A Stumping Valuation On Plum Creek

By Stephen D. Simpson, CFA | October 28, 2008 AAA

Much can be said for investing in timber. After all, not many investment options allow biding your time, letting nature take its course and having your product's value increase.

Nevertheless, investors have sent the stocks of companies like Potlatch (NYSE:PCH), Rayonier (NYSE:RYN) and Weyerhaeuser (NYSE:WY) down hard as the collapse of the housing market and the overall economic slowdown have hurt pricing and demand for wood and fiber products.

Plum Creek Timber (NYSE:PCL) is a name investors should investigate. True, the market hasn't punished this timber REIT stock quite as harshly as others, but public market valuations are nevertheless looking quite interesting relative to implied private values, and this has been a quality company for some time. (Learn about timberland as an investment at Timber Investments Cut Down Portfolio Risk .)

No Clear-Cutting In The Financials
All things considered, this wasn't a bad quarter for Plum Creek. Total revenue picked up slightly as a decline in wood-product manufacturing was offset by better results in timber and real estate. Margins softened a bit, though, and operating income was up just a bit over last year's level.

Although sawlog pricing has softened in the face of the housing decline, demand for pulpwood has been pretty solid. Investors shouldn't worry much about lower prices for sawlog stumpage today. For the most part, there's never any particular necessity to sell a given amount of timber in a given year (assuming you can cover your operating expenses), and whatever timber isn't cut in one year will continue to grow (and generally appreciate in value) into the next.

Same Trees, Different Prices
One intriguing detail about Plum Creek is the dichotomy in public and private valuation for timberland. Plum Creek completed a joint venture in August that valued some of the company's timberland at $1,725 per acre. At the present stock price, though, the company is assigning a value of under $1,200 per acre. This is calculated by dividing the enterprise value of $8.49 billion as of October 29 by the acreage of 7.5 million. (Read why enterprise value is an important financial measure at EV Gets Into Gear.)

This is admittedly a convoluted analysis - different types of timberland in different areas of the country can sell for very different prices, and a meaningful part of Plum Creek's acreage is being held for future sales as higher-value real estate. But given that those factors generally push down the implied value, I feel confident that publicly traded timber companies are selling for less than the private market says the timber is worth. Even allowing for further declines in private timberland valuation as the recession worsens, there's a relative value trade here.

Plum Creek's management continues to purchase its own shares in the market. While I'm not normally a big fan of buybacks (I prefer dividends, thanks), this is a case where I'd make an exception, particularly as the company is a proven operator and still has a healthy amount of capital liquidity. (To learn how to analyze a balance sheet, read Breaking Down The Balance Sheet.)

Only Patient Investors Need Apply
If you're looking for a little more action in the fiber trade (or whatever passes for action), you'd probably do better to look at the likes of Packaging Corp. (NYSE:PKG) or Universal Forest Products (Nasdaq:UFPI). In Plum Creek, though, you have a well-run company with proven management and a valuable asset base. That's not a bad combination for weathering rough times in the market.

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