buy large tracts of land or to invest in timber investment management organizations (TIMOs). That leaves us smaller investors with a handful of publicly traded REITs that specialize in managing timberland.

Out of the group that includes timber pure plays like Plum Creek Timber (NYSE: PCL  ) and Deltic Timber (NYSE: DEL  ) , and diversified forest products companies like Rayonier (NYSE: RYN  ) and Potlatch (NYSE: PCH  ) , my current favorite is Weyerhaeuser (NYSE: WY  ) , which has been in the forest products business for more than 110 years, and looks to be a great value today.

The business
In 2010, Weyerhaeuser reorganized as a timberland real estate investment trust (REIT), but you'll see that label doesn't accurately describe the variety of Weyerhaeuser's operations. The company owns and manages more than 6 million acres of timberland across some of the most productive forest in the United States. About 4 million acres are found in the Southeast, where the company grows primarily loblolly pine. The company's crown jewels are the 2 million acres in the Pacific Northwest that the company uses primarily to grow Douglas fir, which is highly prized for its use in structural lumber products.

Unlike many other timberland REITs, Weyerhaeuser actually derives the majority of its revenue from its ancillary businesses. These include the manufacture of wood products, like lumber, plywood, and structural joists that the company sells to homebuilders and building supply companies like Home Depot (NYSE: HD  ) and Lowe's (NYSE: LOW  ) ; a homebuilding and land development operation; land leasing for mineral and petroleum exploration; and production of specialty cellulose fibers. It should be noted that though Weyerhaeuser's timber business has the favored tax status of a REIT, the other business segments are considered "taxable REIT subsidiaries" and pay full corporate taxes. 

Why buy
Even though Weyerhaeuser's business isn't as concentrated in timber as some of its competitors', there are a number of other reasons I like the company better than the other timber REITs as an investment. One big advantage is Weyerhaeuser's strong position in the Pacific Northwest, which is one of the most productive growing areas in North America. Its proximity to West Coast ports gives the region a distinct advantage for shipping logs to Asian markets where they receive premium pricing.

The lack of forestland in some Asian markets (like Japan, China, and Korea) leads to high demand for imported lumber. Weyerhaeuser has been shipping logs to Japan for more than 25 years and has developed strong relationships in the region. In 2010, 19% of its timberland revenue came from Japan, China, and Korea, and I expect this figure to increase as Japan continues to rebuild after its earthquake and tsunami and China's economy continues to grow.

Also, many of Weyerhaeuser's ancillary businesses are operating at depressed levels thanks to the down cycle in the housing market. (The cellulose fiber business is one exception because of steady demand for its specialty absorbent products.) With just a moderate recovery in demand for new housing, these businesses should see significant operating leverage as mothballed capacity comes back online. Over the past few years, new home construction has been below historical norms and also below the level needed to keep up with population growth. Once the excess inventory from record foreclosures works its way through the market, I expect new home construction to return to historical norms, which should lead to a surge in profits for Weyerhaeuser at some point in the future.

The art of the deal
Weyerhaeuser is difficult to value because of the complex nature of its REIT conversion in 2010 and the company's exposure to the housing market. Rather than project when housing is going to recover and how that might affect all the company's business units, I think a quick back-of-the-envelope calculation can show that Weyerhaeuser's stock is attractively valued right now.

The company's biggest asset is the 5.4 million acres of timberland it owns, divided between the Pacific Northwest and the Southeast. At its current stock price of $16.00 a share, Weyerhaeuser's market capitalization is equal to about $1,550 an acre. According to recent transaction activity reported by the National Council of Real Estate Investment Fiduciaries (NCREF), it looks like timberland in the South has been selling for about $1,500 an acre, while timberland in the Northwest has been trading hands for more than $2,500 an acre. Based on just the breakdown of Weyerhaeuser's land holdings, this amounts to a composite value of $1,870, or about 15% higher than the current market capitalization of the stock. This looks like an opportunity to buy some prime timberland at a discount to its private market value, and get any future success of the other operating segments for free.

The Foolish bottom line
Weyerhaeuser looks like a great way to add exposure to timber to your portfolio with a free option on a recovery in the U.S. housing market. The company is still establishing credibility as a timber REIT and should be able to grow its dividend as business stabilizes in coming years. The location of Weyerhaeuser's infrastructure in the Pacific Northwest and its proximity to ports provide a considerable advantage for supplying growing Asian markets for years to come. I'll be starting a position in Weyerhaeuser for the Total Realty Portfolio with a $1,000 purchase a day after this article is published.

Follow Jeremy on Twitter @TMFTotalRealty.

Jeremy is an analyst for Motley Fool Hidden Gems, a premium small-cap investing service. Jeremy owns shares of Lowe's. The Motley Fool owns shares of and has created a covered strangle position on Plum Creek Timber. Motley Fool newsletter services have recommended buying shares of Lowe's Companies and The Home Depot. Motley Fool newsletter services have recommended writing covered calls in Lowe's Companies. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (5) | Recommend This Article (12)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On November 22, 2011, at 5:28 PM, lebaresq wrote:

    I believe NFG has timber component.

  • Report this Comment On November 22, 2011, at 5:43 PM, xetn wrote:

    How long do you believe it will take for the huge surplus of real estate gets absorbed so that these timber companies will start to see some real growth?

    Just curious if it will happen in my lifetime.

  • Report this Comment On November 22, 2011, at 7:31 PM, TMFTank wrote:


    <i>" Just curious if it will happen in my lifetime"</i>

    Well... that depends on how old you are... just kidding.

    I think it will be longer than most people expect before the housing market recovers, but fortunately WY's future isn't as dependent on selling land for higher and better use (HBU) as a few of the other timber companies. In fact, I think WY is more levered to the Chinese housing market right now, which was showing some signs of weakness this quarter.

    The one point that gives me hope about the U.S. housing market is the significant underinvestment in housing over the last few years. This graph from Calculated Risk via the Economist shows how far below trend we are.

  • Report this Comment On November 25, 2011, at 11:11 PM, skypilot2005 wrote:

    WY: interesting. I am going to take a look at them and put them on my watch list.


    Sky Pilot

  • Report this Comment On December 02, 2011, at 3:16 AM, iknoerle wrote:

    You know Weyerhaeuser has considerable debt so you are paying more than $1500 an acre. Excluding this only bolsters your argument to the half that needs help the most. It's a disservice!

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