Timber companies falter
While we have to eat humble pie, we think the carnage may be overdone. There's a case for this industry, as well as a case against it. We'll present them both and then take a view on the individual companies.
The positive case has always looked compelling. The government is encouraging tree plantation for both environmental and economic reasons – that is why investors get an immediate tax deduction.
Asian demand
And Asian demand for paper and woodchips is growing strongly, with Australia in the box seat thanks to its location and vast tracts of land. No wonder then that the profits of plantation companies have been surging for several years on the back of this positive industry theme.
But investor time horizons lengthened following the tech wreck when they began to look several years down the track.
The negative case stems from that process. To understand it we must first get back to basics. The fundamental question is – how do timber plantation companies make their money?
The simple answer is by selling packaged timber lots to investors. Trees are then planted on purchased land, and the company manages the woodlots for up to ten years. Once harvested, the company takes a percentage of the timber sale proceeds.
Think about it. The companies get a lot of cash from investors in the first years of the project – much of it reported as profit. But as the number of plantations grows, the companies need to spend correspondingly more on maintaining the trees. Clearly costs will rise over time, but all the cash has been received upfront. It is not until trees are harvested years later that the company collects more cash from woodchip sales.
Obviously the timber companies must sell more and more woodlots to keep cash coming in the door. That cash will then help fund plantation management until harvest time.
The market seems to be suggesting the accounting policies are wrong. Too much profit is recognised upfront, while not enough is set aside for management later on.
Rising prices
Combine that with the rising price of land and questions over the past profitability of tax-driven agribusiness schemes and investors are wary. So what does the future hold?
We do think the industry is sustainable, especially as the companies move from being simply woodlot marketers to plantation managers and producers. But for the time being they must keep selling more woodlots to investors. The jury is still out on how easy this will be, but our guess is that the allure of the immediate tax deduction will remain strong.
As always, you should stick with the best managed companies.