Wall Street spent much of 2012 buying into the housing recovery. From wood products companies such as Louisiana-Pacific (NYSE:LPX) (up 135%), to home builders such as PulteGroup (NYSE:PHM) (up 179%), to furnishings/fixtures manufacturers such as Masco (NYSE:MAS) (up 52%), quite a number of stocks tied to residential housing had significant recovery rallies in 2012. So, too, did Weyerhaeuser (NYSE:WY), a well-run company that includes timberland, wood products and real estate investment trusts. While timberland is likely to remain a high-quality long-term asset, and Weyerhaeuser is one of the better operators in the public market, new investors should probably wait for a pullback.
SEE: Investing With Purpose And For Profit: Affordable Housing
Results Look Good, but Underlying Numbers Were Mixed
At first blush, it seems hard to quibble with Weyerhaeuser's fourth quarter when revenue and segment earnings both showed good growth. Quality of earnings was an issue, however, and investors likely walked away from this quarter with some concerns about near-term operating efficiency.
Revenue rose 25% this quarter, with erratic results across the board. Timberland revenue rose 12% with generally better pricing and volume. Wood products revenue rose 2%, but there was a lot of noise here as engineered products were soft, but products such as lumber and oriented strand board were strong on both volume and price. Pulp was down 11% on weak pricing, and the volatile real estate segment saw a 77% improvement in revenue.
Earnings, and earnings quality, were complicated as well. Weyerhaeuser posted a five-cent beat relative to the average estimate, but seven cents of that came from land/lot sales. Gross margin improved by two and a half points, while segment EBIT rose 56% from last year (with margins up 270 basis points). Timberland profits improved by a third, wood products reversed a loss from a year ago, and pulp profits were down more than half as the company's manufacturing profits were disappointing.
SEE: The Financial Considerations Of Building Vs. Buying
Timber Conditions Improving, but Won't Help Everybody Equally
Weyerhaeuser management sounded pretty positive and upbeat on the trends in U.S. housing, and that should be good for the timber and lumber products companies. That's not to say that it will all be equal. Weyerhaeuser saw good results in its Western timberlands (up 8.04%), and the company's strong Pacific exposure is a real value-creating advantage over others such as Plum Creek (NYSE:PCL) and Rayonier (NYSE:RYN), and that advantage could grow if Asian demand picks up again.
Real Estate Still a Big Unknown
One of the sometimes under-appreciated components to the business model for timberland owners such as WY, Plum Creek and others is selectively selling off timberland to real estate developers (or, in the case of WY, which owns a homebuilder, doing it themselves). While well-run timberlands can generate over $100 in earnings per acre per year, that same property can sell for over $3,000 an acre to property developers.
Not surprisingly, those sales shriveled over the last five or six years. Once residential housing construction resumes (and it will need to eventually, to keep up with population growth), it seems very plausible that those sales will pick up as well. This process will be lumpy, however, and can create quarter-to-quarter chatter about earnings quality - particularly when Weyerhaeuser's wood products and cellulose operations aren't running at top form.
SEE: 5 Simple Ways To Invest In Real Estate
The Bottom Line
There's a wide variety of approaches to valuing companies like Weyerhaeuser. Investors can use long-range free cash flow or NOPAT analyst, mid-cycle EBITDA multiples, sum-of-the-parts (SOTP) valuations and so on. While acknowledging that it's not necessarily the most rigorous approach, the SOTP has its uses and is one of my preferred methods for timber companies.
For Weyerhaeuser, I estimate a SOTP value at about $31 per share. This includes assumptions such as $3,500 per acre for timberland that can be sold for real estate, six-and-a-half times multiples for mid-cycle EBITDA for wood products and cellulose, a slight multiple to book for the homebuilding assets and a perpetuity valuation on the timberland of over $100 per acre.
Admittedly there are a lot of moving parts, and investors will almost certainly have differing opinions on how to value each part. With what I see as a plausible range of values from the high $20s to mid-$30s per share, I think Weyerhaeuser may still be a decent hold. But I'd need to see a pullback before committing new money to these shares - even if the housing recovery is real and continues to materialize in 2013.
At the time of writing, Stephen D. Simpson did not own any shares in any company mentioned in this article.
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