Fergus’s Findings: Rayonier (NYSE: RYN) Equity Research Report

Fergus's Findings Rayonier Equity Research Report in white text in front of the Aurora Borealis

Key Stats

Industry: Real Estate (REIT)

Market Cap: $4.6B

Current Price: $30.78 (6/16/2023)

Estimated Value: $34.99

Upside: 13.7%

Preface

We are interested in learning about companies that may offer a strong margin of safety, an identifiable moat and favorable corporate governance. Rayonier appears to be a compelling case for a potential investment as it is operating in a mature industry while having plenty of different strategies for future growth and value creation. They are one of only a few companies within its specialized industry with high barriers to entry.

Company Background & History

Rayonier was founded in 1926 in Shelton, Washington as the Rainier Pulp and Paper Company. Originally, they worked alongside DuPont to produce hemlock pulp and were strongly focused on this side of the business along with acquiring more land and forests to expand production. However, this then changed in 2014 when the company made the decision to spin off the pulping business into a new publicly traded company called Rayonier Advanced Materials. In doing this they changed the existing timber business into a REIT. The remaining entity is a much higher quality business with all the tax advantages of a REIT. They operate with a strong presence in the southeast United States as well as the northwest and in New Zealand.

Today Rayonier owns a total of 2.8 million acres of real estate. Rayonier is all in the business of growing and harvesting and selling timber. Currently the breakdown of revenue (2022) within the three areas is diverse with sales in New Zealand and the Southeast being $274M and $264M respectively while the Pacific Northwest sits at $162M. There also other non-timber related activities that Rayonier has evolved to do and commercialize which includes selling hunting licenses for their land in the pacific Northwest. There are further opportunities for them to utilize their land for different purposes including wind and solar in economically viable locations.

Macro

Timber has been an incredibly volatile commodity over the past decade with prices being significantly inflated largely over the past few years due to the supply chain hiccups that were a product of COVID-19. Rayonier operates in 3 geographic locations: Southeast US, Northwest US and New Zealand. There are different types of timber they harvest which also have further impacts on prices with supply and demand varying within the different species of timber. Currently there are only two major public players in the timberland REIT industry with Rayonier being the smaller of the two players at a market cap of $4.6 billion and Weyerhaeuser having a market cap of $ 22.7B (as of 06/16/2023). The price to NAV for Rayonier is 0.8 which is the same as Weyerhaeuser (as of 06/16/2023).

Another topical macro impact on timber prices has been the recent Canadian wildfires that have burnt 1.65 million acres. This has subsequently resulted in the shutdown of mills and the destruction of timber. Subsequently, this has resulted in an increase in demand for US timber and has increased timber prices which should have positive impacts on Rayonier due to more favorable pricing.

Pacific Northwest Demand & Pricing Trends from Q1 2007 to Q1 2023. — Source: Rayonier

Pricing has been favorable for Rayonier growth and expansion over the past decade with log prices in Northwest US growing steadily. We have seen production fluctuate over time but net out flat while the allotment to exports has shrunk. China’s timber imports have steadily increased with New Zealand’s market share now making up 55% in 2022 from 10% in 2008. The land in the portfolio has appreciated significantly in value resulting in a widening gap of market value vs book value because book value reflects the acquisition price plus net capital expenditures. This leads to a grossly underestimated value of their land on the balance sheet and when they decide to sell, they are going to realize significant gains. Realized average sales have been at an 87% premium relative to book value for land in the last 5 years and a 2022 average premium of 106%. When it comes to the timber and wood industry Rayonier has defied the practices of their competitors, which include manufacturing in their segments and has chosen just to focus on the production and sale of timber. This is largely because the EDBITA margins tend to be significantly more lucrative in the Timber with an historical average 34.5% EBITDA margin compared to wood products which boast a 11.2% EBITDA margin. However, in the past 3 years we have seen the EBITDA margins on wood products climb to very similar to timber historical differentials would suggest that this is not sustainable, and they will drop closer to that 11.2% in the coming years and potentially even negative as we saw these margins go in the period from 2007-2009 should sawmills experience a new wave of excess capacity. Further there is significantly lower volatility in profit margins within timber as opposed to wood products as Timber has had a historical volatility of 11.4% as opposed to 120.3%

In Q1 2022 we saw Chinese imports for US Southern pine face a sharp decline. This made up nearly 600,000m3 of demand as was in its peak demand in Q3 2021 and now we see China making up practically 0 imports of US South log exports and India and Vietnam creating the whole external market currently.

Financial Analysis

Currently, Net Debt to EBITDA is at 4.5x, which is the limit of their current target range, and their Net Debt to Asset is currently 22%, which is well within their 30% targeted limit. Currently they are not issuing significant debt and have seen share issuance as a better alternative to purchasing real estate. This approach is an easy alternative to grow while managing their capital structure with an aim to hold or increase their credit rating from a BBB- (S&P) and Baa3 (Moody’s) which both represent investment grade company. This method of capital raising does dilute shareholders; however, their strategy so far has resulted in them issuing the shares at higher valuations than current market prices as the last 14.8MM shares issued were at $33.05 per share and they have been able to repurchase their own shares at favorable times with 4.7MM being purchased at 23.84 per share. Rayonier’s cost of equity is 9.68% which holds a weight of 75% meanwhile the cost of debt is 5.5% with a weight of 25%. This brings the WACC for Rayonier to 8.5%.

ROIC has been significantly lower than WACC in the previous decade with greater performance only being attributed to 11 years around and earlier when the ROIC was 11.9%, indicating a lack of a moat. However, this calculation may understate ROIC as it does not capture land appreciation in the absence of acreage dispositions. If they can begin to sell more land at higher valuations in areas where the land would be converted to development, we would expect a material improvement in reported ROIC that could be sustained. Rayonier has continued to acquire land at favorable valuations, and it is fair to conclude that they will continue this into the future and try to maintain acreage while dispossessing valuable land as they see fit. Rayonier has slowly been selling small portions of land when opportunistic for them with an average of 1% of southern US acreage sold in 2021 and 2022. When it comes to the profitability of the company operating as the timber business, they are we see the margins are not very attractive as operating income is currently 16% with their average levels fluctuating between 13-24%.

Governance

Rayonier has been successful in issuing dividends to shareholders with a 5-year average dividend yield of 3.4% and a current yield of 3.7%. The total value of dividends being distributed has fluctuated of the past decade between $122MM to $257MM. However, these dividends have resulted in a dividend payout ratio of 205% on a 5-year average. Historically Rayonier has acquired significant land over time as that is a vital part of their business model if they are to grow. We have seen very little disposition of land that reflects they have been able to effectively grow and be patient able the sale of land and be ready for when opportunities arise to do so. They have discussed this in recent investor presentations with new developments encroaching on large amounts of land they own. Rayonier is ready to capitalize on this and sell the land to be developed and by doing so can sell the land at large premiums to what they bought it for and what the current resale would be if not developed.

Executive compensation for President and CEO is 81% at risk based on performance. This performance only appears to be based on one performance metric, which is operational cash flow measured against their budget. By only having one metric it makes it very easy to calculate however may leave executives only focusing on maximizing operating cash flow when they could be further spending to make further long-term value.

Competitive Analysis

Within the United States there are only two Timber REIT’s. These are Rayonier and Weyerhaeuser. There are a few comps that are non-timber REIT’s that focus on farmland including Farmland Partners and Gladstone Land Corp. However, for the purchase of fair comps I would only be considering Weyerhaeuser.

Acquiring land is very difficult and capital intensive to do so while making the land productive while owning and waiting for capital appreciation. However due to the duration that Rayonier have held land it is favoring them more heavily as cities have continued to expand get become closer to their sites giving opportunity for developers to purchase the land and do so at large premiums which other timber companies would not be close to matching. One case where this has materialized was in West Florida where Rayonier was able to sell a 3,100-acre plot for $15,000 per acre. There are a variety of areas that Rayonier currently hold that are in the pipeline for being purchased for development in both Florida and Georgia with significantly more acreage.

A further advantage that Rayonier faces compared to Weyerhaeuser is that the EBITDA margins for Timber have continued to climb at a 3.9% CAGR over the past 32 years. Rayonier is the only pure player in this space as Weyerhaeuser has more than 50% of the revenue coming from manufacturing which is significantly less profitable in terms of EBITDA margins. This allows Rayonier to have stronger margins as a company and create a stronger margin profile.

US Soft Pine is a vital part of the market and there have been few effective pine alternatives that have been produced. There are three primary types of pine that Rayonier plants across the different regions with Douglas-firs being grown in Northwest US, radiata pine in New Zealand and loblolly and slash pine in Southeast US. These three different pine offerings give consumers options and are the most optimized trees to be grown in each of the different climates.

The ownership of land in New Zealand is a large cost advantage through their logistical proximity. Offering extensive penetration into the Asian market at cheaper freight costs than timber from North America. Rayonier is 4th largest owner of real estate in New Zealand and being that large makes it incredibly hard for anyone else to compete.

The beta of the company over the last twelve months is 1.03 reflecting a very close correlation to the market returns. Weyerhaeuser has a very similar beta being 1.08 reflecting that timberland REITS are very similar when it comes to volatility. Today's float of the company is 99% expressing high levels of liquidity. Short interest is currently 1.1% of the float. There is currently 148M shares outstanding. They have slowing grown their shares outstand up by issuing more stock for compensation as well as the acquisition of land. The Largest holders of Rayonier are Vanguard at 14.5%, T Rowe Price at 11.4% and Blackrock at 8.3%. No insiders hold a noticeable percent of stock.

Valuation

For our equity valuation we created three different scenarios for Rayonier. This included a bear, base and bull model. For our base model we projected revenue growth to hold flat while EDITDA expansion to occur at a 3.9% annualized increase per year which is within the parameters which has historically occurred over the past 20 years. Within the model we also expect Rayonier to take advantage of the sale of additional property at attractive valuations in 2024 moving forward. We expect them to sell an additional 0.5% of acreage (12,000 acres) per year in areas being developed at an average sale price of $10,000 in excess to the historical sale of land. In the bear model we do not include this additional sale and hold margins level. In the bull model we project these additional acres being sold at higher valuations with an average price of $15,000, we think this is realistic after analysis in the average sale price of forestry and land in the Jacksonville and Savannah areas where surrounding land to Rayonier has sold in with an average sale price of $18,900 per acre in Jacksonville and $49,300 in the surrounding area in Savannah.

The Valuations lead us to a base resulting in an intrinsic value per share of $34.37, with the bear scenario at $19.91 and the bull at $51.13. After arriving at these valuations, we weighed them for the likelihood of those possibilities occurring. These were weighed 50% for the base and 25% for the bear and 25% for the bull. After implying these probabilities, we reached our estimated fair value of $34.99 resulting in an upside from the current price of 13.7%.

Conclusion

Overall, Rayonier does provide investors with an upside while also offering a strong dividend may make this company a strong candidate for a dividend portfolio offering diversification and a level of capital appreciation. However, Rayonier does need to prove that they are going to be able to dispossess land effectively and do so at attractive valuations. Further, with some uncertainty around market conditions Rayonier does give us some skepticism and we will be monitoring the company for any improvements operationally as well as the competitive environment which may allow for a more attractive opportunity