Investors who are just now recognizing that a broad recovery in the U.S. housing market is well underway are almost too late to the party — nearly every stock connected with the housing industry has run up already. However, despite the broader run-up in prices, some of the uglier and more cyclical businesses still trade at decent prices for investors who want to catch the tail-end of the rally.
Most of the available bargains are near the beginning of the supply chain — lumber producers like Weyerhaeuser Company (NYSE:WY), Rayonier Inc. (NYSE:RYN), and Plum Creek Timber Co. Inc. (NYSE:PCL). These are highly cyclical companies that have become more exposed to the housing sector since the downturn. However, only one is an attractive buy at current prices.
Sorting the decent from the ugly
Companies that manage timberland and related businesses — such as paper and packaging businesses — tend to have low returns on invested capital due to the capital intensive nature of the industry. That is the case for Weyerhaeuser Company (NYSE:WY) and Plum Creek, but Rayonier Inc. (NYSE:RYN) earns a much higher return on invested capital.
Over the last ten years, Rayonier averaged an 8.4% return on invested capital, compared to just 3% for Plum Creek Timber Co. Inc. (NYSE:PCL) and about 0% for Weyerhaeuser. This is unsurprising given Rayonier’s focus on specialty products that command premium pricing and have a degree of differentiation.
Rayonier Inc. (NYSE:RYN) continues to capitalize on its relatively-high return on invested capital by expanding its specialty products capacity; it is currently undergoing a project to boost its cellulose specialties volume by nearly 40% by then end of 2013.
Despite having a large lead in return on invested capital and return on assets, Rayonier does not have the same advantage in return on equity.
This is due to the higher amount of financial leverage used by Weyerhaeuser Company (NYSE:WY) and Plum Creek; while they cannot match Rayonier Inc. (NYSE:RYN)’s return on assets, they can amplify their own return on assets by carrying a large amount of liabilities compared to total equity.
Still, Rayonier wins out in the long-run; it averaged a 19.35% return on equity from 2003 through 2012, whereas Plum Creek Timber Co. Inc. (NYSE:PCL) averaged 14.44% and Weyerhaeuser Company (NYSE:WY) just 5.7%.
The best bet for a housing recovery
Investors looking to cash in on a giant bargain are already too late to the party, but solid housing-related investments still exist. For better or worse, each of the three companies discussed in this article have substantial exposure to the U.S. housing market. In fact, Weyerhaeuser Company (NYSE:WY) sold off its paper business and corrugated packaging business as the housing bubble burst, and is now completely reliant on U.S. housing starts.
If you just look at historical return on equity compared to current price-to-book, the expected returns do not look appealing.