Buy Trees...Sell Timber
At the recent Grant’s Fall Investment Conference, I heard Bob Saul deliver a presentation on investing in US timberland. Saul is a director at the very accomplished investment firm, Grantham, Mayo, Van Otterloo, and is a longtime investor in timberland. He knows his way around trees as well as anyone. And I expected to hear about the great wealth-preserving power of timberland and how to invest.
Saul’s outlook was bleak. In so many words, he said now is not the time. One attendee asked: “What do you think about timber REITs?”
Timber REITs, like regular REITs (or real estate investment trusts), pay out most of their earnings in dividends and enjoy tax advantages that come with the trust structure. Timber REITs, as the name implies, own timberland. Some of the larger publicly traded stocks include Weyerhaeuser, Plum Creek Timber, Rayonier and Potlatch Corp.
“They suck,” Saul said.
Nobody likes to read stories about what to avoid. But in the stock market, avoiding bad ideas can be as important as finding good ideas. This is a story about why you should not invest in timberland.
Saul has a long perspective on the asset. He remembers when nobody cared about timber. This was during the Internet bubble of the 1990s. “You couldn’t sell timber assets no matter how hard you tried,” he said. “Then after 2000 [when the tech bubble popped], timber became cool and the money started to pour in.”
Over the ensuing decade, some 70% of the legacy timberland acres changed hands. Industrial owners sold out to financial owners (i.e., REITs and other investors). “Essentially,” Saul said, “insiders were selling out.”
A bubble then developed in timberland. Yields fell as investors repriced timberland. The housing boom propelled much of the boom, particularly in the southeastern US. But then the housing bubble popped. And now the US timberland market is in a state of severe oversupply and overcapacity.
Particularly hard hit was the US South, once thought a low-risk “noble asset with a knowable history and very stable,” as Saul put it. Yet southern timberland wound up as the highest risk because of the ties that bound it to housing starts. “Most of the diminutions in values we’ve seen have come in the US South,” Saul continued, with 40% drop-offs in prices being common.
Even more disturbing is a drop in processing capacity. Mills shuttered. Demand for logs evaporated. If you’re stuck in a weak market, you are captive to that market. “Timber is a heavy, heavy commodity,” Saul reminds us. “If you are shipping your timber more than 100-120 miles, then you’re shipping air, as we like to say, because your value is being essentially bled out of it by the transportation costs.” So if you didn’t buy it right, you are now waiting for the markets to turn around.
Another disturbing trend Saul pointed to was the drop-off in demand for high-quality timber and bigger logs — which is the higher-margin product. “All you’re producing now is small logs. Your high-margin product is down,” Saul said.
The US South is in bad shape also because it’s landlocked. In the West, you can export timber to China. There, prices hit all-time highs last summer, though the market is very volatile.
Any good news? Pulp demand is stable. “You know all that money we’re printing?” Saul joked, referring to the Federal Reserve’s policies. “We’re making that paper.”
Timberland, for all its troubles, is at least easy to figure out. “This is not rocket science. It’s priced like real estate,” Saul says. As with real estate, location is critical. You want to be in an active area where a good contractor base ensures demand for your timber. If your contractors go away, you’re screwed — as many timberland owners have now discovered.
“The fastest growing trees in the US are in Hawaii,” Saul said, “but the markets there aren’t that great, so pricing isn’t any good. The Pacific Northwest has some of the best forests on Earth — western hemlock, Douglas fir and some cedar. California is Oregon’s biggest export market for that timber, but you can also ship to Asia.”
The South is where the trouble is and where you see timberland actually being converted into agricultural land, which is worth more.
Another problem: Timberlands have lots of obligations, usually long-term contracts. When the supply-demand balance gets upset, it can take a long time to work out of it. So if you’ve lost contractors to bankruptcy and such, you won’t easily find someone else to take your timber. Most of these supply agreements run out to 2015-25. Until then, “investors are hanging on like grim death.”
Unless the US housing market starts building lots of new houses, there isn’t anything to pull timberland investors from the quagmire. Saul was a definite bear on the housing market. (I like US housing for rental property, but this is different from depending on new housing starts, as timberland does.)
So what about those timber REITs?
Saul said: “The problem is that to be a REIT dividending out cash to support your share price, you need excellent cash flow… [But] timber doesn’t grow that fast no matter where you buy.” Perhaps, Saul offered, if you grew nothing but eucalyptus in Brazil or Uruguay, you might maintain an 8-10% dividend. In the US, trees don’t grow that fast. Bob thinks the best one can do is real rates of return of 3% over the very long term.
Anything much beyond that and Saul would suspect “a certain kind of scheme that eventually runs out.” The problem is that timber REITs could keep up appearances for a long time. Most timber REITs are well managed, Saul conceded. “It’s just that the underlying premise is a specious one.” And I would add that, for most of them, they bought a lot of trees during the boom years.
I like to poke around in the aftermath of a crisis, but this is one sector that is still sick.