Clearing the Mist

Clearing the Mist is real-time commentary by Delphi Advisors on developments, clues, patterns, and events we believe could affect the U.S. economy, and particularly the Forest Products sector...

...or sometimes it's just a way to let off some steam.


Thursday, October 30, 2014

Zombie Trees

Halloween seems an appropriate time to highlight a national horror story.  Although this post looks at it through the prism of Idaho, sadly the tale is unfolding in many places throughout the U.S. West.


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We start the tale innocently enough: comparing the number of standing trees per acre on forest land across Idaho.  But first, a bit of background.  In USFS nomenclature “forest land” is the broadest classification of land with trees growing on it, including lands that have at least 10 percent forest cover; timberland refers to forest land that surpasses a productivity threshold and is not legislatively reserved from being actively managed. 

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According to the USFS's Forest Inventory and Analysis ("FIA") unit, there are nearly 21.5 million acres of forest land across the state.  Eighty percent of the forest land in the state is managed by the federal government, with the vast majority (76 percent of the state’s forest land) managed by the United States Forest Service (“USFS” or “NFS”).  The State of Idaho manages six percent of the forest land in Idaho with the remaining 14 percent managed by private land owners.  These lands are interspersed with one another across the state.

With that is background, let’s plunge ahead with our tale.  For the three primary forest managers/owners in Idaho, the USFS, the State of Idaho (“IDL”, for Idaho Department of Lands), and private land owners, the average forest land acre carries roughly the same number of live trees (122 per acre for USFS, 119 per acre for IDL, and 108 per acre for private).  However, the number of standing dead trees per acre on the USFS (43) is roughly double the number of standing dead trees per acre on State (20) and Private lands (14).  Why would this be?  Remember, the USFS doesn’t represent an isolated pocket of property but rather is by far the most significant land manager in terms of geography within the state.

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IDL and private land is generally more actively managed, including higher harvest activity, than forest land managed by the USFS.  For instance, as can be seen in the graph below, although USFS managed lands represent 76 percent of all forest land, it currently accounts for less than 15 percent of the annual timber harvest in the state.   On the other hand, the state, comprising six percent of the forest land acreage, accounts for nearly 30 percent of the harvest.  In the case of private land owners, 60 percent of the annual harvest is sourced from their acreage, representing 14 percent of the forest land in the state.

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To further examine the link between active management and tree mortality, the next chart focuses on USFS land only.  As can be seen there are 10 columns in all, comprising five sets of two columns each.  Each set of two columns shows the number of living trees and the number of standing dead trees per acre.

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The far right set of two columns on the chart above corresponds to the USFS graph shown in the prior trees per acre by ownership chart.  The other four sets of two columns segregate USFS forest land into four different categories.  The first two sets look at more productive forest land  while the second two sets of columns look at less productive forest lands.  The more productive forest land area is further sub-divided between acres that are not reserved, i.e. that are open to active management, and acres that are reserved, or legislatively withdrawn from any active management occurring on them.  Designated wilderness areas are an example, the most common in fact, of acreage that is reserved from active management.  Similarly, the less productive acres are sub-divided between not reserved and reserved.

Several patterns emerge when the data is analyzed in this way.  First, the more productive lands carry more lives trees per acre than less productive lands.  Second, the ratio of the number of dead trees per acre compared to the number of live trees per acres is higher on less productive lands.  But, third, and most important here, is regardless of productivity, there are more dead trees per acre on lands where no active management is possible.  Fourth, on the most productive areas that are open to be actively managed, the number of standing dead trees per acre is still nearly double that seen on IDL and private ownership.  Thus, on the USFS even acres where ostensibly active management can be practiced, not enough is being done and trees are dying.

Beyond, the charts and numbers, the reality is all too obvious to anyone who looks at Idaho’s national forests.  Suppression of fire and significant reduction harvesting, both for regeneration and thinning, have allowed forest managed by the USFS to become overcrowded and old.  In the relatively dry climates of the Inland West, the old, overcrowded conditions weaken trees, making them more susceptible to insects, disease, and death.

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Trees per acre are one thing and seem bad enough but when the number of dead trees per acre are multiplied across the size of the USFS holdings in the state the magnitude of the losses becomes even more sobering.  The next chart compares the volume represented in standing dead trees on the USFS compared to volume in live trees on other ownerships in Idaho.  As can be seen, the volume represented in the standing dead trees on USFS timberland (not reserved and productive lands) exceeds the live volume on any other single ownership class in the state.  Total standing dead volume on all USFS forest land is nearly equal to the total live volume on all other ownerships combined in the state.

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For those concerned about global climate change and green house gases, there is an additional element of this carnage that is often overlooked.  As is well known, trees grow by utilizing atmospheric elements, including carbon dioxide, other nutrients from the soil, sunlight energy, and water.  One result of this growth process is a reduction in carbon dioxide, fixing carbon within the tree's cellular structure and producing oxygen as a by-product  When a tree dies and begins a slow process of decay, the fixed carbon within the tree is released.  However, this process will take a long time in the dry Inland West so a significant amount of carbon remains ‘stored’ in the dead trunk for an extended period of time.  However, no new tree can take its place while it stands, and so that portion of the forest is no longer in effect exchanging carbon dioxide for oxygen as it once did while carbon that had been stored within the tree during decades of growth slowly leaks away.

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But standing dead trees and standing dead volume speaks to what has been --- not what is happening.  The chart below begins to look at what is happening now, not what has been.  It compares the volume in trees that die annually to the volume of trees harvested annually by ownership.
 
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The first two stacked columns on the chart compare mortality on non-reserved forest land acres – acres that are open to active management – to 2012’s harvest.  Each column is sub-divided by ownership to depict the contribution of each ownership category to the state total.  The comparison is made on non-reserved acres because those are the only acres on which active management, including timber harvest, can occur.  The last column on the chart depicts the annual mortality occurring on forest land acreage reserved from active management.
 
Total mortality, on both non-reserved and reserved forest land, is nearly 4 times the amount of volume being harvested annually state-wide.  The annual mortality on the USFS acres that are open to active management is over 18 times the volume of the annual harvest from those same acres.  Finally, the annual mortality on the 3.8 million acres of reserved – Wilderness – acres in the state exceeds the annual harvest on the 16.4 million acres of forest land in the state open to active management across all ownerships.  In a word, the Idaho Wilderness is being slaughtered.

The chart below shows net annual growth and annual harvest on Idaho forest lands.  The ratio of net annual growth to annual harvest ("growth/drain ratio") is a common, sometimes overused, metric used to test harvest intensity.  Net annual growth is the amount of growth occurring in a year minus the amount of annual mortality.    As can be readily seen, not only does state-wide net annual growth exceed state-wide harvest, the net annual growth on each ownership exceeds the annual harvest for each individual ownership class in the state.  Notably, the "growth/drain" on private ownerships (1.33) exceeds the same ratios on USFS (1.17) and IDL (1.12).

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Looking at those results on the USFS one might be tempted to conclude harvest levels could be increased only slightly before harvest exceeds net annual growth, prompting forest inventory to fall.  However, this is one example where the growth-drain ratio alone doesn't provide an adequate picture of forest conditions; in this case, the high level of mortality distorting what is occurring on USFS lands.
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The chart above separates the components of net annual growth apart and further separates them by non-reserved (i.e. open to active management) and reserved forest lands for each ownership class.  As can be seen on this chart, on most ownerships annual mortality is a fairly small relative to annual growth (16 percent on IDL and private forest land in Idaho).  Unfortunately, this is not the case for the USFS.  On USFS non-reserved forest lands annual mortality is a whopping 76 percent of annual growth.  However, on reserved forest land the picture is even more dire; annual mortality is 206 percent of annual growth.  Idaho’s spectacular wilderness and back-country areas are slowly dying.  Dying by starvation, dying by thirst, dying by strangulation.  Combining the non-reserved and reserved acreage results in a slightly positive net annual growth where annual growth exceeds annual mortality by four percent.

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The next chart (see above) now completes the picture, pitting harvest against net annual growth on the acres open to active management.  On USFS it’s clear the net annual growth on acres open to active management exceeds harvest by over 500 percent.  This is a radically different picture than when comparing the annual USFS harvest to the USFS property total where net annual growth is much lower due to the annual mortality occurring in Idaho’s wilderness areas.  However, the extremely positive net annual growth to harvest on USFS lands needs to be understood in the context of other clear trends on USFS lands: rampaging mortality on reserved forest lands and mortality that is rapidly increasing on non-reserved forest lands.

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Will Zombie Trees overrun the national forests in Idaho?  And remember, Idaho is simply a snapshot of the dynamic underway in many public forest lands across the U.S. West.  As bad as it is, unfortunately, the story does not end with a moonscape of standing dead trees.  Ultimately a lightning strike will cremate the standing and tilting remains of zombie trees, polluting expansive air sheds, further ravaging wildlife habitat, exposing streams and rivers to significant sediment loads and reduced shade, and sometimes sterilizing soils for a generation.
 
While popular science and belief stretch to accommodate and explain such ravages as part of the “natural order”, the fuel loads fanning today’s wildfires are not natural and the results rarely orderly.  Yes, thankfully there is a kind of rejuvenation in the aftermath of wildfire’s annihilation.  But in light of the destruction it seems the question is could such rejuvenation be achieved in a manner with less apocalyptic fury and lower societal cost.  Earthquakes, hurricanes, and pestilence are all natural as well.  Yet, we try to operate in a manner to mitigate their damaging effects on society, not amplify them.  As a society will we find the will to halt the advancing scourge of zombie trees?


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Thursday, September 4, 2014

QFR Paper Manufacturing – 2014 First Quarter

With this post we are initiating coverage of the Census Bureau’s Quarterly Financial Review data for the U.S. paper manufacturing industry. Each quarter the Census Bureau samples a broad array of U.S. corporations to gather a snapshot of business sector health and activity. The program, known as the Quarterly Financial Report, or QFR, survey has been collected and published for over sixty years by various Federal agencies, the Census Bureau being the current administrator of the program. These data provide a standardized and comprehensive look at the financial condition of the industry.

Results from sampled businesses are aggregated and reported by the North American Industry Classification System (NAICS) and by asset size category. There are separate NAICS codes for wood product manufacturing (“321”) and paper manufacturing (“322”). Based upon returned sample surveys, the QFR presents estimated statements of income and retained earnings, balance sheets, and related financial and operating ratios by industry sector and asset size category. What’s reported in this blog is only a snapshot of the other data reported by the QFR survey.

The paper manufacturing data is categorized by asset size: firms with less than 25 million dollars in assets (“small firms”), firms with more than 25 million in assets (“large firms”), and all firms regardless of size. While the data is somewhat dated, it provides a useful perspective on business direction and momentum with respect to the current cycle as well as providing benchmarks for individuals firm’s performance.



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Viewing the 2014Q1 data, the picture that emerges is a gradually improving industry sector that was hampered by adverse 2014Q1 weather conditions, which have been widely reported by the financial media as the principal cause behind 2014Q1's negative real GDP print. Comparisons to the prior quarter (2013Q4) are further complicated by significant non-operating income and a significant federal tax credit received in 2013Q4. Granting these complications to in-depth interpretation of 2014Q1 industry results, probably the most significant observation is although year-over-year industry net sales increased by 5.5%, operating margins fell, dropping from 5.74% in 2013Q1 to 3.49% in 2014Q1. However, despite loss of operating margin, the industry’s focus on asset rationalization has maintained both ROE and ROA in the solidly within the upper quartile of performance relative to the past 10 years.

Selected financial results of paper manufacturers’ first quarter 2014 is summarized in the table shown below. Notable highlights (see table below) include:

  • Net Sales – 2014Q1 net sales ($32.9 billion) retreated by 3.2 percent compared to 2013Q4’s net sales, a reduction approximately three times larger (more negative) than the median reduction seen between Q4 and Q1 over the past ten years. Despite dropping from 2013Q4’s sales, 2014Q1’s net sales increased by 5.5% compared to 2013Q1’s net sales level.
  • EBITDA – 2014Q1 operating cash-flow, or Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA), posted 10-year lows for both large firms and the industry.
  • Operating Income – 2014Q1 operating income was in lower quartile of last 10 years for industry and both large and small firms.
  • Pre-tax Income – 2014Q1 pre-tax income posted significant declines to 2013Q4, dropping nearly 52 percent compared to a 10 year average percentage change between Q4 and Q1 of nearly 12%.
  • Net Income – 2014Q1 net income posted significant declines on both a quarter-over-quarter basis as well as on a year-over-year basis. As noted earlier, quarter-over-quarter comparisons are complicated by large non-operating income received in 2013Q4. However, year-over-year comparisons don’t suffer from this issue and point to significant cost structure increases in 2014Q1 vs. 2013Q1: year-over-year sales improved by $1.7 billion while net income fell by $0.9 billion, a combined implied cost delta of $2.6 billion, or 8.3% on 2013Q1 sales of $31.2 billion.
  • Operating Margins – 2014Q1 operating margins showed significant erosion across the board on both quarter-over-quarter and year-over-year comparisons.
  • ROE and ROA – Despite apparently increasing operating costs both Return on Equity (ROE) and Return on Assets (ROA) posted year-over-year increases and were in the upper quartile of performance relative to the past 10 years.


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The key unknown for the industry sector is how much of the increase in 2014Q1 operating costs was attributable to the adverse weather conditions that were blamed for the negative GDP change. The fact 2014Q1 sales contracted from 2013Q4’s net sales level by more than the median percentage between Q4 and Q1 over the past 10 years is consistent with adverse weather impacts. However, 2014Q1’s net sales increase relative to 2013Q1’s net sales potentially challenges weather as the principle explanation for 2014Q1’s EBITDA, operating income, pre-tax income, and net income declines. The second quarter data, due to be released mid-September, will provide additional insights into the industry’s trajectory this business cycle.


QFR Wood Products Manufacturing – 2014 First Quarter

With this post we are initiating coverage of the Census Bureau’s Quarterly Financial Review (QFR) data for the U.S. wood products industry. Each quarter the Census Bureau samples a broad array of U.S. corporations to gather a snapshot of business sector health and activity. The program, known as the Quarterly Financial Report, or QFR, survey has been collected and published for over sixty years by various Federal agencies, the Census Bureau being the current administrator of the program. These data provide a standardized and comprehensive look at the financial condition of the industry.

Results from sampled businesses are aggregated and reported by the North American Industry Classification System (NAICS) and by asset size category. There are separate NAICS codes for wood product manufacturing (“321”) and paper manufacturing (“322”). Based upon returned sample surveys, the QFR presents estimated statements of income and retained earnings, balance sheets, and related financial and operating ratios by industry sector and asset size category. What’s reported in this blog is only a snapshot of the other data reported by the QFR survey.


The wood products manufacturing data is categorized by asset size: firms with less than 25 million dollars in assets (“small firms”), firms with more than 25 million in assets (“large firms”), and all firms regardless of size. While the data is somewhat dated, it provides a useful perspective on business direction and momentum with respect to the current cycle as well as providing benchmarks for individuals firm’s performance.





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Viewing the 2014Q1 data, the picture that emerges is an industry that may have already peaked for this cycle in terms of financial performance. Yet caution is in order: the very tentative housing recovery following the Great Recession could well offer surprises in terms of shape and trajectory of this business cycle. Further, as has been well publicized in the financial media, weather effects were notable in 2014Q1 and these too could be impacting financial results. However, as the graph below shows, net sales have been declining since 2013Q2. Likewise, on trend over the past 12 quarters EBITDA, operating income, and net income increased through 2013Q2 but since then have traced a downward trend. Note net income, operating income, and EBITDA for the weather-affected 2014Q1 is greater than 2013Q4’s (prior quarter) results and roughly on par with 2013Q1’s (prior year) results.


Selected financial results of wood products manufacturers’ first quarter 2014 is summarized in the table shown below. Notable highlights (see table below) include:

  • Net Sales - 2014Q1 net sales ($19.3 billion) fell by 4.2% relative to 2013Q4 net sales. Because the wood products industry is highly cyclical, the median Q4 to Q1 change over the past 10 years is computed and shown in the tenth column of the table for the entire industry to facilitate quarter over quarter comparisons. The 2014Q1 drop in net sales from 2013Q4 is greater than the median Q4 to Q1 drop over the past 10 years (-4.2% vs. -3.6%). On a year-over-year basis, the industry showed a slight increase (+0.5%). The increase in net sales was concentrated on firms with assets less than $25 million (+3.4%) while net sales contracted in aggregate for firms with assets greater than $25 million (-1.2%). 
  • EBITDA – 2014Q1 operating cash-flow was in the upper quartile of 10-year quarterly performance for all firms, regardless of size. Despite relatively high financial performance compared to the prior 10 years, EBITDA still fell on a year-over-year basis.
  • Operating Income –2014Q1 operating income for small firms more than doubled (+115.8%) from 2014Q4’s level while large firms’ operating income increased by 12.3%. Despite the explosive quarter-over-quarter change for small firms, year-over-year operating income expanded by less than 1%. Large firms’ operating income fell by over 8% on a year-over-year basis. The composite results for the industry showed a decline of nearly 5% on a year-over-year basis.
  • Pre-tax Income – 2014Q1 pre-tax income increased by over 140% compared to 2013Q4 for all firms and sizes, nearly three times the median quarter-over-quarter increase between Q4 and Q1 over the past 10 years.
  • Net Income – Despite small firms’ 2014Q1 net income more than quadrupling 2013Q4’s level, year over year net income still fell by nearly 9 percent. Large firms’ quarter-over-quarter performance, a more than 50 percent increase, registered solid positive year-over-year results as well, pulling industry-wide net income high enough to post a year-over-year expansion of 4.4% in net income.
  • Operating Margins – Improved for all firms on a quarter-over-quarter basis but declined for all firms on a year-over-year basis. Despite year-over-year declines, margins were still in the upper 30 percentile compared to the past 10 years, posting an industry average over 8%.
  • ROE and ROA – Despite Return on Equity (ROE) and Return on Assets (ROA) for small firms falling on a quarter-over-quarter their levels remain in upper 15 percentile of the past 10 years of financial performance. Year-over-year performance for the industry as a whole showed improvement, posting 15.42% and 5.76% for ROE and ROA, respectively.



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Second quarter data, which is released the middle of September, will provide important information on either dispelling concerns the peak for this cycle has already been achieved or that recent performance was simply the market grabbing a breath before launching higher still.