Value Investing Forum

So the clear problem with what I did was I ignored debt. So I'll just take a look at PCH and PCL and do some reverse engineering. Basically I'm going to assume market cap = equity. Then I leave everything on the balance sheet the same except what the land value is and increase it to get everything to "balance" out. What I arrive at is:

PCH – $1247/acre

PCL – $1313/acre

Now if timberland is actually going for, say, $2000/acre as the data below suggests, then we're effectively buying timberland for about $.65 on the dollar.

I haven't gone through PCH's 10-k yet but I think I will. And I may take a position in PCL unless I can find any reason not to. Any thoughts?

The only concern with my data set is that it seems to be a bit higher compared with the data from The Timberland Blog. Though that might mean that prices have increased that much in just a year and a half.

In either event, unless PCL's land is lower than average quality, $1000/acre seems like a decent margin of safety.

If what you're saying about the dune beetles has significant results, this could be pretty big.

Just out of curiosity, what are your thoughts on Chano's claim that China is in a housing bubble? Is it possible that demand from China could be reduced?

Post edited 2:01 pm – March 24, 2011 by stormam

That is a great question.  To be fair, I have not done in-depth work on this company but have a friend who specializes in financials and REITs and is a big believer.  So I will give you my view.  I did ask him about it and he told me many of the sales have been from lower-quality regions that have been partially impaired by the dune beetle.  (This thing is real, I'm not kidding.  Look stuff up about it; it is destroying forestry in the US & Canada.  Nuts).

The mark-up to book is basically the land-value appreciation over time plus the timber that is grown.  If I bought land in the middle of nowhere for $100 and sold it for $227, it appreciated $117 over that long time-frame.  Now 2.27x over 20 years is a 4.2% annualized return which is a decent ROA.  If you look back over the last 15 years or so, ROA has generally ranged from about 4%-7%.  It is currently at the low end of this range.  This has generated a ROE of about mid teens over time, which is nice.  So, let's go back to the example of the $227 sale.  I don't know what the proper increase in the land value is vs. the timber, let's say $50 of the gain is land and as such $77 is the timber => land value increased ~2% a year and the grown timber adds a larger chunk of the value.  This seems reasonable.  Now, the timber value is a function of price.  For example, if timber prices double, then you could sell that land for another $77 = $304, which substantially changes your balance sheet value. 

So there is meaningful correlation to timber prices.  What is reasonable to expect in timber prices then?  In 2010, prices bottomed just under $200 and finished the year at almost $300.  Prices have been pretty volatile, but generally are ranging from about $200-$500 over the years, up from the high 100s during the 80s.  Now, using your numbers below, the mkt cap is $6.9 billion.  So what does the timber need to be worth to have this make sense?  If the company gets a 2.38 conversion ratio, then it makes sense.  In my old example, that means the timber needs to sell for $88 instead of $77, a 14% increase in prices. 

Now, here's the fun part.  You read the 10-K which refers to 2010 price levels, which ranged from $200 – $300.  Spot prices are still about $300.  So, depending on when the sales were, it looks like prices are up at or more than 14% ($263 * 1.14 = $300).  So that bridges your gap.  Our $50 land $77 timber split is probably wrong, but let's aim for directionally right. 

Next, the thesis is that supply is being destroyed by the dune beetle while demand for US timber is increasing internationally.  Timber prices are at the lower end of the last decade's range without so much as a hint of a US housing recovery.  When this returns, timber could meaningfully increase in price, offering significant upside. 

For downside protection (you're looking at a commodity related company, so there is never amazing protection) you know that the largest source of timber demand is at an 80 year low (US housing).  Second, ROAs are pretty good at 4% => a levered ROE of mid teens.  So even at these prices, you're getting pretty good ROEs.  Third, as highlighted at the beginning, my understanding is that those 2.27x sales were lower-quality properties.  I don't know the company and can not guarantee you this, but it gives me comfort.  And we get a decent dividend as we wait for the market to come back. 

Post edited 7:58 am – March 24, 2011 by stormam

What is the book value of a tree?  Hehehe, try T-charting that on a balance sheet. 

I was really busy earlier, sorry.  PCL is a timber REIT  with solid management.  The timber market has been under duress as the housing market collapsed.  Every Wall Street analyst that covers this company has spent the last 20 years of their career mapping housing starts to PCL revenue and has no interest in looking at any other metric, so the stock becomes beholden to housing until it can prove otherwise.  The short story is timber demand is sky-rocketing internationally and, strangely, the US dune beetle is destroying our timber stock.  The Chinese are buying so much they even take trees ruined by the beetles.  As such, the industry has seen shrinking capacity with increasing demand.  Because US housing is depressed, there is a lot of demand to soak up, but if/when housing begins some basic improvements, the market will be much tighter than before leading to significantly higher price increases than expected.  Trees grow and replenish sure, but it takes awhile.  The housing market will come back in the next 1, 2 or 5 years and that is before significant timber capacity can be re-established.

PCL

Stormam brought up this article by Jeremy Grantham:

Pavlov's Bulls

One of his suggestions is this:

Yes, we have already recommended forestry, agricultural land and "stuff in the ground".

So anyone have any ideas here? Perhaps together we can come up with one or two good plays.