Timber Investment Report
Investing in Timber
Financial panics have a way of unsettling the nerves. You seek refuge in things you can trust. Assets you can see and watch over. And sometimes those assets hold their own secrets, which are unveiled only after the passage of a century.
And so it was that one C.H. Murphy Sr. found refuge in the loblolly pines of central and southern Arkansas after the Panic of 1907. Here in the deep-fried South, Murphy not only saved a fortune, he planted the seeds for another.
Murphy bought up thousands of acres of timberland. Timberland is one of those old-world assets that never go out of style. Trees grow by the grace of nature’s bounties — sun, rain and warm weather. They hold their value by the grace of a marketplace that needs timber to make things.
If we fast-forward a century, we find that Murphy’s old timberland is now in the hands of Deltic Timber (DEL:NYSE). The Murphy family still owns 26% of this timber stock. Deltic is actually a spinoff of Murphy Oil, having achieved independence back in 1996.
I’ll tell you a little about a unique timber stock: Deltic Timber, which is a fine investment on its own. But the reason I’m excited about Deltic has little to do with trees. It’s more about what lies beneath.
Deltic Timber Corp. is a natural resources company. Deltic owns 437,700 acres of timberland (see the map, “Murphy’s Legacy.” The area highlighted indicates counties and parishes where Deltic owns timberland). It also runs sawmills in Ola and Waldo, and has real estate developments in Little Rock and Hot Springs.
Most of this timber is Southern pine. The company is patient in its cuts. It manages to a 35-year cycle, as opposed to the 20-year cycle for most timber companies. Family ownership will do that, I suppose. They are patient stewards of shareholder capital because it is their own investment, too — always important, this is more so today because many people who run companies have little or no financial stake in the businesses they run.
A recent study by Credit Suisse found that companies in which “founding families retain a stake of more than 10% of the company’s capital enjoyed a superior performance over their respective sectorial peers.” Since 1996, this superior performance amounts to 8% per year.
In Deltic’s case, it’s whooped its peers in paper and forestry, and it’s trounced the popular indexes.
Deltic Timber: A Towering Oak Among Saplings
So Deltic owns lots of timberland. The company also owns a couple of sawmills. Management maintains these facilities are state-of-the-art. These mills crank out all the sorts of things you’d expect a mill to produce: lumber, boards, timbers, decking, finger-jointed studs, etc.
With the housing market falling like an old drunk down a flight of stairs, you might worry about buying a timber company. No doubt, housing woes don’t help Deltic. Lumber prices keep slipping. Last quarter, they were 20% lower than the year before. And volumes are down, too. Not a good combo. Indeed, Deltic’s mills lost money last quarter.However, Deltic made a lot of money in its woodlands segment, in which it harvests timber. Pulpwood prices are up 56% from stronger demand from paper mills. The company also has real estate development projects in Arkansas. These are upscale communities with golf courses and the other trappings upscale communities enjoy.
Strength in these other divisions made up for the loss in the mills, such that first-quarter income rose 65%. Anyhow, this is not an earnings story. If you look at earnings, you see a price-earnings ratio of more than 50 times. Not cheap by the usual standards.
In Deltic, the sum-of-the-parts value of the company’s timberland assets, real estate projects and mills covers your investment, which limits your downside. But what’s really exciting — and what provides the upside — is the potential for the mineral rights of Deltic’s land. Namely, I’m talking about the potential for natural gas under its trees. Secondly, the potential value of its lands’ water rights.
Deltic’s Stake in the Fayetteville Shale Play
Let’s start with the natural gas. Deltic owns 55,000 surface acres within an area known as the Fayetteville Shale Play. Southwestern is the leading energy company operating in this region. Its Web site defines the Fayetteville Shale Play:
“An unconventional gas reservoir located on the Arkansas side of the Arkoma Basin, ranging in thickness from 50-550 feet and ranging in depth from 1,500-6,500 feet. The shale is a Mississippian-age shale that is the geologic equivalent of the Caney Shale found on the Oklahoma side of the Arkoma Basin and the Barnett Shale found in north Texas.”
Natural gas aficionados will recognize the equivalents, in particular Barnett Shale — which some speculate may be the largest onshore gas field in the U.S. As for Arkoma, some call it Barnett’s cousin. That leaves Fayetteville in good company. Fayetteville is a large area — some 2,000 square miles.
Treasure Map: Find the Hidden Natural Gas
Indeed, Southwestern is already producing copious amounts of gas here. The area has also attracted substantial investments from Royal Dutch Shell and Chesapeake Energy. The latter has already leased more than 1 million acres.
As for Deltic, the potential for lease income from its shale properties is the cream on top for shareholders. In fact, Deltic has already leased 15,000 acres to exploration companies. For this, it gets small lease payments. However, if these exploration companies start to produce gas, then Deltic gets a much more significant royalty stream.
Deltic first disclosed this possibility in its 2005 10-K filing, published in March of last year. The market gave it rave reviews, sending the stock to new highs of $60 per share. But speculators are impatient. The stock drifted lower, and now you can pick some up for $50 per share.
I listened to Deltic’s latest conference call. In it, management said they were “anxiously awaiting the results of drilling.” On this call, when it came time for questions, there were none. Not a single analyst follows this stock. Good for us.
Details are scant as to how much gas Deltic’s properties could produce. It is easy to speculate, based on Southwestern’s experience. You could take Deltic’s acreage, assume so many drills and so much gas and back into rough royalty payments. I have fiddled with these numbers in many ways. Before I share my thinking on valuation, there is one other asset on Deltic’s property that is particularly interesting: water.
Deltic’s Big Sale to Central Arkansas Water
In its latest quarterly report, Deltic disclosed that it sold 680 acres to Central Arkansas Water for $8.2 million, or $12,000 per acre. Again, we must speculate as to how valuable Deltic’s water rights may be. Arkansas water rights are not as valuable as Nevada water rights, but they have value. That value ought to rise in the new water-constrained world we are only beginning to see and experience.
In any case, putting a value on Deltic means lots of estimates and guesswork. But when the guesswork gets me numbers comfortably above today’s stock price, even on the low end, I get excited.
Timberland at only $1,000 per acre — which is 20% less than what large tracts of forest have sold for lately — gives you $437 million right way, or about $36 per share. Then you add in the real estate developments, land and mills — and you can tack on another $30 per share. That gets you to $66. Take out the debt and you get about $60 per share in a conservative — and growing — net asset value.
That doesn’t include any estimate for gas or water rights. Assuming the company produces gas only on the 15,000 acres it’s leased gets you another $15 per share or so. Should it produce gas on all 55,000 acres, you get an astronomical figure of around $50 per share. That would double Deltic’s share price. And I haven’t yet guessed at the water.
You have a proven operator anyway, even if none of this pans out — Deltic Timber itself is a wealth-creating business. It has many of the things we look for — chiefly, lots of tangible assets supporting your investment and a strong financial condition. In addition, we’ve got strong insider ownership. But best of all, we’ve got a cheap backdoor play into a promising natural gas and water play.
Deltic’s shares are not very liquid. Buy a small amount now and ease in for some more shares as the year goes by. Be patient. It won’t double overnight. We’re waiting for lightning to strike the pines, so to speak. Look for those drilling results sometime late this year.
Timber Stock Recommendation: Buy Deltic Timber (DEL:NYSE) up to $60 per share.
Deltic’s shares are not very liquid. Buy a small amount now and ease in for some more shares as the year goes by. Be patient. It won’t double overnight. Deltic isn’t the “sexiest” timber stock out there.
But it’s timber stocks like these, the so-called boring stocks, that could triple your money time and time again.
We’re waiting for lightning to strike the pines, so to speak. Look for those drilling results sometime late this year. And be in position to reap the rewards.