Description

The investment thesis for Acadian is based on the following points:

1. Acadian Timber is an attractive absolute value offering an estimated 7% FCF yield, approximate 6% dividend yield, while trading at a low implied value of $358/acre.  Timber REITs Potlach, Rayonier, and Weyerhaeuser all currently offer dividend yields between 3.4% and 3.9%.  While theoretically attractive, none of these companies actually cover their dividend through the generation of free cash through timber harvests.  These comparables cover their dividends through a) borrowing, b) issuing stock, c) selling acreage – i.e. liquidating, or d) through the aid of their wood products or other taxable subsidiary.  Most companies use a combination.  In contrast to these companies, Acadian offers an approximate 6% dividend, which is well covered through the sale of actual fiber – sawlogs, pulpwood, and biomass.  Acadian’s EV/acre is $358/acre.  To be clear – this is effectively close to the private market values of Maine and New Brunswick real estate.  My calculated NAV is $20.47.  That noted in a world where Southern timberland trades at $1,800-2,000/acre, Western timberland often tops $4,000/acre, and NYC townhomes sell for $80MM - $358 per acre is a low absolute price.  Certainly, timber grows slower in the North but current harvest levels for ADN are sustainable.  The bottom line is that at the current price the company pays investors a well-covered 6% yield.  The components of timberland returns are cash yield, real growth in per-acre pricing, real growth in product pricing, and biological growth.  Beginning with very reasonable per-acre values and an attractive cash yield points to a situation where long-term holders of Acadian are likely to generate double-digit total returns over a long time period, consistent with historical timberland investment returns.  

2. Timber is a unique and attractive asset class. Historically the asset class has offered equity-like returns with lower volatility, a positive correlation to inflation, and good historical performance during equity bear markets.  Timber is a renewable resource and a carbon consumer.  Timberland requires effectively no capital and EBITDA margins are high.  While end markets are cyclical, owners always have the option of deferring harvests and seeing the value of their merchantable inventory grow “on the stump.”  GMO notes the following regarding timber:

“Every year the world consumes more than 1.6 billion cubic meters of wood for industrial uses, including paper and board as well as solid wood (construction, furniture) – an amount equal to the consumption of cement, steel, plastic, and aluminum combined.  Wood products are energy-efficient, since the processing of wood products consumes only a fraction of the energy required to manufacture these other materials.  Additionally through repeated cycles of growth wood is a net absorber of atmospheric carbon. The supply of accessible natural timber has not kept pace with demand over the past few centuries.  Natural forests within economic transportation distance of timber markets have been cut much faster than they can grow, and in the meantime, the the rate of land conversion from timber to other uses (primarily pastureland, but also farms and buildings), has accelerated.  The supply of wood from natural forests has been substantially replaced by harvest from plantation forests, especially for commodity softwood products that create the bulk of the timber market. In order to match rising demand with supply from these capital intensive plantations, the real price of wood has had to rise.”

Source: GMO

Source: GMO

3. Acadian is a well-managed company with a history of value creation.  While I do not generally support third-party managements, ADN has historically been well managed.  Brookfield has managed the timber in a sustainable manner and has been able to increase dividends over time.  Their compensation is not egregious.  Brookfield is paid a base fee of $2MM and a performance fee of 15% of the amount by which annual dividends exceed $.9075 multiplied by the number of common shares.  In 2016, the company undertook a strategic review of which nothing occurred.  Over the last decade, the shares have generated a total return of 12% annually, far above both the U.S. and Canadian indices.  

   A conservative near-term target for Acadian is $24.44 or an implied 4.5% dividend yield.  This would still be a more attractive (and covered) yield relative to timber REIT comps.  On a total return basis, this equates to 38%.  I believe that Acadian is a “buy and forget” security.

    

There are multiple risks to an investment in Acadian:

• The core business has some cyclicality and is influenced by fundamentals in the lumber, paper and pulp industries.  For reference, EBITDA fell from $18.3MM in 2007 to $12.1MM at the trough in 2009 before rebounding in 2010.  While the company continued to generate FCF, in 2010 Acadian temporarily cut their dividend to 10 cents per share before moving back to $.82 in 2011.  

• The U.S. Department of Commerce has placed initial duties of between 17% and 31% on Canadian lumber imports.  American lumber producers are seeking a “quota deal” that will limit Canadian imports.  In the past duties have been pulled for producers in Eastern Canada but it is unknown what the impact could be.  I do not believe this will permanently affect the market for Acadian’s sawlogs.  

Below is a brief summary of the operations, financials, and management of Acadian Timber:

Operations

Acadian is a leading supplier of forest products in Eastern Canada and in the Northeastern United States.  The company owns and manages 1.1MM acres of freehold timberland in New Brunswick and Maine and provides land management services to 1.3MM acres of Crown-licensed timberlands in addition to operating a nursery.  The company’s primary activities are forest management, harvesting, marketing and sales in order to realize the maximum value from its timber.  The company serves over 100 regional customers including lumber mills, pulp and paper mills and other buyers of forest products.  In 2016, 53% of sales were solid wood driven by 36% softwood dimension lumber, 10% hardwood lumber, 4% softwood specialty products, and 3% hardwood specialty products.  22% of sales were paper, driven by 15% tissue, 4% groundwood, and 3% freesheet.  12% of sales were pulp, 8% were biomass, and 5% were engineered wood products.

New Brunswick Timberlands

ADN’s New Brunswick timberlands are freehold lands comprising approximately 761K acres in three large contiguous blocks of land in the Madwaska and Victoria counties.  The timberlands are characterized by high soil quality and well drained glacial till and are attractive for both farming and timber growth.  Management notes that the regions climate and high level of precipitation favors the development of tolerant hardwood forest and large stands of sugar maple, yellow birch, red maple and beech.  Coniferous stands of balsam fir and red, white, and black spruce are also grown.  High precipitation levels generally lead to a low frequency of forest fires.  94% of the timberlands are productive with the remaining properties comprised of roads, wetlands and water.  Access is good with over 5,700km of roads.  The LRSY or “long-run sustainable yield” noted above is approximately 761K cubic meters (m3).  This estimate is the annual harvest that management estimates can be sustained over an indefinite period.  Management notes that approximately 45% of the NB Timberlands productive forest is in a “regenerative, immature condition” that will contribute significantly to future harvest activity.  The young forest area includes more than 139,600 acres of softwood plantations and over 40K acres of stands that have been pre-commercially thinned between 1978 and 2016.  

In addition to the owned properties, Acadian manages 1.3MM acres of Crown lands in New Brunswick.  The licenses are administered with 25-year evergreen forest management agreement between the government and Crown licensees.  Licenses are managed based on an 80-year time horizon with forest management plans renewed every five years for the following 25-year period.  The current plan was approved in November 2014.  Management notes that the profitability from the managed lands is far lower than the owned lands but is unwilling to disclose their fees.  In 2016, New Brunswick accounted for $60.2MM in sales and $19.3MM in EBITDA.  

Maine Timberlands

Acadian’s Maine timberlands consist of approximately 299K acres located in north-central Maine in Penobscot and Piscataquis counties.  These are highly productive timberlands that have been professionally managed for over 100 years.  Approximately 93% of the acreage is considered productive and is supported by over 1,400km of roads for forest management.  70% of inventory is softwood and spruce and fir make up 36% of the total inventory.  White pine, hemlock, red maple and cedar are the other significant components of the inventory.  The LRSY of approximately 281K m3 is comprised of 73% softwood and 27% hardwood.  Management notes that 43% of stands are regenerating and young classes including over 54K acres and have been silviculturally managed to improve the growth of valuable species.  Maine timberlands accounted for $20.6MM in sales and $4.1MM in EBITDA in 2016.  

Acadian serves approximately 100 customers.  These customers are generally located within 250km from where the timber is harvested but this may vary.  The customer base is comprised largely of mills to which ADN and its predecessors have sold wood for many years.  Lumber, paper, and pulp mills owned by Twin Rivers accounted for 12% and 26% of sales in 2016 and 2015.  In 2016, ADN’s top five customers accounted for 42% of sales.  Pricing is determined through negotiation with each customer and dependent on species, size, quality, location and other factors.  Terms are often flexible and usually remain in place for six months to one year.  There is no “reliable formal” or independent pricing index for roundwood sold from timberlands in New Brunswick and Maine.  Below is a chart sourced from the company showing historical pricing for spruce/fir sawlogs and hardwood pulpwood for Acadian.  Below that are implied prices per cubic meter for sales in New Brunswick and Maine and associated volumes.  Keep in mind that the Maine prices are influenced by currency translation – thus the strength in prices over the last several years.

Below are transaction comp sheets for Maine and New Brunswick sourced from RBC.  I would note several things.  First, it is widely believed that ADN has superior quality timberlands as they have been professionally harvested for over 100 years.  Secondly in recent years the availability of timber in Eastern Canada has fallen materially due to harvesting restricts in Quebec and Ontario. From 1990 to 2004, the softwood harvest in Quebec was 30.5 to 32.4MM m3 annually.  In the early 2000, the Coulombe commission determined that Crown lands were being over harvested. Quebec cut their average allowable harvest by 20% in 2005 to 24.3MM m3 and then cut it again in 2008 to 23.3MM m3.  In Ontario, the average allowable softwood harvest was reduced from 27.4MM m3 to 20.2MM m3.  Finally, it is worth noting that the Nova Scotia comps are not reasonable.  It is difficult to transport harvested timber out of Nova Scotia, and Nova Scotia largely has a low value hardwood mix.  I believe that the $500/acre Maine value and the $350/acre New Brunswick values I am using are sufficiently conservative.  

Financials

Acadian has a clean balance sheet with good liquidity.  Debt is $95.9MM and cash is $20.6MM.  Net debt is $75.3MM relative to estimated EBITDA of $25.3MM or 3x.  Interest expense is $3MM – thus interest coverage is just under 10x.  Trough 2009 EBITDA was $12MM – thus 4x.  Additionally, “capital expenditures” – i.e. – planting seeds – has ranged between $300K and $400K over the last three years.  ADN’s timber business generates 30%+ EBITDA margins (low relative to Southern peers) and requires almost no capital.  If harvests are deferred, merchantable inventory grows on the stump.  

I have modeled slow top-line and EBITDA growth over the next several years.  I have modeled $25.3MM, $25.1MM, and $26.4MM in 2017, 2018, and 2019 EBITDA.  This translates into $21.8MM, $21MM, and $21.9MM in free cash flow.  

Management

As noted prior Acadian has a third-party management structure with Brookfield, providing management services to the company.  Brookfield owns a 45% stake in the company but executives generally do not own any stock – a structure that I disagree with.  Mark Bishop is the President and CEO of the company and the President of Brookfield Timberland GP.  Mr. Bishop is a COO in Brookfield’s Infrastructure group responsible for the management and strategy of their timberland portfolio.  Prior to joining Brookfield in 2008 Mr. Bishop was a paper and forest products research analyst and held various forest industry operational and financial positions.  He holds an MBA from the Ivey School of Business at Western University and a Bachelor of Science in Forestry form the University of British Columbia.  He received his British Columbia Registered Forester designation in 1990.  He has had this position since 2015.  Acadian named Mabel Wong, CFO in conjunction with their second quarter earnings release.  In this instance, I do not view turnover at the CFO position as a red flag as Brookfield normally shuffles executives.  Ms. Wong has been employed by Brookfield for ten years and has had a number of senor finance roles.  Prior to joining Brookfield she was employed by Deloitte Canada.  She holds a Bachelor of Commerce degree from the University of British Columbia.  

Catalyst

• ADN continues to grow dividends spurring greater investor interest

• Brookfield acts to realize value through accretive acquisitions or an eventual sale of the company

• Investment community recognizes superior cash generation relative to other publicly traded timber alternatives and solid absolute value at $358/acre