Don't Miss the Forest For the Trees
Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The recent rise in lumber futures and last month’s news that October housing starts were at their highest level in four years suggest that this is a good time to look at forest products giant Weyerhaeuser (NYSE: WY), which I posted about back in May. In the earlier analysis of Weyerhaeuser and its competitors Rayonier (NYSE: RYN) and Plum Creek Timber (NYSE: PCL), I stated that Weyerhaeuser “is now close enough to realizing the profits from an upward swing in the housing cycle for a patient investor to consider purchasing shares at the current price.”
The share price back then was around $18.70, adjusted for subsequent dividends, and the company has enjoyed an outstanding surge in its share price to about $27.50 currently. This nearly 50% rise by Weyerhaeuser dwarfs the solid 17% gains for both Rayonier and Plum Creek, which themselves easily beat the 8.5% rise in the S&P 500. The market has gotten excited about the prospects for these companies that are leveraged to the housing market. So where do these companies, particularly Weyerhaeuser, stand now that they’ve risen substantially, and what might we expect in the coming quarters?
Before diving into the current situation and projections for the future, a few points from the earlier post need to be looked at to determine if they remain relevant to the analysis. First, more than three quarters of Weyerhaeuser’s revenue is still tied to the domestic housing market and about a third of its timber acreage is still in the most productive Pacific coast region. This means that the company continues to be well positioned to reap superior profit when the domestic housing market fully recovers. The Pacific coast timber holdings of Rayonier and Plum Creek are not as significant as Weyerhaeuser's at just 16% and 7% of revenue, respectively. To illustrate, on a per acre basis Weyerhaeuser generates about $80 of EBITDA, compared to just $56 for Rayonier and $37 for Plum Creek. Next, supply and demand trends are still favorable for all of the companies, but Weyerhaeuser has a leg up on its rivals because its leading share of Pacific coast timber will allow it to better capitalize on a mountain pine beetle infestation in Canada and a persistent log shortage in China.
Other factors previously identified as specific to Weyerhaeuser include an improving leverage profile, growing dividend, and effective expense controls. Each of these has continued or actually gotten better. Long term debt is now down to under $4 billion, or 48% of capital, from $4.5 billion, or 51%, at fiscal year end 2011. The dividend was increased last quarter to an annualized $0.68 per share from $0.60, which is a long way from the $0.14 bottom in 2010. Despite this recent 13.33% dividend increase, the current forward yield is about 2.5%, which is reduced from the 3.1% in May due to the sharp share price increase. Weyerhaeuser has continued its cost reduction efforts and operating margin improved to 11.4% for the third quarter and 9.8% for the second quarter this year, which are significant improvements over the prior year when operating margin was 6.4% and 7.9% for the third and second quarters, respectively.
Where Do These Companies Stand Now?
Typically I use price to earnings growth (PEG) multiples to compare the relative attractiveness of a set of companies. However, because the value of these timber companies are so dependent on the composition of their specific timber holdings and because their earnings can swing so wildly in response to economic conditions, PEG analysis is not the ideal metric to use. Instead, price to book analysis will serve to place the companies in some relative context.
Over the past decade, Weyerhaeuser has traded at the smallest average price to book at about 2.0x, while Plum Creek has had the highest average multiple of 3.75x and Rayonier has traded on average at 3.25x book. At the most recent book values, Weyerhaeuser trades at a 3.4x multiple, or 70% above its average. Plum Creek has an elevated multiple currently at 5.8x, or 55% above its ten year average, while Rayonier is currently the least above its average at 4.3x or 32% above the average. What this indicates is that the recent price action seems to have gotten ahead of the value being created by each company’s timber holdings, and that this advance is particularly acute in the case of Weyerhaeuser.
This state of affairs suggests that Weyerhaeuser has become less comparatively attractive, which makes sense given the difference in share price gains. However, over an extended period of time, I expect the company to use its higher productivity timber assets to create value at a rate that exceeds its rivals, and this will ultimately be reflected in higher comparative growth in book value.
Where Do We Go From Here?
If published estimates of housing starts at 1.5 million into 2016 are realized, a growth rate of nearly 14% is implied from the 894,000 figure for October 2012. Using the average monthly annualized housing starts of 612,000 for 2011 implies growth of almost 20% into 2016. This robust growth will certainly help the forest products companies with exposure to homebuilding, especially Weyerhaeuser. But at a current PE of 29x the consensus 2013 EPS estimates and an elevated price to book, I think shares are likely to have topped out for now. Weyerhaeuser remains the best of breed with several compelling competitive advantages, but not wanting to miss the forest for the trees, I would wait to have a better entry point before buying shares.
56Steve has no positions in the stocks mentioned above. The Motley Fool owns shares of Weyerhaeuser Company. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!
