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When Does the Bubble Burst?
INITIATION
Initiating Coverage on Timber REITs
Timberland values have continued to rise despite a housing downturn, lumber
prices bouncing around their lows, mediocre sawlog markets, and expected
increases in supply from disease-prone areas. We get a lot of calls from
investors asking if timber values can continue to rise from here. The timber
bandwagon has only gotten bigger recently, and industry sources estimate that
more money (~$4bn+ or 10%+ of the asset class) will pour into timber over the
next few years. Timber investment is viewed as a noncorrelated asset class,
and its inflation protection characteristics and solid historical returns are driving
most of the outperformance, not underlying business fundamentals.
So, with so many investors chasing timber assets, should you be too? Over the
near term, timber values will probably continue to rise, driven by net inflows
bidding up multiples and net asset values on timber stocks. Timber is less
volatile than the market, so investors are also attracted to it as a safe haven as
the US economy slows. But with all the money chasing timber, real returns are
falling from historical levels, and a tighter credit environment will likely drive
timberland values down from historical highs over the medium term. We would
put money to work in timber over the next 24-36 months, but as returns come
down, we would look to reduce exposure. One of the two ways (besides direct
investment) to participate in timber is by investing in a timber REIT.
We are initiating coverage of the timber REITs with an Outperform rating for
Rayonier and Neutral ratings on Plum Creek and Potlatch.
■
Rayonier’s record of sustainable dividend increases, disciplined timber
acquisitions, and a pulp business that is humming should provide solid
returns for income-hungry investors. Our price target of $50 is based on an
average of our net asset valuation ($50/share) and normalized EBITDA
($50/share).
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Potlatch converted to a REIT in 2006, has new leadership, and its
restructuring benefits should continue. Timber is now at the forefront of the
company’s strategy and noncore businesses could be sold (which would
likely take a while), creating a more focused company and reducing the
“paper discount.” Our price target of $48 is based on an average of our net
asset valuation ($50/share) and normalized EBITDA ($47/share).
■
Plum Creek is the only timber pure play among these REITs and it has a
strong track record. Our price target of $44 is based on an average of our
net asset valuation ($45/share) and normalized EBITDA ($681mm at 15.5x).
We like Plum Creek’s diverse timber portfolio and would like to see more
dividend growth and focus on free cash flow.
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