PotlatchDeltic Corporation (PCH) Earnings Call Transcript & Summary

And you talked about the cheap fiber costs in the south, which I think you really were referring more to Arkansas. Just wondering do you expect price tension ultimately in that wood basket? I mean is it a certain level of housing starts or timber inventories need to be drawn down to a certain level? Or is this something that is maybe just kind of structural? And can you contrast maybe pricing dynamics for logs in Arkansas with the acquired CatchMark land?

At the end of the day, if we step back, we've seen southern log prices in our legacy wood baskets. I think largely in Arkansas have been below trend levels ever since the great financial crisis. And really, what's happened there is there's an excess outstanding inventory in the forest as the fundamental situation. Originally, people would talk about harvest deferrals during the great financial crisis, really goes back to some ungoverned incentives to shift row-crop land over to timberlands. Science of growing trees has got better, land's more productive. But there's a standing excess. We've seen progress. I mean at the end of the day, it's always been about increasing the installed manufacturing base. And when you think about, Eric touched earlier about British Columbia and other parts of the country or North America are scaling back and closing capacity, the south has been the place where capacity has been growing. In the last 5 years, it's probably been 4 billion or 5 billion board feet that's been installed. And consequently, we've seen our southern log prices and our legacy basket, again, over in Arkansas have increased 5% each year in the last 2 years. You just heard Eric talk about flattish for '23. We're certainly not giving that up in a weaker economic environment. But I think that's evidence that the right trend is happening. The other thing I'm going to just lay on the table and let you come back to it maybe at some point here, is natural climate solutions. We certainly see opportunities there that will increase the demand on the forest. And I think that's an exciting new trend as well that will cause log prices to go up across the board and particularly in Arkansas.

And if you step back and you think about the U.S. South, it's easy to characterize it as a whole, well, there's converting capacity going into the south. But if you're somebody thinking about putting up a $200 million mill, do you want to put it in a tension wood basket that exists today? Or do you want to put it in an untensioned wood basket? And the reality is you want to put it in an untensioned wood basket because that's where the log prices are the lowest. Our region like in Arkansas, which has seen below-trend pricing, it's poised to gain the most in an upmarket in our view. And the reality is both markets are going to do well because it's the cheapest fiber in the world. But if you drill down even further, it's cheapest in Arkansas and Mississippi.

And can you contrast that, those log price trends and the tension with the CatchMark?

Yes, certainly, CatchMark has realized extraordinary margins, particularly for pulpwood compared to what we're seeing over in our traditional legacy baskets. But those prices are staying strong as well. They maybe are giving back just a little bit here with the recent pullback in lumber prices and sawlog demand. But certainly, no collapse.

And then maybe last question. In terms of the installed capacity or installed sawmill capacity, maybe adding some tension to that southern timberlands, especially in Arkansas. If you look over the last 5 years, I mean, has the pace of capacity adds, has it surprised you to the upside to the downside, have things taken longer to put in, the pandemic obviously impacted things? How would you just?

I think it's easy to say you want to go out and build a sawmill and to find the capital to go out and build the sawmill than it is to actually execute on the idea and get it up and running and get it operational. And I'd tell you that the biggest challenge in my opinion, is the labor side of the equation. You think about where a sawmill gets located. It tends to be in a really small town in the rural south, in really small towns, in the rural south, you're not going to find electricians plentiful, mill rights plentiful, computer technicians. Today's modern mills are sophisticated pieces of equipment, very sophisticated skill sets are required to run these mills. And in these small rural towns, it's hard to find the labor. What you've seen is mills that have been built recently and have started up. They're taking longer and longer to get to their full run rate. We actually, when we did the analysis on modernizing our Waldo Mill, we did the analysis of thinking, "Oh, let's just go build a greenfield mill instead somewhere else." Cost is a little bit more money, but that was a viable option for us. And when we sat back and we thought about it, it's like, "Well, gosh, how are we going to staff this new mill?" Where are we going to find the talent? Because people tend to not want to move. That's the reality. And so yes, we could find a location to put up a greenfield mill, but we wouldn't have the talent to run it. What we did at Waldo is we utilized our existing talent. We're modernizing the mill. We're going to have only a 3-week downtime in late 2024 when there's the cutover to the new more modern mill. But all of our talent is going to stay with us. I'd say relatively easy. It will be an easier transaction than had we built a new greenfield mill. But the pace of new mills and start-up has taken longer, and I think it's because of the labor side of the equation.

And then in the south, you have the Arkansas timberlands that are kind of forward integrated to your sawmills. As you think about the acquired CatchMark timberlands, is there opportunities to either acquire or build or have a sawmill footprint that's adjacent to those plans?

And that's one of the primary reasons we, well we underwrote the deal with acceptable return on our investment to 5% real. That's point number one. But one of the next factors that was a strong consideration was the best deals to be had are the bolt-on deals, either in timberland or in sawmills. But if it's a totally new region for you, you're not just going to venture across the south and go acquire some freestanding sawmill somewhere. But now that we are operating in those areas, and we have an integrated model, we have the timberlands that are proximate to these mills. Yes, I think the likelihood of us finding a mill and kicking the tires and consummating something are reasonably high. And not just on the mill side but also on the timberland side. Our footprint has expanded dramatically in a really positive way after the CatchMark merger.

And you talked a little bit about Idaho. I'm wondering if you could just talk a bit more about kind of your unique market position there, the end markets and kind of the demand that you're seeing there.

Idaho is a great place to do business. We're the largest private land owner by a wide margin. We own over 600,000 acres in the state. The next largest commercial industrial timberland owner by comparison is just under 100,000 acres. It drops off really quickly. And what Anthony is referring to is we have a unique contract in place or a market approach, and we indexed the price of our sawlogs in Idaho, 75% of the volume is indexed to the price of lumber on a 1-month lag. That arrangement has been in place for 12 years because often the question is, how durable is? It's also a 5-year evergreen contract. Every year that we go through, we sit with the primary customer, and we always have agreed to tack on the year that just ran. That's how it stays evergreen. Why is that in place? It's the only place in the industry that, that direct pricing mechanism exists. It starts with our land position. It's a tight wood basket. If you are going to buy logs or be in the business of manufacturing lumber in the state of Idaho, you're going to deal with us, you're going to buy logs from us. For the customer, the large customer, it's actually our largest log customer for the whole company, owns and operates 5 sawmills in North Idaho. It allows them, it really effectively operates as a toll manufacturing arrangement for them. A big bulk of their business is with the Home Centers. They like the fact that even in down markets like today, they still have a bit of a margin. And also the supply allows them to go get financing from banks and capitalize their mills well, which we like as a log seller as well. It's just a unique arrangement, a unique place. This arrangement at the end of the day, has added a ton of value. And our materials, our IRR materials, we benchmarked the EBITDA per acre over a long period of time. And it's higher than the west side of Oregon and Washington, which are widely viewed as some of the most productive timberlands on the planet. Biology, the rate of growth and the density of the wood is probably a little less in Idaho, but this pricing arrangement causes the financial performance to exceed, again, what are widely viewed on a performance basis, what are widely viewed as some of the most productive timberlands in the world.

Maybe just wrapping up timberlands. Can you talk about kind of the current market for timberlands and maybe if there's any kind of general dollar per acre type valuations you're seeing for good quality, maybe industrial timberlands in the south and maybe how pricing trends have contrasted with the kind of pre-pandemic period and during the pandemic?

The market for timberlands is low right now, there's not much timberland on the market. I think demand for timberland is extraordinarily high. Timberland has produced great cash flows. It's an inflation hedge. If you don't like today's prices, just don't harvest the trees, wait a little while. We're now seeing emerging value streams for timberland and natural climate solutions, whether it's for carbon sequestration or for solar farms or selling to pellet mills. There's all kinds of new income streams that are showing up for timberland owners. And I think that's driven up the price of timberland. And even though discount rates have moved up here in the last year or so, you've seen timberland prices only move higher. Naturally, all things equal, higher discount rates mean lower values for timberland, but what has more than offset that move in discount rates, are these new income streams that are appearing for timberland owners. I think the timberland market is slow right now. The M&A market is slow because people are waiting for these new income streams to be even more apparent. We're working on a carbon deal. I know Weyerhaeuse is working on a carbon deal. I read a survey the other day, 2/3 of TIMO investors are putting in carbon values for their M&A work. TIMO is like the private equity of timberland investing. The markets are slow right now, but I think timberland prices are poised to move higher, and we're seeing that with the record prices that were set last year. To answer the second part of your question, typical industrial timberland. I think if you're an untensioned wood basket in the south kind of even age, it's probably around $2,000 an acre. But you get over into some of the better markets like our CatchMark deal, for example, you could easily be in the $3,000 to $4,000 an acre kind of range. But the reality is for timberland, it's like no 2 tracks are the same. When you go to value timberland, you really have to do your homework. You really have to do your due diligence to understand what the opportunity is.

Segueing into kind of carbon solutions or climate solutions, it seems like there's a number of different opportunities, whether it's solar and wind or credits or CCS or mitigation banking. Can you kind of walk through the opportunities and the extent to which you've sort of participated and where you see maybe the opportunity going forward?

I'll do it in a worldwind tour here because there's a lot going on. And we have seen the inbound pace of calls has really picked up starting in the back half of 2022. This is a company that was a bit skeptical about the proximity of the opportunity, and it really was. Carbon credits were too low. And talk about one of the legs on the stool. And what we see is a live example, a European construction firm, so think Steel and Concrete is looking for offsets. They've doubled the price per tonne carbon sequestration and are willing to pay us over about a 2-year period been having these conversations. That's the live opportunity that Eric just referenced. That's real. That will take time to consummate. You have to go get a private letter ruling from the IRS. It's a good REIT income, which has tax implications. You got to go certify the credits. That's some work that has to happen. The first contract, yes, you got a lot of things, you got to go figure out. What happens if the forest burns, for example, a lot of things to sort out. We're very excited about that. We think the price for carbon credits will continue to go up, which means opportunity expands across a broader part of our footprint over time. Carbon capture. Again, I promise it's going to be worldwind. Carbon capture. We've done studies. We own timberlands and the oil and gas kind of plays in the U.S. South. Again, Arkansas, 900,000 acres, Louisiana, Mississippi, we have the right geological structures for that to be a real business opportunity. And that's a matter of continuing to work on specific business opportunities. There will be some more development that goes on before it will -- at some point, that will become a revenue stream. We think about solar. We did what we think is the first solar deal last year. We took 1,400 acres. We harvested it, which is where most of your timberland value is. And then we sold bear dirt that might have been worth $800 an acre for $7,500 an acre to a solar developer, a really nice premium and value capture. We have roughly $100 million of revenue opportunities in the pipeline. Some are under option agreement today. Typically, they're under option for 2 to 3 years for all the diligence and everything to get sorted out government permits and things to get sorted out. We've got $100 million of pipeline, some under contracts, some in negotiation to go under contract and some we just look at and say, "Well, that's quality stuff." And we see the demand increasing for those opportunities. This is largely in the U.S. South. The last thing that Eric just touched on is pellets. We had a large Japanese company as one example, and this is just one anecdotal of a bunch of conversations that we're having is looking at citing 2 large pellet mills in South Arkansas. They would torrefy the pellets, they bought them over to Japan. There's a mandate in place that they shift to more green sources to produce energy. Now you have a coal-fired power plant, for example, that's facing obsolescence unless it can find a way to put a component of biomass in as their furnish mix it with the coal burn and generate power to get within compliance. That's a live opportunity. Each of those pellet plants would be 3 million to 4 million tons of fiber, both sawmill residuals and pulpwood. Back to my earlier thing that I alluded to. Not only is manufacturing capacity going in, which is going to lift prices over time. But now there's competition for the existing finite resource as well through these pellet mills as an example. Overall, when you step back, I was just at another conference and an investor dinner on Sunday, and I'll tell you there's a lumber manufacturer, a large one, and they're already thinking about our log costs are going up. And when you add all that up, that's the next lift in timberland valuations that we're facing. None of that has fully traded in, in the M&A market and certainly it's not reflected in our stock price today.

Before we finish up, I definitely want to touch on kind of optimal capital structure and capital return and you have a wood products business that can generate a lot of cash. How do we think about that in a REIT structure?

That's been a meaningful source of cash, $1.6 billion over 3 years, by the way, that we've generated as a company. The way we manage our capital structure, is we think about cash flow streams into really 2 components. There's stable cash, think timberlands. We have, obviously, the variable cash flows and think lumber price dependent, back to our leverage to lumber and integrated strategy. The stable cash flows really underpin the regular dividend. And we have a great track record, as Eric said, 45% increase per share since 2012. 3 years in a row, we've increased that dividend. That's really based upon the stable, I think, timberlands cash flows primarily. We stress test the heck out of it to make sure we don't get over skis with that dividend. It also maintenance capital and debt service is stable. The variable has provided a really nice opportunity to fund growth with some bolt-on timberland acquisitions. We recently with our stock price being under pressure, about $50 million of shares back, some of that variable cash flow. It would be another example. We play a couple of big special dividends 2 years in a row. I think investors should not expect a special dividend. That's not our preferred way to return cash. We'd rather buy shares opportunistically, and we're willing to be patient and do that at the right time, and that's been our track record. Really, that special dividend is more about as you generate all this cash in your C-corp or your taxable REIT subsidiary. There's a cap on the value of that entity. And as you're shipping $1,500 lumber and you're pilling up cash, the value of that entity has gone up, the release valve is a special dividend. Easily solved. I think shareholders should be worried about, but that's really the premise of the special. When we step back, that's kind of how we think about capital structure and how alternatives fit together.

Well, we're coming up on the shot clock. Eric, Jerry, thank you very much.