KEY POINTS:
If volatility is what you are after, look no further than the forestry sector. Corporate forestry's ups and downs have been further magnified by the use of lots of borrowings.
The recent history of forestry returns has been characterised by more "downs" than "ups" and with leverage the
results have occasionally been fatal.
Sentiment hasn't helped: 10 years or so ago radiata pine enjoyed the sort of cult following currently accorded to residential property.
At seminars we would learn that by investing a small amount today we could be assured of a huge sum tomorrow. Timber prices had historically grown rapidly in real terms (2 to 4 per cent a year), the trees themselves grew in volumetric terms by 3 to 6 per cent a year and a tree's value apparently increased disproportionately as it grew into larger diameter grades with more valuable end uses.
All this translated into projected internal rates of return of 13 per cent a year and higher after inflation.
For some perspective, consider that global equities, even at their current inflated level, have only averaged 5.7 per cent a year in real terms over the past 106 years. Throw in tax deductions, a constantly weakening Kiwi dollar overlaid with an impending worldwide shortage of timber and this was nothing short of an investment nirvana.
Unfortunately it has not turned out quite as the computer models suggested. Wood prices have plummeted over the past 10 years.
By early 2004 the economics of forestry investment in New Zealand had probably never looked worse. The three major listed forestry companies, Fletcher Forests, Carter Holt and Evergreen Forests, had managed to turn $1000 invested for 10 years into an average of around $470.
The prospectus of one new forestry partnership at the time disclosed that, if everything went well, investors would get just a 5 per cent nominal return. The consistent trend of bad news for forestry investments led to many listed entities revising their long-term valuation assumptions.
This progressive downward reassessment of a forest's value reached something of a nadir in 2003 when Fletcher Forest (FFS) revalued its trees sharply downward ahead of putting them up for sale. The subsequent agreement to sell its huge forest estate to a local consortium set a new, low, benchmark for the valuation of New Zealand radiata forests.
The valuation implicit in the sale price was forecast to give the buyer about a 9.75 per cent a year real return.
In other words, based on the new conservative forecasts, and thus lower valuation, the buyer should receive a return of 9.75 per cent plus inflation on the purchase price.
FFS chairman Dryden Spring defended the sales in the Herald, saying: "Over the last decade, with the exception of a brief period in the early 1990s, the forests have never earned the opportunity cost of the capital invested in them."
About this time one of the world's most successful investors, the Harvard University Endowment, bought the Kaingaroa forest from the receivers of the Central North Island Forestry Partnership for a rumoured $970 million. When questioned as to the rationale for the purchase, a spokesman said that Harvard's analysis "looked forward, not backwards" and its investment decisions weren't "constrained by debt".
Kaingaroa had some years earlier been sold by the NZ Government to a joint venture partnership which included Fletcher Forests and the Chinese Government for around $2.2 billion. One of the Government's better deals, as it turned out.
Roll forward to late 2006 and the Government-funded New Zealand Super Fund (NZSF) pops up buying back $300m of the Kaingaroa Forest from our good friends at Harvard.
So, three short years later, how does the price NZSF paid compare with the 9.75 per cent real Spring and his fellow FFS directors sold Fletcher Forests for? Unfortunately the NZSF was reluctant to disclose what sort of return it expected from the recent forest purchase but chief investment officer Paul Dyer noted that "discount rates in many asset classes had been trending downward in recent years" and that the purchase was consistent with the projected 8 to 9 per cent long-term nominal return objective of the fund.
That sounds like another nice profit for Harvard.
Brent Sheather is a Whakatane-based investment adviser.
