Maybe, just maybe, there are finally some signs of life in the U.S. residential construction market. Companies like Illinois Tool Works (NYSE:ITW) have seen some inklings of recovery and investors are slowly getting more optimistic. Be that as it may, though, shares in Weyerhaeuser (NYSE:WY) have already jumped more than 25% in the past couple of months on this improving outlook and that has taken a lot of the undervaluation out of the stock.

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A Surprisingly Strong Fourth Quarter
Weyerhaeuser's fourth quarter results were actually pretty positive in a lot of respects. Total revenue did drop 3% from last year and about 2% from the prior quarter, but they nevertheless came in a little better than expected. Although the large wood products segment saw revenue fall 14% sequentially, cellulose fiber, real estate and timberlands were all up sequentially.

Margins are where Weyerhaeuser really surprised to the upside. Gross margin did slide about a point from last year, but reported operating income rose 24% from last year. Every unit of the company showed better-than-expected pre-tax earnings performance, with timberlands and real estate really jumping out this quarter. All in all, the company more than doubled the bottom-line earnings expectation of Wall Street. (For related reading, see Zooming In On Net Operating Income.)

Timber, with a Twist
Investors who want to invest in the timber space ought to roll up their sleeves and do some thorough due diligence on names like Plum Creek (NYSE:PCL), Potlatch (NYSE:PCH), Rayonier (NYSE:RYN) and Weyerhaeuser.

Of course it's boilerplate for financial writers to advise investors to do their own due diligence, but I really mean it here. The reason is that the operating models can be quite different. Both Plum Creek and Weyerhauser own or control over 6 million acres of timberlands in the U.S., but Weyerhaeuser's is worth more on the basis of where it's located.

Moreover, Plum Creek has traditionally put a lot of reliance on real estate sales for its cash flow and less so on manufactured products like lumber and plywood. Weyerhaeuser, though, gets substantially less revenue from timberland sales and substantially more from wood and pulp sales. That makes them much more like Louisiana-Pacific (NYSE:LPX) or Norbord, relatively speaking, and customers like Procter & Gamble (NYSE:PG) (which buys Weyerhaeuser's pulp for use in products like diapers) make up a bigger part of the business.

Is There Still Time for Timber?
Relative to full-cycle earnings power and underlying timber net asset value, Weyerhaeuser is still undervalued by more than 20%. That said, the company's exposure to wood sales does make it more vulnerable to another "false dawn" in construction and that 3% dividend yield is not exactly eye-popping. (For related reading, see The Power Of Dividend Growth.)

The Bottom Line
I can understand holding Plum Creek, Weyerhaeuser or Rayonier as both a play on a residential recovery and a long-term quality hard asset company. Timberland has shown its worth over many decades. Still, with the recent interest in this space, investors may want to weigh the risk of waiting a bit (to see enthusiasm cool) with the risk that the recovery is real and the stocks don't retrench again until after a respectable run from here.

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