Rayonier Inc. (RYN) Earnings Call Transcript & Summary

Good morning. I'm Anthony Pettinari. I cover the timber REITs at Citi, and we're very pleased to welcome Mark McHugh, CFO of Rayonier. And he's joined by Collin Mings, VP of Capital Markets and Strategy. I think Mark is going to give an introduction to the company, and then we'll move right into Q&A. And I would just encourage those in the room. You can ask questions on the mic or just raise your hand, and we'll do that. So Mark?

Yes. Thanks, Anthony, for the introduction, and thanks, everybody, for joining us today. I'm just going to walk through a handful of slides, and then we'll leave plenty of time for Q&A. I'm going to be referencing the slide deck that's posted to our website under the NAREIT conference presentation. Briefly on Slide 2, Rayonier At A Glance, Rayonier is the second largest of the 3 timber REITs. We own or lease approximately 2.8 million acres across the U.S. South, U.S. Pacific Northwest and New Zealand. That acreage generates a sustainable yield of roughly 11 million tons annually. We define sustainable yield is essentially the volume of timber that we can harvest into perpetuity. It's really the concept of harvesting growth, and we believe it's a very important part of our investor disclosure, which I'll touch on more later. We've worked hard to grow our timberland footprint over the years since 2014 when we spun off our Performance Fibers manufacturing business. We've acquired roughly $2.3 billion worth of timberlands. That includes the Pope Resources merger in 2020. In addition to our core timber business, we also operate a value-added real estate platform. Essentially, when you own millions of acres of land like we do, invariably some portion of that land is going to be more valuable to somebody else than it is to us as timberland. And so we're typically selling 1% to 2% of our Southern land base into that HBU market annually, generally at premiums ranging from 50% to 100% above timberland value. The pie chart on the bottom left there provides a breakdown of our 2022 adjusted EBITDA. Last year, about 80% of our EBITDA came from our 3 core timber segments, with the balance coming from our Real Estate segment, and that's pretty typical. Generally, that real estate segment will contribute 20% to 30% of our overall adjusted EBITDA. Essentially, all of our timberlands are third-party certified for sustainability, that's SFI in the United States and FSC and PEFC in New Zealand. In terms of our mission, it's pretty straightforward. We want to provide industry-leading financial returns while being a responsible steward of the environment and a beneficial partner to the communities where we operate. Slide 3 provides a little bit more detail on our timberland portfolio. Again, essentially, all of our timberlands are located in what we consider to be kind of investment grade softwood producing regions. We own at least roughly 1.9 million acres in the U.S. South, spread across 8 states, roughly 475,000 acres in the Pacific Northwest in Washington and Oregon and about 420,000 acres in New Zealand spread across 5 major resource units. Like I said earlier, we are the second largest of the 3 timberland REITs, but we like to think of ourselves as the largest or really the only pure-play timber RIET and that we don't have any exposure to what products manufacturing assets. So over the last 3 years, if you look at the breakdown of our adjusted EBITDA, roughly 3/4 of that has come from our Timberland business with the balance coming from our real estate operations. And you can contrast that with the peer group which is the [ converse ] of that. It's roughly 3/4 of their EBITDA has come from Wood Products manufacturing and real estate businesses, and only about 1/4 has come from timber harvest operations. Now the reason we think that, that's important is laid out on Slide 5, and that's really the very differential volatility between timber businesses and lumber manufacturing. As you can see over the last 20 years or so, the EBITDA margins in the timber segments,of the peer group have averaged about 35% with pretty minimal volatility, and that compares with an average EBITDA margin for the lumber segments, of those companies of 11% with significant volatility in several years in which profitability was actually negative or breakeven. And so one of the things that we like about our portfolio, again, is that pure-play focus. Lumber has had a very strong run over the course of the last few years in the wake of COVID, but it's historically been a very volatile business. We think one of the hallmarks of real estate investing, and Timberland investing in particular, is really that safety and stability of cash flows. And so we really like that pure-play focus within our portfolio. On Page 6, we highlight a few of the features of our portfolio that we think differentiate Rayonier from our peer group. First, in the upper left, you can see our sector-leading EBITDA per ton in the South, and that's really reflective of the markets in which we operate. Roughly 70% of our timberlands in the South are located in top quartile markets from a pricing standpoint. I recognize that the southern markets tend to be highly localized in terms of the supply-demand dynamics. So there's a tendency to think of the U.S. South and [ case ] with a very broad brush. Reality, it's a series of micro markets with very differential supply-demand characteristics. And so again, 70% of our lands are located in those top quartile markets, which really shows up in that sector-leading EBITDA per ton. So last year, we generated about $25 per ton. EBITDA in the U.S. South that compares to the peer group in the $13 to $16 per ton range. We also have sector-leading HBU realizations. We often say that the HBU business is all about premium. If you're just selling land at timberland prices, you're not really generating any value add for your shareholders. And so we tend to focus very much on premium in that business. And again, you can see that we've led the peer set in terms of our value realizations and premium realizations in that sector. Thirdly, we have an improving harvest profile. So like I said earlier, we've been very acquisitive over the last decade, having acquired 2.3 billion acres of timberland -- I'm sorry, $2.3 billion worth of timberland across all 3 of our geographies, and that's translated to an increase in our sustainable yield from about 10 million tons annually over the last 5 years to project it to be 11 million tons annually over the next 5 years, so an increase of about 10% on that sustainable yield. And lastly, we have a unique exposure to the China export market among the peer set, and that's really driven by our footprint in New Zealand. Roughly 60% of the volume that's harvested in New Zealand goes export. Roughly 80% of that goes into the China market. So we have a very unique access and exposure to that market. China has been a [indiscernible] bit balanced year of late, but it really has been the engine of growth in global fiber demand as well as export demand of the last decade. And so we like our exposure to that market. We expect it will continue to be a major driver of global fiber demand going forward. Page 7 highlights some of the strategic priorities that we have as a company. Yes, we updated these strategic priorities in 2014. We believe that they're every bit as relevant today as they were then. I won't go into all of these in detail, but I'll maybe just touch on a few highlights. First and foremost, we want to manage our assets for the long term. Timberland is a very long-term business. When we plant seedlings in the ground, we're generally not going to harvest those trees for 25 to 40 years depending on the region, and so we have to take a very long-term approach and focus with our business. Second, we want to grow our portfolio through disciplined acquisitions. Like I said earlier, we have been acquisitive over the years. We really focused on upgrading the portfolio both through addition in acquiring lands but also through subtraction where we're divesting lands that we think are going to be lower value add over time. Thirdly, we're always looking for opportunities to optimize the value of our portfolio by monetizing higher and better-use lands. And so we're constantly looking across the portfolio, seeing where we have opportunities to realize, again, a higher value for that property to a third-party buyer than we feel it's worth within our portfolio is Timberland. Next priority, which is relatively new to our set of priorities is to position the company for the low-carbon economy. We've seen tremendous opportunities to develop over the course of the last -- really, just the last few years. around what we broadly characterize as nature-based solutions. And I'll go into some more detail on that later. But this is really -- there's increasingly optimistic view around the value of carbon that's embedded within the forest and our ability to monetize that value over time. And lastly, we want to be the industry leader in transparency and disclosure. I think we've really tried to set the bar for our sector from a disclosure standpoint. We're the only one in the timber REITs that discloses our sustainable yield. We disclosed that within each of our 3 geographies. And again, if there's a single data point you want to know about a timberland portfolio, it's at sustainable yield. And so again, I think that we've really tried to lead the sector from a disclosure and transparency standpoint. Moving on to our capital structure on Page 8. Following the Pope Resources acquisition in 2020, we made a number of moves to improve our balance sheet and build acquisition capacity. We implemented an at-the-market equity offering program in late 2020. In 2021, it's a very low interest rate environment. We took a number of debt actions, essentially restructured every tranche of debt within our portfolio, including issuing $450 million of senior notes. These actions all sort of put us in a position to build acquisition capacity to effectuate a $450 million acquisition in the fourth quarter. which was a highly complementary set of assets in the U.S. South. And so as we sit here today, our balance sheet capacity is obviously more limited, having done a large cash finance deal in the fourth quarter. But we're comfortable with where we sit today. Our net debt to trailing adjusted EBITDA is about 4.5x. Our weighted average cost of debt at cost across our debt portfolio is 3.1%. Roughly 90% of that is fixed with a weighted average maturity of about 6 years. And we're investment grade rated with a stable outlook by both agencies. So again, really like where we're at from a balance sheet standpoint. And particularly our cost of debt relative to a rising interest rate environment, we feel like we're in a very good position. As it relates to capital allocation on the following slide, this highlights some of our capital allocation priorities over the last several years. Really, our mantra around capital allocation is to be nimble and opportunistic with a view towards building long-term NAV per share over time. To this end, we've often pivoted between different capital allocation priorities, where we see the best available opportunity. We bought back stock. We've issued stock. Like I said earlier, we've been active under the ATM program over the course the last couple of years, which has allowed us the ability to effectuate some significant acquisitions for the company. Of course, our dividend is also a key element of our capital allocation strategy. Current dividend is $1.14 per share. But again, we really try to approach capital allocation from the vantage point of being very flexible, opportunistic. We don't go into any given year with prescriptive metrics in terms of how much we want to acquisitions or buybacks. We really try to play the hand we're dealt and with a view towards building that long-term NAV per share. Page 10 highlights some of our ESG priorities. A key element of our ESG story is really the fact that commercial forestry at its core is a nature-based climate solution. We estimate that our forest sequester, nearly 15 million tons of CO2 equivalent annually. In addition, much of that timber that we ultimately harvest goes into the manufacturing of solid wood products, which thereafter store carbon for decades. So of course, all of our timberlands are third-party certified for sustainability as well. On the social front, I know that safety remains a key priority for the company, and we've provided some stats around some of our safety figures as well as benchmarks. And we really had a focus on improving safety performance over the years. And lastly, I believe we demonstrate best-in-class governance practices and really, in particular, around Board diversity. Approximately 60% of our Board represents diversity in the form of gender racial or national origin diversity. So again, I think we've really taken a progressive approach from a governance standpoint. Before we open up to Q&A, I also just wanted to touch a little bit more broadly on nature-based solutions. Slide 11 lays out some of the key areas in which we're seeing opportunities develop around nature-based solutions. Yes, I'd really kind of characterize this whole realm of nature-based climate solutions into 3 broad buckets. The first would be the ability to participate in the voluntary carbon market, and that's where we would undertake carbon project on our footprint either in the form of improved forest management or a forestation towards generating carbon offsets, then we can monetize the third parties that are looking to offset their emissions footprint. And so that would be one category of nature-based climate solutions. The second would include alternative land uses. So for example, where we can lease land for carbon capture and storage or solar installations or wind farms. We're seeing quite a bit of activity in all of those different realms today, particularly in the carbon capture and storage front. And the third would be just alternative uses of wood fiber, for example, for bioenergy or biofuels like sustainable aviation fuels, manufacturing. All of these are fairly nascent in their kind of development stage, but we're seeing tremendous interest and activity on all of these fronts. And of course, our core business, harvesting timber for consumer products and construction-based materials, we believe at its core is a nature-based solution. So we're seeing increased demand for things like mass timber as well as increased demand for paper and wood-based products as an alternative to single-use plastics. And so again, a lot of activity on this -- in this arena right now, a lot of conversations ongoing, and we ultimately think that this is going to be a major value driver for the company. So perhaps I'll pause there, and we can open it up to Q&A either from Anthony or from the audience.

Great. Great. Mark, thanks for that overview. And again, if anyone has any questions, just raise your hand. Maybe we can start off with the nature-based solutions, and you identified kind of the 3 maybe channels or categories. Can you talk a little bit more about, I guess, first, the voluntary carbon market and specifically your experience in New Zealand with credits and then maybe lessons learned or opportunities in the U.S. maybe long term.

Yes. So recognize that New Zealand is not a voluntary carbon market. It's a regulated carbon market. And so New Zealand has a cap and trade system in place, so regulated emissions trading scheme, whereby emitters are issued credits and then they have to retire those credits. Those credits over time will reduce in volume to stimulate investment in emissions reductions over time. And so we've been a participant in that market really since its inception as a forestry owner there. And so again, it operates very differently than the market in the United States, which is currently a voluntary market. And where you see regulated emissions trading schemes, you tend to also see higher carbon credit prices. One of the challenges in the U.S. voluntary market today is that there's just a wide array of perceived quality and credibility among different carbon projects. And so there are carbon credits that trade for kind of mid-single digits per ton, and their carbon credits are trade well in excess of $100 per ton depending on, again, the perceived quality of that credit. And so I think we're optimistic that over time, that market will develop a greater set of standards and consistency so that a credit is a credit is a credit, and you can actually achieve scalability in that market. But suffice it to say, it is still a bit of the wild west in the voluntary market, and there's a lot of concern around green washing. And kind of fast forward 3 or 4 years, you look back and say, "Well, that project wasn't truly additional from a climate mitigation standpoint." And so we're proceeding in that market very cautiously. Again, I think we're optimistic that it will continue to develop and evolve over time and that we -- it will be a value driver for Rayonier. But I'd say we're being very judicious about how we proceed in that market. We have not yet sold carbon credits into the voluntary market in the U.S., but it is something that we expect we'll do longer term.

In terms of the U.S. market, so do you have projects planned for the long term that you could potentially sell credits? And is it -- in terms of what allows the market to kind of -- is it standardized? Is it really standardizing around like a certain registry? Or what could the path over the next like 3 to 5 years look like?

Yes. I mean, again, if you focus specifically on the voluntary market for forestry-related credits, I'd sort of subdivide that into probably 3 categories. One would be some form of avoided deforestation or conservation. That's essentially where we were going to clear this forest. But now we're not, and we're going to get carbon offsets in exchange for that. The second category would be what's called improved forest management. And so that's things -- can encompass things like extending the rotation age in a particular forest or investing in more intensive silviculture to enhance growth rates and thereby enhance carbon sequestration. And the last would be aforestation, where you're buying bare pastureland or grazing land and planting trees that weren't there before. And I'd say that in terms of the quality spectrum, there's increasing perceived quality along the way. We sort of avoided deforestation, really having fallen out of favor from a credibility standpoint, improved forest management, candidly being a bit of a black box, where it can oftentimes be hard to really prove out the additionality at aforestation, I think, really being the gold standard of forestry credits because it's clearly additional. There's no concerns around leakage because you're essentially planting trees that weren't there before. And so that carbon sequestration is clearly additional. But again, it's a wide array of perceived quality in that market. And we're looking at projects, primarily in the improved forest management and aforestation side of things. We have a number of pilot projects that are currently underway. Again, haven't yet sold any credits, but that's something that we certainly expect we will do longer term, but we're trying to make sure that anything that we do in that arena is beyond reproach and sort of meets that gold standard of quality.

Great. Great. And then just continuing with nature-based solutions. The alternative land uses, I mean there's CCS, there's wind, there's solar. Can you talk about what you're doing currently and maybe where the most opportunity is?

Yes. And it's interesting. I mean, we've seen just a lot of activity in that space, particularly in carbon capture and storage and increasingly in solar as well. I mean solar is far and away, I'd say, the most mature in those opportunities. CCS is still very nascent. There's been a lot of activity around locking up land to facilitate CCS, but there's a very long permitting process. And I believe there's only maybe 1 or 2 sort of active CCS where actual injection is ongoing currently. So again, a lot of activity, but it's more forward-looking. It's trying to essentially secure the land to provide the poor space for that. But again, going back 3 years ago, I would have said that we were -- that felt sort of very early stages, whereas we've gotten to the point now where we've executed our first large-scale CCS lease. We can't provide much in the way of detail on that because it's under a confidentiality agreement, but we are seeing a tremendous amount of inbound activity from players that are essentially looking to lock up the land base to support longer-term CCS projects.

Great. And then maybe just rounding out nature-based solutions. In terms of alternative uses of wood fiber, you identified biofuels. Can you talk about that impact to Rayonier?

Yes. Again, still relatively early stages. You may have seen a couple of weeks ago, Drax put out a big announcement that they were looking to construct to BEx facilities in the U.S. South and actively evaluating, I think, an additional 9 potential facilities. And BEx is bioenergy with carbon capture and storage, that's essentially where you're burning some form of wood fiber, wood waste or wood pellets for energy production and then capturing the carbon at the site and storing it underground. And so that's thought to be a carbon negative cycle because carbon is being sequestered as the trees grow. And then through that cycle of bioenergy with carbon capture and storage, you're then sort of permanently sequestering that carbon in the ground. So again, Drax had a significant announcement a couple of weeks ago where they're looking to build 2 of these facilities in the South with several additional ones under consideration. Each of those facilities would be a fairly significant consumer of some form of wood fiber or pulpwood, probably on scale with a large pulp mill. And so again, we're excited about the prospects for that sector generating incremental demand for wood fiber. I think sustainable aviation fuels is also one in which again, the technology is still very much early stage and evolving, but wood fiber is thought of as being a viable feedstock and an elastic feedstock into SAF production. I mean that's been one of the challenges with SAF, is just the limitations on feedstock availability. There's so much -- only so much used cooking oil, for example, that you can source within a radius of a SAF plant. Wood as well as it relates to wood as a feedstock for SAF, it's not competitive with edible feedstock. For example, like corn. So again, I think it's thought of as having some promising applications in the SAF arena, but still very early innings. But again, that's an area where we see tremendous growth potential over time. If you look at the commitments that have been made to SAF by the major airlines, I think the estimated demand is projected to be 3 billion gallons of SAF by 2030 off of a very small existing manufacturing base today. So again, we see a lot of potential opportunity there, but still early innings.

Great. Mark, maybe we can kind of walk through your regions and talk a little bit about sort of market dynamics, who your customers are kind of relative market health, log trends and then maybe the trends in the timberlands markets themselves, and maybe we can just start with the South.

Yes. So in the U.S. South, we clearly saw some price declines when we announced our first quarter earnings year-over-year. We're more significant than perhaps people were expecting across the broader U.S. South. But I note that we also saw much stronger price gains over the prior couple of years. As I noted earlier, 70% of our lands in the south are located in those top quartile markets from a pricing standpoint. So we tend to look at what we refer to as a growth drain ratio, and that's quite simply the volume of timber that is growing in a particular sourcing radius relative to the volume of timber that's being consumed. And what you want to see in a very strong market is a one-to-one relationship, where all the timber that's essentially being grown is being consumed. And when you see those tighter growth-drain relationships, that tends to translate to much greater price elasticity. So when you see kind of a spike in demand, for example, like we saw in the wake of COVID, that translated to very strong price momentum in those markets. Conversely, when markets pulled back, we saw a sharper pullback in those markets. So again, going back to what we talked about earlier, on an absolute profitability basis, we're still performing well above the U.S. South on average and above the peers given where our footprint is located, but I think we've also seen greater price volatility, and so some of the markets of late just kind of given the broader macroeconomic environment that's been prevalent.

And then the market for timberlands or any kind of trends in timberland transactions that you've seen in the south recently?

I mean transaction values have held up remarkably well. You would think that in a rising interest rate environment, that would generally put pressure on any kind of a DCF-based valuation. But we've actually seen -- amidst a rising interest rate environment, we've actually seen continued cap rate compression in the timberland asset class. And they recognize that we value timber using a real -- on a real DCF using real discount rates. And so obviously, that might be disconnected from where nominal rates are at any given point in time. But I really think what's driving that cap rate compression in the timberland asset, particularly in the U.S. south, is just the promise around nature-based solutions and kind of the embedded option value around nature-based solutions. It's very hard today to underwrite a 30-year DCF like we would typically value. Timber, it's very hard to underwrite a 30-year DCF on carbon capture and storage opportunities or voluntary carbon market opportunities or SAF opportunities because, again, a lot of this is still in the evolutionary stage here. That said, I think that there is a lot of optimism that, that will translate to meaningful increments to value over time. And I think that that's ultimately being reflected in would-be buyers of timberland willing to accept a modestly lower real discount rate than perhaps they were willing to accept 3, 4 years ago when these opportunities were kind of further off and probably more speculative than they're viewed as being today.

And in terms of buyers, are you seeing new kinds of buyers? Or...

I mean we're both seeing new kinds of buyers as well as probably new kinds of capital underlying some of the traditional buyers, and so recognizing that the TIMO players continue to be some of the major participants in both the buy and the sell side of timberland M&A. I think the nature of that capital has changed, to some extent. A number of the TIMOs have raised carbon-focused funds where they're seeking kind of a balanced return from traditional timber activities as well as some component of carbon sequestration. In addition, we've seen new entrants to the space. We've seen some large tech companies made commitments to buying timberlands. We've seen some large oil and gas majors make commitments to buying timberlands. We've also seen kind of an array of more kind of ESG-oriented investors, where they're looking to acquire the timberland as kind of a biodiversity play or to generate longer-term carbon sequestration to offset their existing emissions footprint. So yes, I'd say that the universe of buyers has definitely expanded, and there is a discernible trend towards kind of ESG-driven investment concerns kind of going into that kind of investment calculus as it relates to how people think about timberland.

Mark, you talked a little bit about capital allocation. I'm just wondering with your leverage where it is, can you talk about sort of ability to delever and maybe long-term priorities on capital allocation?

Yes. I mean certainly, with where leverage is at today, we're a bit more constrained in terms of our capital allocation capacity. I mean that said, we've taken leverage up to this level twice in the last 7 or 8 years to facilitate large acquisitions. Each time we've done that, we've managed to bring it back within kind of our target credit metrics in relatively short order. One of the unique attributes of timberland is a -- in terms of the credit quality of the asset is we own millions of acres of land, and that land is infinitely divisible, and so we have the ability to really dial in any level of liquidity that we might want at any given point in time. As I said earlier, the timberland transaction market and land values have actually held up incredibly well amidst the macroeconomic headwinds that we've seen, and so we're always looking at opportunities to prune the portfolio of some of the kind of lower-tier assets within our portfolio. Certainly, in the wake of large acquisitions, we've oftentimes sold some tracks of land to partially fund those acquisitions. So in 2016, we acquired a large portfolio in the Pacific Northwest. We sold some lands, roughly $120 million, if I remember correctly, of lands to partially fund that. After the Pope Resources acquisition in 2020, we sold our portfolio in Mississippi, which is also around $120 million worth of dispositions. And so that's something that we always have the ability to do. And given kind of how well land values have held up, that's certainly something that we're looking at currently.

Great. Great. Well, we're coming up on time. But Mark, Collin, thank you.

Thank you.