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Plum Creek Timber Co. Inc. (PCL), Weyerhaeuser Company (WY): Yelling Timber!

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).

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