Lumber is as pleasantly boring as it gets: It grows slowly and provides inflation-resistant returns.
When lumber prices are low, timber companies can withhold harvesting logs. When prices rise, they not only profit on the higher log price, but they make more money per tree since the tree has grown. This steady nature has been benefiting the sector for decades, and the commodity has all the hallmarks of great long-term investment.
However, timber has been anything but boring lately, as saw log prices are fast approaching housing-bubble highs. And even then, a further run in timber prices is plausible — making the typically staid and sleepy sector a huge growth opportunity in the years ahead.
Rising Demand, Falling Supplies
Timber is facing a classic rising demand/falling supply scenario, with much of that rising demand coming from the resurgent U.S. home market.
After a number of years of abysmal new home sales and construction projects, new home starts are coming back with gusto. Builders have constructed more homes in response to an uptick in demand from homebuyers eager to take advantage of incredibly low interest rates on mortgages. Analysts predict that roughly 929,000 new houses and apartments will be built this year. That’s nearly a 20% jump versus average analyst projections for 2012.
“The U.S. Forest Service says log exports from Alaska, Washington, Oregon and Northern California increased about 9% in the third quarter of 2012 — with 62% of those West Coast log exports going to China.”
Already, Chinese demand for timber hit record levels back in 2011, and analysts predict that China will need to import about 182 million cubic meters of wood by 2015. That’s a 70% increase from today’s level.
Yet supplies continue to be restrained due to a number of factors. These include capacity disruptions — as many North American manufacturing plants have been shuttered since the downturn — as well as the direct loss of forest acreage via farmland cultivation, and pests like the Asian longhorn and pine beetle.
All in all, rising demand in the face of dwindling supplies has caused lumber prices to surge to an eight-year high.
Softwoods such as spruce, pine and fir are used in a variety of homebuilding applications, and each new home requires about 14,000 board feet of lumber. Meanwhile, lumber prices have climbed roughly 45% to $408 per thousand board feet — up from $282 in mid-March last year — and oriented strand board prices have doubled to $430 per thousand square feet from $215 in that time.
However, despite the fact lumber and forest-product stocks have been on a tear over the past year, there still is more room for prices to rise as the supply/demand imbalance continues to take hold. Inventory levels continue to remain at 50-year lows, and any continued bump in demand could see timber pushing past $500 per thousand board feet — a price not seen since 2004.
Which is why investors should consider adding the sector to their portfolios now.
How to Play
My preferred method continues to be the big timber real estate investment trusts of Weyerhaeuser (NYSE:WY), Plum Creek (NYSE:PCL), Rayonier (NYSE:RYN) and Potlatch (NYSE:PCH). All of them offer large land holdings, steady cash flows and high dividends. While they have other operations outside of straight growing and sawing logs — Rayonier has a high-tech performance fiber division — the timber REITs are as close as it comes to woodland investing for regular Joes.
The REITs also feature an added benefit as well. If housing construction begins to cool or flatten out, the firms’ dividends — ranging between 2% and 3.2% — can serve as a cushion for investors. And these companies maintained their dividends as the lumber market turned south during the housing crisis, making them prime choices for playing the rise in timber.
Another prime choice: Our neighbors to the north. The large integrated Canadian duo of Canfor (PINK:CFPUF) and West Fraser Timber (PINK:WFTBF) could also be big boomers. Some analysts have postulated that if lumber prices hit that “magic” $500 mark, both firms could see at least 50% upside from today’s prices.
Investors shouldn’t be scared of the firms’ pink-sheet tickers. Both are solid producers of timber and pulp products with market caps in the $3 billion range. These aren’t penny stocks. But if that does make you nervous, shares can be purchased on the Toronto Exchange.
Bottom line: If you’ve missed out on timber’s gains so far, you still have some time.
As of this writing, Aaron Levitt was long PCL, PCH, RYN and WY.