The Effects of an Improving Housing Market

Robinson is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The housing market has been improving recently. The low interest rates set by the Fed to stimulate the economy and the declining unemployment rate have positively influenced the housing market. The demand for new homes is strong. According to several construction companies, there was a rise in new homes orders in the first quarter of 2013.

Houses in the United States are mainly built from wood. Further, S&P expects an increase in home starts of 35% in 2013. I believe that a strong demand for wood is imminent, and it will push commodity prices higher.

Therefore, I would like to look at some companies that might benefit from higher timber prices. Weyerhaeuser (NYSE: WY) and Rayonier (NYSE: RYN) each enjoyed an outstanding performance in the first quarter of 2013, but I believe the companies will continue to grow in the interim.

Rising timber prices should help these companies

Weyerhaeuser is one of the leading U.S. forest-product companies with operations focused in Southern California, Nevada, Washington, Texas, Maryland and Virginia. The company reported increased net earnings totaling $144 million for the first quarter in 2013, compared to $41 million a year ago.

The company pays a 2.5% dividend, which corresponds to a payout ratio of 71%. Before recently, the last time the dividend was hiked was in August of 2012. However, on June 16, the company hiked its dividend again by 10% to $0.22 per share. The free cash outflow narrowed from $124 million to $109 million on a year-over-year basis. As the company continues to expand its free cash inflow, the dividend payment should not be in jeopardy.

In the near future, Weyerhaeuser expects higher sales volumes for all of its forest products. Also, for the second quarter, the company anticipates comparable earnings to the previous quarter.

Weyerhaueser has acquired 645,000 acres of high-value timberland in Washington and Oregon. This acquisition provides huge value for the company as the prices for lumber have declined by 20% year-to-date, and the company has paid a fraction of its price. As the housing market continues to improve, demand for lumber should gain strength, and prices for the commodity should rebound.

In addition, the company has properties in regions where the risks for forest fires are minimal. The prices of lumber should increase in the summer since it is expected to be hotter than usual, and forest fires could consume large amounts of timber. Weyerhaueser is expected to lose a minimal amount of lumber to fires, and it will be able to sell its products for a premium due to a dim supply of lumber.

Overall, the company should fare well in the interim, and a long position is highly recommended.

Rayonier is another major player in the timber business. Its major segment is  fiber production, which accounted for 70% of sales in 2012. The company manufactures high-value cellulose and absorbent-fluff pulp. The price for cellulose specialties is expected to increase 3% in 2013. For the first quarter, Rayonier reported a rise in revenue to $393 million, compared to $336 million last year. Its net income rose to $147 million, or $1.13 per share, from $53 million, or $0.42 per share.

The dividend safety seems stable in the future. The company finished the quarter with net cash and cash equivalents totaling $266 million compared to $236 million a year ago. The company was able to generate $57 million in free cash flow. Dividend hikes may be expected with such a strong balance sheet.

The company has a strong presence in the Atlantic and the Gulf of Mexico. Home prices are expected to rise in that region for the rest of 2013, and Rayonier’s revenue should be higher. Rayonier also exports forest products to China, and the demand should increase for the rest of 2013.

Some companies might not be as profitable

Resolute Forest Products (NYSE: RFP) fabricates a variety of papers, including newsprint, coated and specialty papers. The company did not fare well in the first quarter of 2013. Although its sales rose by $20 million to $1.1 billion year-over-year, an increase in its costs of operation resulted in negative net income. The company's net income resulted in a loss of $50 million, or -$0.05 per share.

What worries me is the negative free cash flow generated from the company. The cash flow from operating activity swung to a loss of $20 million from a gain of $57 million last year. After capital expenditures, its free cash flow flipped to a loss of $60 million. The company does not look healthy in financial terms.

To repay its debt, the company issued $600 million in senior notes due 2023 at 5.8%. The company plans to use the capital to repay $501 million outstanding 10% senior secured notes due by 2018. It sounds like using a credit card to pay another credit card. At some point in the future, the strategy may not work.

Apart from the imminent struggle that the company will have to repay its debt, the future of its paper business does not seem promising. Other companies such as Weyerhaeuser have decommissioned their paper production divisions because they are becoming unprofitable. Technology has pushed consumers to the digital era, and the demand for paper is declining. Also, as the housing market continues to recover, a strong demand for lumber products will increase the costs of operation for Resolute since wood is the raw material to fabricate paper products.

I believe Resolute Forest Products will have financial issues in the near future, and I do not recommend having a long position in this company.

Let’s wrap it up

The housing market is improving. Housing prices and new-home orders are jumping. Therefore, the demand for lumber should increase. Weyerhaeuser and Rayonier are positioned to bring further growth and capital appreciation to their stockholders. Resolute Forest Products is in imminent danger since the company had a negative free cash flow. The demand for its paper products should weaken while its costs of operation will increase.

Weyerhaeuser was clever enough to shut down its paper production facilities. Rayonier will see increasing revenue as the demand for its specialized fabrics grows stronger. For these reasons, having a long position in Weyerhaeuser and Rayonier may not be a bad idea.

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Robinson Roacho has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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!

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