While money doesn't grow on trees, they can still be a great investment. Just ask timberland owner Weyerhaeuser (WY -0.51%). The real estate investment trust (REIT) cashed in on higher lumber prices last year to generate record cash flow. That's enabling it to pay out a monster dividend to investors this year.
Here's a look at payment trends and what investors can expect from the timberland REIT in the future.
Cashing in on a strong lumber market
Weyerhaeuser delivered record-setting results last year. The REIT generated $4.1 billion of adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA). That was up 86% year over year, driven by higher lumber prices, which boosted its timberlands and wood products segments. Weyerhaeuser also generated record full-year cash flow from operations of $3.2 billion and adjusted funds available for distribution (FAD) of $2.6 billion.
The company's unique dividend framework set a target to pay out 75% to 80% of its FAD to investors via dividends and share repurchases. That led it to declare a supplemental dividend payment of $1.45 per share, which it will pay later this month. That's a 3.6% income yield on the recent share price. It complements the REIT's already solid base quarterly dividend of $0.17 per share (an above-average 1.7% yield at the current share price).
In addition to that dividend, Weyerhaeuser also paid a $0.50 per share interim supplemental dividend last year and repurchased $100 million of its stock. Add it up, and the REIT returned $2 billion, or 79% of its adjusted FAD, to investors.
What's driving the REIT's dividend strategy?
Weyerhaeuser unveiled its new dividend framework in 2020. The REIT initially suspended its payout in early 2020 during the uncertainly caused by the pandemic. It reinstated a dividend later that year, implementing a base plus variable supplemental dividend framework.
Driving the dividend strategy shift is the volatility in the REIT's earnings. Unlike most other REITs, Weyerhaeuser doesn't rent its real estate under long-term leases that generate predictable rental income. Instead, it makes money selling lumber harvested from its timberlands, wood products manufactured at its mills, and real estate for higher and better uses. This business model exposes it to commodity price volatility, impacting earnings and cash flow.
Commodity price volatility is driving a growing number of natural resources companies to adopt adjustable dividend frameworks. For example, Devon Energy (DVN 0.20%) unveiled the oil and gas industry's first fixed-plus-variable dividend framework last year. It pays a fixed base dividend that it can sustain throughout the commodity price cycle. In addition, it pays out up to 50% of its excess free cash flow each quarter via a variable dividend. This strategy rewards investors when oil prices are high while giving Devon greater financial flexibility during a downturn.
Other energy companies have adopted similar frameworks of paying variable or special dividends. Likewise, many mining companies have adopted variable dividend programs.
What can dividend investors expect from Weyerhaeuser in the future?
Weyerhaeuser's dividend strategy is to pay a sustainable base dividend that it aims to grow by 5% per year through 2025. It intends to supplement that base dividend with an additional cash return to achieve its payout target of 75% to 80% of its adjusted FAD per year. It has the flexibility to return that money to investors via its share repurchase program -- it has $926 million remaining on the current authorization -- or a supplemental dividend that it would pay in early 2023.
The REIT could pay out another sizable supplemental dividend next year, given its outlook and current lumber pricing. The company expects its first-quarter earnings from timberlands to be significantly higher than the fourth quarter. Meanwhile, it sees slightly higher real estate, energy, and natural resources earnings and comparable results for its wood products segment. Whether it can continue generating strong earnings depends on lumber prices, which have been extraordinarily volatile, rising 45% since September. If lumber remains strong, it will give Weyerhaeuser the funds to pay another massive supplemental dividend.
A REIT to cash in on lumber prices
Weyerhaeuser has a unique dividend framework in the REIT sector. It offers investors a sustainable, growing base dividend. On top of that, it hopes to provide them with additional income during periods of higher lumber prices. That makes it an interesting REIT for investors looking for passive income with upside potential.