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(Recent) Inflation and (Forest Industry) Investment

This post includes topics addressed in the (virtual) Applied Forest Finance course on May 19th, 2022 and in the Q2 2022 Forisk Research Quarterly (FRQ), which includes forest industry analysis, timber price forecasts, and data on North American timberland ownership. 

The U.S. Bureau of Labor Statistics (BLS) on April 12, 2022 reported that average prices for all items in the United States increased 1.20% in March.[1] For context, consider that inflation (CPI) for all of 2020 was 1.23%, and that the ten-year inflation average for 2011 through 2020 was 1.73% (per year). For the twelve-month period ending in March, U.S. inflation increased 8.5%. According to BLS, this was “the largest 12-month increase since the period ending December 1981.” Whew.

Inflation, to review, is the general increase in prices and wages over time and the associated (and unpleasant) reduction in the buying power of money. Rising prices reduces the purchasing power of each dollar. In other words, each dollar is worth less than before. Importantly, inflation speaks to a broad and overall increase in prices, not to higher prices for individual items.

This last point reminds us that some price changes affect us more than others, and that different people and firms buy different things. My higher cost is your higher profit. So, let’s evaluate the components of recent inflation trends and discuss their relevance to the forest industry.

Quarterly Chaos

While the headlines capture attention, the details offer clues for planning and strategy. Consider the underlying inflation trends within a single quarter, from January to March 2022. In January, twelve-month inflation reached 7.5%. Gwynn Guilford at The Wall Street Journal broke down the BLS data into the components comprising the increase[2]:~7.5 = Food (~1.0) + Energy (~1.7) + Everything Else (~4.8). Within Energy, 1.2 of the 1.7 reflected higher gasoline prices and within Everything Else, ~1.1 was used cars, ~0.5 was new cars, and ~1.5 was housing (e.g. home prices and rent).

To summarize the twelve-month data as of January, food and gasoline accounted for 2.2% (1.0 + 1.2) year-over-year, while cars/trucks and housing accounted for 3.1% (1.1 + 0.5 + 1.5). January proved painful for true pocketbook items. In addition, Russia had yet to invade Ukraine; that happened in February.

The topline numbers for March, 8.5% year-over-year and 1.2% for the month, while higher than January, had more nuance. While gasoline prices, heavily impacted by disrupted oil supplies from Russia’s invasion of Ukraine, accounted for more than half of the monthly inflation rate, we already observe gas prices falling from offsetting, increased U.S. production. While grocery prices remain higher, restaurant (dining out) prices have eased. While new car prices remain high and constrained by chip shortages, used-vehicle prices fell 3.8% in March. In addition, overall housing costs moderated since January.

To summarize, March quantified the economic impact of Russian aggressions on already higher energy and food costs (thanks, Vlad). Looking forward, the resurgence of COVID in China (and potential supply chain repercussions) and the continuing invasion of Ukraine remain worrisome (and troubling).

Forest Industry Implications

Inflation does have a way of affecting the investor mindset. One error in discounted cash flow (DCF) analysis associated with forestry investments is failing to account for inflation. In 2000, Steven Bullard and John Gunter published an article in the Southern Journal of Applied Forestry (“Adjusting Discount Rates for Income Taxes and Inflation”) that provided a step-by-step process for adjusting discount rates in this case, which I summarize with a template in Applied Forest Finance class and Forest Finance Simplified.

In their article, Bullard and Gunter note how “forestry investments are most accurately evaluated when the analysis is done in nominal terms on an after-tax basis.” They highlight how incorporating inflation also “accounts for equity erosion,” which can occur with capitalized assets during inflationary periods. While the relationship between assets prices (values) and inflation is complicated and its own field of research, the implication for investors prioritizes the understanding of how cash flows from each asset type (timberland, sawmill, pulp facility) respond to inflation.

Generally, institutional investors and individuals prefer illiquid assets during inflationary periods. These assets – including well-managed private businesses, infrastructure, manufacturing assets, and timberland – tend to appreciate and increase cash flows when prices rise. While these assets are not immune to inflation from higher costs (e.g. energy), they do provide an effective operating platform.


[1] Based on the Consumer Price Index (CPI), which highlights price changes (inflation) over time for consumers. PPI – the Producer Price Index – tracks changes in selling prices received by domestic firms providing goods and services. CPI speaks to price changes relative to a basket of consumer goods.  PPI speaks to manufacturing costs.

[2] “Key Sectors Drive Where Inflation Goes Next” by Gwynn Guilford, March 8, 2022, The Wall Street Journal.

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