Wednesday, October 29, 2008

Valuing Timberland II

This is the second post on timberland valuation. If you missed the first post, which included an Overview plus a discussion on Disaggregation, you can read “Valuing Timberland I” here. Today’s post will focus primarily on productivity and how that fits into today’s appraisal systems which use discounted cash flow techniques to determine the value of timberland.

Productivity is key to determining the value of timberland. Some of the productivity is inherent to the land itself and some is a function of the intensity and effectiveness of the silviculture practiced on the tract.

First, let’s look at the inherent productivity of the land. Foresters measure that with a metric referred to as Site Index. Site Index (SI) refers to how tall a given species of tree can grow on that particular site in a specific number of years. Examples might be Loblolly Pine, base age 25 years, SI 60. Or Red Oak, base age 50, SI 60. Or Cottonwood, base age 10, SI 60. All of these are realistic examples and I have worked in stands with these exact site indices. The sites are not similar though. Note that all of the examples are “Site 60” land meaning all of those species will grow to sixty feet in height but it takes the cottonwood only 10 years, the loblolly pine takes 25 years and the oak takes 50. The land supporting these three site indices would also look very different. So SI defines the productivity for a particular species on that site. As a matter of interest, the SI 60 examples given for Loblolly (25 years) and Red Oak (50 years) are reasonable and quite common. The SI 60 (10 years) for cottonwood is actually a very poor site. Cottonwood on a good site can attain 100 or more feet in 10 years! Neither loblolly pine nor red oak could even survive on these sites due to the prolonged flooding during the growing season. The site determines the best species to plant or to favor with natural regeneration.

Let’s look at site productivity in more detail. In the late 60’s and early 70’s I was buying timberland in North Mississippi and West Tennessee. My counterparts (in other regions) and I were tasked with developing a new appraisal system based upon minimizing the cost to the pulp mill rather than the minimizing the bare land value. A key component to valuation is the objective of the owner and I was working for a pulp and paper company that owned land for the purpose of supplying its mills. And remember this, timberland valuation and fair market value are two different things!! That’s why there is always a high bidder! Under this type of a valuation model (delivered cost), it should be very clear that the more productive the land (i.e. the higher the SI), the more wood that would be grown and the lower the delivered cost per ton would be. In addition, there was already a significant acreage of 10 to 15 year old established loblolly pine plantations on private land in the area that had been established by the U.S. Forest Service Yazoo – Little Tallahatchie flood prevention project. Cattle prices were high and the plantations were being cut, cleared and put into pasture. In general, fair market value for timberland in the area was essentially the pulpwood value of these plantations (very low because of their age) plus bare land value.

Our appraisal system team created the details for a model which estimated a future cost per ton delivered to the mill. Obviously, the tracts with the lowest cost per ton were the tracts most desirable to the company. Bare land value was still there and served as a checkpoint against “fair market value” (FMV). The new method was very different from the old in that it represented the beginnings of a cash flow model and timberland productivity became a very important driver. The “Growing Cost” of the model was actually a future value of the cash flows and was very dependent on the productivity of the tract. The impact of the increase in growth alone between SI 60 and SI 70 for loblolly pine is about 30%. Jack it up to SI 80 and the gain is almost 60%! It’s pretty easy to see the significance of productivity gains on valuations dependent on the amount of timber that will be grown in any given amount of time. The “take home” point of the last couple of paragraphs is that the greater the inherent productivity of the land, the more positive the impact will be on an appraisal system employing a discounted cash flow model. And the greater the price that informed buyers will pay for it. We’ll discuss more about the pine plantations mentioned above a bit later. But first we must talk a little more about productivity that we can impact and something called yield tables.

The second factor addressing forest productivity is silviculture. Silviculture can be briefly defined as - the art, science, and practice of controlling the establishment, composition, growth, and quality of forest stands. Silviculture is to the forester what agriculture is to the farmer. It is a broad term encompassing preparation of the site, selection of the species to be planted, selecting the seed with the best genetic capabilities, fertilization, planting, density control, weed control and harvesting. Silvicultural systems employing artificial regeneration, planting or direct seeding, are more in line with agriculture but natural stands employ similar practices to obtain the desired species composition and density control too. The decision to employ a silvicultural system with a focus on natural regeneration versus plantation management has a huge impact on cash flow and profitability (and therefore valuation). Natural forest management regimes have less cash out and less cash in. Which system, natural or plantation, is best depends on the objectives and circumstances of the owner. So…, site quality refers to the natural productivity of the site whereas silvicultural activities are things that we can do to increase the productivity of the forest. At a cost.

To a degree, the current productivity may be what nature provided us (really it is more what past “managers” left us with rather than what nature provided us with). The existing forest type (a classification of forestland based on the species forming a plurality of live tree stocking) may be a 20 year old oak-pine stand or a 10 year-old loblolly pine plantation. The two have very different productivity potentials going forward. There could easily be a five-fold increase in productivity between the two forest types on similar sites. In some cases, the forest manager has the option of changing forest types through the process of harvesting, site preparation and planting. Greater productivity, greater cost.

Inherent in the example above is greater control of stand density or stocking through planting. Control of stand density is critical to maximizing productivity. So what is stand density? I don’t want to get into a forest mensuration short course here so just think of stocking as the combination of the number and size of trees that will provide optimum growth for a particular site. Stocking charts frequently classify stands as “understocked”, “well stocked” or “overstocked”. A “yield table”, mentioned earlier, combines the stocking level with Site Index to forecast what the yield of forest products will be at some future point. This tool is critical to determining the future productivity of the forest and to the timing necessary for the discounted cash flow analysis. For the purpose of explanation and understanding, I have created the super simple yield table below.

A “real” yield table can go on for pages with many different site indices, ages, stocking levels and products but this one will illustrate the points that I am trying to make. Note how the yield (in this case cords/acre at age 25 but could be MBF at age 20) changes with both stocking (trees/acre at Age 1) and site index. Using these variables we can forecast both volumes and cash flow at the time of harvest. And what if we plant genetically improved stock that increases growth that is the equivalent of a 10 point jump in SI? Or phosphorous fertilization on a P deficient soil? Silvicultural activities have a major impact on the yield but “in the old days” we were pretty well restricted to the yield tables and they served us quite well. Today, however, they have generally been replaced with much more sophisticated growth models which are not only capable of predicting growth based on stocking and SI, but on all of the silvicultural practices that impact those metrics.

I feel that I have rambled a little too much in some places and not been clear enough in others so let me summarize the key points.

Forest productivity, both inherent (SI) and developed (silvicultural activities) is probably the most important driver in the cash flow analysis of timberland. Tools are available to measure and project the volumes into the future. Yield tables for volume projection have been replaced by growth models. You can download and learn to use a loblolly growth and yield model from Mississippi State here (CUTOVER LOBLOLLY GYM). It allows you to manipulate the SI and stand density and to see the future output. It also allows you to assign values by product which we will discuss next time.

Timberland valuation and fair market value are two different things! Remember above when I talked about buying 10 to 15 year old established pine plantations? The FMV (based on comparable sales) was about $125/acre in 1970. We began paying $150 - $175/ acre and easily acquired a significant acreage of these plantations. The value that we were assigning was the future value discounted back to the current age as opposed to FMV. Ten years later we were harvesting $1000/acre worth of chip-n-saw from these sites. We recognized that the FMV was well under the actual value of the plantations and were able to capitalize on that. Some of the early TIMOs were able to do the exact same thing with pre-merchantable plantations on a much larger scale. Some of the early TIMOs saw the value in HBU lands and disaggregation and recognized that the sum of the parts was worth more than the whole. These values are now well recognized in a competitive market and the returns, as expected, are dropping. The lesson is that there is a good return to be had if you can recognize a difference between the real value and the FMV.

Location can be very important or fairly minor. In the case of a forest products company valuing timberland, distance to the mill can be critical (as is the case with an institutional investor committed to a fiber supply agreement requiring delivery!). Some states have real estate tax structures which have a significant impact on cash flow evaluations. But frequently, location has minimum bearing on valuations for an investor.

So much for the value of productivity. The next valuation post will focus on estimates of timber volumes and values, how we get them, and how we forecast them for future year’s cash flows. We will also take a quick look at the confidence you should place in them. --Brian

Tuesday, October 28, 2008

AbitibiBowater to sell 190,000 Acres in Quebec

AbitibiBowater announces intention to sell approximately 76,700 hectares of select timberland assets in Quebec

Last update: 5:41 p.m. EDT Oct. 28, 2008

MONTREAL, Oct 28, 2008 /PRNewswire-FirstCall via COMTEX/ -- ABH (NYSE, TSX)

AbitibiBowater announced today that it intends to divest three forest units located in the Mauricie and Bas-Saint-Laurent regions in the Province of Quebec, Canada. These timberland assets include the Seigneuries of Perthuis, Nicolas-Riou and Lac Metis, which comprise a total area of approximately 76,724 hectares (or 189,508 acres) and have a timber inventory of over 7.7 million cubic meters. Scotia Capital Inc. has been retained as exclusive financial advisor for the sale process, and all inquiries or expressions of interest should be forwarded directly to their attention.
AbitibiBowater produces a wide range of newsprint, commercial printing papers, market pulp and wood products. It is the eighth largest publicly traded pulp and paper manufacturer in the world. AbitibiBowater owns or operates 27 pulp and paper facilities and 34 wood products facilities located in the United States, Canada, the United Kingdom and South Korea. Marketing its products in more than 90 countries, the Company is also among the world's largest recyclers of old newspapers and magazines, and has more third-party certified sustainable forest land than any other company in the world. AbitibiBowater's shares trade under the stock symbol ABH on both the New York Stock Exchange and the Toronto Stock Exchange.

Saturday, October 18, 2008

Valuing Timberland I

How much is that tract of timberland worth? Is it worth the asking price? Is fair market value for the tract a good investment? People have gotten rich buying timberland but rest assured that every purchase has not been a good investment! How the land is managed during ownership is important but it pales in comparison to smart purchasing and smart selling. This is the first in a series of posts that looks at how timberland is valued.

Here is a list of the key elements that should be considered when valuing timberland.

Disaggregation: The old expression “The whole is worth more than the sum of the parts” does not appear to be true. Valuing timberland typically begins by identifying the non-timberland values.

Inherent productivity of the land: foresters normally measure this by a quantitative metric referred to as site index.

Forest types and tree species: These are commonly confused but they are not the same thing.

Silviculture and productivity: Planted vs. natural. Fertilization, genetics, etc. What is impact on future yield (value)? Are records of past silvicultural practices available? Are they tied to a GIS?

Timber volumes: What does the cruise say? What does the inventory say? What is the difference? Are they tied to a GIS?

Timber values: What are the drivers? What are the sources of information? Should current market conditions be used for valuation? Or historical, or future estimates? What roles do harvesting costs and trucking costs play in timber value?

Reproduction values: On well managed land, reproduction values may exceed timber values. How do you estimate these values?

Cash flows: Revenue from timber sales, leases; silvicultural expenses, taxes, management fees.

Location: Important? Can it be quantified?

Final sale price: When you sell the land, how much will you get?

Discount rate: or how much of a return do I need to be competitive with investments with a similar risk?

Disaggregation: This first valuation post will address the issue of disaggregation or breaking the total value of the tract down into several components. Add up the value of the components and that’s the value – more or less. Early in my career (mid 1960’s) I was appraising and buying timberland in the Ohio Valley of West Virginia and Ohio. At that time, we cruised the timber and calculated the timber value, used a “table value” to estimate reproduction value (usually minimal or “0”), and assigned a modest “fixed” dollar/acre value for OGM (oil, gas and minerals) if they had not been previously conveyed. We then subtracted those values from the purchase price to determine the residual “bare land value” per acre. The bare land value was compared to past purchases and other available tracts to determine which purchases to make. So… we disaggregated into four pieces at most – timber value, reproduction value, OGM and bare land value. With the exception of the precalculated “reproduction table values”, the time value of money was not considered. Pretty simple. The objective was to manage the entire tract as timberland “forever”, not to sell off the various components. That methodology was pretty typical of the forest industry.

During the same time period (and earlier), land speculators frequently made money by the simplest form of disaggregation with only two buckets. They would buy a tract of timberland, sell the timber and then sell the bare land separately. Many speculators made a living doing this and some got very wealthy. The sum of the parts was worth more than the whole!

The REITs, TIMOs and their institutional investors have taken disaggregation to a whole new level. The objective is to lower the investment of the timberland purchase by quickly spinning off significant assets or components of the initial purchase. In addition to the components discussed above, the investment crowd values and disaggregates Higher and Better Use (HBU) lands, Recreation lands and Conservation Easements. In addition, future HBU lands are factored into the discounted cash flow analysis. The time value of money becomes an important part of the valuation relative to the early speculators that just bought, liquidated the timber and sold the land.

The impact of the disaggregation also has an impact of the final sale price of the investment. Conservation easements can significantly lower the final sale price. Conservation easements that prohibit development are, in a sense, the early sale of HBU land that just hasn’t got there yet. Conservation easements which dictate how the forest is to be managed in the future are much more problematic and should be expected to have a more significant negative impact on the valuation of the timberland when it is sold.

The next post will focus primarily on productivity and how that fits into today’s appraisal systems which use discounted cash flow techniques to determine the value of timberland. --Brian