Weyerhaeuser Company (NYSE: WY) is one of the largest integrated forest product companies, with annual revenues of nearly $5.53 billion in 2009. As an oft-cited example of vertical integration, Weyerhaeuser has businesses in timberland management, wood products, cellulose fiber, containerboard, and real estate. Cooperation between its segments allows the company to minimize transaction costs and to coordinate supply and demand internally.
However, despite these inter-segment synergies, Weyerhaeuser may decide to focus on its core timber business in restructuring efforts. In 2006, the company sold its fine paper business to Domtar, a Canadian pulp and paper company, giving Weyerhaeuser $1.35 billion in cash (used to pay off long-term accumulated debts) as well as stock in the newly merged company. There is speculation that Weyerhaeuser's possible future focus on the timberlands business is an effort to become a real estate investment trust (REIT), which would secure it significant tax benefits.
Regardless of focus, company profitability is affected by the timber market cycle, which fluctuates due to many external conditions. For example, the housing market and interest rates affect demand for real estate and wood products. Increased digitalization has also cut demand for paper--although this may be balanced by online shopping's boost to containerboard sales. The timber market and Weyerhaeuser may also be affected by environmental legislation, natural disasters, and the growth of cellulosic ethanol.
Weyerhaeuser is an integrated forest product company, meaning that its six business segments cover all stages of timber-based production. Vertical integration allows the company to minimize transaction costs and coordinate supply and demand internally. However, Weyerhaeuser may decide to focus on its more profitable segments in the future with its restructuring efforts.
Due to the nature of the timber industry, the company often lowers production and borrows money when prices are low, choosing to wait until the market is more favorable. In the past, Weyerhaeuser has accumulated a significant amount of debt. Ongoing debt reduction efforts is an indication of the company's strong financial health and improves its ability to endure dips in the business cycle.
Second Quarter 2010 Results
Weyerhaeuser reported net earnings for the quarter of $14 million, or 7 cents per diluted share, on net sales of $1.8 billion. This compares with a net loss of $106 million, or 50 cents per share, on net sales from continuing operations of $1.4 billion for the same period last year.
The Company’s Timberlands business segment manages 6.6 million acres of private commercial forestland worldwide. It owns 5.8 million of those acres and leases the other 760,000 acres. In addition, the Company has renewable, long-term licenses on 15.2 million acres of forestland located in four Canadian provinces. The Timberlands business segment grows and harvests trees for use as lumber, other wood and building products and pulp and paper; exports logs to other countries where they are made into products; plants seedlings, and in parts of Canada it uses natural regeneration, to reforest the harvested areas; monitors and cares for the new trees as they grow to maturity, and seeks to sustain and maximize the timber supply from its forestlands.
The Company is a manufacturer and distributor of wood products in North America. Its wood products segment provides a family of softwood lumber, engineered lumber, structural panels and other specialty products to the residential structural frame market; delivers homebuilding solutions to help its customers meet their customers’ needs; sells its products and services primarily through its own sales organizations and distribution facilities, and supplements its product offerings with building materials that the Company purchases from other manufacturers; sells certain products into the repair and remodel market through the wood preserving and home-improvement warehouse channels; exports its engineered building materials and industrial hardwood products to Europe and Asia, and makes and sells hardwood lumber to manufacturers of furniture and cabinetry in more than 40 countries. The Company operates manufacturing facilities in the United States and Canada. It distributes through a combination of Weyerhaeuser and third-party locations.
The Company’s cellulose fibers segment is a producer of absorbent fluff used in products, such as diapers. It also manufactures liquid packaging board and other pulp products. It has a 50% interest in North Pacific Paper Corporation (NORPAC), a joint venture with Nippon Paper Industries that produces newsprint and high-brightness publication papers. The cellulose fibers segment provides cellulose fibers for absorbent products in markets around the world; works closely with our customers to develop specialized applications; manufactures liquid packaging board used primarily for the production of containers for liquid products, and generates energy, of which 86% is from black liquor produced at the mills and biomass. The cellulose fibers (pulp) products are distributed through a global direct sales network, and the Company’s liquid packaging products are sold directly to carton and food product packaging converters in North America and Asia.
The Company’s Real Estate business segment includes its wholly owned subsidiary, Weyerhaeuser Real Estate Company (WRECO) and its subsidiaries. The Real Estate segment focuses on constructing single-family housing, and developing residential lots for its use and for sale. The Company’s operations are concentrated in metropolitan areas in Arizona, California, Maryland, Nevada, Texas, Virginia and Washington.
The Company’s Corporate and Other segment includes governance-related corporate support activities and Company-wide initiatives, such as major system and infrastructure deployments; transportation operations, including Westwood Shipping Lines and five short-line railroads, which provide services to its manufacturing operations and to third parties, and results of activities related to discontinued operations. The Company’s transportation operations include its marine operations, which provide shipping between North America and Asia, and its railroad operations, which are located in the western and southern United States.
Timber and most timber products are a commodity good, which means that trends usually impact the industry as a whole instead of affecting just one company. As a result, changes in the timber market and fluctuating demand for wood products are the largest forces that can impact Weyerhaeuser's profitability. The way in which Weyerhaeuser deals with production is very important to its success against competitors.
The timber market is influenced by the general business cycle and the health of other markets that demand timber. Although an enormous variety of industries use wood-derived products in some form, some external factors that influence demand include:
However, the nature of timber production offers companies in the industry some unique advantages to weather fluctuations in demand. Since trees increase in value over time, companies can choose to harvest more during periods of high demand. By reducing production with low demand, companies reduce costs while their investments continue to increase in value, independent of economic influences.
Declining demand does not necessarily lead to lower prices. Timber companies can offset lower demand to a degree by reducing production capacity, thereby tightening the supply of timber goods as well. Due to the organic nature of its products, the timber industry has a particular incentive to cut production and wait out periods of low demand. Instead of harvesting more trees and producing more end products to compensate for lower prices, timber companies can reduce output and wait for market conditions to improve. By the time demand for timber products increases again, the companies' timberlands will have grown in both size and value. Though it requires patience and a belief that the timber market will rebound, many companies take this approach, as it maximizes per-tree profitability.
Chinese timber companies, however, have not scaled back production in times of low demand. They have instead increased production capacity, building more plants and mills despite declining global demand. The Chinese demand for timber goods, particularly paper products, is currently stronger than in the global market, and much of the extra production is consumed domestically. In spite of this, the fact that China is importing less paper from other countries exacerbates the already-decreasing demand facing U.S. timber companies. Increased Chinese production capacity can put downward pressure on timber and paper prices around the world.
Timber prices can be significantly impacted by natural disasters. Domestically, timber-producing regions are located in several parts of the country, exposing them to various natural disasters, from forest fires in the West to hurricanes in the East and Southeast. The risk of damaging insect infestations can also pose a substantial threat to timber companies across North America. In the case of hurricanes and wildfires, demand for timber is likely to increase as well because of the need to replace or repair damaged property, pushing timber prices even higher.
Environmental conservation groups often criticize the timber industry, claiming that its logging practices are harmful to U.S. forests. These groups lobby for increased legislation governing the actions of timber companies and protecting certain areas of forest lands. Congress has responded, and there are several federally protected forests throughout the country. The timber industry is always at risk of increased governmental regulation, though there have been few instances of this happening in recent years.
Ethanol is being touted as the new alternative to oil and gas. Traditionally, ethanol has been produced from corn through a rather inefficient refining process. Cellulosic ethanol, however, is a new form of ethanol that can be produced from a variety of plant products, including wood. The entry of cellulosic ethanol into the renewable energy market creates the possibility of a new revenue source for Weyerhaeuser. In the past, wood chips and sawdust from timber production were considered to be waste materials and discarded. If cellulosic ethanol were to popularize, Weyerhaeuser would be able to sell its wood waste to ethanol refineries and monetize what was previously discarded. The demand for cellulosic ethanol is being driven by a number of trends, including rising oil and gas prices and public concern over environmental degradation.
The paper and timber industry has faced the pressure of a shrinking market, as an increasing number of transactions and records are shifting to a digital format. This trend has a direct negative impact on Weyerhaeuser's paper business. The company's timber segment will also be affected, as paper mills decrease their demand for the raw material Weyerhaeuser supplies.
However, the increased popularity of online shopping creates significant demand for packaging material, as shipments become smaller and more frequent. This upswing will be beneficial to Weyerhaeuser's containerboard business. As a result, most predictions about how increased digitalization and the internet will affect Weyerhaeuser's total revenue are somewhat premature.
The timber products industry consists of a diverse array of distinct and interdependent businesses. For example, one company may own and maintain timberlands, while another company uses the timber to produce wood products used in construction. Other companies extract and recycle cellulose fibers, which may then used to produce packaging material and fine papers.
Weyerhaeuser has businesses in all major segments of the timber products industry. It is most appropriate to consider the market in each segment individually.
Weyerhaeuser manages 6.6 million acres of private commercial forestland worldwide and holds licenses. Despite the company's holdings, the vast majority of timberlands are held by small landowners. In the U.S., small landowners control 81% of timberlands, while the industry owns only 11%. This means that although Weyerhaeuser is one of the largest companies in the industry, it does not have significant pricing control due to the amount of private timberland.
It is important to note that timber prices differ depending on type and quality. Weyerhaeuser's timber is of relatively high quality, with 80% of the annual harvest consisting of saw timber, versus the 50-60% for the Plum Creek Timber Company and Rayonier Inc.. Analysts estimate the company's timberland assets to be at a 43% and 74% premium to Plum Creek and Rayonier, respectively.
Containerboard (corrugated case material) accounts for 32% of global paper and paperboard output. The growth of emerging economies has generated demand for containerboard, as more packaging material is required for shipments. Moreover, as online shopping takes off, shipments have become smaller and more numerous.
Global containerboard demand has increased at a rate of 5% per year since 1994. In high growth areas such as China, demand has increased 12% per year since 2000. Asia is the largest consumer of packaging materials, accounting for 41% of global demand, followed by North America (26%) and Europe (22%).
Foreign capacity has grown with the global demand, meaning that North American firms like Weyerhaeuser may not directly reap the benefits of expanding markets. However, in the long term, North American producers enjoy a natural resource advantage compared to producers in fiber-deficient areas like China. With its solid timberlands and its recycled fiber business, Weyerhaeuser is in a good position to profit on this geographical advantage.
The company's ability to compete in the global market also depends on the exchange rate. If the U.S. dollar depreciates, exporters like Weyerhaeuser would enjoy a conversion advantage.
The global containerboard market is highly fragmented, with the top 10 producers accounting for only 32% of total output. Weyerhaeuser is the third largest producer, after U.S. firm Smurfit Stone Container and European firm Smurfit-Kappa, which both specialize in containerboard production.
The range of wood products in this segment is diverse and its manufacturers fragmented. A similar competitor to Weyerhaeuser is the wood products company Louisiana Pacific (LPX).
Weyerhaeuser sold its fine papers business in the Domtar transaction, which consisted of more than half of this segment. One of the company's closest competitors in the remainder of this segment is Buckeye Technologies (BKI), a small company with a market cap of $1.0 billion.
There has been speculation that Weyerhaeuser may become a real estate investment trust (REIT), especially after it sold its fine papers division in the Domtar transaction to focus on its timberlands business. REITs enjoy significantly lighter taxes than traditional corporations. Weyerhaeuser may be an ideal REIT due to its vast holdings in timberlands, as the land itself may be worth more than the harvested timber, especially near high development areas. In order to qualify, the company must derive at least 75% of its total income from real estate transactions. Currently the only two timber producers in the U.S. with REIT status are the Plum Creek Timber Company (PCL) and Rayonier Inc. (RYN).