WY - Housing Turbulence Could Open A Window Of Opportunity With Rayonier

Summary

• Higher interest rates and affordability issues are likely to drive a double-digit decline in new housing starts in 2023, weighing on demand for lumber and the value of Rayonier's timber.
• The U.S. remains fundamentally under-supplied with housing and China's imports of wood continue to grow to meet construction needs there, and Rayonier owns high-quality acreage in attractive markets.
• Rayonier has been a good steward of its acreage over the years, with a strong per-ton EBITDA track record relative to other publicly-traded timber companies.
• Rayonier shares look modestly undervalued today but would be worth reconsidering closer to $30.

While it’s true that timberlands can be a good investment category over time (if bought and managed properly), it doesn’t automatically follow that timber REITs are a can’t-miss investment opportunity, as the market has frequently assigned robust multiples to these businesses. In the case of Rayonier ( RYN ), for instance, an investor who bought the shares on the day after the spinoff of Rayonier Advanced Materials ( RYAM ) and reinvested the distributions would have an annualized return of around 3.5%, while an investment in Weyerhaeuser ( WY ) would have returned around 3.4%, and PotlatchDeltic ( PCH ) would have returned around 6.7%.

Still, for almost any going concern, there’s a price where it makes sense to consider (or reconsider) the investment case. I don’t think Rayonier is quite there today, but were the shares of this timber REIT to sell off on weaker near-term results due to the temporary downturn in U.S. housing, it’s a name I’d certainly consider, particularly for investors who want some resource/commodity exposure.

The Lumber Gold Rush Is Over

A host of factors combined to propel lumber to record prices in the spring of 2021 followed by another boomlet in 2022 that saw prices reach about 75% of the 2021 record, but the market has since cooled dramatically, with composite lumber prices (as calculated by Random Lengths) down from around $1,300 per thousand board feet to something closer to $400 in recent weeks.

Looking through 2023, I don’t see a particularly strong market for lumber or timber. I expect high interest rates and affordability issues to weigh on housing starts, depressing the demand for lumber and timber, as I expect a low double-digit decline in 2023.

That hasn’t shown up yet in Rayonier’s results, with Southern Timber prices up 18% in the third quarter and Pacific Northwest Timber prices up 13%, but I do believe there will be growing headwinds as the year rolls on, particularly as I believe the pandemic pulled forward meaningful demand tied to repair and remodeling projects.

This is a likely to be a temporary downturn. I expect interest rates to peak in 2023 and starting heading lower in 2024, and I’ve seen third-party sources that estimate an ongoing shortage of housing in the U.S. of around 5 million units. On top of that, people continue to relocate to the Southern U.S. (where Rayonier has the bulk of its timberlands) and China has a seemingly ever-growing need for timber for housing that Rayonier can help supply through its Pacific Northwest and New Zealand timberland assets.

Self-Help Shouldn’t Be Discounted

There seems to be a relatively common mistaken belief that silviculture is a simple business – just plant the trees and watch the growth, and if prices aren’t good this year, just wait a year or two to chop them down. This is overly simplistic to the point of error, and there is value to be generated by properly managing timberland assets.

To that end, I think it’s worth noting that Rayonier has led its peers in terms of EBITDA per ton in its Southern operations ($21/ton versus $15 for PotlatchDeltic and $13 for Weyerhaeuser). Likewise, while there are some issues using an EBITDA/acre metric, Rayonier does well by this metric too.

Strong numbers are a byproduct of buying the right timberland (productive, close to demand, easy/cheap to harvest) and managing it well, and Rayonier has been doing this for years in the Southern U.S. With that, more than 70% of the company’s timberlands are in areas that generate top-quartile sawlog stumpage prices.

The Pacific Northwest operations aren’t quite as strong, due in part to a greater mix of lower-value hemlock (versus Douglas fir), and Rayonier trails Weyerhaeuser here in terms of EBITDA per ton and timberland value per acre. Still, I liked the company’s move to acquire Pope during the pandemic, and I do expect management to be opportunistic in looking at potential transactions to further build and improve this asset base.

To that end, I’d note that the company announced a deal in mid-December to acquire almost 138,000 acres from Manulife for $454M. While $3,290/acre looks expensive for Southern timber assets (and management has talked about investor interest pushing up the value of timberlands and making M&A more challenging), these are productive acres and the company is paying less than 20x expected annual EBITDA.

To be clear, “self help” can only do so much. The company has a good track record of growing EBITDA per acre (4% a year since 1990) and maximizing the value of land that can be converted to housing or recreational use, but this is more of a “slow and steady” driver that bears fruit over time. I believe that’s particularly relevant to the real estate operation; Rayonier benefited from some sizable (and lucrative on a per-acre basis) real estate sales in FY’21 that aren’t going to be recurring and a weaker housing market is likely to limit real estate opportunities for at least a year or so.

The Outlook

There are several ways of valuing timber companies, all of which have their advantages and drawbacks. Sum-of-the-parts valuation is useful, but you have to have access to pricing information and some insight into the nature of a company’s acreage. EBITDA-based approaches are simpler, but there’s room for substantial debate on the right/fair multiple to use. Discounted cash flow can also be useful, but accurately calculating residual values can be tricky.

Having access to pricing resources, I do like using sum-of-the-parts, as well as EBITDA-based valuation. With average per-acre values of $2,100, $3,150, and $2,800 for the Southern, Pacific Northwest, and New Zealand timberland assets, and including potential real estate acreage, I believe Rayonier’s sum-of-the-parts value is around $38-$39. For EBITDA, I believe a forward multiple of 21x is fair given the profitability and efficiency of the operations, and that gives me a $36 to $37 fair value based on my FY’23 EBITDA estimate.

The Bottom Line

If my valuation estimates are in the right ballpark, Rayonier is modestly undervalued today, while still offering a dividend yield of more than 3%. I’d prefer a little wider margin of safety, and given the outlook for the housing market, it is possible I may get one. Were the shares to trade closer to $30, this is a name worth revisiting; while I don’t believe timber is ever a “can’t miss” investment prospect, well-managed assets bought at the right price do have some appeal to me.

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