Timberland Investment

Problems at Phaunos Timber (PTF) continue to mount as the specialist investment company faces legal action from a majority shareholder in one of its New Zealand forestry assets.

The distressed portfolio, which recently rejected a takeover from its former manager, has been hit with a legal challenge from Rayonier, the majority shareholder in Matariki Forestry Group.

It has started proceedings at Auckland’s high court over what it alleges is a breach of confidentiality by Phaunos.

The complaint stems from a valuation report on Matariki which was included in a circular Phaunos sent to investors in response to the takeover offer from former manager Stafford Capital Partners, which Phaunos said ‘significantly undervalued’ the company.

Rayonier, which owns 77% of Matariki, said the inclusion of the valuation breached confidentiality and has served an acquisition notice stating that it now had the right to acquire Phaunos' stake in Matariki for NZ$225 million, equivalent to a 20.5% discount to the most recent valuation by the fund.

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The relationship between U.S. Treasuries and discount rates drives discussions affecting timberland valuations. The quarterly data in Figure 2 covers 30 years, from Q1 1987 through Q2 2018. For the first five years, quarterly yields on 10-year bonds averaged 8.5%, while over most recent five years, yields averaged 2.3%. Meanwhile, timberland values increased on average in the U.S. from $600-700 per acre in the late 1980s to over $1,800 per acre today.

Timberland assets are constantly compared with alternative investment opportunities, and history reinforces the relationship between interest rates and valuations. If the core cash flows from an asset don’t change, lower discount (interest) rates support, lead to, cause and correlate with higher values, and vice versa.

Let’s be clear about the organizing principles here. First, timberlands (and mills) require capital. Second, investors have the capital. Third, investors have opportunity costs. If long-term U.S. Treasuries offered a 7% yield, net returns from alternate investments should exceed this. The cash flows and expected yield spinning off an asset justify the capital allocated to that asset. While legitimate reasons justify timberland ownership – diversification, hedging, ESG – increasing interest rates absent changes to cash flow generation increase pressure on valuations.

It ordered the review in part after persistent complaints that increased harvesting on Crown land in western Nova Scotia drove down demand for wood from private woodlots.

Rankin said the freeze on long-term leases to harvest on Crown land will stay for now. "Until we are fully able to digest the report and each recommendation we are not prepared to sign any long-term leases until we actually consider all those recommendations," Rankin said.

McNeil said an initial response will be delivered this fall.

The most recent Crown lease for Pictou-based Northern Pulp expired in July and was renewed for one year.

A renaissance in forestry investment in recent years has largely been driven by increased returns that remain very strong, says Warwick Searle, a specialist forestry broker with Colliers International.

Searle says a new wave of investors from predominantly from Europe, North America and Asia has been attracted by favourable government policies including an ongoing push for sustainability that has reinvigorated an interest in the sector.

"Forestry has long been dominated by a core group of long-term wholesale investors and these players continue to be active. Some 70 per cent of New Zealand's productive forestry land is owned by less than 30 parties," he says.

"What's changed is the entrance of a new wave of investors at a similar scale. We're seeing more big timber funds and private family companies looking at the market, many of which have not been active before."

Searle says the new players are not only attracted by strong returns but the relative safety and low management costs the asset class offers.

"Log prices have been undergoing steady growth in the past decade. Export prices have grown from $121 to $165 per cubic metre a decade ago, to $176 to $222 as of March this year."

Searle says that with the government supporting continued investment in the sector, there is good reason to remain optimistic about forestry's fundamentals.

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Although single-family starts appear to be maintaining a relatively linear upward trend, multi-family starts peaked in mid-2015 and have undulated lower since. As a result, total starts have been increasing along a decelerating trend since 2013. Delphi Advisors provide analytical insights about this topic in Forest2Market’s most recent issue of The Economic Outlook:

June’s sharp falloff in both single- and multi-family starts followed by July’s lackluster gain has prompted a rash of speculation, including references to “peak housing,” over whether construction has topped out for this cycle. Aaron Terrazas, senior economist at Zillow, interprets the slump in starts as “a sign that builders aren’t anticipating as much demand from buyers going forward, and/or that mounting cost headwinds are finally taking their toll.”

Based on the behavior of the exchange-traded fund iShares US Home Construction (ITB), which tracks a basket of 47 US homebuilders and construction-related companies, investors apparently agree. As of August 3, ITB’s share price had fallen nearly 19% from mid-January’s peak. Real private residential investment (PRI) declined for a third quarter in 2Q2018; as a percentage of total GDP, the decline has been in place since 1Q2017. Although both metrics have receded only modestly from their corresponding recent peaks, they nonetheless paint a potentially disconcerting picture.

The drops in starts and sales may be indicating that high home prices and rising mortgage rates have caused demand to tip over. June’s median new-home sales price ($302,100) was 12.0% below November 2017’s record high, but the median resale price (a new high of $276,900) was up 5.2% YoY. The resale YoY change was slightly lower than the 20-city Case-Shiller Index, which rose 6.5% in May, but still nearly double the YoY change in the CPI. And, to paraphrase a point made by economist Joel Naroff, as (especially new) home sales go, so goes ancillary retail spending.

Last month, we highlighted research by Delphi Advisors showing housing supply has not kept up with population growth. Delphi has subsequently added to those initial findings, and estimated that population growth might have supported construction of an additional 380,000 single-family and 450,000 multi-family units. “Perhaps this is a piece in the puzzle that explains why purchase- and rental-price affordability continue to be issues in many parts of the country,” concluded Delphi Advisors’ analysts.

Additional multi-family construction seems justified. The Urban Institute released results of a study quantifying several reasons why the Millennial cohort continues to wait longer than previous generations to own a home, including: delayed marriage and child bearing, education debt, and high rent. Another factor may be that 68% of Millennial homebuyers are experiencing buyer’s remorse. It seems plausible to imagine that communicating these regrets may be encouraging acquaintances to continue renting. In any event, more rental units would help reduce the growth rate of rents, in turn improving the ability—for those ultimately desiring to buy—to save for a future down payment

Using surveys, satellite images and categorizations from various government agencies, the U.S. Department of Agriculture divides the U.S. into six major types of land. The data can’t be pinpointed to a city block—each square on the map represents 250,000 acres of land. But piecing the data together state-by-state can give a general sense of how U.S. land is used.

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Forestland is the last major category of land categorized by the USDA. Unprotected forests and timberland constitute a quarter of the contiguous U.S.

Interior Secretary Ryan Zinke said climate change had "nothing to do" with California's wildfires, as he visited neighborhoods hard hit by the massive Carr Fire over the weekend.

“I’ve heard the climate change argument back and forth. This has nothing to do with climate change. This has to do with active forest management," Zinke told Sacramento station KCRA.

It's a tone the Interior secretary struck throughout his visit to Redwood, Calif., where, alongside Department of Agriculture Secretary Sonny Perdue, he met with local officials and fire crews battling the wildfire.

Zinke echoed President Trump in his assertion that active forrest management -- including logging -- is the key to stopping the forest fires.

"It doesn’t matter whether you believe or don’t believe in climate change. What is important is we manage our forests," Zinke told reporters while visiting the Whisteytown National Recreation Area Sunday. “This is not a debate about climate change. There’s no doubt the (fire) season is getting longer, the temperatures are getting hotter.”

The Interior secretary blamed environmentalists for having their own agenda in keeping officials from logging -- a method he said would remove much of the fuel fed to fires.
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Zinke's argument runs counter to a number of California officials and environmentalists who say the underlying factor responsible for the state's expanded fire season and acres burned each year is drought caused by global warming.

“California has some of the strongest environmental laws in the country, but the impact of extreme drought conditions caused by climate change are intensifying wildfires,” Rep. Mark DeSaulnier (D-Calif.) wrote in a op-ed for The Hill on Friday. “Contrary to his tweets, the Trump administration’s anti-environment policies, not California’s pro-environment reforms, will make matters worse and hurt our planet for generations to come.”

Massachusetts Pension Reserves Investment Management Board returned a gross 10% in the fiscal year ended June 30, documents from the Boston-based pension system show.

The return drove MassPRIM's value to $71.8 billion. It also outperformed the pension fund's benchmark of 8.1% for the year.
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Private equity returned 21.8% in fiscal 2018, followed by global equities at 11.9%; real estate, 9.4%; timber, 7.9%; portfolio completion strategies, 6.9%; value-added fixed income, 3.8%; and overlay, 3.1%. Core fixed income returned -1%.

The current asset allocation is 41.9% global equity, 13.4% portfolio completion strategies (which includes hedge funds), 12.8% core fixed income, 10.8% private equity, 9% real estate, 8% value-added fixed income, 3.4% timberland and 0.4% overlay.

Callan is MassPRIM's public markets consultant, NEPC is asset allocation consultant; Aberdeen Standard Investments, hedge funds; Townsend Group, real estate and timberland; and Hamilton Lane, private equity.

The Financial Times reports that CalPERS lost over $400 million on Lincoln Timber, a failed 2008 purchase of $2.38 billion of timberland in the southern part of the US. CalPERS exited the remainder of this investment in June, for $1.39 billion, a loss of $355 million on the purchase price. Combined with losses on disposals of previous portions of this holding, the total loss was over $500 million.

From the Financial Times:

Combined with previous disposals, it appears that total sales of the forestry land netted $1.85bn, leaving Calpers and its partners with a $534m loss before taking into account lumber revenues, inflation, management fees and debt servicing costs.

The article later states that the giant fund paid $52 million in fees. And of course, there were opportunity costs. Again from the pink paper:

According to Calpers documents, its return on the investment was a negative 0.5 per cent over 10 years, underperforming its benchmark, the NCREIF Timberland Index, by 497 basis points over that time.

“Leverage has exacerbated cash flow issues,” said a Calpers external audit last year. “Assets that would otherwise have been allowed to grow and appreciate, have been harvested to manage the debt.”

It also appears that CalPERS, as it is sometimes wont to do, timed its sale badly. The Financial Times points out CalPERS was in haste to exit its holdings:

After starting 2018 with the seventh-largest holdings of forestry land on the continent, the Texas sale all but takes Calpers out of the asset class.

“They made a decision to get out and they wanted to get out fast,” said Brooks Mendell of Forisk Consulting. “They’ve basically accomplished that objective.

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In the 1990s, CalPERS had been an early entrant into timberland investing, along with Harvard, and had done well with this investment strategy. JJ Jelincic said the Lincoln investment was intended to be the first of a new program, but that a timber portfolio with holdings only in the South, and nothing in the Pacific Northwest, “made no sense”.

Last November, the U.S. Department of Commerce under President Trump announced an average of 21 percent import duties on Canadian timber products entering the U.S. The announcement was greeted with mixed reactions within the construction industry; builders claimed that the tariffs would increase the cost of construction, and American suppliers argued that the domestic timber industry would benefit, expand, and keep wood prices low.

Single-family home construction in the U.S. relies heavily on Canadian softwood for roofing and framing. In 2017, Canadian lumber yards supplied 28 percent of the U.S. softwood lumber market, and home builders have been the first to raise concerns about the new duties, which were in effect by January.

The National Association of Home Builders (NAHB) claims that the imposed tariffs have added approximately $9,000 to the cost of single-family homes and up to $3,000 on multi-family homes. The NAHB doesn’t believe U.S. domestic production is capable of meeting the current market demand and that the tariffs only hurt native manufactures by forcing them to increase their lumber prices. The NAHB is calling for the Trump administration to resume talks with Canada to secure a more mutually beneficial long-term agreement.

David Logan, director of tax and trade policy analysis at the NAHB, says that historically, the U.S. lumber field has never been able to support rapid housing growth. “Buyers are still buying from the distributors they’ve always sourced from despite the tariffs,” he said. “Domestic lumber production has increased marginally in the last year, but it’s not kept up with the housing demand in terms of percentages, so it’s hard to say that we’re meeting the challenge. This has always been the case. We can’t meet that need…not even close.”

Logan also argued that larger lumber companies in the U.S. are profiting unfairly from the deal, citing the Seattle-based Weyerhaeuser, which owns 12.4 million acres of forest in the U.S. alone and manages 14 million acres in Canada, as well as West Fraser, a Vancouver-based company that operates 48 mills across both countries. The NAHB claims that these companies are able to reap the benefits of both markets under the current trade agreement and likely won’t be affected if things change again.
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The U.S. Lumber Coalition (USLC) rejects these claims. “Since the duties were implemented,” the USLC wrote in a statement last week, “U.S. lumber shipments have increased by about 1.4 billion board feet, roughly filling the gap left by the decrease of Canadian imports. U.S. companies continue to invest in expanding their production capabilities to mill lumber from American trees by American workers to build American homes.”
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On behalf of the NAHB, Logan said that his organization doesn’t foresee a new Canada-U.S. deal happening in the near future.

“We don’t think the dialogue will reopen any time soon as long as the North American Free Trade Agreement negotiations are ongoing. If history repeats itself…the last time this happened it took around 5 years to settle,” he said referring to the original SLA. “Hopefully I’m wrong and this is done very quickly. Until then, prices will maybe get a bit higher, but volatility will certainly increase.”

Faced with the worst summer fire season in 10 years, Gov. Jerry Brown is proposing broad new changes to California’s logging rules that would allow landowners to cut larger trees and build temporary roads without obtaining a permit as a way to thin more forests across the state.

The proposal — which has the support of the timber industry but is being opposed by more than a dozen environmental groups — would represent one of the most significant changes to the state’s timber harvesting rules in the past 45 years.

The legislative session ends for the year next Friday. On Thursday, the details were still being negotiated by legislative leaders and the governor’s office behind the scenes and had not yet been formally introduced in a bill or put up for a vote.

“They are trying to get to some kind of a deal,” said Rich Gordon, the president of the California Forestry Association, a timber industry group. “They are looking at what can get done politically.”

Under Brown’s proposal, private landowners would be able to cut trees up to 36 inches in diameter — up from the current 26 inches — on property of 300 acres or less without getting a timber harvest permit from the state, as long as their purpose was to thin forests to reduce fire risk. They also would be able to build roads of up to 600 feet long without getting a permit, as long as they repaired and replanted them.

Timber industry officials say the changes are needed to cut red tape and increase incentives for landowners, particularly in the Sierra Nevada, to thin pine and fir forests that have become dangerously overgrown after 100 years of fire fighting.

Timberlands company Weyerhaeuser Co. WY +0.00% said Monday that Chief Executive Doyle Simons intends to retire.

Weyerhaeuser said its board has chosen Devin Stockfish, currently senior vice president of timberlands at the company, to take over as CEO at the start of 2019. Mr. Simons will be an adviser to the company until April 1 and will leave the board when Mr. Stockfish becomes CEO, the company said.

Huge swathes of the Highlands are being put up for sale in what is said to be evidence of a massive boom in multi-million-pound timber industry.

Forestry director Patrick Porteous revealed sellers were attempting to cash in on a buoyant market, while buyers were keen to reap the rewards of a growing industry – worth about £1 billion in the last year to the Scottish economy and employing more than 25,000 people.

He revealed developers were also desperately hunting precious available land to start up new plantations and take advantage of rising timber prices.

Mr Porteous said a number of landowners who have had woodlands for some time had decided to sell up while the market was at an all-time high.

He added: “Mills across the north are working to capacity to cope with demand, and we have just seen Norbord near Inverness undergo a major expansion.

“Timber prices have gone up substantially in the last year, and it is a very buoyant market. It is a good time to be harvesting and selling and buying.”

On August 8, China's Commerce Ministry released a preliminary list of proposed tariffs on $16 billion in US goods, which came just a day after the U.S. Trade Representative's office released a finalized list of $16 billion in Chinese goods that will be hit with tariffs.

The tariffs are scheduled to be activated on August 23, the Chinese ministry clarified, which is the same day that the US plans to begin collecting an additional 25 percent in tariffs on $16 billion in Chinese goods.

The list identified duties of 5, 10, 20 or 25 percent on 5,207 US imports that include a number of wood products such as softwood and hardwood logs, veneer and lumber, chips, pellets, MDF, OSB, wood pulp, paper and other processed and unprocessed wood materials.
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If enacted, these tariffs will have a significant impact on US markets, particularly the Pacific Northwest (PNW). Due to its proximity to Asian markets, the PNW region exports a number of wood products to China, including softwood logs, lumber, chips, wood pulp, paper, and other processed wood materials.

What will these proposed tariffs mean for the forest products industry in the PNW?

Landowners/Land Managers

Harvests have been near sustainable long-term levels and there has been very little wiggle room in regional private harvests over the last year. Those involved in the log export market could see diminished export opportunities, which will cause a shift to domestic markets that will result in lower pricing due to increased supply.

Sawmills/Veneer Mills

These mill facilities may benefit from increased log supply and lower pricing due to restricted export markets. While lower raw material costs would be a welcomed change for these manufacturers, North American lumber pricing has dropped precipitously over the last two months. Raw material cost gains may be offset by challenging condition for lumber, veneer and residual chip pricing.
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With a potential for a major shift in global markets, it’s more important than ever for supply chain managers to remain nimble and adaptive when circumstances change. Sales and procurement managers must monitor these market changes closely and be prepared to make adjustments quickly.

After jumping 11 percent in May, housing starts dropped 12 percent in June to a seasonally adjusted annual rate (SAAR) of 1,173,000 units. Single-family starts accounted for 858,000 units, which is 9.1 percent below the revised May figure of 944,000. Starts for the volatile multi-family housing segment plunged 19.8 percent to a rate of 315,000 units in June; starts for buildings with five or more units fell to a 10-month low.

Privately-owned housing authorizations dropped 2.2 percent to a rate of 1,301,000 units in June. Single-family authorizations fell to 850,000, which is 0.8 percent above the revised May figure.

Privately-owned housing completions were flat at a SAAR of 1,261,000 in June. Regional performance was down across the board as confirmed by the US Census Bureau report, although unlike like month when the Midwest drove nearly all of the growth, the same region accounted for a lion’s share of the decline. Seasonally-adjusted total housing starts by region included:

Northeast: -6.8 percent (-15.0 percent last month)
South: -9.1 percent (-0.9 percent last month)
Midwest: -35.8 percent (+62.2 percent last month)
West: -3.0 percent (-4.1 percent last month)

Seasonally-adjusted single-family housing starts by region included:

Northeast: +3.1 percent (+10.2 percent last month)
South: -6.8 percent (-3.5 percent last month)
Midwest: -29.1 percent (+44.4 percent last month)
West: -3.6 percent (-0.5 percent last month)

British Columbia Investment Management Corp (BCI), Public Sector Pension Investment Board (PSP Investments) and Alberta Investment Management Corp (AIMCo) have agreed to affiliate their timber investments. The agreement will see TimberWest Forest Corp and Island Timberlands LP, both Canadian timberland companies, share facilities and services, align best practices and work together to enhance forest stewardship. They will continue to operate independently. BCI and AIMCo have backed Island Timberlands since 2005. BCI and PSP Investments acquired TimberWest in 2011.

The California Public Employees’ Retirement System (CalPERS), the largest US public pension plan, has sold most of its poorly performing forestland portfolio, a consultant’s [Wilshire Associates] review of the program shows.

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CalPERS took a double hit with the sale of the $1.559 billion portfolio, consisting of forestland in eastern Texas and western Louisiana, selling the portfolio at a loss after poor long-term investment results.

CalPERS had purchased the timber portfolio sold last month starting back in 2008, paying around $2 billion as part of then-Chief Investment Officer Russell Reed’s efforts to diversify the system’s portfolio and invest in sustainability-oriented strategies.

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Wilshire went on to say that challenges of the investment included “onerous debt arrangements,” and “unfavorable supply arrangements.” It also noted depressed timber market pricing.

CalPERS officials were not immediately available for comment, but it is their policy not to comment on upcoming board agenda material.

The Wilshire report did not detail the exact amount of the loss CalPERS incurred in the sale or who was the purchaser. One source said CalPERS lost approximately $500 million from the sale.

CalPERS data shows that the Crown Pine Timber portfolio made up almost 80% of the value of the plan’s timber portfolio. The remaining two portfolios, one valued at $425 million, and another valued at $2 million, are also for sale, sources say.

CalPERS does break down specific investment returns for the Crown Timber Portfolio. But CalPERS data shows that investment results for the Crown Timber  portfolio, and a second unrelated smaller timber tract combined, produced a negative 4.2% return in the three-year period ending June 30 and  a negative 1.4% return for the five- year period, also ending June 30.

In his first remarks on the vast California wildfires that have killed at least seven people and forced thousands to flee, President Trump blamed the blazes on the state’s environmental policies and inaccurately claimed that water that could be used to fight the fires was “foolishly being diverted into the Pacific Ocean.”

State officials and firefighting experts dismissed the president’s comments, which he posted on Twitter. “We have plenty of water to fight these wildfires, but let’s be clear: It’s our changing climate that is leading to more severe and destructive fires,” said Daniel Berlant, assistant deputy director of Cal Fire, the state’s fire agency.

He and others said that Mr. Trump appeared to be referring to a perennial and unrelated water dispute in California between farmers and environmentalists. Farmers have long argued for more water to be allocated to irrigating crops, while environmentalists counter that the state’s rivers would suffer and fish stocks would die.

The president first addressed the fires late Sunday, writing on Twitter, “California wildfires are being magnified & made so much worse by the bad environmental laws which aren’t allowing massive amount of readily available water to be properly utilized.” He also referred to a debate in forest management about the effectiveness of removing trees and vegetation as a fire control method.
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William Stewart, a forestry specialist at the University of California, Berkeley, said he believed Mr. Trump was referring to the battle over allocating water to irrigation versus providing river habitat for fish.

That debate has no bearing on the availability of water for firefighting. Helicopters lower buckets into lakes and ponds to collect water that is then used to douse wildfires, and there is no shortage of water to do so, Cal Fire officials said.
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Mr. Trump raised another issue when he wrote that officials “must also tree clear to stop fire spreading.” Scientists and forest experts said the president was referring to a valid and continuing debate.

The timber industry has argued that “thinning” forests — removing certain trees to improve the health of the remaining ones and diminish the plants and underbrush that fuel fires — reduces the risk of wildfires. Republicans in Congress have sought to loosen environmental restrictions to allow more thinning. Democrats and environmentalists argue the practice will open the door to expanded commercial logging and threaten wildlife.
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The president in the past has dismissed climate change as a hoax and his top cabinet officials have questioned the established science that rising global temperatures are caused by human activity.

Michael F. Wehner, a senior staff scientist at Lawrence Berkeley National Laboratory, said it was not possible to quantify precisely the likelihood that climate change is having an impact on forest fires, as can now be done with other extreme-weather events such as heat waves.

And, he said, it’s not easy to weigh how much of the problem can be laid at the feet of forest-management practices.

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California fire officials on Monday said the Carr Fire in Shasta County had ravaged more than 160,000 acres while the Mendocino Complex fires grew overnight and had charred more than 273,000 acres across Mendocino, Lake and Colusa counties.

Who Will Own the Forest? 14 is a 2.5 day event, beginning with an evening reception on September 25, conference sessions and evening reception on September 26, and conference sessions on September 27.

Wednesday, September 26, 2018

• Session 1: The Big Picture: Interest Rates, Housing, Labor Markets
• Session 2: Investor Perspectives
  
• Session 3:  Tax and Regulatory Affairs
• Session 4: Valuations and Investment Performance
  
• sion 5 (Part I): Forest Investments in Conservation and Carbon

Thursday, September 27, 2018

• Session 5 (Part II): Forest Investments in Conservation and Carbon
• Session 6: Succession Planning
• Session 7: Supply Chain and Transportation Issues 
• Session 8: Innovation and Technology: Impact on Forest Management and Silviculture
•  Session 9: International Markets