Finding Value In The Forest

Despite the recent drop in prices, commodities are still riding high in 2011. Oil remains above $90 a barrel, gold is flirting with record highs and the agricultural complex is nevertheless going strong. Funds like the SPDR S&P Global Natural Resources (NYSE:GNR) continue to be popular investment destinations for portfolios. However, the overall run-up in prices and popularity of hard assets makes finding values in the sector difficult. One such value area remains, however, and could see great gains throughout the year as the world continues to improve its infrastructure and Japan rebuilds.

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Lumbering Along
With the American housing market still in the proverbial toilet, lumber seems like an unlikely portfolio candidate. However, growth abroad could help return American lumber exports to prominence. Worldwide demand for softwood lumber rose nearly 18% in 2010. Global consumption of wood and lumber products for the first quarter of 2011 increased 20% versus last year. Both China and Japan have seen voracious demand for timber since early 2009. Already China is short 100 million cubic meters of wood, or roughly double major producer British Columbia's entire yearly output of timber. Some analysts estimate that China will need to import about 182 million cubic meters of wood by 2015. This is an increase of 70% from its current timber import levels. These continued increases in demand for raw logs have some analysts predicting that lumber prices could rise from today's $300 per thousand board feet to $500 within the next three to five years.

The potential for increased prices comes on the back of Russia kicking around new export taxes on timber. Russia has held the top log exporter crown for many years and announced a log export tax of 25% in 2007. The country's intention was to increase this tax to 80% by 2009. The economic crisis stalled the idea, but with the global economy beginning to boom once again, the export tax could be back on the table. This tax would put pressures on North American forests, many of which are still feeling the effects of devastating pine beetle. The outbreak has wiped out approximately 80% of British Columbia's pine trees.

The Value of Boredom
From an investment point of view, timber could be as boring as they come. When prices are low, companies can withhold harvesting logs. When prices rise, they not only profit on the higher log price, but they make more money per tree since the forest has grown. This steady nature has been benefiting the sector over the last twenty years. The National Council of Real Estate Investment Fiduciaries Timberland Index has generated an average annual return of 14% compared to 9.4% for the S&P 500, from 1987 to 2009. In addition, many public timberland stocks are trading at discounts to the value of the land they own, and the price for timberland in the private market versus their share prices.

Positioning Your Portfolio With Timber
Expected increased demand from China, higher lumber exports to Japan due to the rebuilding efforts after the earthquake and any continued measured improvements in the US housing market will bode well for timber prices and companies. Both the Guggenheim Timber (NYSE:CUT) and iShares S&P Global Timber & Forestry ETF (Nasdaq:WOOD) offer broad exposure to the sector and are up about 10% for the year. For those wanting some more oomph from their timber investment, here are a few picks.

Trading at an ultra-low P/E of just 6, giant Weyerhaeuser (NYSE:WY) could be a great timber pick. The company recently converted to a REIT (similar to other timber companies like Potlatch Corporation (NYSE:PCH)). Currently, Weyerhaeuser pays a 2.7% dividend, but that dividend should grow as the company's earnings do. Similarly, smaller Pope Resources (Nasdaq:POPE) uses the MLP tax structure to pass on dividends to shareholders.

The Paper Play
The paper production market remains one of few oligopolies left. With so little in the way of players, prices will stay high and cash flow will be abundant. Domtar (NYSE:UFS) is currently trading for P/E of 7 and yields 1.20%.

Finally, one of the more interesting ways to play the increasing Chinese demand is through SINO-FOREST CORP (OTCBB:SNOFF). The company owns 512,000 hectares of forest in China and has announced plans to expand into central and western China. This area is expected to be the hotbed of urbanization over the next several years.

Bottom Line
With so much of the commodities complex rising over the last year or so, it's difficult to still find bargains. However, timber represents one such value. Increasing demand from a variety of sources is driving up lumber prices. Investors looking for a great long term play, the previous stocks along with Deltic Timber (NYSE:DEL), make ideal selections. (For related reading, take a look at Timber Investments Cut Down Portfolio Risk.)

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