In the early days of the COVID-19 outbreak, lumber prices tumbled along with many other commodities because of the impact many expected the pandemic would have on demand. That uncertainty led timberland real estate investment trust (REIT) Weyerhaeuser (NYSE: WY) to curtail some of its lumber production and suspend its dividend.
As things turned out, demand for lumber bounced back sharply because many homeowners started renovation projects to pass the time while cramped renters went shopping for new homes, causing a surge in homebuilding. Because of that, Weyerhaeuser's earnings have soared, which gave it the confidence to reinstate a dividend. However, it's implementing a more flexible dividend framework that follows the pattern of an increasing number of companies with direct exposure to volatile commodity prices.
Meeting volatility with variability
Most REITs generate relatively stable cash flow backed by rental contracts. However, timberland REITs often have more variability in their cash flows because they make most of their money selling commodities like timber and lumber products, the prices of which ebb and flow with supply and demand.
That has certainly been the case for Weyerhaeuser in recent years as its adjusted funds available for distribution (FAD) went from an average of more than $1 billion in 2017 and 2018 to around $500 million last year due to lower earnings from its timberlands and wood products business segments. Because of that, the REIT's dividend payout ratio soared above 100% last year.
Given the volatility in the company's cash flow, it's taking a new approach to paying dividends by implementing a base plus variable supplemental dividend framework. It's starting with a lower fixed based dividend of $0.17 per share (50% below the pre-pandemic level), which is sustainable even at 2019's low point for adjusted FAD. It intends to grow the base payout over time.
The REIT also plans to pay a supplemental dividend that would bring its payout ratio to 75% to 80% of its annual adjusted FAD. It would base the payment on the prior year's cash flow and expects to make its first variable payment in the first quarter of 2022. The REIT would use the remaining funds to pay down debt, repurchase shares, and invest in growth.
Weyerhaeuser's fixed-plus-variable dividend strategy isn't new. Variable dividends are becoming increasingly common in the mining and energy sectors, which continually battle volatile commodity prices.
For example, leading global resources company BHP Group (NYSE: BHP) pays a minimum of 50% of its cash flow in dividends. It allocates the other roughly 50% across several buckets, including paying down debt, buying back stock, growth projects, acquisitions, and additional dividends. As a result of this unique dividend policy, BHP has paid $6.9 billion of dividends ($5 billion via the minimum base payout and $1.9 billion of additional dividends) over the past year.
Other mining companies have slightly different variable dividend policies. Leading gold miner Newmont Mining (NYSE: NEM) pays a base quarterly dividend of $0.25 per share, which is sustainable at a $1,200 gold price. In addition to that, Newmont's framework sees it return 40% to 60% of the incremental cash flow it produces above that gold price to shareholders via a variable dividend. With gold currently well above that level, Newmont recently declared a 60% dividend increase.
Meanwhile, a growing number of oil and gas companies are shifting toward variable dividend frameworks, led by Devon Energy (NYSE: DVN). The company intends to pay a fixed quarterly payout of $0.11 per share, currently about 10% of its operating cash flow. It also plans to pay up to 50% of its excess free cash to investors via a variable dividend as long as it has a strong balance sheet and a semi-positive outlook on commodity prices.
Given this growing trend by commodity producers, it's not surprising to see Weyerhaeuser move in this direction.
Better aligning the dividend with cash flow
While Weyerhaeuser is bringing back a fixed quarterly dividend, it's setting it at a much lower base rate, which should be sustainable if lumber and timber prices slump in the future. Meanwhile, investors will directly benefit from higher prices via the supplemental variable dividends it intends on paying.
Weyerhaeuser's new strategy likely won't become the norm across the REIT sector. However, it could be an option for hospitality REITs, for example, since these companies have a lot more variability in their cash flows compared to other REITs due to fluctuating demand for hotel rooms. That makes the company's move an interesting one to watch to see if it carries over to other property types.