Rayonier Inc. (RYN) Earnings Call Transcript & Summary

Citi's 2020 Global Property CEO Conference. I'm Anthony Pettinari with Citi Research, and we're pleased to have with us Rayonier and CEO, David Nunes. This session is for investing clients only. So if media or other individuals are on the line, please disconnect now. Disclosures are available up here and on the webcast on the Disclosures tab. For those in the room or on the webcast, you can sign on to liveqa.com and enter the code Citi2020 to submit any questions or you can just raise your hand. Dave, I think we'll turn it over to you to introduce Rayonier, and then we'll jump into Q&A.

Sounds good. I'll go through about a handful of slides, and I know you've got some good questions. We can go through after that. So jumping in, Rayonier owns 2.6 million acres in the U.S. and New Zealand. We have $1.8 billion of acquisitions that we've completed since 2011. We're the only company in the space that discloses sustainable yield, and that's -- we define that as the volume you can harvest into perpetuity, which is 10 million tons annually. We have a nice mix from a diversification standpoint, between our various geographic segments. Last year, the U.S. South was 44% of our cash flow; New Zealand, 28%; Real Estate, 22% -- or excuse me, Pacific Northwest, 6%; New Zealand, 28%; and Real Estate, 22%. Our mission is really about returns as opposed to size, and that's really where our focus is. In terms of the distribution of our lands, 1.8 million acres in the U.S. South and roughly 400,000 acres each in the Pacific Northwest and New Zealand. We are the leading pure-play timber REIT, meaning we don't have manufacturing assets over the last few years. Our mix has been about 70% of the EBITDA coming from timber, 30% from real estate, whereas our 2 other large peers have a fairly large component of manufacturing assets. And we really think that translates into volatility, differences between the companies. Some of the portfolio highlights with respect to Rayonier. We have the sector-leading EBITDA per ton in the U.S. South. And we think EBITDA per ton is a more accurate measure to think about timber. Historically, this space has focused on EBITDA per acre, but that -- recognize that you've got a back out rate of harvest, which is differential across the industry rate of EBITDA per ton. We feel it is a more accurate depiction of the footprint in the markets that you're in. We also had sector-leading higher and better use value realizations across the sector. The bulk of the sector has generally been selling at average NCREIF timber values, and we have a meaningful premium. We think that really sets us apart. We've also been growing our sustainable yield over the last number of years. We take a real active portfolio management perspective. Since I joined the company nearly 6 years ago, we have 100,000 fewer acres, but we have 10% more sustained yield, and that's really not an accident. We've been trimming from the bottom portion of the quality spectrum and adding more high-quality portfolio aspects as we go. And then lastly, be remiss if I didn't mention it. We are certainly heavily levered to China. All 3 of our segments have sold into China over the last number of years with New Zealand being the highest. We can get into that more in the Q&A session. We have 5 pillars that we manage against from a strategic priority sense. First is managing for long-term value. We're very focused on kind of balancing biological growth and harvest cash flows as well as responsible stewardship. We have had a focus on acquiring high-quality timberlands. And for us, that's really as much about having optionality. If you have a high-quality property in a good market, you just frankly have more options. When you plant seedlings, you really don't know what the market conditions are going to be like. When those trees reach maturity, all else being equal, if you have more options, you're going to be better off. And so we have a focus on that as we think about the quality of our portfolio. Optimizing the portfolio value. We're always having an attitude of never being satisfied with our portfolio, looking to trim, looking to add, always tweaking it, and focus on quality of earnings. We deemphasized the sale of nonstrategic timberlands after the spin-off to really focus on selling lands where we could get a meaningful premium. There has been a history in this space of selling lands just to fund a dividend that's otherwise unsustainable, and so we felt like that was an important departure. And then last, we take a lot of pride in having a best-in-class stewardship and disclosure. We've spent a lot of effort over the last year developing our ESG disclosures. We expect more on that to come out this year. And also, just in general, the transparency of our disclosures. And then I'll wrap it up with a brief overview of our recently announced Pope acquisition. This was announced in mid-January. We're very excited about this transaction. It is a perfect fit against a lot of the criteria that we've talked about. It's a high-quality asset. It's got a very high component of Douglas fir, 83% of the inventory is -- merchantable inventory is in Douglas fir. So it brings our balance from 60% to 68%. Why is that important? Douglas fir has higher values and more market optionality, especially to the Japan export market as well as the domestic market. Because of the complementary age class of Pope's assets, we are also able to increase our sustainable yield in the Northwest by 32%. And then lastly, there's a lot of synergies from a management standpoint, the land that Pope has a lot more gentle from a topography standpoint that translates into lower logging costs, and, therefore, more favorable harvest metrics. And again, it gets back to that idea of optionality. When you're in -- we want to be buying properties that help us both in good markets and bad markets. In bad markets, when you've got more ground that doesn't require expensive cable logging, it just gives you a lot more options going forward. We do expect this acquisition to be CAD accretive right out of the gate. There's fairly modest synergies of roughly $5 million. We expect the EBITDA over the next 5 years to average $38 million in CAD of $25 million. So with that, I'll pause the opening comments and open it up for questions.

Great. Great. Dave, you recently issued your 2020 harvest outlook. And I was wondering if you could kind of walk us through between your 3 regions kind of expectations around volume and then maybe sort of implied EBITDA per ton.

Yes. So after our fourth quarter earnings release, we released our guidance, and including in that was some slight increases in the harvest volumes. And it's important to note that those are really driven by acquisition activities and productivity improvements that we've made. If you add up the recent acquisitions that we've done in the U.S. South, that equates to roughly 200,000 tons of incremental sustainable harvest, and that's really the range. The low and the high end of the range bumped up accordingly in that. We kept the Northwest the same. Obviously, once we complete the Pope Resources acquisition midyear, that will increase. And then New Zealand also had a slight increase based on some recent acquisition activity that we completed down there. And generally, we like to target the sustained yield when we think about harvest levels, but we always have some flexibility to move that up or down. A good example right now with the current market situation with China is we're tapping on the brakes with New Zealand to not sort of put more volume into that market. So you have some flexibility. But we generally, certainly, from a guidance standpoint, try to think about that in that sustainable harvest level.

Right. And just kind of zooming in on China. Can you tell us what you're seeing there? And sort of how it impacts the New Zealand business, the Western business? And I guess maybe in the south?

Globally?

Yes.

So first of all, every year during the Lunar New Year, China more or less shuts down. A lot of people travel back to their home regions. And what happened this year is with the outbreak of the coronavirus, the Chinese government extended the duration of the Lunar New Year and there were travel restrictions put in place. And that kept people from going back to work. And so what we saw is ports were slower to open. Downstream mill customers have been slower to open. And so we've seen a pretty large build in the level of log inventory in the country. And so that's something that we will certainly take some time to adjust. We're fortunate in the country where we have the most exposure to that, New Zealand. We have a more diverse mix of export business. There are some people in New Zealand for whom China is their only export market. For us, it's about 2/3 of our volume, with the balance primarily going to Korea and India. And so we are working to divert supply really to those 2 other export markets as well as the New Zealand domestic market and will be, as I mentioned earlier, slowing down the rate of harvest to try to reduce volumes going into China. But we think it's going to take some time for that inventory to work itself down. It has been exacerbated by the volume of salvage wood coming from Europe associated with the spruce beetle epidemic. The European market share of log imports into China went from historically a number that was in the -- hovering in the 2% range. By the fourth quarter of last year, it was 26%. They had surpassed Russia as the #2 exporter into China. And so that's going to be an important element. The one bright point on that, I would point out, is that the European volume comes to China by container, whereas the New Zealand and Northwest volume comes in break bulk. And there is a limit to the ability to get containers unloaded. And so we're starting to see that, that container volume hitting a cap, if you will, on how much they can move. And so we're watching the European situation very carefully. We think it will have implications not only in China, but in other markets. We have not seen a lot of additional imports of lumber into the United States associated with this, but we would expect that, that certainly is a potential outcome over the next couple of quarters.

Great. Great. Any way that you'd quantify current inventories in China versus sort of a normalized level or what you've seen more recently?

I mean our data is still coming in. But the -- our current understanding is inventories are roughly 7 million cubic meters. And I would say that, generally, over the last number of years, we've seen that inventory level in the 4 million to 4.5 million cubic meters following the Lunar New Year. So it's definitely at an elevated level, and it's exacerbated by the fact that mills are being slow to open, and then so it will take longer, probably for that inventory to bleed off than we've seen in past years.

And then just moving to the U.S., I mean, a lot of the companies at the conference this week have talked about the strength in the U.S. housing market, the home building season. Lumber prices have risen 11 weeks in a row. Obviously, you don't produce lumber. But can you talk about the demand for your logs in the South and the Pacific Northwest from domestic?

Sure. So a couple of things to point out if you wind the clock back. There were a number of permanent mill closures in Canada in the middle part of last year. And I think much of the market anticipated that we'd see a faster reaction from a lumber pricing standpoint. But what you have to take into account is there was a lot of inventory, lumber inventory in the pipeline that had to work itself out. And that really didn't occur until late last year. And so we started seeing, I would say, more price elasticity on the log side late last year. We definitely saw it in the northwest. We're enjoying some nice increase in pricing in the Northwest both on the domestic side and in the Japan export side. And so that's a bright spot right now in terms of our markets, and it will be nice to have that additional Pope volume to participate in that. And then in the U.S. South, I think it very much depends on the neighborhood that you're in. There was -- if you go back to the financial crisis, we've added 1 billion tons of inventory in the U.S. South, but it's been very differentially distributed. Much more of that inventory in the interior parts of the U.S. South. And so those markets right now have very weak growth to drain ratios, whereas the markets -- the better quality markets are much more in balance. Over 60% of our southern assets are in the top 2 markets, in Northern Florida and Coastal Georgia. And that's a big difference when you think about it from a price elasticity standpoint. And so we're encouraged by how our footprint is. And certainly, the U.S. South has had a lot of new sawmill capacity added. I think that capacity is still ramping up. It's not yet to the level of stated increase. And so we're continuing to monitor that. But we've been encouraged on the margin by what we've seen in terms of demand in the U.S. South as well. And I think you're going to continue to see the U.S. South grow as a proportion of North American production.

And is the amount of new sawmill capacity that's come in versus maybe 2 years ago relative to your expectations? Is it sort of in line? Is it a little bit lighter than expected? Or if the projects taken longer to come online? Just...

I think it's the latter. And generally, you see that, if you talk to sawmillers, there is no such thing as a smooth transition when you build a new mill. It always seems to take longer to get up to that rated capacity, and I think we continue to see that in the market. But the capacity is there. It's operating. And once it gets up and running, it's a positive sign from addressing some of these builds and inventories across the South.

Great. And just kind of switching back to China. I mean we talked about coronavirus and what you're seeing from a Chinese demand perspective. But before that, we had the tariff issue. We have differential tariffs on the West Coast and in the South. Can you just walk us through what the tariff levels are, if they're part of the Phase 1 agreement, if there's any change in that, if you anticipate any change going forward, and how that could impact your business?

We're still in a learning phase as it relates to the tariffs. We had -- you're correct. There were differential tariffs between the west and the south. It had the effect in the south of more or less stopping log exports. We and others who are in coastal areas had been rapidly increasing exports to China, and with the 20% tariff that really put a stop to that. In the Northwest, the tariff hasn't been as high, but it's had a similar effect from the uncertainty of the expectation that, that tariff was going to go up. Now what we have seen is that the softwood logs have been included in the Phase 1 deal, but it's not clear yet how the tariffs will be treated. And I think for the short term, it's important to note that with the inventory in China, you probably won't see much in the way of increases into that market. But we -- we're encouraged longer term. If you fast-forward to the reduction of those inventories and if tariffs are either greatly reduced or eliminated, you should see a resumption of flows out of the U.S. South as well as the Pacific Northwest. Right now, the Pacific Northwest is really a Japan and domestic story, and it's being helped by U.S. housing. If we can add China to that, it will tension that market up considerably. And in the South, what we've been doing is we've been continuing to develop customers in China where we're more or less on par with domestic pricing with the expectation that with the tariff removals, those will be positive markets. And one of the things about Southern Yellow Pine that is attractive even in the U.S., it's a very good product in the treating market. And so we've been working on developing customers in China for that same end use. And so we're hopeful that as those tariffs come down and inventories come down, we'll have nice new markets there that we can kind of have for a longer period of time and keep our markets here well tensioned.

Great. And then you talked about sort of the differential log price trends in the U.S. South and stronger pricing on the Coasts and -- I guess, probably Atlantic Coast, Gulf Coast and then sort of weaker pricing in the interior. Like, rough orders of magnitude, can you give us an example of the price differential that you're seeing maybe over the last year or over the last couple of years where those log prices are trending?

I mean we tend to look at it on a net stumpage basis. So you strip out the effect of logging costs and haul. And then there's roughly a 2:1 differential between the best markets and the worst market. So if you go to that Coastal Georgia and Northern Florida, you're sort of in the $20 to $22 net stumpage. You go into some of those areas, Mississippi, at sort of the bottom end of the spectrum, you're roughly $10. And so that's a huge differential when you think about that from a timber standpoint. And it wasn't -- it hasn't always been that way. If you go back to the last housing cycle, it was a relatively flat relationship. And we think that with this build of inventory and the growth drain relationships in some of those weaker markets, then you're a longer way off to seeing price improvement, and we expect to see that differential stumpage curve steepen over time just because of that inventory imbalance.

And when you think about investing in Southern Timberlands, what is sort of the level of real return that either you or just sort of the industry expects from Southern Timberlands to generate? And when you think about the components of that return, whether it's HBU or price appreciation, how do you think the industry is thinking about it?

Yes. I mean it's -- generally, over the last number of -- first of all, people tend to value timber on a DCF basis. But it's done with a real DCF and with inflation being stripped out. And it's tended to be underwritten in the 4% to 5% real range. You might argue it's -- or excuse me, 5% to 6% real range. You might argue that in recent times we've seen that spread be more in the 4.5% to 5.5% range. It probably depends on who you're talking to. But we break out productivity improvement depending on the site that you're in. We look at the potential for higher better use land sales. In the end, I think one of the riskier elements to underwriting timber is how you think about pricing. And when you sort of break that into a -- there's a return-to-trend aspect and then there's more of a real price appreciation addressing macro features. And I think that's an area where you probably see the most divergent behavior. And in our mind, that's the area where we think about it from a risk standpoint. We're looking for properties that are already in stronger markets where the component of return in order to get to that 5% to 6% real is a small component when you look at the piece of it that's coming from real price appreciation. And I contrast that with a weaker market, where, by definition, you need a much higher component of real price appreciation in order to achieve that return. And so we think about that as -- in a risk sense. And that's one of the reasons that we have a bias towards going after higher-quality assets in the U.S. South.

And can you talk about price trends for industrial timberlands in the U.S. South? I mean South-wide log prices have not really recovered maybe as strongly as people expected. Have you seen it in transaction prices and volumes, like general trends that you've seen?

I think that you're seeing some -- I think you're seeing some differentiation from a quality standpoint. So recognize that in any 1 year you're going to have a mix of properties on the market from good geographies as well as properties that are well run, highly productive. And so we're seeing kind of a natural spread associated with that. I would argue, though, that it's -- we're probably not seeing enough of a spread on some of those lower quality markets, which in our mind translates to buyers are being more aggressive in their price recovery assumptions on some of those lower quality assets. But given that timber is valued on a DCF basis, you just never going to see the price of timberland move quite as much as either the price of logs or the price of lumber. It tends to be a lot more stable.

We have a question from the webcast here. In terms of potential new drivers of demand, whether it's all timber buildings, potentially replacing steel, can you talk about this and any other kind of new products, I guess, end markets that can drive demand for?

Yes, that's a good question. Historically, lumber has not really penetrated commercial markets. And with the advent of mass timber and probably the most popular, well-known product of that being cross-laminated timber where lumber is essentially glued into panels in alternating orientation and you in fact have a wall panel built with wood. And this is a process that started in Europe over 20 years ago, and it's become very popular there. It's just starting to come into North America. In the area that the industry had to focus on really was getting building codes in place for this product. And there was a lot of misinformation out there in the market about this. You think of wood, you think of fire. And what they found in the testing is that it stands up better to fire than steel because it's more predictable. Wood will char. The temperatures of the interior of these panels don't heat up like they do in steel, whereas in steel you tend to have catastrophic collapse at a certain point and it's harder to predict that. And so these cross-laminated timber designs have withstood both the fire tests as well as the structural tests. And so we're starting to see more building codes allowing it, and we're starting to see more of that construction, both being done and announced new capacity being put in place. Walmart recently announced a new headquarters building that's going to be built with the CLT product. And we're excited as an industry in the sense that it will allow us to get into this commercial market really for the first time, and it does have a very meaningful potential. And you think about one of the aspects in the building trades is labor shortage and labor productivity, and that's the other area where CLT really has a big advantage in that you have the ability to build these panels in a factory, deliver them to a site and erect them fairly quickly, and we've seen that in Europe as these technologies evolve. And then lastly, there's just tremendous benefits from an ESG, energy efficiency standpoint. You think about these -- this product is certain -- first of all, it's sustainable. You can continue growing trees. But also from an energy consumption standpoint, it's a fraction of the energy usage to produce steel or concrete. And so we're starting to see this catch on. And I would expect that 5 to 10 years from now, you're going to see it represent a much larger component of demand.

Great. And I guess, related question to that on ESG, I mean CLT and wood products have clear ESG benefits over cement and steel. In terms of the ESG benefits, potentially from just carbon sequestration from your timberlands, can you talk about that? Do you need a really robust carbon credit market? Do you -- have you seen that in New Zealand? Just thoughts on that.

Yes. So with the U.S. pulling out of the Paris accords, we're kind of in a pause in this country. And I think some of the early efforts in this country around carbon had more to do with getting carbon credits on properties that you would not be managing intensively from a forestry standpoint. And New Zealand, however, has an active carbon-trading scheme. And so the way it works is, as you plant trees, you're getting carbon credits. When you harvest those trees, you have to give up credits at the time of harvest, but you end up retaining a spread between those that you're able to monetize. And so we have on the books some carbon credits in New Zealand that are worth roughly $70 million that we have the ability to monetize at our disposal. There's an active market down there, primarily from emitters. And so it's been definitely a beneficial piece of the equation if you think about layers of value in New Zealand. I have to expect that at some point, you'll see something like that in the United States. I think we're a long way off from getting there. But I think the point remains that there is a good potential for it. You are, in effect, sequestering that carbon and the product that you're producing in the wood products and then you can continue to sequester carbon with successive rotations. And that science, I think, has been better established now, better understood, better accepted. And I think that momentum will be favorable going forward, but it's probably going to take some time in the U.S.

Great. Great. Maybe just one last question from me and maybe Mark could speak to it. But just can you talk broadly about capital allocation following the close of the Pope deal, sort of where you'll be from a leverage perspective, where you want to be, and then just sort of uses of cash going forward?

Yes, sure. As we announced at the time of the Pope acquisition announcement, they're about $300 million of cash uses that are going into the deal. And that's comprised of roughly $165 million of cash consideration to the LP and GP holders of Pope as well as about $100 million rollover of debt and transaction fees and expenses. And so if you kind of roll forward our 12/31 balance sheet, assuming the EBITDA contribution and the $300 million of incremental debt that we're taking on to do the deal, the leverage will be at roughly 4.5x net debt-to-EBITDA, which I'd say is generally at the higher end of where we like to target. And so we've indicated that we do expect to focus on some deleveraging in the near to medium term. And again, we have a lot of tools at our disposal to do that. We obviously have the ability to sell parcels of timberland to achieve that, and that's certainly something that we'll be focusing on in the next several quarters.

Great, great. Well, if there aren't any other questions, I think we're coming up on time. Dave, Mark, thank you.

Thanks.

Thanks.