At Plum Creek Timber, It's Still A Waiting Game

By Stephen D. Simpson, CFA | October 29, 2012 AAA

Certain stocks just stubbornly retain value through good times and bad times - even if that means occasional periods where results aren't so good and the valuation looks too high. That's great if you're a long-term holder who already owns shares, but it can be frustrating if you're on the outside waiting for a good time to buy shares. Conditions have yet to really improve for Plum Creek Timber (NYSE:PCL), but valuation still doesn't offer much of a bargain for new investors.

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Demand Returning, but It's in Fits and Starts
Plum Creek delivered results that were basically in line with expectations, but the underlying numbers continue to reflect the turbulence in the market.

Revenue rose 20% as reported, as the company saw significant increases from real estate (up 43%) and manufacturing (up 27%). In the timber operations, revenue rose 18% in the Southern region, fueled by high-teens volume growth in both sawlogs and pulpwood. Revenue in Northern operations declined 4% on a similar decline in volume.

Profitability was a mixed bag, as the volume-driven revenue beat masked some slight disappointment on margins. Operating income rose 14% this quarter, and consolidated operating margin fell more than a point, with margins falling in every segment but manufacturing.

SEE: Analyzing Operating Margins

Will End-Use Price Increases Work Their Way Down?
Plum Creek's results reflect an overall trend in the industry right now - while sawlog and pulpwood prices remain basically flat, the prices for finished products like lumber, plywood, and fiberboard have been increasing pretty meaningfully. Companies like Louisiana-Pacific (NYSE:LPX) and Universal Forest Products (Nasdaq:UFPI), for instance, are seeing better than 30% growth in lumber and related products for the residential construction market.

Some of this can be tied to production cutbacks and inventory run-downs, but those won't go on forever. Companies like Canfor and Georgia-Pacific are restarting capacity, and that should eventually mean better prices for timber companies like Weyerhaeuser (NYSE:WY) and Plum Creek. Not only that, but if residential building activity picks up, Plum Creek should start seeing more interest in its land from developers looking to add to their land banks.

There is a potential fly in the ointment that investors have to consider, though, and that is the upcoming "fiscal cliff." If Congress cannot (or chooses not to) reach a compromise on upcoming tax increases and automatic spending cuts, GDP growth in 2013 could drop by more than 3% (pushing the economy back into recession), unemployment could surge, and all of this positive momentum in residential construction could evaporate. Although that's not a huge threat to the long-term value at Plum Creek (the trees will keep growing and the land isn't going anywhere), it could knock the stock for a loop.

SEE: The Impact Of Recession On Businesses

The Bottom Line
Plum Creek seems to enjoy more patience than many other companies in cyclical businesses. That patience is not without good reason. While the company does have debt to service, Plum Creek's products don't spoil or depreciate with time, and hard assets such as timberlands tend to do quite well in times of inflation and economic uncertainty. Moreover, Plum Creek's implied per-acre land value is still not only well below long-term averages, but also recent reported transactions.

Trying to figure out a fair value on Plum Creek is, at a minimum, a two-part exercise. In terms of near-term earnings (EBITDA) or free cash flow expectations, the shares are clearly expensive. Likewise, the company's dividend yield is still on the lower end of its long-term range. Taking a long-term view of the company's per-acre value, however, there would still seem to be upside to the shares.

Just one word of caution for investors using that metric, though - Plum Creek's historical EBITDA per acre is lower than that of Weyerhaeuser, Rayonier (NYSE:RYN), and Potlatch (Nasdaq:PCH), so I would argue it doesn't deserve the full benefit of the doubt. Consequently, while I do appreciate the long-term value of Plum Creek's asset base, I would likely be more inclined to own Weyerhauser today than Plum Creek.

At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.

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