Rayonier Inc. (RYN) Earnings Call Transcript & Summary

Good afternoon, and welcome to the 3:30 session at Citi's 2022 Global Property CEO Conference. I'm Anthony Pettinari with Citi Research, and we're very pleased to have with us Dave Nunes, CEO of Rayonier, as well as Mark McHugh, CFO. This session is for Citi clients only. If media or other individuals are on the line, please disconnect now. Disclosures are available on the webcast and at the AV desk and for those joining us in-person, to ask management any questions, please use one of the mics or if you're joining us remotely, simply type in your question to the portal, and it will come to me, and I'll do my best to ask it during the session. Dave, we'll turn it over to you to introduce Rayonier, and then move to Q&A.

Sure. Sounds good. And just for folks, we have posted a deck out on our website investor presentation. And so I'll just touch on a few introductory comments that are from that. Rayonier today is the largest pure-play timber REIT, 2.7 million acres in the U.S. and New Zealand. Since the spin-off of the Performance Fibers business in 2014, we've acquired 1.9 billion acres -- or excuse me, $1 billion of timberlands. We have a sustainable yield of 11 million tons per year. All our lands are certified. We have 3 primary geographies. The Northwest, United States, 0.5 million acres, New Zealand, about 400,000 acres, and then the bulk of 1.8 million acres in the U.S. South. We like to talk about being a pure-play timber REIT. This is really around not having manufacturing assets as our peers do. So when you look at our EBITDA over the last 3 years, 73% of that is timber and that really ties to, I think, what a lot of our investors are looking for, which is exposure to timber. Conversely, our peer group has flipped the other way around where 73% is more on the Wood Products manufacturing side. Some -- just some quick highlights on our portfolio, things that set us apart. We have sector-leading EBITDA per ton in the U.S. South, and that's really a function of where our footprint is. We also have a similarly sector-leading higher and better use land realizations, again, based on that footprint. As we've been growing the portfolio and making improvements, we've seen our sustainable yield increased from about 10 million tonnes to 11 million tonnes. And then the last point I'd make is that we have a unique exposure to China, really from all 3 of our geographies, but most heavily from New Zealand. And so with that, I'll turn it back to you, Anthony. We can kind of dive into some of these things in more detail.

Great. Thank you. Maybe starting off with the South. Can you talk about kind of market conditions for Southern logs right now and maybe kind of the key drivers of your guidance for '22?

Sure. I mean a lot of people talk about the U.S. South as one homogenous geography, but you have to keep in mind, it's really a series of micro markets. And so we pay a lot of attention to that. We take each of the TimberMart-South geographies, we break them down into wood basins, and we really look carefully at the supply demand dynamic and the growth drain relationship in those markets. And so for us, we saw a very nice improvement in pricing elasticity this last year where we saw a 15% overall stumpage improvements year-over-year in the U.S. South. And a lot of that is a function of where that footprint is. A lot of our Atlantic seaboard markets that are the most heavily tensioned, saw some really impressive pricing gains. This was both a function of the underlying sawmill demand, some weather disruptions, but also the growing presence of our export program which has added additional tension into that market. And so we're pretty bullish on kind of those overall dynamics that we see in the U.S. South based in part on those various metrics that we track relative to where our footprint is.

Great. And Southern sawlog prices have been flattish or may be depressed for over a decade, and it seems like in the last couple of years and especially last year, we really started to see some tension. The factors that you mentioned, I think putting aside weather, those seem like things that are durable. Can you just talk about the prospect for sustained price improvement or price recovery in Southern sawlogs?

Yes. And again, we think about it for Southern -- our Southern footprint as opposed to the South in general because I think there's portions of the South that aren't going to see meaningful price change for a long time because there's so much inventory build. But in terms of where we're located, keep in mind that a lot of the capacity additions that have come in place are still in the process of ramping up. And so we see that as providing additional underlying demand. Our export program that I touched on is also going to be adding more pressure to those markets. And so that's really behind some of the guidance that we -- that we provided where we had a much stronger 2021, and we expect a stronger 2022 on top of that just based on some of those underlying metrics in the South.

Great. And can you just talk a little bit more about the export dynamics in the South, which have, I guess, historically it's been a domestic market, but there's obviously a growing export exposure.

Sure. We have leveraged our -- in our New Zealand segment, we sell directly into markets in China, Korea, South Korea, India and some minor markets. And so we have a lot of expertise in those markets. And a few years back, we started leveraging that expertise by looking for homes for Southern wood. One of the big markets in the U.S. domestic market right now is treated wood. And so we've been exploring treated markets in China, for example, as something that could have a unique demand posture. China has put in place pine nematode import restrictions that have recently limited market access to a smaller subset of ports than has traditionally been available. We have not shut off our exports to China, but we have limited it to the ports that are taking wood. And we're trying to take a very long-term approach on that. And we still feel like there's going to be a lot of positive out of that. Another market that we're increasingly exploring is India, particularly as it relates to various kind of fumigation rules that are in place in different ports. And so we, again, take more of a view that, that export program is designed to put more tension into that local log market, which I think it has done. And we've lived that in the Northwest. I mean, that's been a fact of life in the Northwest for a few decades now. And so we're trying to take some of those learnings and apply it out to the South.

Great. Maybe last question on the South. You talked about the kind of pricing and inventory supply demand differences between your more coastal Southern land and maybe some inland timberlands. Is there a way roughly you could quantify like the pricing difference and the inventory difference between some of your lands or the micro markets that you're operating in versus maybe something that's more inland or kind of to the East?

Yes. So we look at each of the TimberMart-South regions. We look at the growth-drain relationship on those. I think at the end of the spectrums on the very most tensioned markets. You've got a growth-drain relationship that's in the 1.0 range in the very poorest markets. It's probably approaching 2.5. And so -- and we're fortunately not in any of those markets. We have -- none of our markets are in that bottom quartile market where you see that the most. And so we tend to focus on that attribute. I will say, one of our acquisitions this last year was in Texas. And one of the reasons that we like that market is it's got access to very strong downstream markets and it's still a market that has been adding a lot of capacity. And so we're pretty excited about that. And so it's, again, just trying to find those opportunities where we can further some of the gains that we've made.

Great. Maybe pivoting to the Pacific Northwest, can you talk about sort of activity levels and demand for your domestic customers and your export customers?

Sure. The U.S. Northwest has always been more levered to the domestic housing market and because a larger proportion of the wood goes into lumber products. And so you see more of a strong correlation there. The export market is the other primary market, and you have differential by species between Douglas fir and whitewoods, which for us is primarily western hemlock. One of the things that we put in place this last year was we acquired a small export operation in Port Angeles, which is equidisent between our legacy Rayonier lands on the coast and the Pope Resources lands. And we think that's going to help us extract value out of both of those portfolios again on the margin. And so we're excited about that. I think the Northwest has been relatively more imbalanced than the South. And so we haven't seen the same kind of inventory issues. I think the Northwest has been operating at a pretty nice operating level, and we've seen pretty strong price elasticity with the price of lumber. We've certainly seen that translate very quickly into log pricing and you kind of see that in the results.

And you talked about the Pope acquisition. I mean it's obviously probably very well integrated at this point. But can you talk a little bit about what that sort of brought to your portfolio, both in the Pacific Northwest and just as a company?

Yes. We're excited about it. And certainly, having spent 17 years there myself before I came to Rayonier, very familiar with those assets. And they offer a number of things. First and foremost is a much higher proportion of Douglas fir. And so the legacy Rayonier lands were sort of more at a 60% Douglas fir mix, Pope was more in the low 80s. And so it brought the blended Douglas fir mix to 68%. Douglas fir generally is higher value, more optionality in downstream markets. The second point is much gentle or terrain. Terrain really translates into logging cost. And so if you have -- if you've got more cable logging ground, you're going to have much higher logging cost. And then it also translates into a better proximity to markets, which translates into the haul rates. And so we've seen our OBT, onboard transportation rates in the Northwest come down meaningfully since the Pope acquisition, which is really a function kind of the blend of the footprint across the Northwest. So we're pretty happy with that. And then I'd say, lastly, there are a number of customers that we supply -- that we have supplied historically from Rayonier that Pope also supplied. And so it gives us a little stronger pricing power against those relationships and then just a little bit added scale operationally. So -- and I think it's delivered as we thought it would and more when you think about the way pricing has improved, particularly in the last year.

Great. And maybe just rounding out the regions. Can you talk about New Zealand? You have sort of a unique exposure there for public timber REIT, the market dynamics there in the world of China?

Yes. So New Zealand, one of the things we like about New Zealand is it's historically not been correlated with our U.S. markets. And so we like that from a portfolio construction standpoint, China is by far the biggest global market in wood and New Zealand is very well positioned for that market. And so that's one of the things that we've always enjoyed. Having said that, it's a lot more -- there's a lot more volatility, and you have to deal with the fact that you've got ocean freight issues. This last year was a good example. We saw 29% rise in delivered prices, but we saw shipping rates double and so you have to kind of deal with that. We had very large inventories in China as we ended last year, went through the Chinese New Year that has translated into a softer beginning for 2022 in New Zealand, but kind of, again, putting our long-term hats on. China needs wood and there's a declining sort of availability of that from lots of historic sources. And we think we're really well situated in New Zealand, which has the largest market share into that market.

And then just broadly, can you talk about maybe the potential impact direct or indirect of the situation in Russia and Ukraine. Russia is a large wood products producer. How does that wood sort of flow and to the extent that it's disrupted, what would you expect to see?

Sure. The -- I think the primary thing we see is more of a secondary effect of European lumber that had been flowing into the Eastern seaboard of the United States will probably stay in Europe to offset declining Western Russian lumber imports into Europe. And that's -- in the last few years, that's been the equivalent of one very large scale sawmill in the East. And so as a result of that, we see probably more prolonged strength in lumber pricing in the South. And then certainly, that trickling down into timber pricing as well. It's a little more nuanced in the Pacific Rim, where Russia is the dominant supplier into China of lumber. Starting this year, they instituted a ban on log exports into China. If that holds, I think you'll just continue to see more of the same where Russia will continue to be the dominant lumber supplier. And then it really is a function of kind of other flows coming into that China market. I could see -- or we could see a scenario where a lot less European lumber is flowing into China than has been the case again to offset some of that Russian supply. But we'll -- it's -- that's probably more of a second or third order effect for us.

Into China, European salvage wood has been kind of a factor over the last couple of years. Sort of where are we in that?

So we're on the decline in terms of the availability of that wood. We said all along when this got started, the spruce volume coming out of Europe had a much shorter shelf life. For those that have followed the mountain pine beetle issue in Western Canada, that took a good decade for that wood to kind of move through the system. The European volume, it's going to be more in a 3-year type timeframe, and we're toward the end of that right now. So we're beginning to see some declines in the rate of harvest. And then following along with that declining volumes flowing in, both on log form and lumber form. And so we expect to see that European influence in the China market start to tail off just naturally, irrespective of whatever happens with the relationship with Russia.

Right. And you referenced before, lumber prices are stratospheric. They were all-time records last year. They're kind of back pretty close to that this year. You obviously don't produce lumber, but they're some of your biggest customers. Has it accelerated the pace of capacity growth in the Southeast? Is that something that benefits you? Or does supply chain constraints in the pandemic, has it slowed lumber capacity additions. Can you just talk about sort of the pace of lumber capacity adds in the Southeast, maybe relative to what you would have expected?

Sure. I mean keep in mind that lumber capacity additions are challenged by a few things. One, there's very few producers of lumber manufacturing equipment. And so there's a big backlog. You couldn't just announce a greenfield mill and expect it to be open probably for 3 years. And so you've got a backlog on the equipment side, first and foremost. And then once that mill is up and running, it usually takes a solid year plus before you begin to see that mill functioning at the rate that it was designed for. That's been exacerbated by labor issues in COVID. And so we've seen -- while we've seen a lot of nameplate announced capacity additions. We are nowhere near getting those fully ramped up into production. And so I think that we're going to continue to see a lot of that capacity just moving down that pathway of getting up to the original capacity announcements. Now going forward on the margin, certainly, elevated lumber will probably have some influence on decision-making there. But I think we're much more focused on just getting those existing facilities have been announced, getting those up and running and seeing the influence on markets.

Got it. And then a question from an investor. In terms of supply chain constraints, labor availability and $100 oil, can you just talk about how you pass through these costs or your kind of approach to these headwinds in '22?

Sure. And keep in mind, when we report our results, we're often reporting on a stumpage basis. So it's netting out the delivered cost, which certainly are going to be influenced by rising oil prices. Oil prices affect, not only trucking, but the logging rates pretty meaningfully. And to me, it gets back to the kind of the underlying dynamic of our footprint. If you have a market that is a wash and wood, that's sitting at a growth-drain relationship of 2 to 2.0 then you have very little ability to pass those costs on. Conversely, in the markets that are fully balanced. They're pretty elastic. And so we feel like all of those costs are getting pushed on downstream. And so that's one of the reasons that you see kind of that pricing performance that we've had. And I think going forward, we're certainly very mindful of the influences on rising fuel costs and impacting our costs. We also have -- still continue to have shortage of truckers, which has an influence. But again, I think it gets back to those, being in those better markets, we feel like we'll have more of an opportunity to pass those costs on.

Great. Great. And then maybe just taking a step back, I wonder if you could talk a little bit about the market for timberlands and presumably, the pandemic stopped a lot of transaction volumes, maybe those are picking back up. But in terms of sort of dollar per acre values for good quality Southern and Pacific Northwest timberlands. Can you talk about any kind of level of appreciation versus pre-pandemic? And then sort of what level of maybe real returns you're typically targeting in acquisitions?

Sure. I mean, first of all, there's a bit to unpack there. I would say that with COVID, you saw a decline in timberland offerings. You had a lot of players that simply couldn't bring product or bring timberlands to market. And a lot of that is tied to the inability to travel to do due diligence. You still need to do a fair bit of on-the-ground due diligence. As we've seen travel restrictions ease, we have started to see a pickup in offerings of timberland. And so that is out there, as we speak. And so it's a very busy market right now. In terms of how this has affected sort of values and the dynamic of those transactions, I think you're seeing with more talk of inflation, you're seeing timber drawing -- the timber asset class drawing more investors who are looking for an inflation hedge. I think with kind of the global geopolitical environment, you're seeing a flight to quality coming into the U.S. market. Those things are all contributing to more capital flow inflows. Certainly, as well, just the general optionality of carbon opportunities is contributing to more capital. So I think we're seeing compressed discount rates on a number of transactions that are -- that we're looking at and you're ultimately seeing that translate on an average sense into higher pricing pretty much across the market. I mean, you are now in the West, it used to be $4,000 an acre was considered a pretty strong price. And now it's not uncommon to see $5,000 or $6,000. pricing. In the U.S. South, it used to be a level of $2,500 was considered rich. Now you're seeing the occasional properties that are in excess of $3,000. And so you're seeing some of that. We've certainly seen that in New Zealand. We published because New Zealand is on the IFRS mark-to-market accounting system, we have to appraise those lands each year. And so we release those values. We've seen a steady uptick in valuation there. And that's really driven by some of those same features, more capital trying to get into those markets. New Zealand has a regulated carbon emissions trading scheme that I think has drawn some of that capital. So we've seen -- that's been a contributing factor to some of the value lift that we've seen out of New Zealand.

And in terms of your own acquisition criteria, what are the kind of hurdle rates that you're looking at? And are there -- you're primarily looking at sort of adjacencies with existing lands or maybe new areas or -- any broad thoughts there?

I think generally speaking, we have a strong preference for bolt-on transactions that are complementary from an age-class standpoint. Timber harvest -- sustainable harvest levels are done with an optimized LP. And so if you can find acquisitions that complement your existing age-class structure, you'll be able to add some synergy value from a harvest schedule standpoint. So that's probably one of the strongest dynamics that we look for. We also generally want to be in stronger markets. When you put a seedling in the ground, you really don't have a sense of what those downstream markets are going to look like 20, 40 years from now. What you do have some sense of is what your range of optionality is. And so all things being equal, we want to be in diverse log markets. We think those will continue to be strong. And so we have a bias towards higher quality markets. And then I think lastly, we try to look for negotiated transactions where we can. We think that from a return standpoint, we tend to do better on smaller transactions than on larger ones. Just it attracts less competition, and so we're sort of happy hitting singles a lot on the M&A side. And keep in mind, we're active pretty much all the time in all 3 markets, but you have a lot of at bats that don't translate into completed transactions.

And is there a real or nominal return or yield that you've historically targeted or been able to kind of get?

We tend to look at that geography by geography. So for our very best geographies, we're going to have lower target returns than we would for lower-quality geographies. And so that's how we tend to look at it.

Got it. Can you talk a little bit about ESG and maybe starting off with New Zealand. I mean, New Zealand has a real compliance-based carbon market. Can you talk about your position with credits and pathway to monetization and just your position there?

Yes. New Zealand has had a regulated carbon market for a number of years. One of the big challenges with timber and as it relates to carbon is defining the additionality delineation in New Zealand. They defined that as forests that were in place in 1990. So forests that were in place prior to 1990, which is the bulk of our forest, got treated one way forests that were put in place after 1990 got treated a different way. So for the pre-1990 forests, you had a set number of carbon credits that you could issue -- or excuse me, that you could monetize. And then for the post-1990, as you establish a crop, you get new credits, you have to give back credits when you harvest that block and you end up getting to retain a small increment that you can monetize over time. We have tried to be opportunistic on the monetization of those carbon credits in New Zealand. A good case was last year. we saw a rising environment for carbon auctions, and so we held off selling any carbon credits last year. We saw the price of those carbon units double between 2020 and where they are entering 2022. So we've kind of dipped our toes back into that market and selling some of those. In the U.S., it's a different story. We have -- we do not have a regulated carbon market. We're not sure we ever will. So you're dealing with a series of voluntary carbon markets that are trying to become established. We're taking an approach of understanding all the carbon registries and all the carbon programs, try to figure out what makes sense for us. I think one of the things that we have some concern about is there's not a lot of transparency around these programs right now, and we want to make sure that whatever we put our name to has credibility in the market and so we're taking our time and sort of understanding those options and seeing what they look like. But eventually, we feel that there will have to be some solution. There's too much demand out there for net zero commitments for there not to be some very strong market for carbon offsets in the U.S. The pricing today isn't anywhere near where it would need to be to affect behavior and cause change in the way lands are managed. And so we're continuing to work kind of behind the scenes to understand these and figure out how to position our company going forward.

And I think you touched on this earlier, but maybe to confirm, do you think that the promise of carbon has sort of crept its way into cap rates for transactions that you're seeing? And are you seeing acquirers and timberlands who are just almost wholly motivated by kind of the carbon potential long term?

I don't think we're seeing it quite that simply. I think in New Zealand, you've seen that where you've had bifurcated offers of land only. But in the U.S., I think it's -- I would characterize it more as people are seeing increments of additionality that contribute to their approach on discount rate in a valuation sense because we're still -- we still have ways to go before foreseeing that established in the U.S. And also keep in mind that the carbon prices are pretty low in the U.S. So you don't have enough strength in those prices to really give somebody the conviction to buy it just for that purpose.

Great. Can you talk about your real estate business and which has been very strong for the last couple of years and sort of the activities that are involved there?

Sure. I mean we have a progressive approach to real estate. We generally view that we can sell 1.5% to 2% of our lands in the U.S. South into higher and better use sales at a material premium to timberland values. And much of that takes the form of rural HBU sales where there's no capital involved. And then kind of moving up the food chain. We have other offerings where we put a minor amount of capital into subdividing a land, maybe putting an entrance in there and leveraging that capital into higher values, moving further up. For properties that we think have a longer-term real estate development density market, we'll look at it 2 ways. If we think it's a property that could be readily salable following entitlements, we'll invest in those entitlements and then sell that as an unimproved development sale. And then a smaller subset of that, where it's almost too big of a landholding to sell as a bulk sale. We will catalyze that demand by putting money into the construction of finished lots. And we've done that in 2 projects in the South, 1 North of Jacksonville, 1 South of Savannah, Georgia. I think with COVID, we've seen an acceleration in demand for both of those projects. And we're now well ahead of our original underwriting from a timing of the absorption from those as well as pricing. And so we're pretty happy with the contributions that those have made and feel that we've got a nice runway going forward in terms of looking at the next increments of supply from each of those 2 projects. And then the last thing I'd say is, as part of the Pope transaction, we inherited a nice portfolio in the Northwest as well. in the West Puget Sound area. And so that's been a nice kind of add-on to that portfolio.

And maybe kind of wrapping up, can you talk about balance sheet, optimal leverage capital return and then just your ability to -- or desire to acquire further timberlands?

Sure. If you go back to mid-2020 after we closed the Pope Resources transaction, our balance sheet was pretty tapped out. And relative to our comfort level, we were at about 4.9x net debt to trailing full year EBITDA. And so we set about trying to create some room for growth. And so we did that in a number of ways. We had -- following that transaction, we identified a couple of large dispositions out of our legacy Washington Holdings that the Pope transaction allowed us to sell. That gave us some capacity for balance sheet growth. We also identified the exit of the private equity timber fund business as a way of also providing a little more capacity. We started an at-the-market equity issuance program in the third quarter of 2020, a program that was $300 million at announcement. We made good progress on that over the last year and that had an effect. And then lastly, we really worked hard at restructuring almost every tranche of debt that we had and this included the issuance of a $450 million bond with a 2.75% coupon rate. And all said, the debt restructuring extended our debt maturity from 4 and changed over 7 years and then it brought down our average cost of debt from 3.1% to 2.7%. So we think that set us up really well going forward. And then it also brought that debt leverage metric from that 4.9 to 3.1 at the end of 2021. And we tend to want to operate sort of in that 4.25 to 4.5 range. And so we feel like depending on the transaction and the cash flow associated with that gives us in the ballpark of a $500 million of dry powder.

Great. Great. Dave, thank you so much. I just want to ask one last question. If you had to put an incremental dollar of capital between the South Pacific Northwest and New Zealand, not asking you like to name your favorite child, but like which of those 3 regions do you think is maybe most exciting?

I mean we're looking at all those all the time. So there's more deal flow in the South. So we probably have more options. That's probably where it would end up going.

Right. Great. Thank you, Dave. Thank you, Mark.