Why I’m Buying this Great Resources Play
Matthew is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
If you’ve followed me for any length of time, today’s trade for the “No Drip, No Mess” Portfolio should come as no surprise. There are few companies that I’ve written more about because despite the boringness of their business, the management team is an excellent case study on how to manage a public company for the benefit of shareholders. Not only are they the largest private landowner in the United States, but I view the company as an excellent long term income generator as I’m confident that the management team will keep creating value for investors. For these reasons and more I believe that Plum Creek Timber Co. (NYSE: PCL) deserves a place in our portfolio.
Why Plum Creek?
Plum Creek is one of the big four when it comes to timberland REITs but there are two reasons in particular that I like them the best for the long term. Other than some manufacturing assets, Plum Creek makes virtually all of their money from maximizing the value of their land and of their 6.6 million acres; a full 20% of it is in the Pacific Northwest. With Plum Creek being an income focused trade, I view these as the two keys to our investment thesis.
When looking at the timber REITs the first thing investors need to realize is that they are surprisingly different in terms of their asset portfolio. Both Rayonier (NYSE: RYN) and Weyerhaeuser (NYSE: WY) generate a lot of income from their performance fibers business, and in the case of Rayonier two thirds of the value of the company is derived from these non-timberland assets. Weyerhaeuser is even further diversified away from their timber assets as they have a portfolio of homebuilders that as a combined entity places them as a top 20 US homebuilder. Given the current near depression in housing, that’s not a business that I’d care to be invested in. Potlatch (NASDAQ: PCH) much more closely resembles Plum Creek in terms of asset profile, but one key differentiator - their Pacific Northwest acres – sets them apart.
Plum Creek has about 500,000 highly valuable acres along the northern Pacific Coast and another 900,000 acres in the inland west. At about 20% of their portfolio, these acres with access to both the highly populated west coast and the profitable export market are very important. Potlatch matches Plum Creek nearly acre for acre with their inland west lands, but they don’t have a single acre along the Pacific Coast. This is one of the reasons they had to chop 39% from their dividend at the end of last year. This acreage along the Pacific coast is strategically important as it gives Plum Creek the advantage of selling lumber into China due to quicker access to ports.
Not only has China dramatically increased their imports of logs from the US and Canada, but going forward Canadian production will be substantially reduced due to the pine beetle infestation. When you combine the supply restrictions in Canada between 7% and 15% of the North American lumber market with exports to China consisting of 5% to 7% of the market, you have a total supply impact between 12% and 22%. To put this into context, that’s equal to 15% of US housing starts or 600,000 starts. An investment in Plum Creek combined with our investment in Brookfield Infrastructure (NYSE: BIP) really positions the portfolio for this future supply and demand imbalance. While not core to our thesis for Brookfield, it is noteworthy that they own 655,000 acres in Oregon and Washington and an additional 634,000 acres on Vancouver Island. As Plum Creek is more dependent on timber prices, their Pacific Costal lands are very important to the company.
All this is great, but if we are not getting at least a fair price for the company then it’s not worth adding to the portfolio. In the case of Plum Creek, I think I can make the case that shares are at least fairly valued, if not substantially undervalued. If you look at the current market prices where they own land and multiply this by the acres they own you can get a rough idea as to the value of the company if they decided to just sell the land and not cut another tree. Take a look at the following chart:
|Timberland Location||Market High per Acre||Market Low Per Acre||PCL Acres||High Value||Low Value||Median Value|
|Southern||$ 1,900.00||$ 1,200.00||3,479,000||$ 6,610,100,000.00||$ 4,174,800,000.00||$ 5,392,450,000.00|
|Pacific Coast||$ 4,000.00||$ 2,500.00||492,000||$ 1,968,000,000.00||$ 1,230,000,000.00||$ 1,599,000,000.00|
|Inland West||$ 1,250.00||$ 500.00||899,000||$ 1,123,750,000.00||$ 449,500,000.00||$ 786,625,000.00|
|Northeast||$ 500.00||$ 300.00||999,000||$ 499,500,000.00||$ 299,700,000.00||$ 399,600,000.00|
|Lake States||$ 1,000.00||$ 500.00||770,000||$ 770,000,000.00||$ 385,000,000.00||$ 577,500,000.00|
|6,639,000||$ 10,971,350,000.00||$ 6,539,000,000.00||$ 8,755,175,000.00|
|$ 52.34||$ 24.89||$ 38.62|
If you tack on their net debt of around $2.5 billion and divide those values by their 161 million shares outstanding, you get a median value of just under $39 a share. This is adding absolutely no value for their energy and construction material assets, nor is it adding any value for their ability to sell lands for a higher-and-better-use or their profitable manufacturing segment.
As has been my practice whenever practical, I am recommending writing one November $35 put for a 3.5% allocation in the “No Drip, No Mess” Portfolio. The pricing is decent enough to make it worthwhile as the puts are yielding just a bit more than 3% as of this writing. If successful on this put write we’d be able to pick up shares for about 8% lower than the currently conservative fair value while locking in a dividend yield of nearly 5%. By writing these puts we’ll also pick up another $100 or so in cash to be used at a later date for something much more exciting than watching money grow on trees. When we do finally pick up shares we’ll try to generate more income over time by writing calls when shares are enough over fair value to make it worthwhile. We’ll use Plum Creek as a core income position where we’ll supplement the dividend with recurring option income whenever possible. Housing might be depressed and log prices might be low, but with their access to ports and fantastic management team, I think Plum Creek will continue to keep our portfolio mess free.
latimerburned owns shares of Plum Creek Timber Co. The Motley Fool owns shares of Brookfield Infrastructure Partners and Weyerhaeuser Company and has the following options: short MAY 2012 $33.00 puts on Plum Creek Timber Co. Motley Fool newsletter services recommend Brookfield Infrastructure Partners. 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.