When a company posts record quarterly results, you'd normally expect its stock to be in rally mode. Only that's not what happened when timber real estate investment trust (REIT) Weyerhaeuser (NYSE: WY) reported results on July 30. In fact, the stock, which has been in a downtrend of late, fell even more on the news of record EBITDA and cash flow. Here's why and, more importantly, why long-term dividend investors should be cautious about the future.
An excellent performance
Without a doubt, Weyerhaeuser had a great second quarter. The real estate investment trust posted sales of $3.1 billion compared to $1.6 billion in the second quarter of 2020. Before you protest that 2020 was impacted by the pandemic, the company had sales of $1.7 billion in the second quarter of 2019. Truly, the just-ended quarter was impressive, noting the aforementioned records for EBITDA and cash flow.
However, there's an important missing word in this discussion: rent. While Weyerhaeuser is a REIT, it owns timberland. That's a very different business from your typical REIT, which leases out property to tenants. Essentially, Weyerhaeuser makes money by harvesting the trees on its lands and selling them. Weyerhaeuser specifically has a sizable lumber operation, so it not only sells some of its timber as logs but it also takes its own logs and processes them to be sold as two-by-fours and such. Here's the problem with this situation: Both logs and lumber are commodities.
The early part of 2021 was a period in which lumber was in high demand and prices skyrocketed. So sales were high. To give you a sense of what's going on here, sales in the company's wood products group were a touch over $2.6 billion in the second quarter of 2021 versus $1.2 billion in 2020. That's a more than 100% increase. By contrast, Weyerhaeuser's timberland business generated sales of $541 million in the second quarter this year compared to $480 million in the same stanza of 2020. Lumber was obviously the big story in the first half.
Caution is in order
To be fair, as long as you understand the dynamics here, this isn't a problem. But Wall Street tends to get overly excited about things and that was on full display in the early part of 2021. Weyerhaeuser's stock rose by around 20% at one point in the first half but is now all the way back to, basically, where it started out on January 1. Someone who bought the stock during the rally thinking that lumber prices were heading to the moon would have been sorely disappointed when the proverbial tree didn't grow to the sky.
In fact, in its second-quarter earnings release, the company specifically noted that third-quarter 2021 wood products results would be significantly lower than achieved in the second quarter. The main reason is that the price of lumber peaked and has since begun to fall. That's going to flow right through to the wood products group and the overall company's results. And it highlights the very real risk that investors are taking on when they buy this timber REIT. It should not be relied on as a predictable performer because the products it sells can witness dramatic and swift price swings. In many ways it's a commodity play.
The interesting thing is that the board recognized the inherent volatility in its business in late 2020, implementing a dividend that includes a modest stable base payment and a variable supplemental dividend that's likely to be paid annually, if it gets paid at all. The company has already stated that it expects to pay a "significant" supplemental dividend this year. That's great, but it just doesn't fit the bill if you're looking for reliable, growing dividends.
Who should, and who shouldn't
Weyerhaeuser is not a bad REIT, but it is a very specialized one with unique characteristics. Over the long term, timber has been a pretty good asset class providing property level appreciation and low correlations with other assets. If you're looking for a diversification tool, it might be worth a closer look. Even then, however, it would probably make sense to buy it when lumber prices are in a trough rather than while they're still relatively high, as they are today.
Meanwhile, if you're a dividend investor looking to live off the income your portfolio generates, you should probably stick with traditional REITs that generate more stable rental income and tend to grow dividends slowly over time. The ups and downs involved with owning Weyerhaeuser, with regard to the stock price and the variable dividend, probably won't be worth the price of admission for most long-term income investors.