Myths and Truths

March 18, 2010

[This is the second post in the series, Myths, Truths and a Crystal Ball. The original presentation was to a secular audience - a group of forest landowners, but the underlying principles are based on the Bible and the applications are universal.]

Myth 1. Change is bad. We act as if we believe that screaming; complaining and regulating will keep the good old days forever. As we age, this myth gets stronger and more enticing.

The truth is that the “good old days” were never as good as we remember. And besides, change is inevitable. It is normal and natural. In fact, either we change or we die[1]^, [2]

Consider the changes that have occurred in Forest Products in North Carolina. During the past 10 years, the number of facilities and number of job have declined[3], and

IP announced the shutdown of its mill in Franklin VA
Reduced production at Plymouth and Canton
Ownership changes at Canton, West Point, Plymouth and Roanoke Rapids. and
Product changes at Plymouth
The sawmill at Whiteville is down
Weyerhaeuser is the only forest products company left with timberland, and the company is converting to a REIT.
Paper industry production is only about 70% of its peak
Stumpage prices are lower than low
Demand for product has disappeared.

The paper industry as we knew it will not come back. The furniture industry as we knew it will not come back. "The wood products industry as we knew it will not come back. That’s change; that’s America.

Tough, demanding, painful. Yes. But, normal and natural and necessary.

Myth 2. Our problems are due to the recession. When the recession is over, we will be “just fine, thank you.” A variation of this myth goes like this; if we didn’t allow all the forest products jobs to go to China we would be OK..

The truth is that we began undergoing fundamental change in the paper industry in the 1970’s and are just now approaching some kind of equilibrium. The peak years in terms of performance for the paper industry were 1972-1974.[4] Since that peak, our industry has failed to earn the cost of capital. As a result there has been little money for innovation and today we are not technically competitive with the best in the world.

You are now saying to yourself, “Let’s shoot the messenger. I can’t any more of this negative news.” Don’t shoot yet. News is just news; how you react to the news is what is important.

Myth 3. We can totally control our own destiny.

The truth is that our industry has always been integrated and even more so today. What happens in China, or in Russia, or in South America or in Canada has an immediate impact. For example, lower lumber production in Canada because of less demand in the U.S. leads to less residual chips for the Canadian pulp mills which then have to purchase higher priced pulp wood and in turn shut down some pulp mills due to high costs.[5] The beetles in Canada, Russian tariff on logs, an economic slowdown in China, black liquor credits in the U.S. and BCAP (if it is reinstated) in the U.S. impact the entire world wide forest products industry.

Perhaps the biggest driver for forest’s profitability is the number of housing starts. A recent[6] report headlined, “Some indicators positive, but weakness persists in housing market.” Not only are there many houses under water, but the stagnation of the average household income means less money available for housing. The average size of houses will continue to decrease and the number of households buying houses will decrease and engineered lumber will take the place of wides.

Myth 4. Every acre of land must earn a return – as high as 15%. Economists would say each acre must earn the weighted cost of capital. Another variation of this myth is that the bioenergy market will make all tree farmers rich. Of course, the extreme of this is also a myth – that energy wood is free.[7]

The truth is that the owner’s goals and management plan determine the target return for a specific acre of land. If you are a TIMO, you must earn a return for your investors. Ten-fifteen years is about the maximum time for a TIMO to hold land. Most of you are not TIMO’s; the value of your land today unless you are selling is a meaningless number. You need a market for the products or services you want to sell. And unless you have a lot of acres, money comes in chunks rather a uniform stream. Cash flow is important to you.

The truth is that today unless one is talking about high value land, forest land is not going to earn anywhere close to 15%.[8] And economically it should not. Forests year in and year out should earn somewhere between Treasury notes and AAA rated bonds. The risk is substantially less than that associated with the ownership of stocks.

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[1] I am a good example of change. I was born in 1946. My grandfather worried about where I would work because farming was dying as a provider of jobs. I went to work 23 years later for a company that did not exist when I was born, making products that were unknown when I was born and retired quite comfortably at the age of 50.

[2] Consider the paper industry. Paper making was invented in China and eventually came to the U.S. by way of Europe. Imagine all the complaining in the early part of last century when the industry moved to the southeast because of cheaper labor and abundant resources. The industry has moved back to China and Indonesia and to South America for the same reasons. The truth is that products will be manufactured where perceived manufacturing costs are the lowest.

[3] Ashcraft, David. “Economic Impact of “Forest Products in North Carolina. “Annual press release, July 2009.

[4] Kellison, Bob. Unpublished paper.

[5] Wood Resources International. “Forest Products Market Update.” January 2010.

[6] Joint Center for Housing Studies of Harvard University. “Housing Review.” Fall 2009.

[7] Kingsley, Eric. “The Free Wood Myth.” 2009 SC Forestry.

[8] Assume an investor purchases an acre of land for $1000 and intends to grow trees. His target return is 15%. This means that he must net an average of $150 per year as long as he owns the property. If you assume a 30 year rotation and selling price of $4500 per acre with some pulpwood at the first thinning and chip n saw at the second thinning, then the investor earns more than his target of 15%. With today’s land prices of $1500 - $1900 per acre, 15% becomes almost impossible unless the price of pulp wood increases substantially due to increased demand for fuel.