Weyerhaeuser Like Watching The Grass Grow

By Stephen D. Simpson, CFA | April 28, 2012 AAA

Nobody ever said that owning Weyerhaeuser (NYSE:WY) was going to be exciting, but that's the nature of owning a company focused on timberland and wood-derived products. This is a company where value can accrete slowly by virtue of the company's timber assets, sweetened by growing exports to Asia and an eventual recovery in the U.S. housing market.

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OK Results in a Tough Market
Weyerhaeuser's earnings weren't great, but then nobody expected them to be. Revenue fell 5%, with declines in pulp and and real estate mitigating growth in timberland and wood products. All in all, conditions in the wood products business seem to be getting modestly better, though from a pretty distressed base.

Overall profit performance was not as good. Gross margin fell almost four points, and although reported EBIT grew 15% from last year, "core" operating income was down more on the order of 30%. Moreover, EBTIDA dropped about 15% from last year and 36% from the prior quarter. Profitability was lower across the board, with timberland and pulp profits offering the largest deltas.

SEE: Understanding The Income Statement

The Recovery Won't Come Fast Enough
There's anecdotal evidence that the worst is behind the housing market, but there's no reason to believe that there's going to be a rapid recovery in building activity. That's a reality that applies across the timber industry, including Plum Creek (NYSE:PCL) and Rayonier (NYSE:RYN).

That doesn't necessarily mean that Weyerhaeuser is stuck, though. For starters, the company owns more Pacific Coast timberland than those other timber companies and that's an increasingly valuable asset base. Not only have British Columbia timberlands been severely damaged by insects, but it's a convenient source of timber for the Chinese market - a market that is not so strong today, but likely still has ample growth in the years ahead.

In the meantime, Weyerhaeuser and Louisiana-Pacific (NYSE:LPX) are seeing marginally better wood product markets. Some of this is due to inventory run-down and some is due to better cost containment. But there is finally some level of optimism that modest homebuilding growth could resume before long.

Stick and Stay, Make It Pay
Investors should not expect anything especially dynamic from Weyerhaeuser. Yes, Procter & Gamble (NYSE:PG) is a big customer of the pulp business (cellulose pulp goes into a variety of absorbent products like diapers), but Buckeye Technologies (NYSE:BKI) and Glatfelter (NYSE:GLT) are better plays on that theme. Likewise, there is a chance that wood pellet-based biomass plants will have a role in the renewable energy market someday, but that's not going to be the case in the next quarter or the next year.

Instead, investors have to be content to collect dividends and see the steady appreciation of the company's timber assets. Luckily, there's a pretty long track record here, and as an asset class timberlands rank pretty well in terms of long-term potential.

The Bottom Line
Plum Creek offers a better dividend, but I dare say that Weyerhaeuser offers a better business in terms of its pulp and wood products businesses as well as the location and composition of its timberlands. It's also worth mentioning that Plum Creek has historically relied much more heavily on land sales to the real estate market for its cash flow.

Valuing Weyerhaeuser on either a mid-cycle EBITDA or NAV basis clearly demands some assumptions about what the "new normal" is going to look like, and that introduces the risk of downside. Nevertheless, fair value on these shares looks to be in the mid-to-high $20s and that makes it a worthwhile stock to consider for patient investors who can buy it for its three-to-five-year potential.

SEE: 5 Must-Have Metrics For Value Investors

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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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