At The Motley Fool, we poke plenty of fun at Wall Street analysts and their endless cycle of upgrades, downgrades, and "initiating coverage at neutral." Today, we'll show you whether those bigwigs actually know what they're talking about. To help, we've enlisted Motley Fool CAPS to track the long-term performance of Wall Street's best and worst.
Weyerhaeuser whiplash
Make up your mind(s), Wall Street. Two weeks ago, Deutsche Bank took an ax to Weyerhaeuser (NYSE: WY). Noting that the shares had enjoyed a bull run on reports that China was buying up U.S. timber, the Teutonic megabanker shouted "Timber!" and urged investors to sell.
According to Deutsche, log prices are dropping, inventories of cut timber are stacking up from here to China, and "there has been no normal spring pick-up in wood products demand." Weyerhaeuser just trimmed second-quarter guidance, yet even as its bull thesis collapsed in the woods, no one noticed. Indeed, investors still aren't noticing. Since Deutsche's report came out, Weyerhaeuser shares shed only 1.8% of their value -- barely half the 3.4% decline on the S&P 500.
Perhaps it's this show of strength that got DA Davidson to rethink its sell rating on Weyerhaeuser yesterday. Although Davidson doesn't see a "near-term catalyst" that could result in significant gains, the analyst argues that Weyerhaeuser's "3% dividend yield" and $32-per-share "net asset value" make the shares worth at least $22. With the shares currently changing hands for just $20-and-change, Davidson made the logical decision and upgraded Weyerhaeuser to neutral.
Wait. Hold up a sec. Did you say $32?
Right. That threw me for a loop as well. According to Davidson, Weyerhaeuser possesses "superb timber holdings" and "significant earnings leverage [if and when the] housing markets recover." Granted, the analyst worries that until housing recovers, Weyerhaeuser will lose money on "wood products." And yes, Davidson reduced its earnings estimates to $0.37 per share this year, and $0.80 in 2012. Regardless, the analyst thinks even weaker earnings don't require selling the stock anymore, because Weyerhaeuser is still a fine "defensive" company.
I disagree.
Let's go to the tape
Listen, I sympathize with Davidson's predicament. It's warned investors away from Weyerhaeuser for years. It's stuck to its guns through housing boom and housing bust, only to find itself underperforming the S&P 500 by seven points on its prediction. I get that the analyst may no longer enjoy the "pain," and may be ready to throw in the towel on its sell recommendation. But the plain fact of the matter is that Davidson is wrong. (And not for the first time. According to our CAPS stats, fully 60% of Davidson's recommendations in the paper and forest products industry have historically underperformed the market.)
Consider: Weyerhaeuser sells for less than six times earnings today, and yes, that sounds cheap. On the other hand, few analysts expect Weyerhaeuser to grow very fast; 2.5% annual growth for the next five years is the consensus best guess. That's better growth than Plum Creek Timber (NYSE: PCL) is expected to produce, but worse than the growth rates at lumberjacking rivals Rayonier (NYSE: RYN) and Lousiana-Pacific (NYSE: LPX).
Cash doesn't grow on this tree
Even if you think six times earnings is a low enough price to accept minimal growth, consider this factoid: Weyerhaeuser's low P/E depends largely on the company's $1.4 billion in GAAP earnings. But in fact, the company's cash flow statement shows that actual cash profits back up just 13% of these reported earnings. Over the past 12 months, Weyerhaeuser generated a mere $183 million in free cash flow -- and that's the good news. The bad news is that historically, the company's done even worse than that. Over the five-year period from 2006 through 2010, Weyerhaeuser actually burned $1.4 billion worth of cash, even as it reported positive earnings of $803 million.
Foolish final thought
Fools, I'm no fan of investing in cash-burning enterprises. To me, Weyerhaeuser looks entirely too combustible. That said, there is one point in Davidson's moderately bullish rating that bears special mention. Let me preface it with a series of news items that have been catching my eye lately:
- For months, The Wall Street Journal has been reporting on a home-buying spree by Chinese investors in Canada.
- Yesterday, the Journal cited comments from Toll Brothers' (NYSE: TOL) CEO that suggest a rebound in housing sales could soon arrive in the U.S. Citing attractive pricing, low interest rates, and pent-up demand, Toll's booster-in-chief argued that he's starting to see homebuyers "move off the fence and into the market."
- That same day, International Paper (NYSE: IP) announced a hostile takeover offer for Temple-Inland (NYSE: TIN), a clear sign that valuations have gotten out of whack in the paper and forestry products industry. (At least IP thinks so.)
- Last but not least, this morning, the Journal noted that China is on an acquisition spree, shopping around the globe for places to invest its massive reserves of foreign currency.
If all of this is true, then Davidson's argument that Weyerhaeuser's net assets are worth $32 a share sets up the potential, at least, for a takeover offer from China. China's leaders certainly seem interested in the North American housing market. We know Weyerhaeuser's profits are tied to it. And we know China's already buying timber from Weyerhaeuser ...
Personally, I think Weyerhaeuser is overpriced. But China's no stranger to overpriced acquisitions. Plus, it's already buying from Weyerhaeuser; I wouldn't be shocked to wake up one morning and read in the Journal that it's decided to go ahead and buy the whole shebang.
