Weyerhaeuser: A Timber REIT To Buy On Dividend Growth

As indicated in our previous article, the housing sector has continued its rebounding phase, evident from the recently released data. Due to all these positive developments, homebuilder companies benefited the most, as their share prices climbed enormously. We expect them to continue their upward incline but a few related companies like timber REITs are expected to benefit even more. So, we offer investors an indirect way to play a full-fledged recovery in the housing sector; taking long positions in timber REITs, especially Weyerhaeuser Company (WY).

Positive Housing Data

All of the three composite S&P Case-Shiller Home Price Indices haveincreased simultaneously for the first time since the summer of 2010. Today, the National Association of Realtors released data for July pending home sales, which are 2.4% higher and have reached their highest levels since April 2010. In addition, new-home sales and existing-home sales have increased by 26% and more than 10% respectively, on a YoY basis. A leading indicator of homebuilders' confidence, the National Association of Home Builders/Wells Fargo Index, has also augmented to its highest level since 2007, in August. Groundbreaking on new homes unexpectedly dropped by 1.1% in July from the prior month, but was still 20% more than last year's levels. In addition, the building permits in the U.S. have also surged to four-year high levels.

Weyerhaeuser Company

WY is a timber giant and it manufactures forest products, builds homes, and grows and harvests trees, which are used as lumber, pulp and paper, and other wood and building products. The company has five major business segments: wood products, cellulose fibers, timberlands, real estate and related assets, and corporate and other.

The company was given a REIT status from 2010 onwards, and consequently, its earnings are taxed at 15% instead of the usual corporate tax rate of 35%. In turn, the company has to pay high amounts as dividends, explaining the company's attractive dividend yield of 2.44%. Other publicly traded timber REITS are Plum Creek Timber (PCL), Potlatch Corp (PCH), and Rayonier Inc. (RYN). However, being a homebuilder also, we feel that WY is poised to benefit the most from housing's recovery, which makes it our favorite among these timber REITs. In addition, WY has a "large network of lumber mills in its portfolio," which gives it a distinct competitive advantage over most of its peers who closed their lumber mills during the recession. According to an analyst of Vertical Research Partners:

 

The supply chain in the wood products industry was largely destroyed in the housing depression. So, as a result, if you are a survivor like Weyerhaeuser, and you have a lot of lumber mills, you re in great shape.

 

In a client note dated July 9, Citi Research upgraded Weyerhaeuser from Neutral to Buy, as it feels that:

• Lumber prices will continue their upward trend in 2H2012 and will be stronger-than-expected because dealers have yet to build "adequate inventories to meet housing construction demand."
• The company is poised to "see upward earnings revisions in a sector where estimates are generally drifting lower."
• Given a sustained U.S. housing recovery, the company is set for long-term dividend growth. In fact, Citi expects WY's dividend payout to increase by 50% by 2014, assuming 75 percent of its funds available for distribution go to dividend.

The following graph shows the price chart of lumber's November futures, which have touched their 15-month high levels on August 15.

(Click to enlarge)

Source: CME Group

WY reported its 2Q2012 earnings last month when its adjusted EPS of 9c narrowly missed consensus estimates of 10c. The primary cause was a weakness in the real estate market in the past few years, which negatively impacted its wood products, construction, and timberlands sales. However, the company is optimistic about its future prospects, citing a rebounding U.S. housing market. It is also bullish about the performance of its cellulose unit, as reduced maintenance expenses and lower fiber, chemical, and energy costs augur well for the segment.

The following table shows the results of its homebuilding sector. Number of orders and backlogs in 2Q2012 are higher on both a Q/Q and a Y/Y basis, which is a healthy signal. Order cancellation rate has increased from last quarter's levels, but is lower than last year's levels.

In the last 12 months, the company had cash flow from operations of $500 million while dividend payout has been $320 million. The following graph shows its historical margins:

(Click to enlarge)

Valuation

Source: Yahoo Finance, Google Finance, Reuters

This table shows that most of the timber REITs are trading close to their 52-week high levels and have already appreciated by a large amount this year. WY is the best performer, as its share price climbed the most (more than 31%) this year. The consensus estimates for 2012, 2013, and 2014 earnings for WY are almost 40c, 80c and $1.2, which show that the future prospects of the company are quite lucrative. Plus, the historical 5-year average of its price-to-earnings is almost 50x, and hence its forward price-to-earnings ratio of 29x seems relatively cheap.

Conclusion

Given its diversified operations, a large proportion of lumber mills giving it a competitive moat, good performance expected from its cellulose unit, and a projected increase in dividend payout, WY is our favorite timber REIT to play the housing recovery. We are buy-rated on its stock.