Investing In Timber Stocks

by Louis Basenese

Investing In Timber Stocks: These Investments Are Always a Good Buy - Especially Right Now

by Louis Basenese, Advisory Panelist, Investment U

Thursday, September 20, 2007: Issue #712

About two years ago, Robert Saul planted 35,000 trees on his Massachusetts farm. And it's not because he wanted to do his part to combat deforestation (which would be a perfectly legitimate motivation).

He just embraces timberland as an investment. And for good reason.

The $35,000 he spent should net him about $5 million. Or a return of 14,186% (that's not a typo). All he has to do is wait 20 years.

Don't have that much patience? Or the 70 acres necessary to plant that many trees? Don't worry.

You can still profit from investing in timber stocks. I'll show you how in a moment. But first, let me convince you it's a wise (and timely) investment...

Investing In Timberland Is Better Than Stocks?

Although trees hardly lend themselves to compelling conversation, fact is, they are a better investment than stocks. From 1973 to 2003, managed timber returned 15% per year. Meanwhile, stocks returned about 11%.

Even better, timber did so with considerably less risk. Case in point: in the last 45 years, timber investments were down only three times. In comparison, stocks slumped 12 times.

There's a simple fundamental driving this out-performance. No matter what's going on in the world or the markets, trees keep growing, silent and unattended. And so does their value.

The average North American forest produces about 8% more timber every year. Plus, as the trees get larger, they command premium prices. Put simply, timberland is a no-cost factory. And when selling conditions are soft, it also functions as a warehouse, as the product can be "stored on the stump."

Given this backdrop, why isn't everyone rushing to own timber? They are just not on the public markets.

Who Owns Timberland and Why?

The majority of timberland (71%) is privately owned. And most active investments are facilitated through TIMOs (timberland investment management organizations).

TIMOs cater to the "smart money" - institutional investors such as the Harvard Endowment, CALPERs and anyone else that can afford the stiff $5 million entry fee. In recent decades, this "smart money" has been quietly piling into the woods...

Right now, they have approximately $20 billion invested in timberland. That seems modest, until you realize as recent as 1989, this level stood at $1 billion.

Rest assured, these institutions aren't simply chasing performance. They're attracted to timberland for two equally important reasons:

  1. Like other commodities, timberland provides a natural hedge against inflation. Research indicates that real prices for timber have steadily risen for more than 100 years.
  2. Timberland sports a low correlation with most major asset classes. Accordingly, adding timberland to a well-diversified portfolio enhances the return potential, while reducing risk (volatility).

It's the second point that makes timberland a timely investment. Should the stock and bond markets slump, timberland should perform well. And this time around, the out-performance could be significant.

4 Timber Stocks About to "Zag"

In addition to having a low correlation with most major asset classes, timberland also exhibits a negative correlation with commercial real estate. To be clear, negative correlations are extremely rare in the capital markets.

And what it simply means is this: as commercial real estate zigs, timberland should zag. Based on the chart of the iShares Dow Jones US Real Estate ETF (AMEX: IYR), these conditions could be upon us.

Shares Dow Jones US Real Estate ETF (AMEX: IYR)

The ETF is heavily weighted in commercial property REITs. As you can see, prices started to collapse in February and haven't recovered yet. Since stock prices react faster than real estate prices, it's safe to consider the ETF a leading indicator of what's to come in the commercial real estate market.

Here's another chart I found interesting. It's from California's Construction Industry Research Board (you know the saying, "As California goes, so goes the rest of the country.").

Timberland Permit Chart

Notice the record level of commercial permits and how residential permits peaked in 2004. As we all know, it took another year before the residential market started to decline. Given that lag, commercial real estate's turn for the worse could be just around the corner.

That being said, now could prove to be the perfect time to start hugging some trees. And you can do so by investing in publicly traded timberland. Deltic Timber Corp. (NYSE: DEL), Plum Creek Timber Co. (NYSE: PCL) and Rayonier (NYSE: RYN) are three possibilities worth considering.

If you're Canadian, TimberWest Forest Corp. (TOR: TWF.UN) is another possibility.

The recent results for each have been hampered by the housing slowdown, but this is temporary. Remember the companies can simply hold off until selling conditions improve.

In the end, treat the depressed prices as an attractive buying opportunity.

One more thing. If you're worried about natural disasters wiping out your investment, think again. Fire and other disasters ravage less than 0.5% of privately owned forests annually. Plus, damaged timber can still be sold. For example, after Mount St. Helens erupted, nearly 80% of the scorched timber was still suitable for sale.

Just one more reason timberland is such a low-risk, high-reward investment.

Good investing,

Louis Basenese

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