Is Plum Creek’s Dividend Really Secure and Reliable?
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
I’ve been invested in Plum Creek (NYSE: PCL) for a long time, happily collecting dividend and option income along the way. Shares for the most part have meandered along like a calm mountain stream; however, their underlying cash flows have been drying up. The question that investors should be asking is if their dividend is as secure and reliable as management would seem to indicate.
As a Real Estate Investment Trust (REIT), Plum Creek is required to pay out 90% of their ordinary income as dividends to their shareholders to avoid double taxation at the corporate level. These dividends from REITs are taxed at the investor’s ordinary rate. However, in the case of Plum Creek and other timber REITs, most of their profit is generated from the sale of standing timber, which is considered capital gains and thus only taxed at the 15% long term rate. These advantages give these timber REITs exceptional characteristics for dividend seeking investors.
The problem right now is that industry fundamentals are weak thanks to housing, which is causing the weak lumber pricing. That, in turn, has been drying up the cash flows. Across their industry peers we’ve already seen a dividend payout reduction from Potlatch (NASDAQ: PCH) to the tune of 39% last December, which coincided with a 15% reduction in harvest levels.
Rivals Rayonier (NYSE: RYN), on the other hand, increased their dividend by 11.1% a year ago while Weyerhaeuser (NYSE: WY) has only recently converted to a REIT. Both Rayonier and Weyerhaeuser have very stable performance fibers businesses that have helped solidify their cash flows to offset weakness in their core timber business. So the question investors need to be concerned about is if Plum Creek follows Potlatch in chopping their dividend, or if they can grow it like Rayonier.
The Cash Flow
It all comes down to the cash flow at Plum Creek, and if it keeps heading lower that dividend won't remain at its current level. According to the latest investor slide deck from the company’s presentation at a Deutsche Bank conference, investors should have no concern:
However, just looking at the slide in cash flow, it’s hard not to be concerned. If housing has not bottomed, how can they be so sure that the dividend is indeed secure and reliable? Management said they are expecting growth in EBITDA in 2012 from $450 million in 2011 back to around the 2010 level of $500 million. They see improved prices and higher harvest volumes with stability in their rural land markets, manufacturing business and non-timber resources. Exports to China are playing a major role in both volumes and stability and with 20% of their acreage in the Pacific Northwest they have exceptional access to this growing market. When you factor in the pine beetle problems in British Colombia, which have caused harvest levels and lumber production to plummet, you can see why Plum Creek has less reason to be concerned than Potlatch, which doesn’t have the same access to export as their acreage in the region is much further inland.
As management gazes into the future they see four major drivers that will increase their cash flow over time: volume and price improvements, cyclical recovery in the sawlog markets, structural changes in the market and eventual inflation.
The structural changes due to the pine beetle and China alone could double current EBITDA in their timber resource segment over the next decade. Overall they see that segment’s EBITDA going from just under $200 million last year to nearly $700 million over the next decade. Even if demand doesn't increase and with that prices don't improve, management can simply stop delaying harvests and just take the market prices. Their practice has been to let trees keep growing and maximize the value when demand lifts prices. They are doing this to the benefit of long-term shareholders, and they have the flexibility to manage their harvest levels to lock in current cash flow. While a lot must go right in their markets for their projections to play out, they do have other opportunities ahead of them.
A small but growing segment is their non-timber resources segment. This segment consists of their wind and surface assets, construction materials and their energy assets. They project their revenue to grow from around $20 million last year to nearly $40 million in the next decade. While it will never be a large business it is driving incremental revenue and could grow beyond their current asset base. Just recently they invested in a producing construction materials asset that was accretive to cash flow. They spent $12 million to purchase 28 million tons of aggregate reserves, which will generate $1.3 million in cash flow this year. The potential is there for Plum Creek to acquire similar assets from either distressed or cash-strapped operators at exceptional values.
Plum Creek continues to manage their portfolio of timberlands for their highest value. Of their 6.6 million acres, only 5.4 million are viewed as core by the company. The rest of the portfolio can be sold not only to support the dividend if needed but also be reinvested in core timberland purchase. They’ve had to seek unconventional ways to access timberlands given the currently limited marketplace, as there simply are no natural sellers. What they’ve done is engaged in both a joint venture and timber deed transition to continue to reposition their portfolio. Overall, the management of their portfolio is to the benefit of shareholders and as volume and prices do improve their rebalanced portfolio mix will lead to increase cash flow.
Even though the fundamentals appear weak, Plum Creek has the flexibility to continue to manage their dividend through smart capital allocation while they wait for improvements in their cash flow. They have a well laddered debt portfolio and just a 24% debt to enterprise value to go with a 4% weighted average cost of debt and an investment grade rating. They have multiple levers they could pull if needed to ensure they have the cash to pay their dividend and I have no doubt they intend to use them. Given the future industry fundamentals I think management’s patience will pay off. Not only will the dividend be sustained but when cash flows do improve, investors will be rewarded with a growing dividend.
latimerburned owns shares of Plum Creek Timber Co and is short AUGUST $38 calls on Plum Creek Timber Co. The Motley Fool owns shares of Weyerhaeuser Company and has the following options: short MAY 2012 $33.00 puts on Plum Creek Timber Co. 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. If you have questions about this post or the Fool’s blog network, click here for information.