Forest firms try to add value to trees

Peter V O'Brien

Friday 26th March 2004

The five listed forestry companies had another tough time in the past 12 months in terms of share price performance, matching their profits. Price information since last March is in the table.

Tenon (formerly Fletcher Challenge Forests) gained 33% but that came from the company's decision to return capital to shareholders after selling the majority of its forestry assets.

Carter Holt Harvey's 12.6% increase arose from market perceptions of prospects for the company's non-forestry businesses.

The slight improvement in Opio Forestry Fund could have been a slight downturn, depending on the strike date.

Reasons for the market's downgrading of forestry (particularly the ownership of actual trees) has been well- canvassed in company reports.

Tenon chairman Sir Dryden Spring was blunt when he addressed the Fletcher special meeting, called to consider the sale of forest assets.

"Since the company was established as a standalone entity in 2001, the forestry assets have not earned the cost of capital."

"Over the past decade, with the exception of a brief period in the early 1990s, the forests have never earned the economic opportunity cost of the capital invested in them."

Sir Dryden said the share market had recognised that by discounting the shares significantly below asset backing.

(He was speaking on February 20, when the discount was 11%).

Sir Dryden's comments were equally applicable to other tree-owning companies, as was a general comment.

"The company has large amounts of capital invested in assets, producing commodities, for world markets which are highly cyclical."

That results in forestry companies being, in business cliché terms, price takers, rather than price makers.

That concept arose, at the Tenon meeting when chief executive John Dell said sale of the forests would "significantly advance the company's objective of transitioning from a pricetaking commodity producer to a consumer-focused manufacturer of sophisticated high-margin wood products."

The exchange rate, international prices and shipping costs have been three more recent pressures on forestry companies, particularly those exporting unprocessed or semi-processed material.

Exchange rate movements and their effect on all exporters, particularly those trading in products priced in US dollars, are well known.

Changes to shipping costs are less well known.

Shipping costs for logs to Asia have trebled in the past year, from $US17 a tonne to $US50.

Forest industry sources cited massive demand from China for wood product as the reason for the increase.

The movement in base shipping costs far outweighed the benefit New Zealand shippers received from the exchange rate.

Organisations with a debt structure are at a disadvantage when assets earn less than the cost of capital. Most companies have such structures.

It was suggested to The National Business Review that that factor, combined with both the longstanding and current pressures on forestry, had resulted in a change of ownership structures.

Substantial overseas pension funds had entered forest ownership. They had a relatively low cost of capital, could be satisfied with lower returns than companies and were basically equity funded.

Tenon has said it will concentrate on processing, which is the usual way commodity traders try to move from price taking to pricemaking.

Companies without processing facilities, beyond mere shaping and so on, would face substantial capital expenditure for high-level processing.

The meat industry had big problems moving from the export of full animal carcases to processed product often of high sophistication.

Meat companies already had suitable space in their works for processing carcases into specialised cuts.

The additional equipment was usually less sophisticated than in, say, a particleboard plant.

Moves to additional processing of wood product are under way but they will take a long time for companies whose sole interests are forest ownership.

The trick is to get the right product.

People in the industry point out that China is a massive importer of unprocessed wood and the world's biggest manufacturer (and exporter) of ready-to-assemble (RTA) furniture.

The RTA product has the advantage, when being shipped, of having less unoccupied space than fully builtup items.

Forestry companies have been in a long downwave phase of their cycle.

They and their share prices could stay there for some time before they enjoy the upward wave, with consequent rises in wood prices, forest valuations, profits and share prices.

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