Timber as a growing asset class

Plum Creek Timber (Ticker: PCL)

Branching out

“He plants trees to benefit another generation” said Caecilius, a Roman comic poet. The sentiment remains admirable, but modern investors are putting money into trees to reap benefits in the nearer term. A growing number of rich individuals, endowments and pension funds are including timber as a “hard asset” in portfolios.

No wonder. Average annual returns on timber – meaning managed preserves that are eventually harvested – have outstripped those from leading global stock indices, property, oil and gold for the past decade. Worldwide, timber has attracted more than $20 billion of investment from institutional investors. Advocates say managed timber reserves are good for the environment too, preserving biodiversity on lands that might otherwise be logged recklessly.

Trees typically take decades to mature, making them especially appealing to institutions, such as pension funds, which are looking for investments to offset long-term liabilities. Returns are not correlated with those on stocks, and yields are predictable. There are risks, of course. Foremost among them is potential exposure to any general economic downturn, which would tend to cut demand for wood, pulp and paper.

Investors not inclined to buy actual trees might want to take a look at Seattle-based Plum Creek Timber (Ticker: PCL), one of only three timber real estate investment trusts and the largest private timberland owner in the U.S. On Monday it reported earnings per share for the third quarter 18% above the previous year. Trouble is PCL’s shares, which rose 20% this year to a record high in mid-September, have since reversed sharply, shedding more than two-fifths of their value, though today the stock jumped $7.53 to $38.28.

Timberland values, rising from about $1,100 to more than $1,700 an acre in the past seven years, have helped support share prices in spite of weak demand for logs thanks to the housing slump. But Plum Creek, with 8 million acres across 18 states, can call off the lumberjacks. Similar to petroleum producers, timber companies reduce output when pricing dips. But unlike the black stuff, trees continue to grow, adding about 5% to 7% a year in value. With southern sawlog prices down 18% year on year this quarter, for example, Plum Creek reduced its harvest by 13%.

Meanwhile, the reduction in activity at lumber mills means less residue for paper makers, boosting demand in Plum Creek’s (admittedly lower margin) pulpwood business. Investors fear that a slowing economy will dent demand there also. There are worries, too, that land values may have peaked and the credit crisis could hamper land sales, and therefore cash flow.

The latter looks overblown. Plum Creek did temper its outlook for real estate sales – which for the first three quarters of the year only accounted for about a fifth of revenues – and has in the past cut its generous dividend. But the company has been paying down debt and continues to buy back shares, now trading at about half net asset value, arguing that this is a cheap way to increase its holdings of timberland. Investors, too, should consider a stroll in the woods.