The Best Way to Invest in the Housing Rebound Right Now

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It's no secret that home builders are in a funk. They've built just 500,000 to 600,000 new homes in each of the past three years, which happens to be the three lowest years on record (the data go back to 1959). And it's just half the average rate seen during the past 40 years.

Lumber prices have followed suit, falling sharply from the middle of the last decade.

Timber is a highly price-sensitive commodity , When demand marginally outstrips supply, prices can soar. Unfortunately, the opposite has been the case in recent years, so timber companies have been seeing some pretty lean times. Lumber traded above $400 per 110,000 board feet (of random lengths) in the middle of the last decade and is now trading at around $270 per random length today.


 

Might a turn be at hand?

Although many expect another subpar year for new home construction in 2012, industry activity may pick up by 2013. Considering the housing industry's recent period of under-building, there's a lot of pent-up demand. That's why some say we'll see a million new homes built annually by 2014 or 2015. This would be a return to levels seen prior to the recent economic meltdown.

You can already see the improving sentiment toward timber stocks by glancing at the Guggenheim Timber ETF (NYSE: CUT ) . This exchange-traded fund ( ETF ) holds 27 publicly-traded timber and paper producers. Some of those holdings are outside the United States, so it isn't purely correlated with housing.



The fund was launched at $25 in 2007, plunged sharply during the next few years, and still remains below that initial price. But the recent rebound in housing stocks has led to fresh interest in timber stocks. That's because an upturn in housing may create an even greater upward move in timber prices than the homebuilders themselves. For example, a 20% upturn in housing construction, coupled with a 30% upward move in timber prices, could yield potentially robust share price gains for these timber producers.

Since the CUT ETF (along with the more thinly-traded iShares S&P Global Timber & Forestry ETF (Nasdaq: WOOD ) ) may be weighed down by exposure to paper companies as well, a direct investment in timber producers likely makes more sense.

Most of these companies are structured as real estate investment trusts (or REITs), which means they aim for dividend payouts rather than share price appreciation . Still, a sharp upward move in timber prices would surely boost shares and help boost payouts.

Take Plum Creek Timber (NYSE: PCL ) as an example. The company saw annual sales rise to $1.6 billion in 2005 through 2008, thanks to a combination of strong volume and rising prices for timber. Plum Creek earned an average of $1.55 a share in those years.

Fast-forward to 2012, and sales are now expected to be in the $1.25 billion-range, generating roughly $1.20 a share in earnings . Plum Creek has maintained its annual $1.68 a share dividend for the past five years, and a combination of current cash and ongoing asset sales should help maintain the payout.

The best timber REIT
Although some analysts prefer Weyerhauser (NYSE: WY ) or Potlatch Corp. (NYSE: PCH ) , it is Rayonier (NYSE: RYN ) that appears to be the industry player with the greatest operating momentum. The company's dividend has been steadily hiked to a recent $1.60 a share, and though that equates to just a 3.6% yield, shares appear to have the most upside of the group.

Beyond simply owning real estate and harvesting trees, Rayonier has had strong gains in its performance fibers division, as the company's cellulose fibers are seeing an increasing number of industrial applications. The company's 2012 production capacity has already been sold out, and a new facility in Jesup, Georgia is likely to also sell out its production capacity. This capacity makes Rayonier the largest producer of high-performance fibers in the world.

Although analysts expect sales to grow just 5% in 2012, due in large part to lower real estate sales, a rebound toward double-digit growth is expected in 2013. Analysts see earnings rising about 15% to $2.50 per share in 2013, and notably, those forecasts assume still-weak demand for timber in housing construction.

Analysts at DA Davidson say expectations that 2012 will be a slow year are off the mark. They say the company's recent guidance "was conservative, given Rayonier's recent history of outperformance, and would not be surprised if they (sic) handily beat their own forecast, as they did in 2011." The analysts see shares rising from a recent $44 to $55. Toss in the 3.6% dividend yield , and you're talking about gains of nearly 30%.

Looking for a timber play that isn't a REIT? Check out the Forestar Group (NYSE: FOR ) . The Austin, Texas-based firm owns more than 200,000 acres across nine states, and some of the land is used for timber harvesting while other portions are being drilled for oil and gas.

[block:block=16]Forestar doesn't offer a dividend, but is a clear value play. The company's stock is valued just 5% more than tangible book value . As demand for both timber and real estate development finally turn back up, the company's holdings are likely to be valued much higher.

Risks to Consider: Further pain in the housing sector would likely keep a lid on lumber stocks.

Action to Take --> These stocks may not look especially cheap in the context of 2012 results, but rising timber prices and rising demand for timber in a housing-related recovery could help tangibly boost these stocks and ETFs.

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-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC does not hold positions in any securities mentioned in this article.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Investing Ideas

Referenced Stocks: CUT , ETF , PCL , WOOD , WY

David Sterman

David Sterman

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