Timber trades for a housing upturn

Given the cost cutting that lumber companies have done in the past 2 years, any price boost should fall directly to their bottom lines.

By TheStockAdvisors Oct 8, 2012 1:27PM
Home under construction copyright CorbisBy Glenn Rogers, Internet Wealth Builder

We still have a long way to go in the housing market, but it certainly appears that the healing process has begun.

One related sector that is also showing strong evidence of a recovery is lumber and building supplies. A recovery in housing would have a positive effect on lumber prices. Given the cost-cutting most of the timber companies have done the past two years, any price boost should fall directly to the bottom line.

Weyerhaeuser (WY) converted to a real-estate investment trust (REIT) in 2010, as did most of the timber asset companies, which makes it a good dividend play.

Currently, the stock is yielding 2.3% but if the positive improvement in demand pricing unfolds they will be able increase that over time.

Converting to a REIT dropped the level of taxation on earnings to 15% from the 35% rate applied to corporations. This should set up well for income investors over the long haul, assuming that Congress does not do something crazy as the fiscal cliff approaches.

Weyerhaeuser has been slowly divesting itself of underperforming assets including spinning off their fine paper business to Domtar back 2006. Later it sold its packaging business to International Paper for $6 billion.

The result is that they are even more heavily leveraged to the housing market which, as Barron's pointed out, is not a bad thing at this moment in time.

Another operation I like in the same sector is Plum Creek Timber Company (PCL). It pays out an even higher dividend -- at $1.68 a year -- and is yielding 3.8%.

Plum Creek trades at a slightly less lofty price-to-earnings (P/E) ratio than Weyerhaeuser, although both companies look pricey by that measure because their profits have been so squeezed in recent years.

Plum Creek owns over 6.6 million acres of timberlands across 19 states. This makes it the largest and most geographically diverse private landowner in the nation.

In addition to simply selling timber, the company also has some high-value products like plywood and fiberboard, which will benefit from increased housing construction.

The company's outlook is in line with what economists are predicting, which is a gradual recovery in domestic demand over the course of the year with slowly improving fundamental performance of the various business segments within the company.

I think with improving housing sales and a generally improving economy, and with very little exposure to international markets, these companies offer good income-producing plays over the next couple of years.

Action now: Buy Weyerhaeuser with a target of $33 and/or buy Plum Creek Timber with a target of $46.

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