Rayonier Inc. REIT (RYN)

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Rayonier (NYSE: RYN) is a real estate investment trust that manages timberland and produces basic wood products (i.e. lumber and wood chips) and fibers that are used in products such as textiles and diapers. It is one of the largest private landowners in the U.S., with over 2.7 million acres of land in the U.S., Australia, and New Zealand ^[1]. Like other timber companies, Rayonier has made money by selling off desirable parcels of land - specifically its coastal land in Florida and Georgia - to home developers. The company generally makes money profit from the initial sale of the land as well as receiving a portion of the proceeds when finished homes are sold to homebuyers.

Rayonier enjoys a greater degree of insulation from fluctuations in U.S. housing market than other types of REITs. When the housing market slumps and demand for timber drops, the company can sit on its land - unlike other goods, timber appreciates in value over time as trees grow.

[edit] Business Overview

Rayonier's businesses are conducted through two entities. The company's U.S. timber operations are conducted as a real estate investment trust (REIT) under the name Rayonier Forest Resources, L.P. REITs can avoid paying federal income taxes by distributing 90% of their taxable income to shareholders. A REIT has to pass two main tests:

• 75% Income Test – at least 75% of REIT gross income (Pre-tax net sales minus cost of sales) must be derived from real property sources (including the sale of timber)

• 75% Asset Test – at least 75% of the value of the REIT’s gross assets must be comprised of real estate assets (including timberlands), cash, and government securities.

The company's non REIT-qualifying operations (i.e. performance Fibers, wood products, and real estate development) are under the entity Rayonier TRS Holdings Inc. This entity is still subject to corporate-level taxes.

Rayonier's three core businesses include Timber, Real Estate and Performance Fibers.

RYN 2006 Annual Report^[2]

• Timber: RYN owns, leases or manages approximately 2.6 million acres of timber and land in the U.S. and New Zealand. RYN's timberlands in Georgia, Florida, and other Southern U.S. states are close to pulp, paper and wood products facilities, which drives demand for the company's timber. ^[3]

• Real Estate: RYN holds over 200,000 acres of property which can be used for residential and commercial development, in areas such as costal Georgia and costal Florida. RYN sells or develops these higher and better use, or “HBU properties” by partnering with real estate developers. ^[4]. This segment was only responsible for 9% of the company's revenue in 2006, but contributed approximately 23% to the company's EBITDA.

• Performance Fibers: RYN is one of the world's leading producers of high-value specialty cellulose fibers, which are used to make a wide variety of consumer products such as LCD screens for televisions and computers, pharmaceuticals, paints, cosmetics, textiles, cigarette filters, etc. RYN also produces highly absorbent fluff fibers which are used in diapers, feminine hygiene products, etc. ^[5]

The company also makes wood products such as lumber and wood chips, which are primarily used for residential and industrial construction. ^[6]

[edit] Business Financials

RYN's revenues grew around 4% in 2006 to $1,230 million. This growth was led by the real estate segment (30% growth) and performance fibers (7% growth). Timber sales remained essentially flat in 2006, impacted by higher prices but lower demand due to a weaker housing market, ^[7] while wood products revenues dropped nearly 20% as lumber prices declined 18% due to weaker housing and higher quantities of Canadian imported lumber. ^[8] The company's EBITDA, or earnings from continuing operations before interest, taxes, depreciation, and amortization declined by $12 million primarily due to weakness in the wood products division.

RYN 2006 Annual Report^[9]

RYN generates over 35% of its sales abroad. However, most of the company's sales are denominated in U.S. dollars, which mitigates any foreign exchange risk. ^[10]

RYN 2006 Annual Report^[11]

[edit] Trends and Forces

[edit] Timber market cycle

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:

• The U.S. Housing Market - The largest end market for timber products is the construction market, particularly the residential construction market. An average new home built in the U.S. contains over 14,000 board feet of lumber. As such, conditions in the housing market can have a significant impact on lumber-grade timber prices. Increases in residential construction would increase demand and prices for lumber, while housing slumps can put downward pressures on prices as demand declines. In 2006, RYN's wood products sales declined $26 million due to 18% lower lumber prices largely as a result of reduced demand in the housing market. ^[12]

• Interest rates - Rising interest rates can decrease consumer spending, especially in the housing market. As interest rates rise and it becomes more expensive to purchase a home, residential construction will likely slow, decreasing demand for lumber. Similarly, decreased interest rates would increase the demand for lumber.

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, RYN can choose to harvest more during periods of high demand. By reducing production with low demand, RYN reduce costs while their inventory (trees) continue to increase in value, independent of economic influences.

[edit] Chinese overcapacity

Declining demand doesn't necessarily lead to lower prices, as described above briefly: 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.

[edit] Natural disasters

Timber prices can be significantly impacted by natural disasters. Domestically, RYN's assets are located in places such as Washington, Florida, Texas, Louisiana, and Georgia, exposing them to various natural disasters, from forest fires in the West to hurricanes in the Southeast. In the case of hurricanes and wildfires, the company can have a negative or positive outcome. If the natural disaster damages their property/timber, they can lose money. However, if it doesn't damage their property, but damages a lot of other property in the area, they can make money because of increased timber demand to rebuild or repair damaged property. For example, in the Southeast U.S., the impact of three major hurricanes in 2004 resulted in lower volumes and some temporary price decreases before improvement in 2005 when repair and rebuilding drove demand. ^[13]

[edit] U.S. Environmental Legislation

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. A Democratic victory in the 2008 presidential election could spur a rise in the number of bills aimed at conserving forests. Legislation such as this would likely decrease the size of commercially harvestable timberlands and drive timber prices upward.

[edit] Cellulosic ethanol

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 RYN. In the past, wood chips and sawdust from timber production were considered to be waste materials and discarded. If cellulosic ethanol were to popularize, RYN 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.

[edit] Exposure to Florida Real Estate

RYN's real estate segment is highly exposed to the Florida residential housing market, where they hold most of their HBU properties. In 2007, South Florida had largest decline in home sales in the nation. ^[14] If the current weakness in Florida real estate continues, RYN's real estate segment may have a tough time with their real estate development.

[edit] Competition

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. Some of its competitors include:

• Plum Creek Timber Company (PCL) - is the largest private landowner in the US and has operations primarily in timber, real estate, and manufacturing.

• Weyerhaeuser Company (WY) - is one of the largest integrated forest product companies, with businesses in timberland management, wood products, cellulose fiber, containerboard, and real estate.

Timber companies are often hard to compare because of the different ways in which they operate. Plum Creek harvests and sells raw timber, sells and leases land, and manufactures some wood products. Other timber companies operate differently, participating in different stages of the process of turning a tree into paper. Weyerhaeuser Company (WY), for example, participates in nearly every aspect of timber production, harvesting trees, making paper and containerboard, producing lumber and wood pulp, recycling paper, and dabbling in real estate. International Paper Company (IP) focuses mainly on the production of end products like paper, lumber, and packaging materials, but it also harvests some timber (around 20% of the amount it needs every year) and engages in real estate transactions.

Plum Creek's competitors' relatively diverse sources of revenue could be advantageous, allowing them to capitalize on economies of scale and earn revenues from both timber and timber products. If Plum Creek's operating income breakdown is any indication, however, timber product manufacturing is far less profitable than timber resale, which could mean put Plum Creek at a relative advantage.

As the largest landholder in the U.S., Plum Creek's large resources allow it to produce timber at lower costs, putting it ahead of competitors in terms of profitability. As one of the only timber REITs (Rayonier Inc. REIT (RYN)), also pays fewer taxes, which can mean significant cost savings. Because of these savings, it can keep its prices low while still making a profit, making its products more attractive to timber customers.

[edit] References

1. ↑ RYN 2006 10k, Pg 1
2. ↑ RYN 2006 10k, Pg 19
3. ↑ RYN 2006 10k, Pg 2
4. ↑ RYN 2006 10k, Pg 3
5. ↑ RYN 2006 10k, Pg 4
6. ↑ RYN 2006 10k, Pg 4
7. ↑ RYN 2006 10k, Pg 27
8. ↑ RYN 2006 10k, Pg 28
9. ↑ RYN 2006 10k, Pg 19
10. ↑ RYN 2006 10k, F-16
11. ↑ RYN 2006 10k, Pg 5
12. ↑ RYN 2006 10k, Pg 28
13. ↑ RYN 2005 10k, Pg 5
14. ↑ Miami Herald