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|Subject: Plum Creek Timber PCL||Date: 7/25/2004 10:11 AM|
|Author: kitkatklub||Number: 833 of 1264|
Jeremy Grantham and the Timber Industry
According to Jeremy Grantham, "timber is the only low- risk, high return asset class in existence. People are not familiar with it. What they are not familiar with they avoid. But timber is the only commodity that has had a steadily rising price for 200 years, 100 years, 50 years, 10 years. And a unit of wood, just the price of a piece of wood - in real terms - beat the S&P over most of the 20th Century, from 1910 to 2000."
Thus does Mother Nature, in her wisdom, reward patient investors while punishing the day traders...and give the highest profits to a business which has benefited little from productivity enhancements. Even in the Information Age, it can take 50 years for a hardwood tree to mature. But the annual return from planting trees has been 40% higher than the S&P.Timber is a growing and renewable resource that, when properly managed, increases in volume and value as it grows over time. Larger diameter trees command a higher price than smaller trees because they may be converted to higher value end-use products such as lumber and plywood.
"The price of a piece of wood actually outgrew the price of a share of the S&P, which is an unfair context, because there is some growth embedded in the share of the S&P and there is no growth embedded in a single cubic foot of wood. The yield from timber averaged about 6.5%. The yield from the S&P averaged 4.5%. The current yield on the S&P is 1.25% and the current yield on timber is 6.5%." Due to growing demand combined with limitations on supply caused by environmental restrictions, urban sprawl and overcutting, prices for Douglas-fir and Southern Yellow Pine timber have exhibited a compound annual growth rate of approximately 4% and 3%, respectively, from 1975 through 2003.
Not only have trees proved to be good for good times, they've also proven good investments for bad times. "In each of the three great past bear markets--1929-'45 and 1965-'82, and a third one that's off everyone's radar screen, which is post-World War I, 1917-'25 - the price of timber went up. It is the only reliably negatively correlated asset class when you really need it to be.
"One reason for that is that you can withhold the forest. If you find the price of lumber is no good, you don't cut. Not only is there no cost of storage, the tree continues to grow and it gets more valuable”. Timber companies have some flexibility to increase their harvests when prices are high and decrease their harvests when prices are low, allowing timberland owners to maximize the long-term value of their growing resource base.
There are five primary end-markets for most of the timber harvested in the United
States: products used in new housing construction; products used in the repair and remodeling of existing housing; products for industrial uses; raw material for the manufacture of pulp and paper; and logs for export.
Plum Creek Timber
On October 6, 2001, six former subsidiaries of Georgia-Pacific Corporation, merged with and into Plum Creek. The Timber Company held all of the assets and liabilities attributed to Georgia-Pacific's timber and timberland business. PCL is a REIT and as a REIT it is required to distribute all such earnings and profits before years end. Because it is a REIT, the income generated by Plum Creek is generally not subject to federal and state income tax.
Plum Creek Timber is the second largest private timberland owner in the United States, with 8.1 million acres of timberlands located in 21 states. They classify their timberlands as northern resources segment --3.7 million acres of timberlands in Idaho, Maine, Michigan, Montana, New Hampshire, Oregon, Pennsylvania, western Virginia, Washington, West Virginia and Wisconsin. Itcontains an estimated 132 million tons (44 million cunits) of standing timber And the southern resources segment-- 4.4 million acres of timberlands (including 350,000 acres of leased land) located in the states of Alabama, Arkansas, Florida, Georgia, Louisiana, Mississippi, North Carolina, Oklahoma, South Carolina, Texas and eastern Virginia, containing an estimated 165 million tons (47 million cunits) of standing timber.
It is important to note that in the northern segment, Montana has been particularly hard hit by drought and to a lesser extent so has Idaho. This may impact future harvests from these two states. Montana lost $4 million worth of trees due to a severe wild fire season in 2003. The southern forests have not has similar problems recently.
Plum Creek is also involved in natural resources development on their timberlands (natural gas and methane) and they operate four lumber mills, two plywood plants, two medium density fiberboard (MDF) facilities, and two lumber remanufacturing facilities. These facilities are located near the company owned timberlands in Montana and Idaho.
Plum Creek understands the need to manage their timberlands for profit today and providing for products and profits in the future. With trees we are talking decades in the future. Newly-planted seedlings take 20 to 30 years to reach harvest maturity in the Southern United States, 45 to 60 years in the Northwestern United States, 45 to 70 years in the Northeastern United States and 70 to 90 years in inland regions of the Western United States. They thin stands of young trees, fertilize, research and plant genetically modified seedlings and use computerized models to manage inventory. It is their policy to ensure that every acre harvested is promptly reforested. Based on the geographic and climatic conditions of the harvest site, harvested areas may be regenerated naturally by leaving mature trees to reseed the area.
Natural regeneration methods are used on a substantial portion of timberlands in the northern resources segment. In the southern resources segment,substantially all reforestation is done by planting.
Part of their growth strategy is to continually acquire new timberland while selling real estate that is less valuable for timber and deemed to have higher value for other uses. Since 1989,they have increased timber holdings from 1.4 million acres to 8.1 million acres. These acquisitions enhanced operating flexibility and reduced exposure to regional timber market fluctuations. Of the 8.1 million acres of timberlands, 1.35 million acres are more valuable as real estate and 1.4 million acres are non-strategic timberlands. The 1.35 million acres will be sold over the next 15 years for conservation, residential or recreational purposes. Approximately half of the non-strategic timberlands are expected to be sold in large blocks over the next two years. Non strategic tracts are generally small and have less value as either timber producing land or as alternate use real estate.
One thing I like about PCL is their acknowledgment that conservation measures are necessary. Granted, some of this is legislated by the Endangered Species Act, but they seem to regard it benevolently.
“We adhere to the philosophy that environmentally sound management practices contribute to the company's growth in value by providing greater predictability in the management of its natural resource assets. Our practices follow the principles and objectives of the Sustainable Forestry Initiative(R) program ("SFISM"), which sets forth a comprehensive approach to responsible forest stewardship. The SFISM program principles, which can be found on the company's website at www.plumcreek.com, are designed to ensure that forest management is integrated with the conservation of soil, air and water resources, wildlife and fish habitat, and aesthetics.
Consistent with these principles, we have actively engaged in habitat conservation planning. We currently manage 1.9 million acres under five habitat conservation agreements. The habitats of hundreds of species are protected by these agreements, including 15 species listed as threatened under the Endangered Species Act. These conservation agreements include: the Central Cascades Habitat Conservation Plan, which provides habitat protection for 315 species and impacts 0.2 million acres of our timberlands in Washington State; the Swan Valley Grizzly Bear Agreement, which covers 0.1 million acres of our lands in western Montana; the Native Fish Habitat Conservation Plan, which provides for habitat protection of 18 species of native trout and salmon on 1.4 million acres of our land in Idaho, Montana and Washington State; the RedCockaded Woodpecker Habitat Conservation Plan, which covers 0.3 million acres of our timberlands in Arkansas and Louisiana; and the Karner Blue Butterfly Habitat
Conservation Plan, which extends to 23,000 acres of our timberlands in Wisconsin. “
During the third and fourth quarter of 2003,they acquired 139,000 acres of timberlands located primarily in South Carolina, Arkansas and New Hampshire for approximately $162 million. The Southern timberlands are dominated by mature loblolly pine
plantations. The New Hampshire timberlands contain both softwood and mixed hardwood stands.
307,000 acres of timberlands were acquired in 2002 located primarily in Wisconsin for approximately $141 million. These timberlands contain a diversified mix of tree types and age profiles, including mature mixed hardwood stands, mixed natural conifer
stands, and hardwood and conifer plantations.
Canadian imports into the U.S. capture a significant share (between 33% and 34%) of the U.S. lumber market. A U.S. industry coalition believes the Canadian government, which owns most of the timberlands in Canada, provides unfair subsidies by selling timber at below market prices. Prior to 2002, a trade agreement with Canada limited imports of lumber into the United States. Since May 2002, the U.S. has imposed duties on Canadian imports. At the same time, the U.S. and Canada have been trying to reach a negotiated settlement, but to date no settlement has been reached. Furthermore, reports indicate that the U.S. imposed duties have had the unintended consequences of causing some Canadian lumber manufacturers to increase their lumber production to lower their average production costs.
For the past several years, the U.S. dollar has been strong compared to other major currencies in the world. The strong U.S. dollar has given Canada and other exporting lumber countries a cost advantage over U.S. lumber manufacturers. The U.S. dollar declined, however, during 2003 against the Canadian dollar (which appreciated by approximately 20% during 2003) and several other major currencies. During the second half of 2003, U.S. lumber prices improved in response to the stronger Canadian dollar. You can easily see the price increases if you have undertaken any building projects in the last 6 months.
*common and select boards
*wood chips are sold to regional paper and pulp mills or used in MDF. A substantial portion of residual wood chip production is sold to Smurfit Stone Container Corporation under a long-term supply agreement, which expires on February 28, 2006.
*high-grade softwood plywood
*oriented strand board continues to capture an increasing percentage of the North American structural panel market due to its low cost. Oriented strand board has now
captured over 57% of the structural panel market, and this percentage is expected to increase over the next several years
*medium density fiberboard (October 2001 a new $80 million thin-board production facility began production) This new thin-board line has a capacity of 95 million square feet annually and increases overall capacity by 70% to approximately 230 million square feet. During 2002, the two lines combined produced approximately 178 million square feet of MDF. During 2003, the two lines produced approximately 198 million square feet. In 2004, they expect to run both lines near full production capability.
*natural resources currently produce royalty revenue from the extraction of oil, gas, coal and minerals. Since 2001, one of PCL's taxable REIT subsidiaries has a joint operating agreement with Geomet, a coalbed methane developer. During the first quarter of 2004, PLC entered into a binding agreement to sell their working interest in the joint operating agreement to Geomet for $27 million. The agreement also provides for contingent additional sales proceeds of up to $3 million payable in 2008. The transaction is scheduled to close in the second quarter of 2004. Royalty interest is retained
Potential Expensive Clean-up
In connection with The Timber Company Merger in 2001, Plum Creek agreed to
indemnify Georgia-Pacific for substantially all of the liabilities attributed to The Timber Company. During the fourth quarter of 2003, Georgia-Pacific provided Plum Creek with information for the first time about the existence of mine tailings and approximately 4.5 billion gallons of acidic surface water on approximately 90 acres in Hot Spring County, Arkansas on former Georgia-Pacific properties. Barite mining and related activities were conducted on the site between 1939 and 1981 in part by lessees of an entity that was acquired by Georgia-Pacific. The environmental issues associated with this site are
currently being investigated and no remediation plan has yet been approved.
There is not sufficient information, therefore, to adequately assess the costs. There is no pending or threatened litigation involving the company.
Income Statement Ratios
Some Discussion of 2003
Margins are declining from a combination of things including increasing cost of sales, SG&A and interest expense. Part of the cost of doing business is the depletion allowance. That varies slightly yoy. The other big expense is the contracts where PCL delivers logs and incurs the expense of harvesting and transporting. Depending on the mix of contracts(some specify that the buyer absorb the expense of logging and transporting) these costs can escalate.
The interest expense has increased as the level of debt increases and that impacts margins unfavorably. The cost of producing some products(MDF) has also increased in part due to necessary components for manufacture.
Growth has been sluggish partly due to over-supply of lumber in 2003 and pressure from Canadian imports.
2001 was also notable for a large tax benefit that pushed net up and half the interest expense.
Northern Resources Segment
*revenues decreased by $11 million, or 3%, to $309 million in 2003. This decrease was due primarily to a 12% decrease in softwood sawlog sales volume in Montana as a result of one of the worst fire season in decades, offset in part by harvesting from timberlands in Wisconsin that were acquired during December 2002. Sales volume from timberlands in Wisconsin that were acquired in December 2002 increased revenues by $13 million.
*operating income was 27% of revenues for 2003 and 25% for 2002. Costs and expenses decreased by $13 million, or 5%, to $227 million in 2003 due primarily to fire-related harvesting curtailments and lower depletion rates
*$4 million fire loss as a result of forest fires during the third quarter of 2003 on approximately 45,000 acres in Montana. The $4 million loss represents the book basis of the timber volume destroyed by fire.
Southern Resources Segment
*revenues increased by $22 million, or 5%, to $445 million in 2003. This increase of $22 million was due primarily to a higher percentage of delivered log sales ($33 million) and a more valuable mix of logs ($7 million), offset in part by lower softwood sawlog prices ($15 million) and lower harvest volumes ($9 million).
*Softwood sawlog prices decreased by 6% due primarily to harvesting of smaller
diameter logs and mill curtailments. The diameter of sawlogs temporarily
increased during 2001 and 2002 due to the increased conversion of slow growing
natural stands to faster growing plantation stands. Mills curtailed production
during the first half of 2003 due to weak lumber prices. Sales volume decreased by 3% due to a planned reduction in harvest levels. These results demonstrate how a timber company can manipulate what type of logs it cuts and their ability to decrease cutting and manufacture of wood products if the market environment is unfavorable,. They don't make as much for the year, but can increase productivity when prices are favorable. This strategy preserves their assets and they are not forced to sell cheap.
*operating income was 49% of its revenues for 2003 and 54% for 2002. This decrease was due primarily to lower softwood sawlog prices and the increased percentage of delivered log sales. Costs and expenses increased by $33 million, or 17%, to $229 million. This increase was due primarily to an increase in log and haul costs as a result of a higher percentage of delivered log sales compared to sales of standing timber. They have other agreements with customers where the buyer accepts all the costs of cutting and hauling. More of these contracts are helpful in decreasing costs.
Real Estate Segment
*revenues increased by $26 million, or 27%, to $124 million in 2003. This increase of $26 million was due primarily to the sale of non-strategic timberlands and a higher number of acres sold. During the second quarter of 2003 29,000 acres of non-strategic timberlands was sold for $13 million.
96,000 acres of higher and better use timberlands was sold during 2003 compared to sales of 38,000 acres during 2002. Revenues from conservation easements decreased by $20 million compared to the prior year.
*operating income was 38% of revenues for 2003 and 65% for 2002. This decrease was due primarily to sales of non-strategic timberlands, fewer conservation easement sales and the recording of a $5 million impairment loss.
*the 29,000 acres of non-strategic timberlands sold for $13 million had a book value of $22 million ($9 million of the $22 million was recorded as an impairment charge during the first quarter of 2003). They sold more acres but fewer conservation easements during 2003. It is probable that 28,000 acres of non-strategic timberlands would be sold during 2004 in which the book basis exceeds the fair value by $5 million. As a result, an impairment charge of $5 million was recorded in 2003. This is recorded before the sale, but according to GAAP it is OK to record impairment of assets whenever a company evaluates assets and finds them impaired. It does not have to happen at the time of the sale. If the sale doesn't occur, the assets will be carried on the balance sheet at their new value.
Manufactured Products Segment
*revenues increased by $16 million, or 4%, to $397 million in 2003. This increase of $16 million was due primarily to higher MDF sales volume ($14 million) and higher plywood prices ($10 million), offset in part by lower lumber prices ($8 million). MDF sales volume increase by 20 million square feet to 198 million square feet due primarily to the new thin-board mill, which began operations during the fourth quarter of 2001 and was in a startup phase during most of 2002. Plywood prices temporarily skyrocketed during the second half of 2003 due to wholesalers and distributors maintaining low structural panel inventories and housing starts continuing at unanticipated record levels. Lumber prices decreased by 5% due primarily to an industrywide excess supply of boards as a result of log salvage operations from 2002 forest fires and excess production capacity for studs and dimension lumber throughout North America.
*operating loss was $5 million during 2003 compared to $1 million of operating income during 2002. This decrease in operating performance was due primarily to lower lumber prices and higher MDF operating costs. Costs and expenses increased by $22 million, or 6%, to $402 million in 2003. This increase of $22 million was due primarily to higher MDF production volume and higher MDF resin and maintenance costs.
*the provision for income taxes was $6 million benefit for 2003 compared to $2 million expense for 2002. This change of $8 million was due primarily to the $6 million decline in operating performance for the manufactured products segment and lower sales of higher and better use timberlands through the taxable REIT subsidiaries during 2003. As a REIT, Plum Creek is generally not subject to corporate income tax s.
During 2003, they harvested a total of 19.0 million tons compared to a total of 19.3 million tons during 2002. They expect to harvest approximately 19 million tons during 2004.
How They Calculate Depletion Costs(part of cost of sales unique to timber)
Depletion, or costs attributed to timber harvested, is recorded as trees are harvested. Depletion rates for each region are adjusted annually. Depletion rates are computed by:
Add the sum of the original cost of the timber less previously recorded depletion to the estimated future silviculture costs (including the impact of inflation, that are expected to be incurred over the next harvest cycle)
Divide by the total timber volume that is estimated to be harvested over the harvest cycle.
The harvest cycle can be as short as 20 years in the south and as long as 90 years in the north. The estimate of future silviculture costs is limited to the expenditures that are expected to impact growth rates over the harvest cycle.
This expense shows up in cost of goods and is fairly stable over the years so you can rely on this expense being there year after year.
Balance Sheet Ratios
*the current ratio shows twice as many current assets as liabilities. If you believe in the flow, this is not the best level to be at. If you place more credence on the current ratio concept, they have sufficient assets available to cover short term debt and liabilities
*the quick ratio shows adequate cash and liquidity to cover short term liability.
*AR growth is low but as net income is down, this should also be flat or negative
*days sales outstanding is stable from 2002 and much better than 2001
*inventory under good control
*high debt levels as per the company's stated policy
*ROE,ROA and ROIC all below what you might find acceptable for other types of business. These ratios are comparable to the other major timber REIT Rayonier. Part of the reason for the very low returns are the incredibly high assets represented by the timberlands. This creates large amounts of equity compared to net income.
*timber and timberlands, including logging roads, are stated at cost less accumulated depletion for timber previously harvested and accumulated road amortization. The company capitalizes timber and timberland purchases and reforestation costs and other costs associated with the planting and growing of timber, such as site preparation, growing or purchases of seedlings, planting, fertilization, herbicide application and the thinning of tree stands to improve growth. They also capitalize the cost of constructing roads. These expenses are reasonably capitalized. The activities do pave the way for future profits.
Cash Flow Statement
*free cash flow positive
*not burning through operating cash at a rate exceeding revenue
*net not keeping pace with operating cash flow
*capex reasonable percentage of operating cash flow
*despite the $35 million decline in operating income, net cash provided by operating activity increased by $1 million to $369 million in 2003. This difference was due primarily to a $26 million increase in timberland sales and a $14 million impairment charge related to real estate held for sale. Real estate basis and impairment charges are non-cash expenses, which reduce operating income but do not impact net cash provided by operating activity.
*during 2003, Plum Creek paid dividends of $257 million or $1.40 per share.
Dividends of $0.35 per share were paid quarterly in February, May, August and
*during 2002, Plum Creek paid dividends of $275 million or $1.49 per share. A
dividend of $0.57 per share was paid in May 2002 and August 2002. A dividend of $0.35 per share was paid in November 2002.
In October 2002, the company was authorized to buy up to $200 million of
outstanding common stock. During the first quarter of 2003, the company purchased two million shares of common stock for a total cost of $43 million at an average price of $21.53 per share.
Assuming an average long-term rate of return on plan assets of 7.75%, aweighted average discount rate of 6.25% and a 4.5% rate of increase in compensation levels,pension expense for 2004 will be approximately $7 million, a $1.3 million, or 23%, increase compared to 2003, and will rise to approximately $8 million annually by 2006. Over the same time period, the annual cash funding required under the present funding policy is expected to be approximately $3 million during 2004 increasing to approximately $6 million in 2006. The company has made at least the minimum contributions required by law each year. They intend to fund annually such that the fair value of plan assets equals or exceeds the actuarially computed accumulated benefit obligation. In other words, the plan will remain underfunded(legally) and only be funded with enough cash to make current payments. I have seen other companies do this. It appears to be a common strategy and saves them large amounts of money(both in the amounts that would have to be paid in and the funds that would sit in the pension gathering dust and not available to the company). However, there is always the worry that the funded status may become worse as investments begin to return less and that they may eventually end up contributing large amounts to be in compliance. They are estimating 7.5% returns. This may prove to be optimistic. I feel better when companies estimate returns of 6% and below.
The value is $77M and the obligations are $95 M. The deficit is $18 M.
The estimated fair value of the company's debt, based on current interest rates for similar obligations with like maturities, was approximately $2.21 billion and $2.00 billion at December 31, 2003 and 2002, respectively.
At December 31, 2003,they had a $600 million revolving line of credit maturing on September 30, 2005. The rate for the revolving line of credit was LIBOR plus 1.5%, which included facility fees. Interest rates vary and are based on a series of borrowings with maturities that can range from one week to six months. The interest rate for the $600 million credit facility was 2.7%
Borrowings on the line of credit fluctuate daily based on cash needs. On January 2, 2004, $248 million of the borrowings under the line of credit was repaid. On January 15, 2004, the company refinanced its revolving line of credit. The new $650 million facility has a maturity of five years.
PCL believes it has adequate liquidity based on its cash balance of $260 million at December 31, 2003, the replacement of its $600 million line of
credit with a new $650 million line of credit on January 15, 2004 and expected
proceeds from non-strategic timberland sales during 2004.
The company's leverage strategy is to maintain a balance sheet that provides
the financial flexibility to pursue strategic objectives. In order to maintain this financial flexibility, the company tries to keep an investment grade credit profile. This is reflected in moderate use of debt, good access to credit markets and no material covenant restrictions.
In 2006 and 2007, the company has significant long-term debt principal payment requirements. They intend to refinance these principal payments at the time of maturity. The company, however, may not refinance the entire amount and may use cash generated from operations for a portion of the principal payments.
Balancing debt repayment and debt origination is an important part of their strategy. They are not interested in being debt free and paying down all debt may not be the best business strategy for them. I know a debt free balance sheet is preferred by many investors, but it is not going to be part of the plan for PLC. They intend to use their power to borrow to the further their business plans. If they generate enough income to refinance and pay down necessary principal, in the final analysis vis a vis free cash flow, this benefits the shareholder.
fair value per share $ 3.27
Total shares 185 M
Total dilution 1.3%
Total value of options $7.8 M
Value per share $0.04
Value if all granted options were exercised $10 M
Options are minimaly dilutive
A two stage dividend discount model gives a value of !4.60. The high growth rate stage was 5 years at 6% and stable growth at 3%. Cost of equity was 9.7%. Dilution from options was minimal and not counted. Since the 52 week low was $24.83, it is unlikely the stock will ever reach this value. At $14.4 the yield would be 9.6% and the P/E would be 10.3. At $14.40 Plum Creek would be an extremely attractive company to own. It is unlikely to drop that far. It was trading at a 5 year low in 2003 of around $19. There is not much price appreciation in PCL at current levels. Buying this company would have to be for the yield and the undeniably rich assets the company owns. The lumber industry is likely to survive any serious downturn in the economy or the market. The timberlands will not evaporate. However, at current prices, the only return from PCL will be the dividend. I would not be a buyer at current prices. If the price falls or the dividend increases, I would reevaluate the yield and as it began to look significantly better than 10 year treasuries, PCL might become a buy. At the 52 week low of $24, the yield would approach 6% and the stock would be moderately attractive. Value Line has predicted that the dividend will be $1.40 in 2004.
Currently yield is 4.5%
From Value Line
Plum Creek Timber has gotten off to a strong start in 2004. In the first quarter, the company posted earnings of $0.48 a share, which was significantly above both our estimate and last year's tally. This performance was driven by several factors, including better log and lumber prices, stronger volumes, and much-higher-than-expected real estate sales. The last point was especially influential. The company initially guided towards $60 million in timberland sales, but booked closer to $70 million. The difference is mainly the result of timing issues. Because of this, some of the real estate profits generated in the March interim will come at the expense of future quarters, so our estimate for total property sales for 2004 remains unchanged at between $140 million and $160 million.
There's no denying the fact that Plum Creek's performance will inherently be tied to the movements of log and lumber prices. However, we believe ongoing environmental pressures will continue to limit the amount of timber available for harvest, which will keep the supply/demand balance in favor of lumber producers. Moreover, we believe the company is one of the most geographically diversified producers. Its timberlands are spread across several regions of the U.S., making Plum Creek less vulnerable to local problems.
I would add that a slowing housing industry will likely impact the earnings this year and next and we could see PCL drop in price.
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