Something I’ve been trying to do for Alluvial’s “Global Quality and Income” strategy is to build in a little additional inflation protection. Equities offer a decent inflation hedge in and of themselves, but I believe certain industries offer especially good protection, typically industries that own hard assets. One specific industry with attractive inflation hedging qualities is timber. In the course of seeking out a suitable investment candidate, I’ve come across what I believe to be an extremely well-managed but over-looked timber company: Pope Resources, LP. Pope Resources boasts a long history of success, an astute management team and a strong collection of forestry and development assets.
There’s something delightfully simple about the timber industry. Plant a forest. Tend to it as it grows. At the proper time, harvest the timber and re-start the process. I don’t mean to imply that forestry is easy or doesn’t require a lot of skill. On the contrary, I’ve seen what goes into a well-managed forestry practice, and it requires an incredible level of scientific and market knowledge. And the labor involved at the ground level can be backbreaking and dangerous. But compared to the complicated financial engineering, frantic advertising and ruthlessly short product lifecycles that characterize many industries and companies, forestry seems a calm, timeless enterprise that has occupied mankind for thousands of years and will continue to do so.
Pope Resources was spun out as an MLP from Pope & Talbot in 1985. Over the years, the company has stewarded its forests, harvesting according to market conditions and also selling off various parcels to real estate developers. Today, Pope Resources owns 110,000 acres of timberland in Washington and Oregon, plus another 2,900 acres of property held for development in Washington. Additionally, Pope Resources has a private equity business that manages timberland funds holding 91,000 acres. Pope’s own interest in these funds is approximately 15%.
I’m no timber expert. I did grow up in a timber-producing region and spent a miserable summer toiling in a sawmill, but my knowledge of the financial and investment aspects of the industry come solely through my readings on the subject. I don’t know if the acreage held by Pope Resources is more or less productive than other parcels in the Pacific Northwest, nor if the company’s specific species mix and tree age profile will result in higher or lower yields in coming years. However, I believe I can trust management to get the most from its assets. I may not be a timber expert, but I believe I can recognize a well-managed company when I see one.
Short-term stock returns are driven by all sorts of factors, some within management’s control and others, not. But long-term returns to shareholders are strongly influenced by the quality and composition of a company’s assets, and the competency with which those assets are managed. A look at Pope Resources’ historical returns to unitholders indicates just how potent the combination of good assets and good management has been. Short-term performance has been competitive, while long-term performance has been superior.
I did my best to construct a set of comparable companies, against which to compare Pope Resources. Some of these companies also have operations in pulp, newsprint and other timber-adjacent businesses, but for the most part they make their money the same way as Pope Resources. Besides Rayonier, which benefited from its performance fibers business for most of the time periods in question, Pope Resources is the clear champion, multiplying unitholder wealth more than sevenfold over the past two decades. Of course, past success is no guarantee of future excess returns. But I have found that competent management teams typically continue to behave competently, while inept management teams usually continue to…..well, just take a look at Louisiana-Pacific. I trust Pope Resources’ leaders to continue to steward the company well. Management’s own holdings in the company are currently worth nearly $40 million, easily enough to incentivize them to continue to growth the company’s worth. It’s not just me who thinks highly of Pope’s management. Rayonier recently split into two companies, with the CEO headed to the spin-off fibers company. Who did Rayonier tap to take over leadership at the legacy company? None other than the CEO of Pope Resources, David L. Nunes. Pope has since replaced Mr. Nunes with Mr. Thomas M. Ringo, previously the CFO. With 25 years at Pope, Mr. Ringo is a fine choice to take the reins.
Pope’s management has put out a series of helpful presentations to investors which highlight the company’s strengths. Among them are:
1. An attractive asset mix – Pope’s standing timber has a high concentration of Douglas Fir, which commands a pricing premium.
2. Strong export capabilities – Pope’s location allows it to meet surging demand from Asia for premium wood products. The export market accounted for 40% of revenues in 2013.
3. Excellent development opportunities – Pope’s development properties are situated just outside the Seattle. The Seattle metro is one of the best-performing markets in terms of job creation and unemployment in the US, a fact that should help Pope profit on sales of land to developers. Thus far in 2014, Pope has reaped $15 million from land sales, more than twice the book value of the land sold, and expects to “harvest” large rewards from land sales in the Seattle area from the present through 2015. At quarter’s end, Pope’s land held for development had a book value of $27.6 million.
Pope Resources may possess a strong mix of assets and a savvy and an incentivized management team, but I still wouldn’t be so interested if the company’s trading price exceeded the value of its assets. Fortunately, that’s not the case. On a per-acre basis, the market values Pope at a discount to comparable timber properties in the Pacific Northwest.
Because GAAP rules force the company to consolidate its managed funds, Pope’s GAAP balance sheet is a little misleading. Fortunately, since the company provides detailed information on the timber acreage and associated debt of each fund, it is possible to determine the company’s proportional acreage and to compare this against adjusted enterprise value. First, the acreage.
Pope’s net acreage of 123,650 excludes the 2,900 in development land, but I’ll account for the that in the enterprise value. Net comes the task of calculating enterprise value.
The final step in calculating Pope’s value per acre of timber is to adjust enterprise value for the company’s development land. This is more of an art than a science, since the selling price of the Washington land can’t be predicted with any degree of accuracy. Recent land sales have occurred at more than twice book value, so I’ll consider three scenarios: one where the land is worth book value, one where it’s worth 1.5x book value and one where it’s worth 2x book value.
Book value multiples of 1.0-2.0 imply per acre valuations of $2,112 to $2,335. Either end of this range is below the average valuation of comparable properties in Pope’s location and market segment. The most recent data from NCREIF pegs valuations for Northwestern US timberlands at right around $2,400 per acre. Pope’s strong asset profile likely justifies an above-average valuation, but I’m fine using NCREIF’s estimate as a measuring stick. NCREIF notes that timber valuations are experiencing support from Asian demand, but housing starts in the US remain well below their pre-crisis levels, tempering prices. Should housing starts pick up steam, timber prices may rise. Or, they may fall. I don’t waste my time trying to predict moves in commodities prices. As uncertain as the market can be in the short run, I am confident of one thing: Pope Resources will continue to reward unitholders for many years to come.
Pope Resources, LP is a master limited partnership. MLPs carry unique tax considerations, especially for tax-deferred accounts. Investors should carefully examine these tax effects before investing in MLPs.
Alluvial Capital Managment, LLC holds shares of Pope Resources, LP for client accounts.
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