3 Top Dividend Stocks in Lumber

The lumber industry can be an excellent source of income for investors because many of these companies choose tax-friendly corporate structures, such as real estate investment trusts (REITs) or master limited partnerships (MLPs). That's clear by looking at the following chart, which shows that companies structured as a REIT or MLP yield more than twice that of their dividend paying C-Corp competitors.

Data source: Yahoo! Finance. Dividend yield as of June 5, 2017.

While five of those forestry stocks offer eye-catching payouts right now, we're going to focus our attention on the top three because each offers investors a slightly different way to invest in the lumber sector.

Image source: Getty Images.

A higher risk high-yield stock

Catchmark Timber Trust is the top-yielding lumber stock in the group by a wide margin. However, investors need to take on a bit more risk to collect that higher reward. That risk comes in the form of the company's elevated debt metrics, which at 10.3 times net debt-to-adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), and a 42% net debt-to-enterprise value are well above the industry norms. For example, lower-yielding Rayonier has an industry-leading 19% net debt-to-enterprise value metric, while Potlatch is only slightly higher at 21%. Another potential concern for Catchmark Timber Trust investors is that 54% of its debt is floating rate, which could come back to bite the company if interest rates rise rapidly. Contrast this with Rayonier, which has 95% of its debt locked into fixed rates, with an average maturity of 6.7 years.

One other thing that differentiates Catchmark from some of its peers is the fact that it's a pure play on timberland, which makes it similar to Rayonier and Pope Resources. That focus puts it at a disadvantage to vertically integrated rivals, such as Potlatch, Weyerhaeuser, and Deltic Timber. These companies not only own timberlands but also operate lumber mills. That diversification gives them higher leverage-to-lumber prices because they can capture the value created by turning timber into other products.

That said, for investors willing to take on more risk for a tree-topping yield, Catchmark is the way to go. 

Different structure, similar high-yield result

Pope Resources is the only lumber company structured as an MLP, which while more common in the energy sector, still fits because timber is a natural resource. It's a decision that has its share of trade-offs. For example, MLPs issue a Schedule K-1 for tax purposes, versus the 1099s REITs provide their investors, which can complicate an investor's annual tax filings. Furthermore, MLPs aren't the most suitable investments for IRAs. That said, the structure has its benefits, which (as Pope notes in the following slide) include the fact that it has the highest after-tax yield in the lumber industry.

Source: Pope Resources investor presentation.

Another difference between Pope Resources and other lumber companies is that it manages three private equity timber funds in addition to owning timberlands on its balance sheet. The company does this to leverage its earnings without leveraging its balance sheet because it earns profits from its investment in the funds, as well as from management fees. As a result, it has maintained a conservative capital structure at just 20% net debt-to-enterprise value. 

Because of that, Pope offers a lower risk income option to investors who don't mind the additional tax complications that come with the K-1s.

The lumber behemoth

Weyerhaeuser is the granddaddy of the industry, which makes it a top lumber stock. It's by far the largest private timberland owner in the U.S. at 13 million acres. For perspective, it has a more than 10 million acre lead on Rayonier, which is the second-largest timberland REIT in the country. However, Weyerhaeuser is more than just a timber company. It also has an extensive real estate, energy, and natural resources segment, which it uses to maximize the value of its land holdings. It's also a leading manufacturer of wood products.

Because it's a fully integrated lumber company, Weyerhaeuser is one of the lowest-cost producers of wood products in North America, which gives it a competitive advantage over pure-play lumber manufacturers. That's clear from the slide below, which shows that Weyerhaeuser's wood product margins are as good as, if not better than, its competitors'.

Source: Weyerhaeuser investor presentation.

One other thing worth noting about Weyerhaeuser is that it has a rock-solid balance sheet, complete with an investment-grade credit rating and low leverage metrics of 3.5 times net debt-to-adjusted EBITDA and 21% net debt-to-enterprise value. That strong balance sheet, when combined with the company's diversification, makes it an excellent core holding for income investors.

Investor takeaway

The lumber sector can be the perfect place for income investors because many of these companies have dividend-friendly corporate structures. Because of that, investors can allocate their dollars based upon personal preferences and risk tolerance. For example, those who are willing to take on more risk can catch a higher yield with Catchmark. Meanwhile, investors familiar with the tax advantages of an MLP might want to opt for the higher after-tax yield offered by Pope. Finally, those who would rather avoid the risks and the tax hassles can go with the sector's top-dog Weyerhaeuser. Needless to say, there is a lumber stock option for almost any investor preference.