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Weyerhaeuser Company (NYSE: WY) is one of the largest integrated forest product companies, with annual revenues of nearly US$ 22 billion. 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.
[edit] Corporate Overview
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 (see below), 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, with nearly $13 billion in long-term debt in 2002. It has halved this number since then, to $6.6 billion in 2006. 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.
[edit] Business Segments
[edit] Timberlands
Weyerhaeuser's timberland business manages 6.4 million acres of private commercial forestland in the U.S. and has licenses to 26.8 million acres of government-owned forestland in Canada. Timberland management involves monitoring trees as they grow to maturity, harvesting mature crops, and reforesting harvested areas with new seedlings.
Harvesting timber represents the first stage of the manufacture of a wood-based product. Weyerhaeuser uses the majority of the timber that it harvests in its other business segments, but also sells timber to unaffiliated customers.
In addition to harvesting trees, the company also derives revenue from the lease or sale of natural resources such as minerals, oil, and gas on its vast land holdings.
[edit] Wood products
Weyerhaeuser processes raw timber to create lumber for use in everything from construction to furniture. The company sells to wood products dealers, do-it-yourself retailers, builders, and industrial users. Wood products is the company's largest segment, bringing in 35% of total revenue.
Sales declined by 17.4% from 2005 to 2006 due to tough market conditions and a voluntary reduction of production capacity. See Timber Market Cycle.
[edit] Cellulose fiber and white papers
This segment of the company produces cellulose fiber (pulp) for production of paper products such as tissues and textiles, office-use paper, and paper packaging products such as milk cartons. Until recently, it also produced refined white papers (more next paragraph). Pulp and paper are both derived from softwood.
In 2006, the company sold its fine paper business to Domtar, a Canadian pulp and paper company. The transaction gave Weyerhaeuser $1.35 billion in cash, which it used to pay off debt, in addition to stock in the newly merged company.
[edit] Containerboard, packaging and recycling
Weyerhaeuser manufactures a variety of packaging products including corrugated cardboard, linerboard, and paper bags. In production, cellulose fiber is first formed into large sheets of containerboard (corrugated cardboard), which is then manufactured into packaging boxes and other products. Packaging is the largest portion of this segment, representing $3.9 billion of the segment's $4.9 billion in sales. The company also collects and recycles used corrugated boxes and paper in this segment of its operations.
[edit] Real estate
The company's real estate business is one of the top 20 homebuilding companies in the U.S, with annual revenues of $3.3 billion. This segment focuses mostly on single-family homes in high-growth areas. Profitability depends heavily on housing market conditions: for example, revenues increased by 6% from 2005 to 2006 due to an increase in the average price of single-family homes and increased land and lot sales. The current weakness of the U.S. real estate industry will be a serious challenge for this segment.
[edit] Corporate and other
This segment of miscellaneous business includes international operations, support activities such as transportation services, and joint ventures such as forest plantations.
[edit] Trends and Forces
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.
For details on the timber market, see timber prices.
[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.
- 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.
- The publishing industry - A large amount of paper demand stems from the publishing industry - books, magazines, newspapers, etc. With the rising popularity of digital media, the publishing industry is facing increasing competition. Many newspapers are considering going digital because of declining subscriptions and considerable loss of advertisements to internet sources.
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.
[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, 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.
[edit] 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 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.
[edit] Increasing digitalization and internet activity
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, which brought in $2.47 billion in 2006 revenue. 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.
[edit] Comparison to Competitors
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.
[edit] Timberlands
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.
[edit] Containerboard
Containerboard (corrugated case material) accounts for 32% of global paper and paperboard output. The growth of emerging economies have 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. As of 2006, Weyerhaeuser was the third largest producer, after U.S. firm Smurfit Stone Container and European firm Smurfit-Kappa, which both specialize in containerboard production.
[edit] Wood products
Wood products is an unpredictable segment, with revenue of $459 million in 2003 versus $1.5 billion in 2004. In addition, the range of wood products is enormously diverse and its manufacturers fragmented. A similar competitor to Weyerhaeuser is the wood products company Louisiana Pacific (LPX).
[edit] Cellulose fiber
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.
[edit] Real estate
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).
[edit] References
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