Timber

A report in the Figaro yesterday brought good news. Europe is enjoying a baby boom, with France leading the way. Birth rates had fallen so low that it looked as though Europeans might be exterminating themselves. But the world wasn’t going to end without a bang, it appears. Now birth rates are rising sharply. Europe is saved.

Another article in Figaro included a photo of a forest being burnt off so that the land could be used for farming. This, along with the baby boom, served to focus our attention on a subject we promised to address many weeks ago: trees.

Jeremy Grantham has surveyed the investment landscape of the last 100 years. He noticed that every bubble – wherever, whenever and in whatever it occurred – had sooner or later reverted back to trend. He also found that one investment – trees – had provided fairly consistent healthy yields throughout booms and busts, bulls and bears, inflation and deflation.

What about war? The interview pre-dated the terrorists’ attack and so no mention was made of it. But we presume that, even during wartime, trees – like children – still grow.

We promised to look into the matter. In the following letter, we keep our promise.

Our research took us back to an issue of Grant’s Interest Rate Observer from December 1999, a month in which the Grant’s team had evidently decided to shrug the burden of watching interest rates and go back to nature.

There, we discovered that throughout the last century “trees beat stocks,” as Grant’s put it. A chart shows real growth in timber prices rising at twice the rate of the real rise in S&P prices, 12.8% compared to 6.4%.

There, too, we found Jeremy Grantham, discussing what must be a favorite subject: “Since 1910,” said Grantham, citing U.S. Forest Service data, “real timber prices have compounded at 3% per annum.” Compare this to the real price per share of the S&P 500, which compounded at 2.2%, he suggested, or real earnings per share of the S&P 500, which compounded at 1.4%. And though timber pays no interest, it does produce yield: on average 6%.

But here at the Daily Reckoning, we are suspicious of very long periods of above-market performance. They are often followed, we’ve noticed, by very long periods of below-market performance.

“The risk in timber,” Grantham explained, anticipating by two years our objection, “is that it stops raining, or the sun stops shining. [Or] if we have a meteorite hit and we get several years of dust.” In addition, there are man-made disasters, such as bear markets. “There were three this century for American stockholders,” Grantham continued. “In each of them, however, timber prices were as stout as oak.”

But we Daily Reckoning readers are skeptical. Nature does not give something away without taking something back.

“What’s the catch?” we ask ourselves. “The catch is that it takes patience to grow a tree,” we answer our own question, “and the expectations are modest, after all.”

Grant’s article was written at a time when the world had little patience and very immodest expectations. Investors greatly preferred the fast growing weeds of the “new economy” to the great oaks of yesteryear. Two timber companies were featured in the article. Evergreen Forests was then selling at a 38% discount to net asset value, with a market cap of just $32 million.

Sino-Forest, another timber company with large holdings in China, was compared to a dot.com with interests in the same part of the world:

“China.com is valued at 191 times annualized nine-month revenues; Sino-Forest at 0.88 trailing 12-mo. revenues; China.com at no multiple to nonexistent earnings, Sino- Forest at a multiple of 4.2 to fast-growing earnings. Sino-Forest has a website, too.”

What happened to China.com might have been predicted. It is now trading at a little over $2 – down from a split adjusted peak of $166 (which occurred, ironically, a month after the Grant’s article was published). What’smore, China.com has a big N/A in the P/E column.

What about the timber companies?

I turned to my old friend, Rick Rule, who discloses that he is a major shareholder in Evergreen, for an update: “The timber markets are headed broadly lower,” Rick writes, “with Evergreen being no exception. Globally, pulp and paper demand is soft and getting softer, while dimensional lumber (used in frame construction) demand is plummeting.”

Rick tells me that “Wild Harvest” supply – timber from non-cultivated sources – enjoys an implicit subsidy in many areas. It is often owned by governments that distribute cutting rights below fair market value as economic development incentives…or for other less popular reasons.

“My belief is that the next two years will be lousy for log pricing,” says Rick, “except in the good old U.S.A. where quasi-protectionist legislation shields U.S. producers from formidable Canadian competition, NAFTA not withstanding. In New Zealand (Evergreen’s domicile) the near-term woes are compounded by the impacts of 35 years of direct and indirect government subsidy to the silvicultural industry. Timber plantations that are currently maturing have substantially more timber available than the milling and processing industries have either markets or physical processing capacity for. The situation is so extreme that the standing inventory – unharvested trees – is referred to as ‘the wall of wood.'”

So why play in such a decimated sector?

“Because two years is not such a long time,” suggests Mr. Rule, “and because the assets are of extraordinary quality and CHEAP.” The finest timber play on the globe for most investors, he says, is right there in the good old USA…

“Plum Creek Lumber: a REIT owning about 7,000,000 acres of fee timberland, making it the second largest fee landowner in the country. The company’s enterprise value (market cap + net debt) values the land at roughly $800 per acre…very cheap. The company sells at a steep 23 times trailing earnings and 12 times trailing cash flow to yield 8.4%.

“Longer term the company’s superb timber assets will pay for a lifetime. If panic selling brings the price of this company down to 22 this will be a legacy buy.”

Of the Grant’s recommendation from ’99, Rick has this to say: “Evergreen is a special case. They control some of the finest cultivated timber in New Zealand. The short term outlook for New Zealand timber is lousy, but 5 years out it is superb…”

Evergreen currently sells for about a third of what Rick estimates its replacement value to be and half of his estimates for the discounted value of its future after tax cash flows.

“Timber land is the only ‘developed’ real estate asset I know that truly grows over it’s productive life,” says Rick, “but this game is not appropriate for the impatient speculator.”

Bill Bonner, biding his time…patiently.
October 18, 2001

“The United States historically has had a perfect record when it comes to rebounding from the most difficult times,” writes Peter Lynch in a double-page spread in Barrons. “In the past 50 years, we’ve had 9 recessions and we’ve had 9 recoveries…If you believe in the strength of the American resolve, hard work and innovation, then take a long-term view and believe inour economic system. I certainly believe.”

“Rate cuts, tax relief and fiscal stimulus will aid the rebound in consumer spending and corporate investment,” writes market strategist Joseph V. Battipaglia.

“The catastrophe could turn out to be the catalyst for an economic and market recovery,” adds my old friend Robert Carlson.

Barrons, eager to give readers a way to take advantage of this great opportunity, gives readers a “shopping list” of “solid stocks…marked down 75% and more…”

On the list, we find Sun Microsystems, down 84%, and now available at just 88 times earnings. There is also EMC, down 87%, at the bargain price of 74 times earnings. And Yahoo!…now priced at only 113 times earnings…after the market knocked off 95% of its value.

Are these great bargains, or what? And, as we all know, corporate earnings are going to bounce back in2002, right?

Well, maybe not.

“It seems inevitable that for a long spell to come, we’ll be a nation looking over its shoulder,” writes Alan Abelson. “To illustrate the potential economic impact of a more apprehensive consumer, let’s suppose he or she chooses to save a little more, spend a little less, not an unreasonable disposition in the circumstances.”

Abelson then does the same math we have done in the Daily Reckoning, but uses a rounder number: “By one reliable reckoning, [not ours], every 1% increase in the savings rate is equivalent to $100 billion. So if savings rise by only 1%…all the fiscal stimulus that Washington is proposing, and then some, would be canceled out.”

What if baby boomers get in a panic about having money for retirement…and savings go back to early 1980 levels? I would still believe in our economic system…but I wouldn’t want to own Yahoo!.

Eric, what’s the news from Wall Street?

*****

Eric Fry in New York:

– Another day, another anthrax sighting. Or two. Or thirty. This ubiquitous bacteria is proving to not be bullish – except perhaps for the oil market. (More on that in a moment).

– The stock market jumped higher from the opening bell, thanks to some not-horrible earnings reports from IBM and Intel. But early morning glee gave way to anthrax- induced gloom, when the news hit the wires that the deadly spores had turned up in Governor George Pataki’s midtown Manhattan office.

– Trying to explain the inexplicable rallies in the face of continuing crisis, Options Underground’s Adam Lass writes of “Two things that I can see…One is the inverse of the panic selling we saw at the top: ‘Panic buying’ driven by the fear that one would miss out on a wartime rally. While there are certainly gains to be made…early entry into these rallies is frequently punished by the bottom.”

– The second is what Lass calls the “visible” hand, or “someone buying like mad in the last 30 minutes of trading…regardless of news or even sanity. Moves like this were the hallmark of the Clinton era ‘Plunge Protection Team.'” (Options Underground)

– Even if there is such a beast in place with the Bush administration, he was nowhere to be seen yesterday. The Nasdaq, which had gained almost 2% to start the day, tumbled 4.4% by the closing bell. The Dow fell 151 points to 9,233.

– The bio-terrorism wave sweeping over Manhattan is making this thriving metropolis feel more and more like a vast petri dish. And yet, anthrax or no, I had lunch yesterday at the Oyster Bar in Grand Central Station. My Pemaquid oysters from Maine were delicious – and, I’m delighted to report, contained neither marine bio-toxins nor bio-terrorist toxins.

– But fear and anger are in the air, if not on the menu. And that is likely to have a major effect on world oil prices. In the Middle East temperatures are rising. In Washington, even Democrats are sounding hawkish. There’s an old saying that a conservative is a liberal who’s been mugged. How true this is turning out to be: Al Gore’s former sidekick, Democratic Senator Joseph Lieberman, has taken the lead in the U.S. Senate in calling for the ouster of Saddam Hussein.

– Not that Lieberman is alone. Each new anthrax attack unifies “both sides of the aisle” in Congress in their approach to terrorism: Bomb the bastards.

– Iraq’s Hussein is clearly the next target of choice – and that may mean that anthrax is bullish for the price of oil. “If [U.S.] intelligence agencies find an Iraqi link to the anthrax attacks, that would obviously increase the chances of a major military offensive against Saddam Hussein,” says ISI’s political analyst, Tom Gallagher. “Iraq exports more than 2 million barrels of oil a day, which could be directly disrupted. In addition, our coalition partners in the Middle East, including Saudi Arabia, could be expected to strenuously object to an attack on Iraq and might be less cooperative on keeping oil prices lower.”

– Our man in the resource sector, Outstanding Investments editor John Myers, has been cautioning for weeks of the simmering instability in the global oil market.

Just days before the World Trade Center attack, Myers wrote, “Even as you read this letter, the clock is ticking down on Middle East peace. Soon a bomb could erupt that will blow the lid off of energy prices and put a premium on North American oil and gas supplies… North America’s vulnerability is that conventional oil supplies in United States and Canada have fallen dramatically over the past two decades. That means there is a critical reliance on Persian Gulf oil.” (see: Wolf At The Back Door)

– For now, complacency rules in the oil market. According to Tuesday’s American Petroleum Institute inventory report, the country is swimming in crude oil. But if our national cross hairs train on Iraq and Saddam Hussein, we could expect to see a little less crude oil in inventory and much higher prices.

– Suddenly inflation doesn’t seem so far-fetched a possibility.

– For those investors who anticipate resurgent inflation, or even the possibility of it, but still can’t bring themselves to buy gold – you know who you are – Jim Grant proposes an alternative: The Treasury’s inflation-protected securities (TIPS). A recent issue of Grant’s Interest Rate Observer noted that TIPS were priced to reflect an implicit CPI inflation rate of 1.6% a year over the next 10 years, even though, since 1970, the CPI has never averaged less than 1.9% over even a three-year time-frame. “TIPS [are] a bargain.” (http://www.grantspub.com)

– The flip-side of buying TIPS is to sell financial service stocks. That’s because inflation leads to the kind of rapidly rising interest rates that shrink or eliminate the profit margins on lending. “There’s a developing opportunity in short selling and put-option buying on U.S. financial and banking stocks,” DR Blue editor Dan Denning writes this week.

– Mr. Denning might be on to something; mortgage lender Washington Mutual dropped 11% yesterday. When Grant’s Investor analyst Robert Tracy examined this financial stock last month, he concluded, “Wall Street looks at Washington Mutual and sees a safe haven. We see worsening asset quality with insufficient reserves and riskier loans with paltry returns. Take a long look at WM’s stellar results – they won’t last.”

*****

Et Voila…Mr. Bonner:

*** Back in Dublin…I’m just passing through, on my way to visit the International Living worldwide headquarters in Waterford Ireland.

*** The anthrax hysteria has reached Ireland…a man called police after receiving a letter with white powder…

*** But by page 3 of the Irish Times, the paper has found its stride. It reports that a woman is suing her employer, the prison system, after accusing her boss of “breaking wind and belching” in her presence. Later in the paper, a model has also sought justice in the courts, after falling upon a board with two nails sticking up. She claims that she is left with what she describes as “Dracula bite marks on my bum.”