May 11, 2022

Weyerhaeuser goes 3D with its efficient land use (NYSE:WY)

AlessandroPhoto/iStock via Getty Images

Weyerhaeuser (NYSE:WY) benefited from a few quarters of incredibly high lumber prices that fueled record profitability, but that has little to do with making it a solid long-term investment.

Wood prices will fluctuate, but WY is operational efficiency will consistently put him ahead of the pack. Even amid the commodity price frenzy, WY continues to demonstrate its attention to detail and commitment to operational efficiency. Small optimizations matter a lot more than it initially appears and they often go unnoticed in the market as they seem small compared to WY’s $28.8 billion market cap.

Over time, WY’s higher trades should lead to outperformance and it is currently trading at an opportunistic valuation.

Let me start by digging into the idea that small operating efficiencies can add up to big impacts on the bottom line. I will then follow with concrete data and actions taken by WY that demonstrate their commitment to efficiency.

Large cap companies often outgrow their britches

As businesses grow, small expenses can start to seem meaningless as their impact on the bottom line becomes a rounding error. However, losing sight of these small expenses can erode company culture.

  • Maybe they stop making comparisons when buying equipment
  • Maybe they stop focusing on worker efficiency and high productivity workers start to feel neglected.
  • Maybe the chain of command is too cluttered with intermediaries that might not even be needed.

A number of issues like this can arise and they become more common as businesses grow. To get a sense of the magnitude of these problems, we can consider Iron Mountain (IRM) as a case study.

Hundreds of millions in annual savings

As Iron Mountain has become the world leader in information storage and security, its success has come with some bloat. Bill Meaney, CEO, recognized this problem and set out to solve it by launching Project Summit. IRM had a significant number of redundant middle managers, so the Summit project involved a serious reduction in management along with other efficiency initiatives. As we approach 2022, the estimated savings from the effort are $375 million on an annual basis.

So while each unnecessary individual hire was peanuts for the size of an MRI company, it boiled down to a huge number. By cutting fat, IRM has found a huge amount of incremental revenue and efficiencies are largely responsible for IRM’s outperformance in recent quarters.

MRI stock chart

HER

Weyerhaeuser’s watertight vessel tightens

Last quarter, WY was #1 or #2 in its peer group by EBITDA margin in each manufacturing segment. It also has the highest EBITDA per acre among Western Timberlands.

Its effectiveness is already quite good, but can still be improved. Through 2025, WY plans to increase its annual margins from $175 million to $250 million according to their presentation:

WY Targeting Price

Wyoming

This would represent an additional $0.28 per share of EBITDA at the midpoint. That’s a lot and the latest transaction gives me added confidence that they can do it.

Underground land rental

Occidental Petroleum (OXY) through its green subsidiary 1PointFive on March 28and leased 30,000 acres of land from WY with undisclosed financial terms. The carbon capture industry often does not disclose financial terms, but I think there is enough information here to determine that this is a clear win for WY.

I understand that there are many views on carbon capture and I’m not going to comment on this because from the perspective of WY shareholders, it doesn’t matter which side of the debate you are on. Airbus (OTCPK:EADSY) is paying OXY for 400,000 tonnes of CO2 removal and OXY is paying WY for the land.

The counterparties are massive, so there is minimal risk of default on the lease and although financial terms have not been disclosed, there is reason to believe the rents will be substantial.

Quite simply, the scale of this thing is huge. Until now, the largest Direct Air Capture (DAC) installation in the world was owned by Climeworks and according to Bloomberg

“The plant will capture 4,000 tonnes of CO₂ per year, making it the largest direct air capture facility in the world.”

This new OXY plant will have the capacity to capture 1 million tons per year, making it the largest by orders of magnitude.

Speak Announcement from OXY:

“Construction of the first DAC facility is expected to begin in the second half of 2022 in the Permian Basin. When fully operational, the DAC facility is expected to be the largest in the world, with an annual CO output of one million tonnes2 disposal volume capacity »

Let’s convert that to dollars.

Note that DAC is one of the more expensive forms of carbon offsetting/removal as it performs very well in terms of permanence and additionality. Companies looking to improve their ESG will pay for the DAC because it is highly rated by third-party governance organizations.

Airbus has strict standards on what it will count as carbon offsets in its annual report:

“Carbon offsets must be certified by the Gold Standard (or Verra for certain projects) and the supplier must prove that each of the criteria mentioned has been met.”

As such, DAC commands a premium price per ton.

According to world resources institute:

“The cost range for DAC is between $250 and $600 per ton.”

Thus, the 400,000 tons for Airbus would cost between 100 and 240 million dollars. I guess that’s down assuming the scale has benefits.

It’s just the Airbus contract. Presumably, by building a DAC facility with an annual capacity of one million tons, OXY intends to provide the service to companies other than Airbus. At the rate of $250 per tonne, the annual revenue capacity would be $250 million.

Since financial terms have not been disclosed, it is unclear how much of this will go to WY as rent, although I think it must be quite a large number as 30,000 acres is a lot of land, the terrain needs a specific geological formation to be suitable for capture and there must be detailed data on the geology of the land.

A pure victory for WY

The brilliance of this deal for WY is that it’s a near 100% margin.

By owning millions of acres of timber land, WY owns it.

A picture containing mountain, outdoor, sky, nature Description automatically generated

Wyoming

But what is often overlooked is that they also own the ground beneath the forest.

The footprint above ground of the OXY facility is negligible and WY will be able to continue logging operations on the 30,000 acres per normal.

This means there is little to no disruption to existing WY revenue streams and OXY’s rental stream is additional revenue.

$100 million EBITDA per year

WY announced plans to build a $100 million annual EBITDA business through green efforts. This OXY chord is a good start and it’s the right way to do it.

For most companies, ESG is an expense line, but for WY, it’s high-margin revenue.

Overall valuation

Weyerhaeuser’s core wood and lumber business easily justifies the valuation. In 2021, Adjusted EBITDA of $4.09 billion facilitated a special dividend of $0.50 per share and a second special dividend of $1.45 per share in addition to their normal dividend of $0.17 per quarter . In 2022, WY increased its regular quarterly dividend to $0.18 and is expected to earn an additional $3.26 billion in adjusted EBITDA, which would likely result in another large special dividend.

At $38.79, the $2.63 in 2021 dividends represents a 6.7% yield. The $3.26 billion in expected EBITDA represents an EV/EBITDA of 10.46X.

By any metric, WY looks pretty cheap. Granted, EBITDA should drop a bit after 2022 because I think timber prices will stabilize a bit lower than they have been, so maybe yield and EV/EBITDA are a bit less attractive than the figures above.

That said, there are significant growth drivers in the form of annual EBITDA savings of $175-250 million from operational efficiency initiatives and $100 million from high-margin ESG initiatives.

Given the unpredictability of lumber and lumber prices as well as those of manufactured wood products, it is difficult to determine an exact fair value, but given the range of lumber prices, I think WY looks undervalued.

This speculative EBITDA-based valuation is backed up by a much more concrete NAV valuation in which WY trades at 86% of NAV.

The bottom line

I like owning large tracts of land because it is an asset that has always increased in value. WY allows me to buy this land at less than fair value and it provides a significant income stream while waiting for this land to appreciate. WY operates at a higher level of efficiency which I believe will lead to outperformance against its peers and the broader market.


Source link