Author: SC
1. Results Overview
It was interesting to see all Timberland REITs reporting progress on and highlighting the monetization potential of land-based climate solutions including carbon credits and leasing out land for solar power plants.
Lumber markets remained relatively subdued, but we have been seeing actions by lumber producers to manage capacity and bring the market back into balance. Lumber companies are trading on the market at significant discounts to book value, potentially and selectively offering an interesting level of price relative to value for long-term investors.
Homebuilding in the U.S. remained resilient, as opposed to the declining trend in residential construction activity in Europe, especially in Northern Europe. While European weakness is a drag in the short-term, such low levels of construction activity do not seem sustainable and create upside potential in the medium and longer term, in the face of housing shortages in key European markets. Leading wood products companies such as engineered wood products specialist Louisiana Pacific offered probably the most optimistic views in quarters on normalized channel inventory levels and upside potential in the case of normalizing interest rates.
Download the report as PDF
2. Timber Construction
North America – Timberland REITs
Weyerhaeuser, the largest timberland REIT, reported a relatively stable top-line in Q4, with sales only slightly down (-2.7%) vs. the previous year’s period, while profitability was lower, driven by wood products. The last quarter represented an important symbolic milestone for WY as it sold its first carbon credits: 32’000 credits at $29 each in relation to an improved forest management project. While the amounts are tiny relative to the size of WY’s business, they represent a first step towards a new stream of monetization that should in principle lead to better environmental results, as it creates incentives to manage forests not only with the goal of maximising production.
Rayonier, the more “pure-play” timberland REIT, reported Q4 sales and income higher than last year, even adjusting for the large timberland sale in December that generated a $105m gain on a sale of $242m, highlighting the discrepancy between private market valuations and book values. Management is due to provide more details on the so-called land-based solutions business at the end of February during the company’s investor day. Land-based solutions include land leases aimed at building solar and wind power plants, as well as for carbon capture and storage projects. The quarterly results of Rayonier also show very well the optionality and the levers embedded in the timberland business model: harvesting was reduced in the Pacific Northwest area as prices were particularly weak, leaving growth for better future market conditions; the sale of timberlands, that in this case was used to reduce debt, but in other situations can be used to buy back shares, especially when public valuations are significantly lower than private market valuations; the potential for real estate development, highlighted by new entitlements for 15’000 residential units, as well as other commercial properties, on 15k acres in Wildlight, FL, 7k acres of which are to be preserved for conservation.
Being more exposed to lumber prices, which were down double-digit QoQ as well as YoY and led to weak wood products and Northern timberland segment results, PotlatchDeltic delivered a breakeven quarter, with lumber weakness compensated by stable roundwood prices in the U.S. South and a particularly strong real estate segment, with almost 7k acres sold for $3’100/acre. Management highlighted the progress in natural climate solutions, with a 50k acres carbon credits project in the U.S. South in the certification phase, and monetization potential through solar power projects on company-owned land.
Figure 1: Average realized log prices for Potlatch and Weyerhaeuser. Sources: company reports.
The role of carbon credits and land-based climate solutions, while still small, may increase in both scope and relevance. The two projects mentioned above by Weyerhaeuser and PotlatchDeltic have been developed on ca. 50k acres of land – this corresponds approximately to 0.5% of timberland owned by WY and 2% for PCH. They fit well within the business model of timberland REITs as they provide even more optionality with regards to the monetization of the timberland asset base, should the price of carbon credits be high enough to justify the allocation of timber resources for carbon purposes rather than industrial operations. Another interesting point highlighted by the timber REITs is the increasingly relevant role played by timberland investors focused on carbon projects, which includes deals such as the $1.8bn acquisition in 2022 of 1.7m acres of timberland led by Oak Hill[1] and investment vehicles such as Manulife’s Forest Carbon Fund or Stafford’s Carbon Offset Opportunity Fund, aimed at monetizing forest carbon credits[2]. While each type of timberland buyer has his own criteria for acquisition and the actual development of this business remains to be seen, increased interest in forest carbon credits should, all-else-equal, support timberland prices as a) a new type of demand arises and b) carbon credits compete with timber harvesting, which may reduce timber supply and support roundwood prices.
While formally not a REIT, the Canadian timberland company Acadian Timber also highlighted in the quarterly call the progress over the last quarters on carbon credits and solar leases. Acadian’s improved forest management project was registered in June with the American Carbon Registry, covers 176k acres of land – more than three times as much as WY’s and PCH’s projects mentioned earlier – and resulted in 770k initial registered credits. The initial sale of credits was very small, but achieved $25 per credit, in line with WY’s. Commenting on the future of carbon credits for timberland companies, Acadian’s CEO stressed the importance of providing high-quality carbon credits and expressed his conviction that these markets are here to stay. It will be interesting to monitor the development of credit monetization in the next quarters.
North America – Primary and Secondary Wood Products
Canadian “pure-play” lumber producer Interfor reported revenues in line with expectations but a significantly weaker bottom line affected by an impairment charge and other one-off costs. The company’s medium-term outlook is for continued weakness in lumber prices – which, on the positive side, is a driver of capacity reduction in commodity industries that leads to market balancing.
Lumber and OSB heavyweight West Fraser (WFG) beat top-line and adjusted EBITDA expectations thanks to a solid North American EWP result. Europe and lumber segments were weaker than expected. WFG recently completed the divestment of a pulp mill and is completing another sale, further concentrating on solid wood products. The company highlighted the stagnant lumber supply in North America over the last decade and the long-term potential for demand arising from the ageing of the housing stock and pick-up in R&R once interest rates will normalize.
Results by Western Forest Products, the smaller player focused on specialty lumber and expanding its mass timber business, were broadly in line with the overall picture, with adjusted EBITDA around breakeven and slightly better than consensus.
In this weak lumber price environment, lumber manufacturers have been addressing overcapacity by closing mills: West Fraser announced in January the closure of one sawmill in B.C., one in Florida, and the indefinite curtailment of one in Arkansas. This corresponds to ca. 0.4 Bfbm vs. ca. 6.7 Bfbm capacity at the end of 2022. Boise Cascade also announced the curtailment of a sawmill in Alabama. Canfor announced last November the curtailment of a sawmill in B.C. after announcing the permanent closure of two other mills (one of which however to be replaced by a newer one) always in the troubled B.C. region. While it is obviously painful in the short-term, it is the most pragmatic way to address oversupply and bring the market back to balance. Interfor has reduced its 2024 capex plans in response to both the weak lumber market and cost inflation and a couple of days after the quarterly call announced production curtailments in Oregon and B.C. While it is impossible to predict the exact timing of the cycle bottom, the market is already discounting a high degree of negativity in the sector with lumber companies trading at significant discounts to book value, potentially offering an interesting level of price relative to value in specific cases.
Louisiana Pacific offered probably the most optimistic tone in their quarterly call, pointing to normalized inventory levels and the upside in repair & remodelling in the case of normalizing interest rate. The company completed its capital investment plan and will now be stepping up marketing investments, which should improve capacity utilization and margins over time.
Builders FirstSource, the building materials distributor, reported solid results, significantly above expectations. Despite some pressure in multi-family that is expected to weigh on margins, the company expects a robust 2024. As with other companies, there is a general expectation for lower interest rates that should provide support to homebuilding.
Boise Cascade, the manufacturer and distributor, reported solid results, boasting a very solid net cash position, and offered a cautious outlook on pricing pressures while stressing its readiness for a pick-up in construction activity in spring and summer.
With a diversified portfolio of timber products, ranging from engineered wood products – for structural as well as exterior applications with branded products – to wood packaging, UFP Industries delivered solid results. While it highlighted some slowdown in the packaging business as U.S. economic growth is normalizing, it also noted the promising growth in composite products where it competes against plastic-wood composite manufacturer TREX, which managed to beat consensus on both bottom- and top-line.
Mercer International, which has been diversifying from pulp into mass timber, wood packaging and bioenergy, highlighted the strong growth in the North American mass timber niche, pointing to growth of ca. 20% over the years, and boasting a backlog increase from $54m to almost $100m, with the mass timber business becoming material on a consolidated basis and representing ca. 35% of North American capacity based on the company’s estimates.
Europe – Integrated Forest Products and Secondary Wood Products
In Europe, forest owner and integrated forest products company SCA provided a relatively upbeat outlook. The CEO’s remarks highlighted normalized inventories and tight wood supply in Europe as key factors for a relatively optimistic view going forward. While 4Q results were significantly lower YoY, the company remained solidly profitable thanks in part to revaluation gains on the company’s forest assets, driven by growth in standing timber and three-year average price per m3 increasing +8%. In 2023, though, there was a slight correction in Swedish timberland transaction prices. In the quarterly call, SCA’s CEO also addressed some of the criticism against the company from short sellers with respect to its estimation of standing inventory, highlighting surveys made in 2016-2018 and pointing to regular verifications of inventory when harvesting. In any case, this debate supports the idea of valuing companies holistically based on different approaches, including (e.g., EBIT-) multiples and discounted cash flows (see our sample research reports), instead of putting too much emphasis on forest values, especially in the case of forest products businesses that use the forest by means of vertical integration (rather than for asset management). That said, companies need to provide robust valuations, as these are preconditions for credible governance.
SCA’s peer Holmen, reporting five days after SCA, discussed in more detail than usual the topic of forest valuation. Management noted that real discount rates for Swedish forests rose in 2023, while they had remained relatively stable during the period of near-zero long-term government bond yields, so in fact valuation models should be using real discount rates comparable to those used in the past when long-term risk-free rates were at similar levels as they are today. The CFO also provided details on the assessment performed by a third-party appraiser over the 2019-2023 period, supporting the company’s valuation of its forest assets. Unsurprisingly, just like SCA, Holmen noted timber market tightness with Swedish wood prices at historically very high levels while sawn wood and pulp margins are in line with historical levels after spiking in 2021-2022.
Figure 2: Swedish roundwood prices. Source: Swedish Forest Agency.
Holmen remains bullish on the prospects for wood construction, noting increasing interest for wooden frames, and management also pointed out that competition from green steel would likely lead to higher demand for pulp used as bioenergy by the steel industry. Stora Enso highlighted elevated fiber prices also in Finland and discussed its progress on the restructuring program.
German wood fiber insulation specialist STEICO reported preliminary numbers roughly in line with expectations and expects 2024 to be in line with 2023 both in terms of revenues and profitability. Considering the weakness of the underlying construction sector in Germany, which is the largest market for Steico, and the continued weakness in Europe expected by most players, 2023 results and 2024 outlook are robust.
[1] https://www.green.earth/news/wall-street-company-makes-a-1.8-billion-investment-in-the-carbon-market
[2] https://carboncredits.com/manulifes-forest-carbon-credit-fund-closes-224-million/
3. Paper & Packaging
SCA reported weak results in its pulp segment, with EBITDA marginally above breakeven, on lower prices YoY. On the positive side, pulp inventories have been normalising and are reported to be in line with historical averages. UPM managed to deliver solid margins overall, but these were driven by very large gains from energy refunds in Finland and Germany. Some areas of the business, like label materials, were affected by extraordinary destocking activity in recent quarters – the company expects a normalization of demand going forward. Adjusted profits above consensus were not enough to offset unadjusted profits below consensus and a moderately optimistic outlook for 2024 with multiple mills in maintenance in 1H24. Holmen’s results in paper and paperboard were mixed, with weak paperboard offset by declining but still remarkable profits in the paper division, supported by a competitive advantage arising from the company’s vertical integration with own fibre and renewable energy. Stora Enso’s comments were prudent, highlighting challenging markets – the company reported completion of its restructuring program announced last year. Despite weak results, Mercer also pointed to normalization in its pulp business for the same reasons highlighted above, noting the bottom in prices appears to be widespread market consensus.
4. Equipment Manufacturers
Nordic equipment manufacturer Husqvarna’s top-line results were in line with expectations, while the bottom-line was below consensus, although operating results excluding restructuring costs and costs connected to the exit from Russia were better than expected. The company is deleveraging and has been implementing cost-reduction initiatives, while at the same time working on its product portfolio that covers forestry, gardening and construction, with a vision towards automating, electrifying and decarbonizing tools. Management highlighted continued weakness in Northern Europe, while the U.S. remains resilient and picked up in January after a slowdown at the end of the year.
Deere beat consensus on both top and bottom line, while at the same time providing a softer outlook for 2024. Deere’s construction & forestry segment had flat revenues YoY.
Finnish forestry machines specialist Ponsse reported results below market expectations but still solid given the macroeconomic context, helped by resilience in Finnish and Swedish forestry operations, which in line with the comments from the Nordic integrated forest companies. Ponsse is turning around its Brazilian business and reorganising its operations around regional customer support.
5. Homebuilding and Real Estate
While the homebuilders discussed in this section are not included in the Timber Finance Carbon Capture & Storage Index, they are included here as they provide useful insights into a key element within the construction value chain that drives demand for durable wood products.
D. R. Horton, the largest American homebuilder opened the earnings season and reported quarterly earnings in line with the previous year but slightly below consensus. The stock closed down -9% on the day of the announcement as the outlook was neither particularly strong nor weak, but did not match market expectations, indicating how optimism was priced in. Meritage, focused on entry-level homes, beat on both top and bottom lines – nevertheless, the market punished the 2024 outlook, where management guided towards lower revenue and margin ranges; while management provided positive comments on the start of the year after pressure in Q4 from higher interest rates, the CFO noted the need for incentives still significantly above historical average. MTH stock tanked close to -9% on the day of the announcement, in line with DHI previously, again pointing towards excessive optimism priced in by the market.
In Europe, the slowdown in construction activity, especially in the Nordic countries, is being felt by homebuilders including the Swedish Peab AB, which however highlighted a “divided market”, with weak housing construction across Sweden, Norway and Finland, but resilient public building construction. Norwegian construction company Veidekke reported strong results, with a resilient order intake supported by public buildings and infrastructure offsetting weak residential construction (particularly in Sweden). There are several other examples of weak construction activity in Northern Europe – the topic has already been discussed in other reports – and it should be noted that such a strong reduction in construction activity, while clearly having a negative impact in the short-term on companies’ results, can lead to (new or stronger) housing shortages and increased future demand for housing and building materials. French developer and pioneer of timber construction Nexity reported strongly slowing demand, with the rise in interest rates identified as the key driver. Sweden[3], France[4], Germany[5] and the UK[6], crucial European markets for timber products, are all characterised by tight housing balances and the construction slowdown from higher interest rates is likely to re-accelerate once rates will normalize.
Figure 3: Swedish households vs. dwellings. Source: Statistics Sweden.
As in Figure 3 above, we see that the increase in housing stock has been well in line with household growth, suggesting a reasonably balanced demand and supply at country level. The sharp decrease in dwelling starts in 2023 is likely to tighten such balance in the short-term if household formation remains stable and this may lead to an increased need for new construction in the medium and longer term.
[3] Sweden Commercial Property Market Data | Sweden | Cushman & Wakefield (cushmanwakefield.com)
[4] Housing crisis: Are you prepared to wait 6 months to rent a studio in Paris? | Euronews
[5] Germany: Housing is almost unaffordable – DW – 08/03/2023
[6] Housing | Centre for Cities
5. Disclosures and Conflicts of Interest
Some or all the companies mentioned in this report may be included in the Timber Finance Forest-Based Construction Basket tracker and are part of the Timber Finance Carbon Capture & Storage Index. Timber Finance Management and/or the Timber Finance Initiative may have commercial relationships or be in discussions with some of the companies mentioned in this report. Specifically, Stora Enso is a member of the Timber Finance Initiative association.
Please note that this research is prepared for information purposes and targeted to institutional investors in Switzerland. They do not represent investment advice and do not take into consideration the individual requirements, risk tolerance and goals of an investor. Recipients who are not Swiss institutional investors should seek the advice of their independent financial advisor prior to taking any investment decision based on this report or for any necessary explanation of its contents.
The information presented in this report is obtained from several different public sources that we consider to be reliable. Nevertheless, we cannot guarantee the accuracy of the presented information. The information used may change quickly and we are not committed or obliged to modify the reports base on new information. The opinions and views expressed in this report reflect those of the author at the point in time of its compilation and may vary at any time. Valuation methods like DCF and any other analysis or expert judgement do not provide any guarantee that the target price or fair value will be reached, for example because of unforeseen changes in financial or economic conditions.
For more details and questions, please do not hesitate to get in touch with us at info@timberfinance.ch or:
Timber Finance
Ausstellungsstrasse 36
CH-8005 Zürich
Tel. 044 991 13 44
General disclaimer © 2023 Timber Finance Management AG (“Timber Finance”). All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of Timber Finance. Timber Finance Management AG makes no representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and Timber Finance Management AG and its third-party licensors shall have no liability for any errors, omissions, or interruptions of any index or the data included therein. All data and information is provided by Timber Finance “as is”. Past performance is not an indication or guarantee of future results. This document does not constitute an offer of any services. It is not possible to invest directly in an index. Exposure to an asset class represented by an index may be available through investable instruments offered by third parties that are based on that index.
Copyright © 2023 Timber Finance Initiative. All rights reserved.