WY - Weyerhaeuser: Potential Earnings Trough In 2023

Summary

• Sales for Weyerhaeuser were down 0.2% Y/Y in 2022, with adjusted EBITDA, diluted EPS before special items and adjusted Funds Available for Distribution all down 10-11% Y/Y.
• Lumber futures have erased COVID-19 gains and are back to 2019 levels.
• 2023 should be a trough year for the company due to weakness in the Wood Products segment, with 5.5% growth in fee harvest volume expected.
• WY has a very conservative capital structure, with net debt of just $3.5 billion and a market cap of $23.2 billion. Its 10-year bonds are also very appealing, with a yield of 6.5%.
• Growing alternative uses of wood and a Natural Climate Solutions business could boost earnings post-2023.

Company Overview

As outlined in the company's 2022 Annual report :

Weyerhaeuser Company ( WY ) is one of the world's largest private owners of timberlands. We own or control 10.6 million acres of timberlands in the U.S. and manage an additional 14.1 million acres of timberlands under long-term licenses in Canada.

We are also one of the largest manufacturers of wood products in North America. We manufacture and distribute high-quality wood products, including structural lumber, oriented strand board, engineered wood products and other specialty products.

Weyerhaeuser reports results for three main business segments, namely Timberlands at 18.2% of 2022 sales, Real Estate, Energy & Natural Resources at 3.6% of 2022 sales, and Wood Products at 78.1% of 2022 sales:

Operational Overview

Given the somewhat seasonal nature of Weyerhaeuser's business (for example, a slowdown in residential construction in the winter months affects the demand for building materials such as wood) it is advisable to observe annual performance trends rather than quarterly figures. Thus, here is a snapshot of the company's performance in 2022:

Wood Products was the weakest segment in 2022, with sales down 3.2% Y/Y and Adjusted EBITDA dropping 18.5% Y/Y.

Timberlands delivered a 13.6% Y/Y revenue increase in 2022 while Adjusted EBITDA was up 13.1% Y/Y.

Real Estate, Energy & Natural Resources is the company's highest margin segment (it accounted for 9% of total Adjusted EBITDA in 2022 despite its small weight in total sales of 3.6%). The segment saw sales up 7% Y/Y in 2022, with Adjusted EBITDA increasing 11.1% Y/Y.

On a consolidated basis, sales were relatively flat in 2022 (down 0.2% Y/Y). Adjusted EBITDA dropped 10.7%. Diluted EPS before special items declined by 10.4% to $3.02/share.

The company targets a payout of 75-80% of Adjusted Funds Available for Distribution (Adjusted FAD), which is basically net cash from operations minus capital expenditures and adjustments:

Adjusted FAD was $2.3 billion in 2022, down 11.3% Y/Y, driven by lower net cash from operations (-10.4% Y/Y) and a small increase in capital expenditures (+6.1% Y/Y).

Capital Structure

Weyerhaeuser runs a fairly conservative capital structure, with a net debt of $3.5 billion and a market capitalization of around $23.2 billion:

The company spent 23.9% of Adjusted FAD on share buybacks in 2022 and increased its quarterly dividend by 5.6% to $0.19/share on February 9th.

2023 Outlook

Weyerhaeuser expects a more challenging 2023 in light of lower lumber prices relative to 2022:

Fee Harvest Volume, a metric tracking harvested timber throughout the company's portfolio, is expected to be up 5.5% Y/Y to 35 million tons, still below the 38 million tons harvested in 2018-2019.

Despite interest rate hikes by the FED, interest expense is seen at $270 million, flat relative to 2022. The company is one of the least exposed equity REITs to higher interest rates thanks to its small net debt position. The company's 2033 6.875% bonds currently trade above par at a yield to maturity of about 6.5% and offer an attractive low-risk alternative to gain exposure to the company.

Capital expenditures are seen declining 6% Y/Y to 2021 levels of about $440 million.

Conclusion

The elephant in the room of course is the highly volatile price of lumber, which after jumping hundreds of percent during the COVID-19 pandemic is back to 2019 levels:

This will continue to impact the Wood Products segment and Adjusted FAD. That said, I expect 2023 to be a trough year for Weyerhaeuser due to:

* Expectations for interest rate cuts later this year and in 2024, which will stabilize the housing market and demand for wood. Currently, the housing market is already suffering while the rest of the economy is relatively robust. I expect general economic conditions to deteriorate later this year. We may even see a point where there is a housing recovery against the backdrop of general economic weakness.

* Growing alternative uses of wood for packaging, biofuel, substitute for cement, etc.

* Weyerhaeuser is building a Natural Climate Solutions business, currently at $43 million of Adjusted EBITDA, and a target of $100 million in 2025.

Overall, I would expect Adjusted FAD to trough at $1.2-1.5 billion in 2023 and to grow from there, driven by a stabilization of the Wood Products segment. Thus, taking the low point of $1.2 billion and adding in interest expense of $0.27 billion would result in a current yield on enterprise value of about 5.5%.

The 5.5% return is excellent for a real estate business which grows with inflation and with assets that don't really depreciate, unlike housing or other commercial buildings. However, the variations in operating performance experienced by Weyerhaeuser are usually far more dramatic than those in other REIT sectors.

Thus, the stock seems suitable for investors with an above-average tolerance for volatility. More conservative individuals may want to consider the company's bonds, or employ yield-enhancing strategies such as covered call selling.

Thank you for reading.

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