PotlatchDeltic Corporation (PCH) Earnings Call Transcript & Summary

All right. Thanks for joining us for the 8:45 session. My name is Buck Horne. I'm the Raymond James analyst covering homebuilding, residential REITs as well as timber REITs. And I'm really thrilled to be able to introduce PotlatchDeltic to you. We got Eric Cremers to my left; and Wayne Wasechek to his left. And we're going to talk all things timber and lumber and wood products. So I guess I'm going to just start off with an open -- Eric, you can start with any opening comments, thoughts, view of the world as it stands and then we'll jump into some Q&A.

Yes. Thanks, Buck, and good morning, everybody. So if you're not familiar with PotlatchDeltic, we're a timber REIT with about a $4.5 billion enterprise value. We've got, in terms of assets, 2.2 million acres of timberland, about 600,000 acres up in Idaho and 1.6 million acres in the U.S. South, spread across 6 Southeastern states. We've also got 7 manufacturing facilities, mills, basically 6 produce lumber and 1 produces industrial-grade plywood. And then we also have a real estate business that sells roughly 1% of our acreage every year. We sell for higher and better use values in that real estate business. It also has a master planned community just outside Little Rock, Arkansas called Chenal Valley. So with our 2.2 million acres, we harvest about 7.7 million tons per year of timber. And with our mills, we produce about 1.1 billion board feet of lumber. So we're the tenth largest lumber producer in the United States. And then as I mentioned, our real estate business, we sell roughly 1% of our acres every year for higher and better use values. Think about conservation-type outcomes, things like that. And then the master plan community will sell roughly 150 residential lots per year, and then we'll also sell some commercial lots that go along with it. We do no vertical development in our real estate business in Chenal. So that's a little bit of background on the company. Buck?

All right. [ You put it very simple, no ]? All right. Well, let's start kind of high. I'm going to take it to the housing level for you, just try to give you some context for what we're seeing and hearing. Talking to the homebuilders that are out there, and clearly, we've been whipsawed by what's happened with mortgage rates and go back 6 months and certainly look like the sky was falling with cancellation rates for homebuilders seeing up 50%, 60%, orders are down 80% in some cases. Low and behold, January comes around total shift of sentiment, buyers seem to adjust. Builders are rolling out various incentives, and they seem to be working. That momentum carried straight through the spring selling season. I think universally, the consensus is the builders had a certainly much better than initially expected spring selling season. I guess, sales are still down year-over-year, but certainly, there's momentum even through the month of May. It sounds like that builders had a pretty good month, and that there's a lot of pent-up demand for single-family housing. So starts are holding in. Permits are up, I think, 15% or 20% from the bottom. And yet we've got this huge disconnect with lumber. Lumber seeming to just kind of languish and still drifting either sideways or lower in terms of pricing. So there's a lot of different factors at play here. I was kind of wondering if you have some thoughts in terms of what the -- why is this disconnect between lumber and housing playing out? Is it -- is this something short-lived? How does this shape -- or how does this shake out as we look at the back half of this year?

Yes. It's a good question, Buck. So new residential construction, so that's true whether single-family or multifamily, represents about 35% of the demand for lumber in the United States. Repair and remodel is actually the largest market segment. Roughly 40% of lumber demand is repair and model. Yes, so if you go back to the start of the year, the outlook was pretty negative for the homebuilders, and some of them were seeing some pretty dire things. And I think what we've seen over the past couple of months is that things are actually much better now than what they had expected. So that doesn't mean things are good relative to last year. It means they're just not quite as bad as what they had thought. So if housing starts were 1.6 million units in the United States last year, I think the latest outlook is in the 1.3 million, 1.4 million units. So we're down, call it, 300,000 units year-over-year. And I think the outlook for next year is for things to be right back up to 1.6 million or so. And I think the reason housing has stayed relatively stable is the fact of the matter is the U.S. is underbuilt. Estimates vary anywhere from 2 million to 4 million units short. And it all goes back to the great financial crisis back in '08, '09 when the U.S. was way overbuilt. Credit was widely available. You guys remember the term liar loans. Well, all of a sudden, the aftermath of the great financial crisis was nobody could get credit. All that excess inventory got taken up, and nobody was building. For many years, very little building was going on in the United States. So now the U.S. is dramatically underbuilt. So there's a fundamental underlying demand for housing. Combine that with the fact that we've got this millennial age cohort, the largest number of millennials, roughly age 30 to 35, which is the prime home buying years, is the largest it's ever been in the United States. And the backdrop is for relatively strong housing demand. No doubt the shift in mortgage rates going from 3% to 7%, it did some damage to the demand for housing. But I think as we've heard some of the homebuilders say, consumers are getting used to these higher rates, and the builders are doing what they can to offer incentives to keep demand flowing. So I think as we get through this year and even if rates stay at this higher level, as we get out into next year, I still think you're going to see housing get back up to the 1.6 million, maybe even 1.7 million units. And so the disconnect back to lumber is that we've seen demand for housing drop this year. And with that drop in housing demand, you've seen the drop in lumber demand right along with it, roughly 3 billion board feet out of a 50 billion board foot market is what we think lumber demand has dropped. And of course, whenever you see a drop in demand like that, you'll see a drop in prices. And that's what we've seen over the past year is a pretty dramatic drop. Where we sit today, I think we're kind of bouncing along the bottom. We've seen a lot of mill curtailments and permanent closures, particularly up in British Columbia. It just got a relatively high cost structure. But again, I think as you work your way into next year, demand comes back, I would expect things to look a lot better as we get out into next year.

So can we dive into a couple of those topics there. Certainly, I agree with you on what we're seeing, the builders saying and doing and going into next year, they certainly seem committed to "building through the cycle" and keeping their operations rolling through and putting more spec homes and starts in the ground that seems to be working and they'll basically buy down the mortgage rate to whatever is necessary to keep the assembly line flowing. But we've also seen, I guess, one factor this year is certainly seems to have been a surge of European wood lumber particularly that's shown up in the ports. How is that affecting your business? Or what are you seeing related to European wood? Is that a short-term phenomenon? Do you see it kind of dissipating? What happened there?

Yes. I think so Europe, Central Europe has got a market beetle infestation of the Spruce tree. And basically, trees are dying a lot of them. And you can salvage those trees. You can harvest those trees now and still turn them into good lumber. But if you wait just a year or 2 or 3, you can no longer harvest those trees and turn them into lumber. So basically, there's a lot of cheap logs in Europe right now. And so when we had those record high prices last year up in the $1,400 per thousand board foot range, it stimulated a lot of exports out of Europe. Really high lumber prices, really cheap input costs in the form of logs. That stimulated a lot of lumber production in Europe. That turnaround got exported to the United States. I do think that is going to turn around. I think things are going to be relatively flat year-over-year in terms of imports from Europe. And I think as you get out into next year, I think things are actually going to roll over a little bit. Europe is doing much better than it was before. I think the dollar has been really, really strong. That's worked for European exporters into the U.S. I think there's a chance that the dollar rolls over a little bit here. And so we've also seen with these prices coming off, it's not nearly as attractive as it was like last year to export lumber to the United States. So I think it is going to roll over. We've seen European imports represent as much as 10% of U.S. demand here in the past couple of months. But I've heard the most recent print was something more like 6% or 7% of U.S. lumber demand. So we're already starting to see signs of it cooling off a little bit. But certainly, that's had an impact on lumber prices in the U.S.

Got it. That's a helpful color. And then on the Canadian topic, just in terms of -- you mentioned that certainly we have seen some curtailments, but it seems like we've also seen a number of mills just continue to operate at relative to British Columbia's marginal production cost that doesn't make a lot of economic sense. How long does that situation maintain itself? Do you anticipate more permanent capacity? Or is there enough -- what's the willingness of these Canadian producers to just produce unprofitable wood?

Yes. That's a great -- that's a really good question, Buck. I mean, the way I think of it is, right now, the BC producers are way underwater by and large. Now every mill is a little bit different in terms of their cost structure. But I like to think of it every 1,000 board feet of lumber that goes out the door at $400 or $350 per thousand board feet that they're selling it for, there's a $100 bill stapled to it because that's roughly what they're losing per thousand board feet. So I think there is more capacity to come out of BC. We've already seen a lot of capacity come out of BC. We don't operate there. So it's kind of a little bit hard for me to speculate on the outlook for each competitor or each mill, but it's pretty widespread in the industry that BC is a very high-cost producer. I will say the Canadians, their lumber mills, they made a lot of money over each of the last 2 years. And so they've got deep pockets to play with. But nonetheless, an uncompetitive mill is an uncompetitive mill, and things are only getting worse up there as more and more land gets set aside for conservation purposes and the provincial government up there is not very friendly to the forest products industry. So I do think there are more closures coming, it's just going to take some time.

Got it. And I want to shift gears a little bit to timber and just lumber has been one aspect, but there's a lot of value tied up with the timber and the acreage alone, and you've got the unique arrangements with your Idaho acreage. Maybe you can highlight a little bit about what's differentiated or different about your arrangements in Idaho. And then just also the U.S. South. It's an asset class, I think, in general, that I think some people -- certainly, investors have struggled to understand. Why are the values for timber holding up so good in a rising interest rate environment? How do you help them understand the disconnect between how the private market is valuing timber right now versus every other asset class in the REIT industry that's facing a rising interest rate headwind?

Yes, it is quite remarkable. It's going on with timber right now. And in fact, he made -- Buck made an important point. I mean, if you think about our company's net asset value, I would guess, 85% of it is made up with our timberland holdings, something like that, 80% to 85%. So it is our largest asset class. And it's ironic to me that as our stock has sold off here on the housing downturn, timberland values have only gone up. Timbers land is selling for record prices right now in the United States. And I think it's one of the beautiful things about the timber asset class is, it's, well, #1, it's a diversification tool; and #2, timberland consistently has good cash flow metrics through good markets and bad. And now increasingly, there's optionality with natural climate solutions, trees, sequestered carbon. And if you're worried about global warming, well, trees are taking CO2 out of the air every single day. So it's ironic that in spite of these tough lumber markets that timberland is selling for such high values. So one thing that is interesting about our company is that our Idaho log sales, they're indexed to the price of lumber. Roughly 75% of our sawlog production in Idaho is indexed to the price of lumber. So as lumber prices go down, our log prices are going to go down, and earnings in Idaho are going to go down as well. The South is not like that. The South is just a competitive open market. And prices are not indexed to the price of lumber in the U.S. South. But regardless, in each of those 2 markets, we're still generating considerable cash off of our timberland holdings.

And also, I want to dive into the U.S. South a little bit further because you made a major strategic acquisition with CatchMark Timber, I guess going back to last year. And kind of want to dive on how the integration of that has gone? What have you learned as you've kind of gotten into those assets a little bit further? And maybe also break apart CatchMark's wood baskets in submarkets versus your more legacy or traditional markets? What's different about those 2 asset classes?

Yes. So we acquired CatchMark last year. It was about a $900 million acquisition for us. CatchMark has some of the best timberland in the U.S. South. So we call it site index, which is how fast the trees will grow and get to maturity. So they're in some really attractive markets from that regard. But then also, they are in some really very well tensioned wood baskets, which means there's a lot of mill demand very close to where their timberland is. And that has a tendency to push log prices up higher, be it pulp logs or sawlogs. And that contrasts with the legacy PotlatchDeltic Timberland really in Arkansas, Alabama, Mississippi. And in those markets, they're not quite as well tensioned. And so prices were a little bit softer in those markets. Now CatchMark was a great acquisition for our company. It diversified us into 3 new states in the U.S. South, got us some great timberland. As I mentioned, productivity on that ground is much higher than the legacy Potlatch ground, and we picked up some new customers as well. What we've also gained through the acquisition is we picked up some great employees that have come on board and are now helping us manage our combined business going forward. And we extracted some $21 million of synergies out of the business. So it was a very accretive acquisition for us. And it was mostly taking out overhead. We don't need 2 Boards of Directors, 2 CEOs, 2 CFOs, all the list goes on and on and on. So it was a great acquisition for us. One learning that we did get from the acquisition is kind of interesting, but -- so the legacy PotlatchDeltic markets were in weaker wood baskets. So to describe a wood basket, it's kind of like all about the growth to drain. How fast is the forest growing versus how much is being harvested from it. So in weaker markets, the growth will be much higher than the drain or the harvest. The opposite is true of a tension markets. The forest isn't growing as fast as what is being harvested year in and year out. So prices are -- they're more tension is the term that's used. Well, when you get into a weak environment like we're in now for lumber, what's happened is the more tension to markets are the ones that are giving up pricing the fastest because mills cannot make a margin or as much margin with high log costs as they were previously. So the interesting thing is that the weaker markets before log markets before actually holding up better than the more tension markets. It's kind of an interesting phenomenon.

And I want to dive in a little bit on kind of some of that tensioning kind of some of the -- what's coming out. How important is the pulpwood demand to CatchMark's acreage in terms of how pulp affects log demand overall? And is that -- are we seeing some sort of structural weakness with pulp end market demand right now?