A little over a year ago, I pointed out that timber makes an interesting investment. During hard times, most companies see sales drop, and as their inventory ages, it declines in value. Timber companies are different. While the price of timber as a commodity may fall from lack of demand, a timber company's actual "inventory" – i.e., forests – will increase in value, both due to the simple fact that trees grow and also because older trees have higher-quality wood. When demand comes back, the company has more and better things to sell.
While I made no CAPScalls in that article, it's worth noting that three out of the four companies I mentioned have significantly outperformed the market since then. Part of this has to do with the housing recovery finally taking hold. Construction of new homes has begun rebounding, which means demand for timber is coming back. Read on to see which of those companies I'm making a CAPScall on today, and why.
Barring a delayed Mayan apocalypse, 2012 is on track to be the first year since 2006 to show a gain in housing prices, albeit a modest one. Unlike 2010's dead cat bounce (even a dead cat will bounce if you drop it far enough, as one of the market's more disturbing adages goes), this one seems legitimate. As my colleague Morgan Housel noted recently: "New home construction is up 42% in the last year. Homebuilder confidence is at the highest level in six years. 1.3 million fewer homes have an underwater mortgage today than did in the second quarter."
The rise in new home construction is sure to benefit retailers like Home Depot (NYSE:HD) and Lumber Liquidators (NYSE:LL), both of whom have seen same-store sales increase during the year. Lumber Liquidators in particular has had an amazing year, with net income up almost 60% thanks to the company's three-point plan to boost sales and reduce costs, moves which recently helped CEO Robert Lynch win the Motley Fool's CEO of the Year contest.
Part of what makes Lumber Liquidators' performance this year impressive is that it was done against the backdrop of rising lumber costs. Lumber prices are up 47% this year, reaching a seven-year high. Because the housing recovery is still in its infancy, some are predicting that lumber will continue to be one of the top-performing commodities in 2013. As the price of homes rises, the price of the construction materials needed to build them does as well, but lumber is also being helped along by the fact that many mills closed down during the downturn, so inventories are now low even as demand is growing.
How to invest
Wood itself is a difficult commodity to invest in, unless you want to try your hand at the futures market. Most timberland is owned privately, but there are four main real estate investment trusts that give access to ordinary investors. None of them focus purely on timberland, but Plum Creek Timber (NYSE:PCL) comes the closest, getting about 72% of its 2011 sales from timber and manufactured wood, compared to just 53% for Weyerhaeuser (NYSE:WY), which owns the most timberland.
A big part of Weyerhaeuser's sales come from paper products – things like sanitary tissues, printer paper, and food packaging, none of which are particularly connected to a housing recovery and some of which are undergoing long-term declines as people use more e-readers and less paper. Plum Creek's greater focus on construction has allowed it to beat Weyerhaeuser's sales by a modest amount this year. The company's sales should pick up more in 2013, as there is a slight lag between timber prices and lumber prices, which management expects to shrink over the next few months.
One major concern is that Plum Creek carries a lot of debt. The company's debt grew significantly during the recession, but if a true recovery takes hold, its real estate holdings should rise in value, bringing its debt-to-equity ratio more into balance, and increased sales will help the company pay its debt down.
Another concern is that the company's stock isn't exactly cheap. But with a dividend of nearly 4%, I'm not terribly concerned about the P/E ratio.
The long-term nature of timber makes this a great stock to own period, and the nascent housing recovery makes it an even better stock to own now. That's why I'm putting my CAPS all-star rating on the line and making an outperform CAPScall today.
Jacob Roche has no positions in the stocks mentioned above. The Motley Fool owns shares of Lumber Liquidators and Weyerhaeuser Company. Motley Fool newsletter services recommend The Home Depot and Lumber Liquidators. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.