Timber REITs could win big on a housing recovery

A few weeks ago, I wrote an article titled “Stay grounded: blueprints vs. buildings.” That’s where I introduced the term “HALO” to the Wide Moat Research community.

It stands for Heavy Assets, Low Obsolescence.

I didn’t make HALO up myself. That credit goes to Josh Brown of Ritholtz Wealth Management, who wanted to highlight investment assets that couldn’t be disrupted by artificial intelligence (AI).

As I detailed in “Stay Grounded,” such uninterruptible companies include:

Each of these businesses involves high barriers to entry, long-term usefulness, and durable cash flows. Several of them offer mission-critical services as well.

The same goes for timber REITs, which own and cultivate woodlands, mostly for the purpose of selling lumber. After all, there are few assets less susceptible to technological disruption than trees.

Better still, trees keep growing regardless of whether there’s a recession or not. Plus, there’s a limited supply of productive timberland… yet long-term demand for what can be produced from it, such as houses, packaging materials, and construction products.

Of course, these REITs’ largest customers are all in the construction and building industries. And we know how stagnant the housing market has been for years, in part because of elevated mortgage rates…

Which likely aren’t going down anytime soon since associated interest rates were just maintained last week – and might very well get raised from here.

Even so, I’m seeing green in these landowners, with plenty more of that AI-impenetrability to come.

Last week’s housing data updates didn’t look promising at first glance, with housing starts falling 15.4% in May. That means a seasonally adjusted annual rate of just 1.18 million units, marking their weakest pace in six years.

However, that weakness was largely due to notoriously volatile multifamily movement. Single-family starts – which are more closely associated with timber demand – fell just 1.9% for the month and 6.7% year over year.

And while builder sentiment remains under clear pressure from affordability, financing, and regulatory concerns, pending home sales still rose 3.8% in May. That was its strongest monthly gain in almost two years and the fourth time in a row that it’s risen. So buyers do seem to be re-entering the market again despite all the reasons not to.

Perhaps they’re just sick of waiting.

Regardless, there are many reasons to be bullish on homebuilders specifically. For starters, the U.S. still faces a structural single-family house shortage after over a decade of underbuilding. And while millennials are increasingly entering their prime homebuying years… existing homeowners don’t want to swap out of their 4%-or-lower mortgage rates.

In which case, that demographic (and others in their same boat) will have to turn to new supply. And new supply requires new lumber, plywood, engineered wood, oriented strand board, and similar timber byproducts.

Ipso facto, timber REITs are in for increased business.

If you think that conclusion is being a bit too generous, you might not have read my “Berkshire’s big builder bet” article from earlier this month. I explained how Berkshire Hathaway (BRK-A) (BRK-B) just bought upscale homebuilder Taylor Morrison Home Corporation (TMHC).

In addition:

That means there are prominent people believing a housing market recovery isn’t far off at all. They’re trying to play it one way; I see another way opening up altogether through timber REITs like Weyerhaeuser Company (WY).

Weyerhaeuser is the undisputed timber REIT king with a market capitalization of roughly $17.5 billion. It boasts approximately 11 million acres of timberland under ownership and management. Plus, it runs a diversified platform consisting of its:

That latter category focuses on growing real estate, natural resources, and climate solutions in impressive and profitable ways. Weyerhaeuser gets to unlock value from its land this way through everything from carbon initiatives and conservation projects to mineral rights and renewable energy developments.

As for its more well-known offerings, Weyerhaeuser is already experiencing rising shipment volumes across several product groups. And we expect that to continue throughout the year, along with strengthening pricing trends – modest though some of that might be so far.

Admittedly, not every part of Weyerhaeuser’s business is facing favorable conditions right at the moment. For instance, certain Southern regions of the U.S. are experiencing elevated log inventories and increased timber supply.

However, considering the company’s scale and geographic reach, we think it can navigate those issues just fine.

Weyerhaeuser currently offers a decent dividend yield of about 3.5%. Better yet, it’s delivered a five-year dividend growth rate of roughly 10.5%.

Combined, that makes it an attractive consideration for most investors seeking a blend of income and growth.

Then there’s Rayonier (NYSE: RYN) with its market cap of roughly $6.3 billion.

Once a pure-play timber company, it merged with PotlatchDeltic in January to become a premier land resources business. Rayonier now has access to over 4 million acres across North America, a real estate platform, and wood products manufacturing.

That’s why management is targeting approximately $40 million of annual run-rate synergies within 24 months. And at least half of that should be realized during year one.

Already, the combined company's Q1 results showed adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) totaling $94 million – despite continued industry headwinds. EBITDA from its Southern timber operations rose 68% year-over-year and 45% from the Northwest.

Its new Wood Products segment, which also did well, should continue to benefit from improving markets. Average lumber pricing, for instance, has recently and significantly risen to about $505 per thousand board feet.

As for Rayonier's real estate platform, it generated quarterly revenue of $60 million. Plus, the company is pursuing renewable energy opportunities – with approximately 80,000 acres under option for lease or sale as of this writing to solar developers.

Shares are currently yielding around 5%, complete with a five-year dividend growth rate of almost 17.9%. And management aggressively bought back some 1.5 million shares during the quarter on the belief that the stock is trading at a meaningful discount to net asset value (NAV).

If it continues to pursue that path, shareholders could see substantial per-share value from here.

This makes Rayonier every bit as attractive as Weyerhaeuser as a HALO stock, even if it’s in different ways. The latter remains the sector's premier franchise, while the former has more upside potential – trading roughly 20% below my target buy price.

If I had to choose between the two, I’d have to go with Rayonier. But either one should profit nicely once the housing market recovery gets more obviously underway.

Until then, enjoy their lowered pricing points… for as long as those might last.

Happy SWAN investing!

Brad Thomas
Editor, The Wide Moat Daily

SpaceX is still all over the news, making headlines and causing commentary left and right.

But over here at The Wide Moat Show, we’ve got other stocks we want to talk about – like the seven “boring” bargain stocks Nick Ward and I covered in last week’s episode.

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