Rayonier Inc. (RYN) Earnings Call Transcript & Summary

Good afternoon. This is Anthony Pettinari. I cover the timber REITs here at Citi, and we're very pleased to moderate this session with Dave Nunes, CEO; and Mark McHugh, CFO of Rayonier. We'll have plenty of time for Q&A. But first, I think we'll turn it over to Dave to discuss the company portfolio and maybe what differentiates Rayonier from other timber REITs. And then we can launch it into Q&A. And for those in the session, you can submit a question by typing into the Q&A window, and I can read that off later. So with that, Dave, I think we'll hand it over to you.

All right. Thanks, Anthony. And for those out there, I'm going to run through a half a dozen slides out of our investor deck, and that should leave us plenty of time for Q&A. So with that, let's get started. Just a quick view of Rayonier at a glance. We have 2.7 million acres in the U.S. South, Pacific Northwest and New Zealand. Since the spin-off of our Performance Fibers business, it is now considered -- called Rayonier Advanced Materials, we acquired $1.6 billion of timberland so we've been pretty busy over the last 6 years. We have a total of 400 employees. One of the things you see in the center of this slide, I think that is -- distinguishes us is we're the only company that discloses our sustainable harvest. This is the harvest that we can do into perpetuity. And that's a very important number, just from a stability standpoint, from a confidence around the level of dividend coverage, that sort of thing. And so that's something that we're very proud of to have led the sector. In the lower left, you kind of see the breakdown of our fiscal year 2019 adjusted EBITDA with a nice balance between our U.S. South, Pacific Northwest, New Zealand and Real Estate segments. We got started nearly 100 years ago in Western Washington. And the other thing I would say is that we are under 3 different sustainability certifications. In the U.S., we are sustainable under the SFI system and then in New Zealand, both the FSC and PEFC systems. And then lastly, I'd point out on this page. Our mission is really around having industry-leading returns. It's not about being the biggest, it's really about -- it's all about returns, and we're very focused on that as an organization. I'll touch on that a little bit later in these slides. This next slide looks at just the breakdown of our geographic footprint. You can see in the U.S. South there, we have 1.75 million acres. This is split with a section that's centered in the Atlantic Coastal region and Gulf. And then we have a Western section, Texas, Louisiana, Oklahoma and a little bit in Arkansas. Then we have 0.5 million acres in the Pacific Northwest, dominated really by our presence in the state of Washington. And then last year, we have 400,000 acres in New Zealand, and we're the only company in the space with a New Zealand exposure. We think that's very important to us from a -- not only a diversification of species, but also markets, and it's tremendously additive from a cash flow standpoint. And that really kind of plays into this next slide, which is really looking at the peer group over a 3-year period, 2017 to 2019. And this looks at the breakdown of the EBITDA for each of the peers between Timber segments and all other segments, be they Manufacturing or Real Estate. And you can see that 70% of our EBITDA during this 3-year period came out of our 3 Timber segments, and that's significantly higher than our peers. And that's really a statement of future volatility of cash flows. The wood products manufacturing is a very cyclical business and it's very volatile from a cash flow standpoint as we've seen this year. And for those investors who are serious about investing in timber, we have the largest exposure to that relative to the rest of our business. Some other aspects about our portfolio that are unique and help provide a little bit more color around the diversification. In the upper left there, this looks at our EBITDA per ton. A lot of historical perspective in this sector has been looking at EBITDA per acre. And what that misses is rate of harvest. There's definitely been periods of time where different companies within the sector have harvested at more or less elevated levels. And that can skew the EBITDA per acre considerably. And what this chart does is it strips out rate of harvest and equates it to an EBITDA per ton. And what this really is a statement of is the footprint, the quality of the market in that footprint. And you can see that the quality of our market is a step shift above that of our peers. And a lot of that really stems from the fact that we have 62% of our ownership in the top 2 markets in the U.S. South. And that's a real key point to make as it relates to the U.S. South. In the upper right, this looks at the real estate value per acre sold over the 2-year period, 2018 and 2019. And you can see with the peers, they're all clustered around values that approximate U.S. South values. And you can see that our realizations are substantially higher than that. And a lot of that gets back to very intentional strategy on our part to focus our real estate efforts on extracting premiums as opposed to just churning timberland at timberland value to perhaps provide cash flow for dividend coverage or other reasons. We really focus our real estate strategy on generating premiums. On the lower left, you can see the activities that we've been doing, particularly, in the active portfolio management context where, as I said earlier, we acquired $1.6 billion of timber. We've also sold a lot of timber. And I'd say we've generally been gradually improving our portfolio over that time frame by trimming some of the lower quality lands and adding some higher quality lands. What that's allowed us to do is bring our sustainable yield from roughly 9 million tons to 11 million tons, looking back over the last 5-year period versus the next 5-year period. And then finally, on the lower right, we have a real unique exposure to the China export market. China is a huge market. It's the biggest market for wood products globally, and we're uniquely positioned to benefit from that. Our New Zealand segment has roughly 35% of its volume flowing into that market. We have roughly half of that or about 15% from the Northwest. And then we have a small but material in a subregional sense in the U.S. South to give our total exposure to right around 15%. And so we think that this is really important. And we kind of think of ourselves as somewhat expert in that market, given that we are selling on a delivered basis with our New Zealand employees. Rayonier's strategic priorities. These were done back when I joined the company along with Mark. And while they were established in 2014 after the spin-off, I'd say they are still as applicable as they are -- or today as they were back in 2014. And this really speaks to the long-term nature of our business. Frankly, these strategic priorities should not change that much. And we continue to operate against them and to gradually improve. And there's really 5 key pieces. The first is managing for long-term value. We really have a focus on that. Our measurement systems are skewed to long-term metrics. All the discussions that we have and the actions that we take are really keyed around that. We have -- the second is to acquire high-quality timberlands. We have a very strong bias towards higher-quality lands. We believe when you put a seedling in the ground, you really don't know what the market conditions are going to be like when that tree reaches harvest age, and so you want to have as much optionality as you can. And generally, higher quality lands, higher quality markets are going to give you a lot on quality there. The next is to optimize our portfolio. As I touched on earlier, as a pure-play timber REIT, we feel we have a lot of levers to both add and subtract timber from our portfolio. And we feel like this is an important area where we generate alpha on behalf of our shareholders. And then the last two focus on quality of earnings. This is something that I think is really important. As I touched on earlier, you can generate a lot of earnings by harvesting at an excessive rate. We really focus on harvesting at a sustainable rate. And then we also, as I mentioned earlier, have deemphasized the sale of nonstrategic timberlands is a way to augment cash flow. And then lastly, we have a focus on best-in-class stewardship and disclosure. We're really excited about rolling out some more disclosure on the ESG front. This is something we've been working on this year, particularly around carbon sequestration. And we really have established Rayonier as the industry leader from a transparent disclosure standpoint, and we work -- we're going to be working to continue to push that to new levels. The last slide I wanted to cover is the recent merger that we did with Pope Resources. This is something we're very excited about. We worked on it for a long time. We got it done in the midst of the COVID pandemic, and we're very happy with how it's gone. We're happy with how the fit is as well. I mean it's a great fit. It adds 124,000 acres of fee ownership in the Northwest, increases our sustainable yield by 57 million board feet and it really does a number of things from a portfolio standpoint. First of all, in the Northwest, there's 2 primary species, Douglas fir and Hemlock. Rayonier had a portfolio of about 60% Douglas fir whereas Pope Resources was 83%. And so it allowed our Douglas fir inventory to increase from 60% to 68%. It also improved dramatically the proportion of our ground-based logging, where we had -- where we are increasing the gentle topography associated with much of Pope's lands, and that's going to bring down logging costs across our ownership and really help from a cash flow generating standpoint. And then lastly, we think it's going to improve our geographic log market diversification as well as supplier power. We are supplying a lot of similar customers to Pope Resources, and so it increases the scale of doing that. And then on a more ancillary level, we're adding about 17,000 acres from a look-through standpoint from Pope's private equity fund business. And then we have a nice add on Pope's higher and better use real estate portfolio. So we're excited about that. We're excited about the team from Pope that has come over to Rayonier. Roughly a little over 70% of the employees at Pope are now employees of Rayonier, and we've mixed and matched people, both geographically and functionally, and we think we have really retained the best talent and put them in areas where we think they can excel. We touched on this earlier in the year when we rolled out the deal, but there's a lot of financial benefits to this transaction. There's a nice amount of synergies from -- of $5 million from the reduction of redundant public company costs. This is a transaction that's going to improve our cash flow per acre as well as per ton based on the attributes I described earlier on the portfolio. We expected to add roughly $38 million of adjusted EBITDA over a 5-year average period going forward, and it's going to be immediately accretive from a CAD standpoint. And while our leverage has increased modestly following this transaction, we expect to work that down over time. And then the last point I'd make on this is that the UPREIT structure that was used, we're very excited about. This is something we've talked about internally for a long period of time. This is a structure, a unique structure within the timber REIT space. It's been used within the broader REIT sector. But we think that this structure is very well suited to a number of family ownerships of timber in the U.S. We've already had discussions with a few families who are interested in this potential vehicle. And we see it as a way where we can leverage our equity and grow the quality of our portfolio over time. So with that, I've concluded just the prepared slides, and I'd like to open it up now to questions. And we'll have Anthony kind of shepherd those for us as we move forward.

Great. Great. That's a great overview. And maybe it would be helpful to start off to kind of walk through in a little more detail what you're currently seeing in the 3 key markets that you talked about. I guess, with regards to price and volume and just underlying demand for sawlogs and pulpwood. We got some very strong housing data this morning. So maybe, I don't know if you want to start in the South.

Sure. We can just kind of go around the horn. Yes. In the South, keep in mind that we have a heavy mix of pulpwood in the South, roughly 60% of our total mix goes into that. The balance of that sawlog demand is dominated really by the flow-through effects of lumber. And so if you think -- if you break those two apart, first of all, on the pulpwood side, of that pulpwood mix, roughly 2/3 of it goes into linerboard applications. And so that's a very strong business right now. The U.S. South is globally very competitive. And so when you think about things like the growth in organizations like Amazon with at-home shopping, that's a nice underpinning of some of that linerboard demand. And then on the lumber side, as you touched on, we've got -- we've had very strong, both repair and remodel as well as new home start data. And some of this is driven by the macro environment, the stimulus that has been applied in the face of COVID, and that's driven interest rates down. It has really helped the housing recovery considerably. And then with more people being at home, we've seen that translate into stronger demand for lumber. And so from our standpoint, where this really becomes key is what regions -- how does that flow through in terms of log prices? And in the U.S. South, much has been discussed about the growth in inventory in the U.S. South. And following the global financial crisis, the U.S. South saw roughly a 1/3 increase in the inventory of standing timber, but that inventory was widely or was unevenly dispersed. And so we have some sectors of the U.S. South that have disproportionately grown their timber inventory. And that's something that we look at very carefully when we look at our portfolio. The top quartile portfolio -- or the top quartile market in the South is one that is balanced. It has a growth to drain relationship. That's 1.0. And we have over 60% of our portfolio in that top quartile market. That's one of the reasons that we've seen more price elasticity flowing through to our log values. And then augmenting that has been the resurgence of the China log export business in the U.S. South. And we're very fortunate to have a lot of our ownership tributary to Savannah, which is a very large port as it relates to log export activity going to China. So that's a real quick thumbnail in the U.S. South. The Pacific Northwest is very different. First of all, you have different species, but you also have a very different mix of sawlogs and pulpwood. And so you have roughly an 80/20 mix of sawlogs to pulpwood. And so in the Northwest, it's much more heavily levered to lumber and domestic housing as well as repair and remodel. And then it, too, like the south is augmented by log export market optionality, which provides additional tension into those markets. And so that's the reason if you look at our -- prices quarter-over-quarter... [Technical Difficulty]

Dave, I think you're breaking up a little bit.

Yes. I saw it went dark on me. Is that coming out okay now?

Yes. Yes, definitely.

All right. Yes. So part of the increase in the Northwest was really a function of the higher amount of Douglas fir we had available as well as some of the lower logging costs that I touched on earlier. But we're very happy with that improvement in performance and that higher price elasticity we had out of the Northwest. And I think it just sort of shows the power as well of adding the Pope Resources portfolio. And then finally, the New Zealand portfolio. New Zealand is heavily levered towards the China market. Roughly half of the output in New Zealand goes between the domestic market, which is very strong and the export market. And then within the export market, about 2/3 of that goes to China. New Zealand's primary species, radiata pine, fits the China market very well and has a couple of very kind of unique aspects of how it competes in China. One is with plywood and then the other is furniture components. And those two markets, radiata pine competes very well. We've seen -- as the COVID restrictions have played through, we've seen inventory levels come down considerably in China. And so we think we're really well positioned in that market right now.

Great. Great. And Dave, from a holistic perspective, can you talk about your harvest expectations pre-COVID? Or maybe how you thought about the year at the beginning of the year? And then how that kind of evolved into March, April, early months of the pandemic? And you obviously just reported 3Q results, sort of where we stand right now kind of going into the end of the year? And maybe any early thoughts on '21?

Sure. I mean I think generally speaking, we like to target our sustainable harvest. So I think that 11 million ton number, and that's a post Pope Resources transaction. That's what you should expect on a typical going forward sense. But going back to the beginning of 2020, I think our expectations going into the year were certainly impacted as COVID came about. We thought there would be a much deeper reduction in harvest activity. We didn't feel that our dividend was at risk, but we definitely expected to see disruptions on the -- in our customer level. And I think what we found in reality was that was quite differential. And if you kind of step through portions of the portfolio, early in the year at the beginning of the COVID, we saw all the shortages of things like tissue. And so we saw a strong demand initially in the year for pulpwood heavy volume. And then as we saw lumber prices start to take off with repair and remodel and then later housing, we saw our sawmill customers ramp up production. I would say that they still have had supply issues in terms of bringing wood into that market. And I don't think we're back to that kind of normalized run rate. In the Northwest, I think we saw a much more substantial increase in terms of production out of our customer base. And New Zealand is probably where we have the biggest reductions because the New Zealand government chose to shut down the entire country, including the forests for about a month. And from a practical standpoint, it was about 6 weeks of lost production. Subsequent to that, we've made up a portion of that New Zealand volume. So I think when you look at the year in total, we'll probably be slightly under our expectations in terms of volume, but I think we'll be at/or above our expectations from a financial performance standpoint. So that just speaks to the improved pricing environment. And then I think next year, we would expect to see a slight increase in volume just in the sense that we'll be making up for that lost volume out of New Zealand this year. But we're very encouraged about how we're positioned for this subsequent year from both a volume and pricing standpoint.