The dust hasn’t yet cleared on the collapse of America’s construction industry, but the fallout is there for everyone to see. Residential construction sites have ground to a halt in the cities as cranes are drawn down and labourers laid off. In suburbia, new-builds have been abandoned as first-time buyers are cut off from credit. And now, out in the country, it’s the turn of the timber companies. Wood has been piling up at lumber mills across America as prices plunge below the cost of production. American lumber consumption is expected to drop from 64 billion board feet in 2006 to 43 billion board feet this year. That’s equal to the total output of the top 20 US lumber producers last year.
For some US timber groups though, the sight of lumber stacked high in the mill isn’t a total disaster. Companies who own the timber forests, such as Plum Creek and Rayoneir, will fare better than the paper and saw mills who chop the timber up. Soaring input prices – from gas and chemicals to distribution costs – are eroding profit margins in the timber production industry. But if the raw timber isn’t fetching a good price, the likes of Plum Creek can always just leave it to grow on the stump – their high-quality tracts of forest will hold their value until demand picks up again. But while America’s timber trees will probably be left to stand for the next two to three years, Chinese forests are being chainsawed as fast as they’re planted. With Beijing still preparing for the Olympic games and Chinese furniture exports thriving, China is crying out for timber. Until recently, China had far less forest (roughly 18%) covering its land than other countries. But harvesting trees has been contentious in China ever since the Yangtze burst its banks in 1998, killing more than 3,000 people and costing the economy some $24bn.
With rapid deforestation seen as a major cause of the disaster (forest cover helps absorb rainfall, so its absence means more rain to swell waterways), Beijing imposed restrictions on harvesting timber and has thrown its weight behind creating man-made plantations. In the meantime, China has relied on imports to make up for shortage of timber. Imports to China increased tenfold from $53bn in 1990 to $561bn in 2004, with the bulk in recent years coming from Russia. But just as the Kremlin is happy to use its energy reserves to hold economies to ransom, it is squeezing its timber customers as well. Russian export taxes on timber rose to €15 per cubic meter on 1 April and are expected to balloon to €50 next year.
Still, while the taxes are creating misery for Chinese wood-buyers, says Richard Kelertas of Dundee Securities, they represent opportunity for the firms growing trees in the country (see below). With severe winter storms knocking over a tenth of China’s forests earlier this year, log prices should rise 5%-7% a year over the next half-decade, says Kelertas. But as fans of timber, we would encourage you to look even further ahead than that. If there’s ever been an asset that’s perfect for investors to buy and hold, it’s timber. As Jeremy Grantham says, timber is the only low-risk, high-return asset in existence, returning an average of 6.5% a year over the last 100 years and rising in three out of the four market collapses of the 20th century. The best stock to buy is below.
The best play on timber
With huge tracts of timberland spread across America, Plum Creek (NYSE:PCL) and Rayoneir (NYSE:RYN) are ideally placed to wait out the downturn in US building. As we’ve noted before, these real estate investment trusts have performed very strongly in recent years, while paying out handsome dividends. But with forward p/es of 32 and 20.5 respectively, there are cheaper ways to buy into timber.
First among these is Toronto-listed Sino-forest (TSX: TRE). With more than 312,000 hectares of timberland across ten Chinese provinces, Sino-forest is one of the biggest forest owners in the country. Sino-forest has been growing strongly ever since it went public, delivering average annual growth in earnings per share of 21%.
Unlike other forest owners in China, Sino’s pine forests were left largely undamaged by the snowstorms at the turn of the year. Sino reported a 26% rise in profits for the first quarter. With little debt on its books, there is plenty of scope for increasing its forestry holdings. Sino-forest is valued on a forward p/e of 16, but with a PEG ratio of 0.8, the continuing growth of earnings comes cheap. Dundee Securities analyst Richard Kelertas maintains a 12-month target price of C$31.50 – the stock currently trades around C$19.