A big investment theme last year involved inflation and how rising commodity prices affect the economy. One of the best-performing commodities last year was lumber, which doubled in price during the summer.
Lumber is the primary product of timber real estate investment trust Weyerhaeuser (WY 0.04%), which just reported record earnings driven by rising lumber prices. Here is why the company expects the trend to continue in 2022.
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Weyerhaeuser benefited from rising lumber prices
Weyerhaeuser is a North American timber REIT that owns or controls nearly 25 million acres of timberland in the United States and Canada. The company also manufactures wood products, including structural lumber, oriented strand boards and engineered wood products in its 35 manufacturing facilities in the U.S. Its products are used primarily in residential construction.
The big increase in lumber prices drove record revenue and earnings for Weyerhaeuser. Revenue increased 35% to $10.2 billion, but earnings before interest, taxes,depreciation, and amortization (EBITDA) rose 86% to $4.1 billion. This increase represents the effect of rising commodity prices: Revenue rises, but the cost to produce is generally unaffected, so the additional revenue drops straight down to the bottom line.
Rising interest rates shouldn't be a major problem for the company
The big question for Weyerhaeuser is going to be the effect of rising interest rates. The Federal Reserve is poised to raise the Federal Funds rate starting with the March meeting, and rising interest rates generally translate into higher mortgage rates. If mortgage rates rise too much, too fast, it could depress demand for housing. That would translate into slower homebuilding.
CEO Devin Stockfish was asked about this issue on the company's earnings conference call, and he said that the company's big homebuilding customers are not making any adjustments to their order flow. One thing to keep in mind is that compared to historical averages, mortgage rates are still quite low, as you can see in the chart below:
30 Year Mortgage Rate data by YCharts
In addition, housing starts are still nowhere near boom levels and have been relatively depressed since the real estate bubble burst and the financial crisis began back in 2007. This has created a shortage of houses, and for-sale inventory at the end of December hit a 23-year low at only 910,000 units. At the current annualized sales pace of 6.1 million, this represents a 1.8 month supply, which is a record low, according to data from the National Association of Realtors.
The increase in mortgage rates is also being matched by increasing incomes, which will offset some of the cost of rising mortgage rates. The bottom line is that the supply and demand situation is so constrained that it will take years of building to get back to any semblance of normalcy. In addition, homeowners who are priced out of the market may choose to remodel, which is another big source of demand for Weyerhaeuser.
Weyerhaeuser just declared its supplemental dividend
The increase in lumber prices is also good for Weyerhaeuser shareholders, as the company has an unusual dividend policy. It pays a quarterly dividend, which is meant to be sustainable across the entire homebuilding cycle. It then pays a special dividend based on the company's earnings during the year. The company just announced its special dividend for 2021, which was the first under the new structure.
Weyerhaeuser paid normal quarterly dividends totally $0.68 per share for the year, declared a special dividend of $0.50 a share in December, and just announced its supplemental dividend of $1.45 a share, which adds up to $2.63 in per-share dividends for the year. If you had bought the stock at the end of 2020, you would have received a 7.8% dividend yield. The company also bought back $100 million worth of shares, and between the dividend and buyback, the company distributed 79% of its funds available for distribution. Weyerhaeuser intends to grow the quarterly base dividend by 5% per year going forward. As long as lumber prices hold up and homebuilding remains strong, Weyerhaeuser remains a stock that provides a hedge against inflation, something all investors should consider when building a portfolio.
