PCH - PotlatchDeltic: Cash Flow Dries Up As Lumber Prices Tank

2023-07-11 04:51:02 ET

Summary

• PotlatchDeltic Corporation has seen declining revenues and FFO as Lumber prices have continued lower.
• The REIT trades at 70X FFO for 2023 and over 30X FFO for 2024.
• We go over one metric which still shows it as cheap and tell you why that likely won't save it from downside risks.

When we last covered PotlatchDeltic ( PCH ) we opined on their purchase of CatchMark Timber. While the price was slightly higher than what we would pay, we did not think it changed the PCH thesis in a material manner. We also downgraded the company being acquired as there was little upside left.

PCH likely has overpaid, but it is not material enough to change our view. In any case, the market has punished it right away. So we are maintaining our neutral rating and will again look for long opportunities near the $45 mark. For CTT, we are downgrading this to a HOLD/NEUTRAL, as the acquisition has crystallized the hidden value and we don't see a higher bid coming.

Source: PotlatchDeltic Buying CatchMark: What You Need To Know

PCH has taken a roundtrip to almost exactly the same spot. Total return has been strong thanks to special dividends declared late in 2022.

We update our outlook for PCH and tell you why we have an asymmetrical setup here.

The REIT

PotlatchDeltic Corporation is a leading REIT that owns 2.2 million acres of timberlands in Alabama, Arkansas, Idaho, Louisiana, Minnesota and Mississippi. While timberlands are the primary core business, the firm also operates multiple sawmills and plywood mills. It also has a residential and commercial real estate development business. The non-timberlands portion is done through its taxable REIT subsidiary. The integrated business model gives the REIT some more resilience in down cycles, one of which we are going through now.

Q1-2023

The latest available report showed that revenues had a sharp decline from Q1-2022 and contracted by about 37%. As it happens with most companies, the cost side is far less amenable to the same downside and hence margins tend to collapse.

Net income per share was down by more than 90% as a result. Of course, as this is a REIT, net income takes less importance relative to cash flow and funds from operations ((FFO)). While the drop in net cash from operations was less gruesome, it did show a similar trend to the net income drop.

These numbers are even worse when you take into account the fact that PCH completed the integration of CatchMark acquisition in September2022. CatchMark's revenues were absent in Q1-2022. So what caused the huge drop? Well, PCH is a price taker and in the commodity business, almost no commodity has done worse than lumber Below we show a 5 year chart and you can see how close we are to the lows reached during COVID-19.

It actually gets worse here for PCH. In Q1-2023, the prices were far higher than what we see today.

Wood Products Adjusted EBITDDA decreased $2.4 million from Q4 2022

Average lumber price decreased 8% to $435 per MBF in Q1 2023

Source: PCH Q1-2023

You can see the change by zooming in on the Lumber price chart. Q1-2023 benefitted from a huge spike in February.

Current prices are far lower and the adjusted EBITDA/FFO/Net income, all will be going lower.

Outlook & Valuation

PCH is dependent on lumber and timber prices and those commodities are tied to construction spending. In the current cycle, residential construction spending has been declining, while non-residential has held up strong. This is a fairly unusual cycle and it is hard to predict how things will play out. That said, we have seen past cycles where residential tends to lead and non-residential finally moves down. The 2006-2009 is a great comparative for our purposes.

This brings us to the important question, if these commodities are so weak now, what will happen when non-residential spending goes into a freefall? The answer cannot be anything good, but it is possible that commodity markets have discounted some of this at least.

On a valuation front, PCH looks somewhere between expensive to "are you kidding me?" when we see the FFO multiples.

71X multiples are generally not things you want to find when risk-free rates are at 5.25%. Interestingly though, the average estimate for the net asset value or NAV paints a different picture. According to S&P Global, the mean NAV estimate is near $60.00 per share. The belief here is that timberlands holds value even if timber itself is trading low. So PCH looks incredibly expensive on a cash flow basis, but perhaps fairly valued on a NAV basis.

Verdict

The risks here are to the downside and in a big way. PCH has a fairly solid debt maturity profile, so we don't expect that to influence matters.

But one could wake up one morning and realize that the FFO for 2023 does not even cover half the current dividend. One could also realize that Lumber is trading at the lowest point relative to PCH . Note the chart below shows a ratio.

In other words, even if you are bullish on lumber, PCH may not be the best way to play it. While we get that concept of "buy land (timberland in this case), as they are not making any more of it.", the current valuation is just too rich to dabble in PCH. The NAV estimate might provide comfort, but as we examine longer term charts, we note that PCH has many times traded as low as 40% below consensus NAV estimates. That would bring us to around $36 in this case. PCH gets a 7 on our potential pain scale rating.

Please note that this is not financial advice. It may seem like it, sound like it, but surprisingly, it is not. Investors are expected to do their own due diligence and consult with a professional who knows their objectives and constraints.

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