PotlatchDeltic Corporation (PCH) Earnings Call Transcript & Summary

Good afternoon, and welcome to Citi's Global Property CEO conference. I'm Anthony Pettinari with Citi Research, and we're pleased to have with us PotlatchDeltic CEO; Eric Cremers; and CFO, Jerry Richards; this session is for Citi clients only. So if media or other individuals are on the line, please disconnect now. Also, disclosures are available on the conference website. For those joining us today, to ask any questions, just type those into the question box on the screen, and they'll come up directly to us, and we'll do our best to ask them during the session. So Eric, we'll turn it over to you for maybe just some introductory comments on PotlatchDeltic, and then we'll move right into questions.

Great. Thanks, Anthony, and good afternoon, everyone. So yes, Eric Cremers. I've been with PotlatchDeltic for about 14 years. I'm the CEO of the company. And joining me on the call here today is Jerry Richards, our Chief Financial Officer. So by way of background, PotlatchDeltic is the third largest timber REIT in the United States, got an enterprise value of around $4 billion. And of the timber REITs, we are most the leveraged to lumber. So if you like lumber, if you like housing, you like where lumber prices are headed, we think we're a great play. We also happen to have the best balance sheet in the industry. So with our business, we have 3 different business units. We got our Timberlands division, about 1.8 million acres, about 600,000 acres in Idaho and about 1.2 million acres in the U.S. South. And with the acres, we produce and sell about 6 million tons per year, about 2 million in Idaho and 4 million tons down in the Southeast. We also have a Wood Products division. We operate 7 mills. And of those 7 mills, 6 produce lumber and 1 produces plywood. Our plywood mill is an industrial-grade plywood, now it's a specialty mill and used for applications like both truck panels, furniture frame, RVs, that sort of thing. With our 6 lumber mills, we produced about 1.1 billion board feet per year. We're the timbers -- lumber producer in the United States. We have those in Idaho, Minnesota, Michigan and 3 in Arkansas. And then finally, we have a real estate division. Our real estate division's got 2 different products that they sell. One is higher and better use property. They will take a rural acre that we do in that present value calculation on what that acre's worth for growing trees. And they seek out buyers that are willing to pay us a large premium to what that underlying land value might be if left in the timber growings. That's 1 of their product lines. Their other product line is a development project. We have in Chenal Valley in Little Rock, Arkansas. It's a master planned community, about 4,000 acres in size. We produce and sell-out 140 to 150 residential lots per year. Those lots cost us about $50,000 on average to produce, and we sell them for about $90,000 on average, so nice, high-margin business for us. We also sell commercial acreage in Chenal Valley as well. One thing I want to highlight for investors is that capital allocation is extremely important to us. We're very nimble. We think we're very good at it. And returning cash to shareholders in the form of a sustainable dividend is an important component of our capital allocation process. Our current yield is around 3.1%. Our dividend is very well supported. In fact, growing our dividend about 32% since 2012, uninterrupted. And over the past few years, we bought back over $46 million worth of stock at an average price down in the low to mid-30s. And today, our stock closed at, I think, $54 a share so very opportunistic buyers of our stock when we see it at depressed levels. As I mentioned at the outset, our balance sheet is in excellent shape. We, of course, we're investment-grade rated by Moody's and S&P, but importantly, our debt to enterprise value is just 13%, which is the lowest of the timber REITs. And finally, we just got done publishing this last year our inaugural ESG report, and that's gaining a lot of traction to investors both here in the U.S. and over in Europe. So with that, Anthony, I'll turn it over to you and you can ask questions.

Great. Great. Thank you, Eric. Maybe we can start with lumber because lumber prices seem to be breaking new records every single week. I'm just wondering -- can you talk about demand and kind of the key trends that you're seeing in end markets like repair and remodel and new residential and maybe industrial and other markets. And can you just talk about sort of the inventory levels and the drivers of this kind of current price strength and what you're seeing on the ground right now on lumber?

Yes. Thanks, Anthony. Yes. So to start off with lumber inventories are -- at very low levels. We've seen insatiable demand for lumber here over the past couple of quarters. And it's really driven by 2 different factors: One is the residential construction is just gangbusters. I think if you go back to December when we did our planning for 2021, anticipated housing starts to be around 1.4 million, 1.5 million, something like that. That's multi-family and single-family combined. And we've seen numbers early this year, 1 in 7 in with the skew towards single family, which uses like 3x more lumber than multifamily. So -- and we also saw a permits number back in January that I think was like $1.8 million, $1.9 million, just off the charts kind of demand for housing. And of course, that's driven by the backdrop, which is really low mortgage rates, down around 3% or so. And frankly, a relatively strong economy that's recovering from COVID. So really strong demand on the new residential construction front. And on the repair and remodel segment, which is another large demand driver for lumber use. There too, demand is off the charts, go look at Home Depots and Lowe's, go look at their comps. They're running plus 25%, plus 30% converse. And we've got a sizable business that goes into the home centers. And constantly, demand is really, really strong. So we're in an environment where industry-wide supply is struggling to keep up with demand. And whenever you get into a situation where there's some events like that, you're going to see really strong pricing. That's where we're at.

And not -- obviously, not asking you to predict lumber prices. But when you think about those underlying drivers of demand, do you view them as basically sustainable as you think about the year? Do you think there's any reason that it would reverse later in the year. Maybe COVID recovery, people getting out of the house. Just how do you think about sort of the sustainability of the drivers in 2021?

Well, view is -- it's going to be pretty strong going forward. The U.S. was pretty underbuilt since the great financial crisis. A lot of people that estimate the U.S. underbuilt by like 4 million house units, which is a really big number. You got a strong economy here. You've got really low mortgage rates, back market pushing up against all-time highs. You got this millennial age cohort now getting into their prime home buying years of age 28 to 32. Our view is housing is to stay strong for the next 4 or 5 years. So we think demand is going to remain relatively robust as long as mortgage rates don't get out of control. And as long as demand stays relative firm and supply struggles to keep up with that demand, which we think that's almost inevitable, every mill in North America -- virtually every mill is running as hard as they possibly can right now because margins are just through the stratosphere. So there isn't a lot of spare capacity lying around right now that can produce incremental lumber. So where is the lumber going to come from going forward? Well, it's going to take new capacity. And new capacity takes time. A new mill 2 years and $200 million to get up and run. So our view is that the outlook here, the run rate is pretty strong. Now could prices roll over a little bit as we get into the half of the year? Sure. But do we think prices are going to remain well above long term averages? Absolutely.

Great. Great. And then you talk about running full out. Are there barriers, whether it's supply chain tightness or COVID disruptions or costs that are keeping you from kind of fully capitalizing on the strong demand? And then can you talk a little bit about some of the mill investments that you made over the last couple of years? And are there sort of projects that could debottleneck or improve capacity across those 6 sawmills that you operate on the lumber side?

Yes. So we did run into COVID related issues with our production volumes last year. We had a lot of employee absenteeism, as you might imagine, whether somebody had COVID or they were contact traced out of the mill. Afraid to come to work. They had issues they're going to deal with or their parents or whatever. We had a lot of absences, and we estimate that impact in production roughly 5 million to 10 million feet per quarter. So added up over the course of the year was as much as 3% or 4% of our production was held back due to COVID absences, but what I'd tell you is that as we get into this year, those issues are dissipating. People are showing up for work, we have very few absences on any day. So there really are no production constraints today other than what can the machinery produce. And I can assure you that we are doing anything and everything we can to produce, again, every stick of lumber we can just because margins are so doggone high. So back to your other question about investments that we can make. You're right. We have been making a lot of investments into our mills over the past several years. Investing in our mills is one of our high capital allocation priorities. Our returns are generally in the 30%, 35% kind of range. They're very low risk, very high IRR kinds of projects. And not all of them are to increase production, some are to improve recovery, which means getting more lumber out of a log or at a lower cost, automation table out of the mill, take labor costs out of the mill or improve the yield. Instead of a number two, great piece of lumber, make it a #1 piece of lumber. So our investments will run the gamut, and we're always looking for projects to improve profitability. And these are, again, very low risk, very high-return kinds of projects for us. And I expect that this year, yes, our production volumes, our shipments this year are most likely to be higher than where we were last year by who knows, 20 million, 30 million feet from these investments that we've been making over the years.

And when we look at your footprint, you talked about 600,000 plus acres in the Northern region, the balances in the South primarily in Arkansas. You're generating a lot of cash with these extremely attractive lumber prices. Would you use this as an opportunity to get bigger in timberlands? And then some of your peers are -- publicly traded timber REIT peers are maybe a bit more concentrated in Pacific Northwest and U.S. South. How do you view timberland acquisitions and maybe some of the regional timberland markets that you participate in and some of your competitors participate in?

Yes. We absolutely will pursue timberland M&A. That's one of our capital allocation priorities. The one thing I do highlight is that we're only going to pursue Timberland M&A or for that matter, mill M&A or a combination, timberland and mills, if we can find the right deal at the right price. We don't want to overpay for something. That's called the winner's curse. And so we're going to be very careful. It has to be accretive and it has to meet our cost of capital. Otherwise, we're not going to do it. And the key for us is to be very patient in trying to find those deals. And I would just like to highlight that we merged with Deltic here years ago, and we had identified Deltic as a perfect merger partner for us some 10 years earlier. So we had to be a patient, wait for the stars to align. In this case, it was an activism that was taking a large position in Deltic wanting to take the company up and argue for change. We just have to be patient to find that right M&A opportunity. Now where would we go in U.S. or abroad with that M&A, it's most likely to be in the U.S. South because there's a lot of activity in there. It's less likely to be Washington or Oregon over on the West side of the Cascades, it's very competitive over there, and we don't operate over there today. We'd love to find something to do in Idaho, but Idaho is a pretty concentrated market. We're already the single largest private landowner in Idaho and very few acreage comes to market. So I would hazard to guess that most of these places is going to be in the U.S. South.

And can you talk a little bit about the dynamics around log pricing in the U.S. South? We hear about South wide averages, which haven't really recovered to sort of pre-2008 levels. There are some coastal regions where it seems like prices are actually seeing quite a bit of tension, and then there are some inland regions where we haven't seen that. Can you just talk about log pricing in the U.S. South? And then obviously, the regions that you are concentrated in, and what you think the south needs to see, whether it's inventories or sawmill capacity or housing starts that might move those prices?

Yes. So there's a glut of timber in the U.S. South. We call it the growth to drain ratio. What is the forest growing versus what is being harvested each year? And right now, every year, there's more tons left over at the end of the year. The forest is growing by roughly 15 million tons per year, if you look at the South in total in aggregate. So there's an overhang of timber supply in the south. And of course, it all comes back to supply and demand. And even though lumber production in the U.S. South has doubled since the great financial crisis, having gone about 11 billion board feet a year up to 22 billion board feet per year. That's not enough to put an end that timber supply overhang, if you will. Now I think if you fast forward out in future, you see a lot more greenfield mill construction, which if these prices stay at these levels, you will see more greenfield mills be installed. I think eventually, you'll lead into that timber overhang and you will get a price response, but it probably isn't, I don't know, 5 to 7 years away, is what I would guess. That's what supply and demand tends to -- that's about when it's going to come in the south. With regard to certain its having more tension than others, I kind of think that's overplayed. If you look across the U.S. south, there's not huge regional differences. And if you look over the past 3 or 4 years and compare our prices to our peers' prices, the change is not dramatic at all. We are more inland. We haven't had -- we are theoretically in one of the more tougher baskets, if you will, where there is more supply than demand. What I'll I tell you is if you dig into the data and you look at the more coastal markets, you won't see log prices enjoying this big run-up because lumber prices have run up. They've been pretty flat on the coastal markets as well. So I would contrast that with Idaho where our [ solar ] prices are indexed to the price of lumber. And so as we've seen these prices run-up to over $1,000 per 1,000 board feet, that's translated back into the stump for us in Idaho. This is a very unusual arrangement that we have got. None of our competitors have this arrangement and it gets back to what I said at the open, which is we are the timber REIT that is most leveraged to lumber and it's because of that supply relationship that we have in Idaho.

And can you talk a little bit more about the Idaho market and sort of what makes it unique? I mean, some of your publicly traded peers have some properties in maybe the inland west that are sort of less attractive, and you've been able to generate just these great returns in Idaho. Can you talk about sort of the unique characteristics of that market?

Yes. You are correct. Yes. It really is a unique market for us. As Eric mentioned just a minute ago, we are the largest private landowner by a wide margin. That's probably our single most valuable asset, to be honest, is our Idaho timberlands. And maybe to set the stage, we've generated average EBITDA per acre $155 over about a 5-year period. Just really nice profitability. And that's really -- a closer comp is really Western Oregon, Western Washington timberlands than anything else in the inland west or the northern tier that you're referring to. And there's 2 key parts to that story and reason. The first is really biology and geography. So when you think about elevation and volcanic soil and precipitation and mild climate, that really gives rise to growing very similar species, doug fir, for example, would be one, Cedar is another that you see on the West side of the Cascade mountains. So a good part of it, it's much more productive land than you see anywhere else in the inland west or in the northern Tier. That's the first leg of that story. The second way we've already touched on, which is the index arrangement. So as Eric mentioned, we do index roughly 75% of our sawlogs in Idaho to the price of lumber and about a 4-week lag. We've been doing that for about 10 years, and it was put in place back at a time when we really had, as a company, a very optimistic forward look on lumber price. And as we look back, it's created a lot of shareholder value by putting that arrangement in place. And it's certainly an arrangement that certainly, it works for -- our largest log customer as a company as well is under that index arrangement. So you have that unique pricing arrangement, which really does make sure that these high lumber prices trade back to the stump, picking back up on Eric's point just made. We also have a fair percentage of Cedar. And Cedar is a scarce resource, and it goes into a lot of high-end applications. And Cedar has really been on fire more recently as well. So we're benefiting from strong cedar prices as well. So those would be some things that really make our Idaho timberlands unique across the space.

Got it. Got it. That's very helpful. And then maybe just jumping back to southern logs. Can you remind us in terms of how much of your sawlogs are used internally in the south. Do you have a little bit of a hedge there? And then could you increase the percentage of sawlogs that you're using internally or sort of what would be the ideal mix for you in terms of internal use of your sawlogs?