This post is the second in a series related to the Q3 2020 Forisk Research Quarterly (FRQ), which includes forest industry analysis and timber price forecasts for North America. The post includes excerpts from our featured research on applying long-term timber price forecasts to timberland valuation models.
In May 2020, Karen Langley of The Wall Street Journal reported on how shareholders in public firms, due to uncertainty about an economic recovery during the current pandemic and recession, “can’t rely on a traditional playbook…Investors who just months ago were scrutinizing projections for growth are now turning to measures of survival, such as cash burn and debt loads…”
So how should we think about this in terms of applying timber price forecasts to long-term timberland valuations? When valuing timberlands, these price forecasts serve as direct inputs into budgets, harvest schedules and valuation models that rely on estimates of net cash flows to, in turn, estimate profits, net present values (e.g. NPVs) and rates of return (e.g. ROIs and IRRs).
Over the past two months, we reviewed literature on long-term trends in commodity prices, evaluated the impacts of different timber price assumptions on timberland values, and conducted interviews with professionals in the forest industry to assess key issues and best practices when applying timber price forecasts to long-term applications. One of the consistent themes across this work was wariness and caution for applying timber forecasts that depend on economic cycles.
As one timberland executive noted “we don’t want to hook our harvest schedule or valuation on cyclical guesses in a price forecast…we want to leverage the biologic growth of the forest and what we know is happening [on the ground], not on varying outlooks on the economy.” This point was made several times with respect to how current prices deviate from the trend and expectation due to a current economic slowdown. Rather, the long-term stability and value expected from timberlands were, in a way and ironically, enhanced by the near-term volatility and not reliant on a cyclical pattern.
At the end of the day, we forecast products that we believe satisfy demand now and moving forward. We look decades into the future, while understanding that this nature of production and demand may fundamentally change. When it comes to wood, we rely heavily on the belief and understanding of forests and their preeminent importance to the planet and to demographic patterns that profile the underlying source of demand, labor and markets associated with wood products. Unlike buggy whips or straightedge razors, we know we will have forests and people.
Paying too high of a price (acquisition cost) for timberland will almost always result in overall poor investment performance. It seems many “timber” companies divested their timber holdings because the anticipated investment returns of holding were not attractive financially and instead rely on longterm timber supply agreements which are usually drafted in their favor. Normally there is biologic growth but if harvesting is delayed then cashflows are delayed and supply / demand dynamics change. Extending (delaying) harvests (cashflows) normally require investment returns to be much higher.
Brooks, I have noticed that many timberland appraisers incorporate a positive “return to trend” assumption when cyclical prices are below trend but don’t assume a negative adjustment when cyclical prices are above trend. Obviously a bias that drives timberland appraised values upward.
Sam: thank you for this note. Yes, we observe the same. Exceptions might be when prices for log exports or certain hardwood grades spike, then folks assume prices moderate. We are trying to think through “what is the trend?” given our understanding of forest productivity, technological efficiency and aggregate demand. To your point, the lines must cross at some point.