Timber REITs Are Falling

Plum Creek (NYSE: PCL  ) is one the largest names in the U.S. timber industry, especially in the northwest where it has planted its Seattle headquarters. Despite a strong brand name, Plum Creek, as well as other timber REITs, are facing considerable hurdles in the near future.

Shrinking opportunity
One of the main issues facing the timber industry is a lack of newly available and harvestable timberland. While most timberland is already earmarked as wildlife preserves or commercially utilized territories, there are still available lands; however, a relatively new surge in non-commercial competition has made these lands poor investments. According to the CEO of Potlatch  (NASDAQ: PCH  ) , major universities continue to increase funding for forestry programs and as a result are able to consistently outbid commercial cutters like Plum Creek in order to use those lands for the private use of the university. Conclusions similar to this are also supported by studies from the USDA and local forestry agencies.

In addition, companies like Rayonier (NYSE: RYN  ) have attempted to fuel growth by better utilizing their existing timberland. Rayonier began utilizing the pulpwood from its lands to produce pellets for use in stoves acting as alternatives to traditional wood stoves. While popular in Europe, the growth of these pellet stoves appears to be idling and with Rayonier already the primary U.S. competitor in that market the cost of developing an influence in the area is likely to keep competitors away from entering the region.  In a recent note, Deutsche Bank's Mark Wilde stated "recent contract negotiations suggest a drop in 2014 cellulose specialties (CS) and slower transition to CS."

Consolidated
A natural inclination among financial managers faced with the prospect of essentially no remaining positive net present value projects may be to bid for competitors. The timber industry is already largely consolidated, however, with only four major publicly traded timberland REITs including Plum Creek, Rayonier, Weyerhaeuser (NYSE: WY  ) , and Potlatch. These four companies have seen stable appreciation in their stock price since 2008 as the U.S. housing industry has recovered; however, with minimal growth prospects and P/E ratios around 29, 15, 27, and 24 times, respectively (remember that Rayonier at 15 times also earns much of its revenue from pulpwood pellets that are in declining demand), it appears that the entire industry is poised for declining share prices.

Dividend troubles
As REITs, all four of these companies pay 90% of funds from operations to shareholders in the form of dividends as mandated by the IRS. In order to help boost these dividend payouts in recent years the timberland REITs have turned to selling what are known as higher-and-better-use (HBU) properties. These properties are generally classified as those that could generate more revenue if used for non-logging purposes (imagine felling timber around a hot spring that could instead be surrounded by a hotel, restaurant, and its very own gift shop).  As the REITs continue to sell HBU properties their supply is certain to run out eventually and along with those HBU properties may go a substantial portion of recently boosted dividends.

Avoid the timberland REITs
The timber industry faces a number of challenges including increased activity among non-commercial timberland purchasers and limited investment in new or innovative timber-based technologies. While typically an industry more concerned with the stability of the housing market than the potential for growth opportunities, the timberland REITs recent reliance on HBU sales doesn't bode well for the future of the company's dividends. Additionally, high valuations could lead owners of the shares into more trouble as prices decline. For now, it appears that the timber industry has gotten ahead of itself and may be poised for a correction.

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Read/Post Comments (8) | Recommend This Article (2)

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 January 17, 2014, at 3:04 PM, YouThinkSoReally wrote:

    Zach,

    Do you understand what you are saying? This piece only demonstrates that you have no clue what you are talking about. PCL, WY, and RYN have made significant land purchases in the last three years and Rayonier has nothing to do with pellet manufacturing.

    Wow,

  • Report this Comment On January 20, 2014, at 12:37 PM, Jeff6715 wrote:

    Also agree that Zach is less than informed.

    University trusts have been very active in buying commercial forests as they have a continuous payback from timber sales that beat alternative investments. If market prices for timber are not attractive they just let the trees grow thereby increasing per acre tonnage and later more income. They are safe, reliable investments that are great inflation hedges also. If it's good for Harvard, why not the timber REIT's?

    Likewise the housing crisis has caused the timber REIT's to delay harvests. In the south alone there has been tremendous growth of assets from delayed harvests. However the REIT's do not adjust their per acre valuations to reflect that growth.

    Lastly, the HBU sales are many times the sale of lands included with forest acquisitions that are not forested or commercially viable for plantings. That's why they are classified as HBU and the sales do not generate that much to the dividend payouts. Hardly a prime source of dividend growth.

  • Report this Comment On January 22, 2014, at 11:02 AM, ONEAL wrote:

    Please review the Nov. 19 Motley article about PLC recent (more than positive) land and timber acquisitons. After I read this article I felt pretty good about having a stock positon in PLC.

    Now this article lumps PLC with all timber REITS, seemingly ignoring the previous robust observations made by Motley Fool advisors.

    Someone at Motley needs to take control over publications to prevent knee-jerk reactions and market volatility.

  • Report this Comment On January 24, 2014, at 12:56 PM, GunDawg85 wrote:

    I don't believe The author of the above article understands the timber business

  • Report this Comment On January 26, 2014, at 10:27 PM, Seanickson wrote:

    Jeff,

    You said "If it's good for Harvard, why not the timber REIT's?"

    The difference is that harvard is making these investments at cost, whereas if you buy the timber reits, youre paying a large multiple to net assets

  • Report this Comment On January 29, 2014, at 12:05 PM, earthmaster wrote:

    possibly the most clueless financial article ever written;

  • Report this Comment On January 29, 2014, at 9:37 PM, GunDawg85 wrote:

    Seanickson,

    Please explain your statement " Harvard is making these investments at cost".

  • Report this Comment On February 04, 2014, at 7:42 AM, Intrepidation wrote:

    Not to pile on, but as a REIT, PCL pays distributions, not dividends.

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