In increasingly changeable market conditions, the research shows that timber delivers as it always has. Carbon negative and a superb hedge against inflation, the commodity keeps punching above its weight in return on investment.
Timber’s versatility and resilience go hand in hand. For years, skeptics pointed to the rise of digital and decline of paper as a reason to be bearish, but if recent trends continue, investors in forestry have nothing but positives to look forward to.
Senior Portfolio Manager of Timber Strategy at Pictet Asset Management, Christoph Butz, highlighted that there are three trends diving the rise in fibre’s prospects, namely:
Demand for wood products been tied to population growth and a rise in GDP per capita since the commodity has been traded. Wood for construction, paper-based packaging and other products has in developing economies, such as China, are seeing steep rise among the middle class, which has boosted demand for wood-based products, and is likely to do so for decades to come.
This change in consumption habits is playing in favor of the timber industry, with the shift towards online shopping and ecommerce generally accelerating the shift. The drive to move away from polymers towards sustainable and renewable alternatives is compounding the growth.
As the only scalable renewable raw material on earth, is has somewhat plastic qualities itself. Timber is dynamic, providing pulp, energy, building materials and host of downstream products and applications. According to the Swiss investment firm and many other analysts, the companies that own forests and who can control the flow of wood will be the winners of tomorrow.
Timber alleviates climate change’s effects in two ways:
The first is via carbon capture, storage and substitution. Forests absorb CO2 from the atmosphere and sequester it as biomass. Secondly, timber offsets the impact of fossil-based materials through wood-based alternatives, which keeps hydrocarbons beneath the earth’s surface, avoiding unnecessary emissions.
The effects on consumption are significant. In the EU, 20% of total annual fossil emissions are compensated by the European forest industry.
The substitution is not limited to steel, concrete and bricks in construction, or paper over plastic in packaging. The forest industry has innovating new technologies and applications for wood and wood derivatives for virtually anything that can be made from fossil sources.
This positive climate mitigation increases over many cycles of planting and harvest, whereas in an unmanaged forests, the carbon absorption reaches a plateau.
A company in Germany, for instance, is already producing wood-based biodiesel, which does not compete with the human food chain, and it is also currently building an industrial scale biorefinery to produce wood-based chemical compounds that can be used to replace oil-based materials . This new bio-based economy represents enormous future growth potential.
From timber, one can make an extremely wide range of products, from carbon neutral building materials such as the traditional lumber and wood panels, but also cross-laminated timber, which allows for constructing wooden buildings up to 20 stories high.
Sustainable paper-based packaging alternatives are seeing a major revolution in range and capacity, and wood-based textile fibers are now on the market, which consume 90% less water to produce than cotton, and do not shed microplastic in the washing machine, as polyester and acrylics do. Bio-based chemicals and wood-based biofuels for the future circular bioeconomy are likewise seeing meteoric growth and development.
Timber has been with us for centuries and will only become more important. The theme will evolve from within, as established timber companies continue to transform and evolve from traditional uses of woods into new materials & products. The trend towards reducing CO2 emissions globally will result in increased growth rates both in traditional and new usages of wood as a sustainable and renewable raw material that can reduce the usage of fossil-based raw materials. Furthermore, once this growth translates into increased and more stable earnings, there is a high likelihood that this will also lead to higher valuations of sustainably managed timberlands, as the ownership and control of this unique resource will become more valuable. And finally, the companies that develop and market these new products should also see a substantial re-rating of their multiples, as a result of improved profitability and higher growth.
Having enough real asset exposure in the form of forest land is an important pillar of a diversified investment strategy. What is a forest land asset? It is a piece of land where you grow the trees and you harvest the trees to plant new ones. The trees that you have harvested are turned into cash flow. Therefore, the similarity to a bond is that the trees that you harvest is the coupon of a bond. In the case of timber, the cash flow is in the near term, which when discounted for a higher discount rate (because of higher inflation), will suffer much less than those of companies that receive cash flows at a later stage. As for underlying land; it is per se a good inflation hedge.
Lastly, we have observed that companies operating in this space have historically, in periods of high inflation, been able to raise their end product prices faster than their costs (labour, transport etc). So all in all, we are convinced that our strategy can offer a reasonable protection against inflation.
Plastic bans or any taxes on non-renewable and fossil materials will be beneficial to the timber industry. The main reason why lots of packaging is still made of plastic is cost; a PET bottle for water, for example, is still considerably cheaper than a paper-based alternative. A plastic ban policy such as the one that China will implement from 2025 onwards will act as a further tailwind for the timber industry. The current market share of wood-based packaging is 33% against a 36% of plastic based packaging (Source: Company Presentations of Mondi, Metsa Board, Stora Enso, WestRock and Sig Combibloc), hence there’s still a lot of market share to take, once the true environmental cost of the ‘cheap’ plastic packaging is recognized.
Heightened awareness for health and sanitation has initially increased the demand for cellulose-based hygiene products such as tissue, wet wipes or even masks. But even more important is probably the ongoing influence of Covid on the U.S. housing market as people tend to move away from inner cities and want to live further out in single family homes, which in the U.S. are still predominantly built from wood. People locked at home or working from home invest more in repair and remodeling, adding an additional room or a wooden deck to their home. All this adds to lumber and wood product demand. But probably the longest lasting effect is on the packaging side. Covid has only accelerated the ongoing transition to e-commerce, and all these goods people buy online come in corrugated boxes and cardboard packaging which is made by our companies. This has led to very favorable conditions and higher pricing on packaging paper markets.
We have seen a very strong performance since the market meltdown a year ago, and in our view the conditions for a continued strong performance remain favorable . Over the last decade, we have more or less performed in line with the broader market, but then, it is fair to say, that the unprecedented dominance of growth over value has made it almost impossible for us to beat the broad market over this period. Investors also need to know that our fund exhibits quite a bit of volatility. Years of significant outperformance can be followed by years of significant underperformance. This volatility is due to the fact that our Timber strategy is closely tied to the real (manufacturing) economy, and many timber commodities tend to fluctuate with the economic cycle. Of course, this also opens interesting timing opportunities for investors, and has allowed us to create value for our investors across several underlying cycles over time.
The long-term drivers for our strategy, particularly the sustainability angle, are stronger than ever before. From a more short to medium term perspective, all the underlying markets are strong and prices for our timber commodities are currently rising fast (lumber & wood product prices, pulp and packaging paper). And then, from a factor perspective, the strategy has an inherent bias towards value and smaller capitalized cyclical stocks. So, the strategy is interesting for investors who think that the rotation into cyclicals could continue and that the unprecedent outperformance of growth over value, which we have witnessed over the last decade, might mean-revert at some point.
Evergreen Forestry is a vertically integrated, sustainably focused forestry company managing seven plantations across the KZN Midlands. Evergreen Forestry grows its own trees for pulp and sawmilling, with an increasing focus on the sawmilling value chain.
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