Better Volumes, But Not Better Value, At Plum Creek

By Stephen D. Simpson, CFA | August 02, 2012 AAA

There's a certain amount of "broken record" when it comes to talking about Plum Creek Timber (NYSE:PCL). Conditions in the housing market, and by extension the forestry market, haven't changed all that much, but neither has the Street's overall confidence that patience here will pay off. While valuation and potential liquidity challenges don't argue for this stock as a must-own, investors are likely to remain firm in their conviction that better days will validate the premium on these shares.

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Some Good News for a Change
There have been some gradual shifts towards more positive numbers from Plum Creek, and this quarter would seem to continue that trend.

Revenue rose 4% this quarter, fueled by strong year-on-year improvements in the core forestry operations, coupled with a solid number from the company's manufacturing business. Revenue (derived largely from harvesting trees) rose 27 and 25% in the Northern and Southern operating regions, respectively, as the company saw over 30% increases in sawlog harvests and over 20% increases in pulp harvests. Manufacturing revenue rose 15% on greater lumber and plywood demand, while real estate revenue dropped more than 40%.

Because of the larger contributor of lower margin businesses, Plum creek reported a 13% drop in operating income. Both the Northern and Southern regions showed margin improvement (more so in the Southern), while manufacturing margin also improved significantly.

SEE: Understanding The Income Statement

The Good and Bad of Mix
It's not unreasonable to look at Plum Creek's numbers and think that maybe market conditions are getting better. I worry, though, that the current trends don't really favor what drives so much of the value of this company.

Relative to a company like Weyerhauser (NYSE:WY), Rayonier (NYSE:RYN) or Louisiana-Pacific (NYSE:LPX), Plum Creek's manufacturing operations are of modest size. Consequently, it's only a relatively small part of the valuation calculation. Likewise, even if there is a sizable increase in Asian demand for logs and lumber, these are lower-margin businesses for the company - nothing else that the company does can compare to the profitability of its real estate operations, which are still very much in a lull.

Wait for Value, but Watch the Liquidity
Part of the bull thesis on Plum Creek has always been that low demand for a stretch of years is really a non-factor in the company's long-term value - the company can simply sit and watch the trees grow. That's true to a point, and I don't think anybody will argue that the long-term value of the company's land isn't likely to be higher at some point.

The problem is that it's not completely true that Plum Creek can just sit and wait. Investors expect their dividends and bondholders expect their interest and principal repayments. Against just $260 million in cash on hand, Plum Creek has about $600 million in debt coming due over the next 18 months. I think it is highly unlikely that Plum Creek will have any trouble rolling over and refinancing that debt, but it will be interesting to see what sort of terms the company gets.

SEE: 5 Must-Have Metrics For Value Investors

The Bottom Line
It's not at all that easy to find a metric by which Plum Creek shares are undervalued. The dividend yield is towards the lower end of the scale of the past decade, while neither free cash flow nor EBITDA analysis suggests any particular undervaluation. Perhaps Plum Creek is undervalued on the basis of some multi-decade "super-cycle" analysis, but I have a hard enough time predicting the next six months to try my hand at a 20-year or 30-year projection for housing demand and land value.

Accordingly, Plum Creek remains what it has long been for me - a stock I'd happily consider at a lower price, but one that seems overvalued relative to alternatives like Weyerhaeuser and Rayonier today.

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

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