While this commodity doesn’t get as much attention as its popular cousins oil and gold, wood is also a scarce and valuable natural resource. What’s more, I think the secular case for lumber is strong due to how the world is changing. As countries develop and industrialize, they typically follow a pattern of building and resource consumption. It starts with demand for concrete to lay out a foundation of roads.
Next comes steel demand for more sophisticated infrastructure like bridges and railways. Finally comes the demand for lumber as rising living standards start to desire those white picket fences (houses). With a long line of countries still developing, I think the long-term case for lumber is solid.
Recent lumber prices
With that in mind, it’s worth noting that lumber prices have fallen by more than 20% from their year to date highs. The chart below shows lumber futures prices from February to the end of May, data provided by NAHB.
There are plenty of possible reasons for the sell-off. As the housing market gained steam, suppliers stepped up production to catch up with builder demand. At the time, rising mortgage rates and increasing real estate inventory are giving rise to a wall of worry. Justified or not, the market hasn’t wasted any time “yelling timber” and chopping down lumber prices. From a big-picture perspective, this short-term volatility may be a good opportunity to build on a longer-term position.
One way to gain exposure to this market is through stocks that are likely to be impacted by lumber prices. Of course, the exposure is indirect and imperfect, and you also need to take the details of the company into consideration. Nonetheless, dealing with stocks may be more practical than trading futures or brokering wood logs. Below are a few ideas you can dig into to get started with.
Positions to consider
Plum Creek Timber Co. Inc. (NYSE:PCL) is a $7 billion company based in the US. Structured as a Real Estate Investment Trust (REIT), it’s one of the largest landowners in the country and owns more than 6 million acres of timberland across 19 states in the US. The company basically grows trees and harvests them to produce products like lumber and plywood. Clearly, Plum Creek Timber Co. Inc. (NYSE:PCL) has direct and significant exposure to lumber prices.
Sales and earnings growth have been anemic. In fact average sales and earnings growth have been negative over the past five years, -4.4% and -6.2% per year, respectively. However, despite the negative growth, the company does have a long history of delivering earnings and cash flow.
Plum Creek Timber Co. Inc. (NYSE:PCL) has posted positive values in both categories every year for the past decade. Something I would be more concerned about is the amount of financial leverage Plum Creek Timber Co. Inc. (NYSE:PCL) uses. Its most recent balance sheet shows almost $2.6 billion dollars of long-term debt and a debt-to-equity ratio of 2.4%. While it’s not uncommon for a company like Plum Creek Timber Co. Inc. (NYSE:PCL) to be highly levered (the industry average D/E is 2+), I’m not a big fan of it. You may think differently and that’s fine – that’s what makes a market after all!
Weyerhaeuser Company (NYSE:WY) is a $16 billion REIT based in the US. It markets itself as a “forest products company.” In practice, it does everything from owning and managing timberland, to producing wood products and building homes.
Like Plum Creek, sales and earnings growth have been weak. Average annual growth rates for two of the past five years have been -8.4 and flat, respectively. In addition, Weyerhaeuser Company (NYSE:WY) has a choppier history of earnings and cash flow – earnings were in the red from 2007 to 2009. Again, like Plum Creek, Weyerhaeuser Company (NYSE:WY) is highly levered. Its most recent balance sheet shows more than $3.5 billion in debt. That being said, compared with Plum Creek, Weyerhaeuser Company (NYSE:WY) is less leveraged in relative terms (its D/E ratio is approximately 0.9 versus 2.4 for Plum Creek).
Given its wider range of businesses, the company is less of a direct play on lumber prices. Of course, the company still clearly maintains exposure to lumber prices through all of its business lines.
If picking tree-farming stocks isn’t your idea of a good time, then you can consider using one of the various exchange-traded products that have come to market. One choice is the iShares S&P Global Timber & Forestry Index . The underlying index tracks the 24 largest publicly traded companies engaged in the ownership and management of timberlands, as well as supply chain related activities with respect to lumber.
The fund averages trading volume of 40,000 shares per day. That volume doesn’t scream depth when compared with behemoths like SPDR S&P 500 that trade almost 200 million shares a day, but liquidity is better than you might expect. To wit, the bid-ask spread is only $0.02 (via Fidelity). Last of all, the expense ratio for this fund isn’t the lowest, but at 0.5% it’s quite a bit lower than the average natural resource mutual fund, which is above 1.5%.
The bottom line
In summary, nobody knows if lumber prices have found a bottom. While they could keep falling, I think it’s safe to say that prices are already much lower than where they were earlier this year. If you’ve been following the big picture lumber theme but have been waiting to build a position, now may be an opportunity to start. Whatever you decide, just be sure to take your positions in moderation and as part of a diversified portfolio appropriate for your needs.
Victor Lai has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned.
Victor Lai is an investment adviser representative with Bellwether Capital Management LLC, a registered investment adviser. Victor Lai does not own any positions in the securities referenced in this posting. Clients of Bellwether Capital Management LLC may own positions in the securities referenced in this post. This post is for informational purposes only and does not represent advice. You should conduct proper due diligence and/or consult with professional advisors before taking investment action.
The article Yelling Timber! originally appeared on Fool.com and is written by Victor Lai.
Victor is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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