Description

Background

Just as a brief background, I’ve been looking for ways to play what I believe will be a better US housing market than what the market appears to be discounting.  Broadly speaking, economic conditions in the United States seem favorable for housing with unemployment remaining low, the Fed signaling it’s going to raise rates at a slower pace, and overall population and household formation continuing to grow.  We’ll see how all of these factors play out over time, but for now, it seems increasingly less likely that the US will experience the “gloom and doom” and “upcoming massive recession” that’s been sensationalized by the media over the past few months, one of the factors causing the S&P500 Index to decline almost 20% from September to December 2018. 

With that as a backdrop, I think CatchMark Timber Trust, Inc. (CTT), a timber REIT, presents an interesting long opportunity.

 Company Description

As a timber REIT, CTT generates recurring income and cash flow from the harvest and sale of timber, as well as from non-timber related revenue sources, such as rent from hunting and recreational leases.  Opportunistically, the Company also generates income and cash flow from timberland sales.  In addition to current income, CTT expects to realize long-term returns from the biological growth of its standing timber inventory.

In 2017, CTT generated its revenues from the following sources:

·         Timber Sales – 78%

·         Timberland Sales – 16%

·         Other Revenues – 6%

CTT owns interest in more than 1.6mm acres of high-quality commercial timberlands, predominantly in the US South as shown in the list below:

Alabama – 78,900

Florida – 2,000

Georgia – 291,000

Louisiana – 20,600

North Carolina – 600

South Carolina – 78,100

Tennessee – 300

Texas (joint venture) – 1,135,300

Oregon – 18,100

Total – 1,625,800

Investment Thesis

The reason CTT is an interesting long opportunity is because (i) purchasing the stock is effectively a leveraged bet on lumber prices in the US South, and hence a bet on the corresponding housing market, (ii) the REIT currently pays an attractive 5.9% dividend yield so one gets paid to wait while the fundamentals pay out, and (iii) in one of the largest timberland industry acquisitions in more than a decade, CTT completed a highly strategic purchase of 1.1mm acres in Texas and Louisiana (the Triple T transaction) on 7/31/18 through a JV structure which not only increases the underlying cash flow of CTT but also provides significant value-creation opportunities in the next few years. 

Here’s some additional information on each of these three aspects of the thesis: 

Regarding the housing market, since the recession of 2008-2009, US Housing Starts have steadily increased from around ~600K to ~1,250k currently.  For the most part, US Household Formations have exceeded housing starts during this time.  Further, the sustainable rate of US Housing Starts is often quoted as being ~1,500k, with ~1,200-1,300k used to satisfy demand from household formations and the remainder toward replacing teardowns in the existing base.  For reference US Housing Starts averaged ~1,600k from 1994 through 2008.  Given that US Housing starts have remained below the 1,500k sustainable level for ~10 years, demand is being pent up and should create a positive fundamental backdrop for Housing Starts going forward.  In addition and more applicable to CTT, lumber futures have recently been picking back up, and are now at $419/bf, up from $300/bf in October 2018 but still way below the highs of $650/bf in May 2018.

As far as CTT’s dividend yield, the biggest question for any REIT investor is how stable and sustainable is the dividend payout?  Here’s the simple math for CTT:  The Company is guiding to $47-53mm in EBITDA for 2018.  At the midpoint, that’s $50mm.  Cash interest expense is about $12mm annually and capex is about $5mm annually.  That’s $33mm in cash flow available for distribution.  The current dividend payout is $26.5mm, so the dividend is about 1.25x covered.  Thus, while CTT is highly leveraged, it appears that its dividend payout is sustainable.

Finally, CTT’s strategic purchase of 1.1mm acres in Texas and Louisiana not only increases the underlying cash flow of CTT but also provides significant value creation opportunities in the next few years.  The purchase of the acreage took place through a JV structure in which CTT partnered with a series of investors to finance the transaction.  CTT committed to invest $227.5mm, financed through a term loan, into the JV, with the remaining $1.39bn purchase price financed through investments by PTG Pactual, Highland Capital and Medley Asset Management.  In exchange for operating the JV, CTT receives management fees.  While CTT has chosen not to disclose the particulars of the management fees, they did note that the transaction is immediately 2-3% CAD (cash available for distribution) accretive as the management fees for the JV are greater than the incremental interest expense from the $227.5mm term loan.  Importantly, the nature of the timberland assets CTT purchased provides significant value creation opportunities in the next few years.  The timberlands are within ~100 miles of three of the top five US homebuilding markets - Austin, Dallas and Houston - affording logistical cost advantages vs. other sources of lumber.  In addition, due to the timberlands’ age, the property can support increasing harvest volumes while expanding standing inventory.  The timberland features a rapidly improving inventory profile growing from the current 2.8mm tons of annual harvest volume to more than 5mm tons by 2028.  During the conference call to discuss the transaction, management noted that the incremental investment required by CTT to harvest the increasing tonnage will be minimal.  Accordingly, the asset should enable CTT to steadily increase both its cash flow profile and dividend payout 2020 through 2028.

Valuation / Price Target

In terms of valuation and price target, there are many ways to look at timber REITs, ranging from NAV’s based $/acre for timberland to EV/EBITDA, Price/FFO, to Dividend Yield.  I’m primarily viewing this as a dividend yield play with upside optionality through both the timber markets and CTT’s cash flow growth through the Triple T transaction. 

Right now, CTT’s dividend yield is 5.9%.  From mid-2014 through 2018, CTT’s historical dividend yield was ~4.5%.  Assuming reversion to prior levels, CTT’s stock could reach $12/share, or >30% upside from current levels.  This is without the Company increasing its current dividend distribution.  With the Triple T transaction CTT has the potential to steadily increase its dividend payout for the next decade.  This would provide even further upside to the stock, and investors get paid to wait as the fundamentals play out.

Catalyst

The main catalysts for the stock are:

• Continued upward movement in US Houshold Formations and Housing Starts
• Cotninued upward movement in lumber prices
• Dividend increases