Acadian Timber

The lumber/pulp market has been dramatically affected by the housing crash. New home starts are near post-WW2 lows and little is likely to change in the short-term. The paper industry is in terminal decline. Softwood prices are at near-historic low prices. Hardwood prices remain in OK shape due primarily to Asia furniture demand. And there is no reason to expect any serious improvement for, potentially, decades. With all this bad news, one would expect timberland company stocks to be at low prices. But, in general, they aren’t. Timberland prices seem very high. Plum Creek Timber (PCL) sells at an equivalent of $780/acre. This really is outrageous — until one understands that most public timber REIT’s are mainly anti-timber plays. These REIT’s generally earn their money by selling timberland to convert it into something else (tax deductions, vacation homes, etc) – not mainly by harvesting timber from timberland. At core, they are land developers. Likewise, “timberland” in the US has really been hyped as an asset for a couple of decades so institutional investors have plowed into it like lemmings — driving up timberland prices — while the housing crash has shown just how cyclical that business can be. At those sorts of land prices, actual timber production will never produce more than a 2-4% return even if wood demand increases back to bubble prices. And with the debt that timberland at those prices requires, there is gonna be a need to overharvest (hence oversupply) just to pay the debt loads. There is gonna be a bucketload of institutional selling of timberland over the next few years as they realize how stupid they’ve been. Asian forestry is mostly either a Kyoto carbon-credits scam or hardwood poaching. The underlying long-term supply/demand equation for forest products is still sound though. Shrinking forest acreage — and a lot of people in emerging markets who will use more forest products as their incomes rise. Not to mention the “option” possibility of game-changers such as biofuels.

Acadian Timber (ADN on the Toronto exchange – C$5.90, ACAZF on the pink sheets) is the only cheap forest-only company I’ve found. It owns about 1.1 million acres of New Brunswick and Maine forests and manages another 1.3 million acres in Canada. It owns no mills and depends on a limited number of customers to process its trees – so a bit of risk there. It makes virtually no money selling its land for development – and not much money “renting” its land for vacation/campground type stuff. It used to be structured as a Canadian income trust – but changes in the law are making it convert to regular corporation. That change (along with the housing crash) has created some selling pressure on the stock in Canada as income-oriented investors (who were used to a 15-20% yield) look for other high-yielders. It now yields 4% or so. Its former parent company (Brookfield Asset Management – BAM on NYSE) owns 45% of the company so a bit of a risk there.

It has a bank loan that is coming due in Feb 2011. That bank loan of $35 million is secured by its Maine timberland (310,000 acres – or $113/acre). Acadia won’t be able to pay off that loan in full (currently has cash of $11 million) so there are two options the bank can take — partially/fully extend/renew the loan (Acadia earns more than enough to pay for it) or take possession of the Maine timberlands and try to sell them – and one option that Acadia has — find a buyer for the Maine timberlands. It’s unfortunate that it is stuck doing bank loans because those are likely to always be on a short-term basis making it impossible for the company to accumulate a slug of cash to pay off its debt and rendering it victim to bank sector problems.

However, assume the bank takes the Maine forests because it can make a profit selling those forests to some shark looking for a tax deduction. Acadia will then be virtually debt-free (only a $10 million line of credit for its working capital) — with 800,000 acres of owned forest land (with a good mix of hardwood and softwood) in New Brunswick. With 16 million shares outstanding – selling at C$5.90 each, that’s roughly C$100/acre. It can currently make about a 10% return on timberland at that price – with half returned to shareholders as a dividend. If the lumber market ever recovers, it can double that return and probably triple the dividend. And even better if the bank renews the loan and leverage provides a bit of juice. THAT is what timberland investments used to look like before the land prices ran up.

Why is this stock selling so low? IMO – it is mostly because it is almost completely illiquid. The changes in the Canadian law re income trusts eliminated the stocks natural buyers. There are only a few hundred shares that trade hands every day. So institutions can’t possibly get in. Hell, that is almost too illiquid for anyone who even wants to invest a few thousand dollars if they might need to sell it anytime soon. Can’t imagine who is selling — people who need normal liquidity and the few Rip van Winkles who just woke up to discover a housing market crash. This is, by illiquidity, a buy-and-forget-about-it-for-awhile stock.

Risks — apart from illiquidity. A controlling shareholder who might just screw minority shareholders and take it over. Personally, I think the risks of that are somewhat low since that shareholder spins off assets regularly and might be hesitant to piss off precisely the sorts of shareholders it needs for future spin-offs. But it is still there. Obviously the bank loan is a risk — but that has a clear and certain date attached. The dependence on a few customers is a bit of a risk. I don’t think softwood prices or new housing starts recovery are a risk. They are already at marginal production costs (or virtually zero) and can’t go lower. An existing 4% dividend yield is completely sustainable in almost any circumstance. Even if they have to shut the forest down completely — the trees will still grow at 2-3% per year and the land itself is well-split between over-mature, mature, growing, and young forest. Final risk is geographic concentration. Climate changes or infestation/disease could wreak havoc – but perhaps less so with the variety of hardwoods/softwoods.

I think this stock is worth a GTC bid at current prices — on the Toronto exchange. Maybe with a relook in late Feb 2011 – the bank loan date – for another bid. Do not bother with “day-only” bids and don’t bother with the pink sheet. It literally might take two weeks for even a small order to fill. This is precisely the sort of market/time/stock where one buyer can create the floor in a stock.

On the pulp side, there is another Canadian income trust called CanFor Pulp Income (CFX-UN on Toronto; CFPUF on pinks). It’s only asset is a 49.8% ownership of pulp mills. It currently sells for C$13.75 and yields 19% (dividends paid monthly) — but that is hugely at risk. Pulp prices skyrocketed earlier this year because of some strikes/damage in Finland/Chile – which combined with low inventories which shrank over the last 10 years with pulp mills closing down and with the credit crunch last year. Pulp prices are already falling — but this stock has already seen its own skyrocket. From C$2 at the low last year to C$13.75 now — yeesh, 700% stock price appreciation and a near 100% dividend yield if you bought last year at the lows. This makes shipping stocks look like pikers. That said, it seems too late for this one. Might be a good one to watch if/when the markets tank. With all commodities, high prices ALWAYS create the seeds of their own destruction — and the time to buy them is when prices are low because they can’t go to zero.

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