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How to Invest in Lumber

By Reuben Gregg Brewer - Nov 27, 2017 at 8:10AM

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Lumber is a unique investment and, perhaps, one of the most renewable resources around. Here's how to invest in the cyclical timber market.

From the walls of buildings to tables and chairs, lumber is all around. In fact, wood is the core of all the packages from online retailers and the padding that keeps baby bottoms dry at night. It's even found in cigarette filters. But what companies do you want to own to invest in this ubiquitous material? Here's how to invest in lumber, one of the most renewable resources in the world: Go directly to the source with real estate investment trusts (REITs) Weyerhaeuser Co. (WY 3.14%), Rayonier Inc. (RYN 3.36%), and Potlatch Corporation (PCH 4.90%).

The biggest tree hugger around

Weyerhaeuser owns or controls 13 million acres of timberland. It's the largest private timberland owner in the United States. The REIT's assets are spread across the country, with material landholdings in the southern, western, and northern regions.

A man standing in front of a huge pile of cut trees.

Image source: Getty Images.

Like all of the companies here, its forests are managed with great care to ensure that they are robust and healthy. That includes planting new trees when mature trees are harvested. This isn't a slash and burn business, Weyerhaeuser and its peers work hard to ensure that the forests they manage are a renewable resource for its shareholders and the world.

Weyerhaeuser has grown quickly in recent years, more than doubling its landholdings since 2012. That rapid pace of expansion is unlikely in the future, with smaller bolt on acquisitions more likely than large transformative ones, like the 2016 acquisition of Plum Creek, which was once one of its largest competitors. Weyerhaeuser's focus has shifted a little over this span, with its business now centered around the management of its timberlands (38% of adjusted EBITDA in the third quarter of 2017) and the production of wood products like lumber (48%, the remainder came from land management). Weyerhaeuser is the No. 3 lumber producer in the U.S. market with 19 mills, but it also produces a host of other wood products, like veneers and fiberboard.

All of that said, the company's revenues and earnings can vary considerably from year to year because wood is a commodity. And when it comes to the products that Weyerhaeuser produces, there is a tight correlation to the construction market. So expect some variability if you buy this, or any, timberland company.

An international feel

Rayonier Inc. is a much smaller timber REIT, with a portfolio of nearly three million acres. It's portfolio is heavily focused on the southern United States, with smaller positions in the northwest and New Zealand. Like its larger peer, Rayonier has used acquisitions to grow in recent years. However, because of the scale difference, it will be easier for Rayonier to expand its timberland business from here. Smaller acquisitions can still add material scale to its land portfolio, which is less than a quarter the size of Weyerhaeuser's. Rayonier doesn't own any lumber mills, though that is what much of its harvest is used for.

A pie chart showing the end markets for Rayonier's New Zealand business

A quick snapshot of Rayonier's New Zealand business and its key end markets. Image source: Rayonier.

One of the most important distinctions here, however, is Rayonier's exposure to foreign markets. The northwest has historically exported timber to Asia, so both Rayonier and Weyerhaeuser have an international reach. However, Rayonier's New Zealand assets serve only foreign markets. This country accounted for 40% of adjusted EBITDA in the third quarter of 2017. The company exports around a quarter of its northwestern timber, so a back of the envelope estimate is that nearly 45% of its business is tied to foreign markets, largely China.

Heavy lumber exposure

Potlatch Corporation owns around 1.4 million acres of timberland across five states, with exposure to the south, north, and northwest markets. It's small size relative to the above peers suggests that growth will be easier to achieve through acquisition, but also that Potlatch could easily end up an acquisition target itself.

One of the key distinguishing features here is Potlatch's use of timber sales contracts that are tied to lumber prices. The company's own lumber mills make up around 32% of EBITDDA (the extra "D" there is for depletion) and its lumber-linked contracts account for about 25%. In total, more than half of its EBITDDA is tied to lumber sales, which gives this tiny competitor the most direct lumber exposure of the trio.

Potlatch's expectation of continued increases in U.S. housing construction growth shown in two charts.

The U.S. housing market's slow comeback is expected to continue. Image source: Potlatch.

It also makes Potlatch the most reliant on the ongoing health of the U.S. housing construction market. Which might be exactly what some investors are looking for, but can also lead to large swings in the company's financial performance. To put it bluntly, Potlatch would be hit particularly hard if there were another housing led downturn like the one that occurred between 2007 and 2009. It and its peers are benefiting from the U.S. housing market's slow recovery, but Potlatch's leveraged exposure to lumber is something to keep in the back of your mind.

Invest for the wood, not the yield

The interesting thing about this trio of REITs is that they don't have huge yields. Weyerhaeuser's yield is only about 3.5%, Rayonier's is 3.2%, and Potlatch's is just 3%. These are relatively low yields for real estate investment trusts, which means they don't interest me all that much. The reason to own any of these REITs is their unique focus on timberland -- a truly renewable asset. If you are in the market for that exposure, all three of these companies should be on your watchlist. Weyerhaeuser is, by far, the largest player, Rayonier offers unique foreign exposure, and Potlatch's results are the most tied to lumber prices.

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Stocks Mentioned

Weyerhaeuser Co. Stock Quote
Weyerhaeuser Co.
$39.38 (3.14%) $1.20
Rayonier Inc. Stock Quote
Rayonier Inc.
$38.72 (3.36%) $1.26
Potlatch Corporation Stock Quote
Potlatch Corporation
$55.03 (4.90%) $2.57

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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