Hancock Timberland Investor

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1 Hancock Timberland Investor Hancock Timber Resource Group Fourth Quarter 2 US levies 29 percent import duty on softwood lumber from Canada: what is the impact on timberland investors? The U.S. Department of Commerce has alleged that Canadian provincial governments subsidize Canadian lumber manufacturers via excessively low charges for public timber and through restrictions on the export of logs across provincial borders. On March 21, 22 the Department announced its intention to levy a 29 percent duty on softwood lumber shipped from Canada to offset these alleged subsidies. In the short run, these duties should drive up lumber prices in the United States. In turn, higher lumber prices should result in higher timber prices. While the precise magnitude and duration of the impact is difficult to estimate, this is a positive development for U.S. timberland investors. The Issue Softwood lumber is the single most important product manufactured from softwood timber by volume, about 51 percent of all softwood harvests in the United States contribute to this product. Because sawlogs comprise the most valuable portion of the tree, the share by value is far higher. Canada now supplies about one third of the United State s demand for softwood lumber.as a consequence, the economics of this source of supply has a strong effect on the value of softwood timber and timberland in the United States. Canada-U.S. trade in softwood lumber comprises the single largest forest products trade flow in the world, but, despite the long and important history, cross-border trade has not been without controversy. Specifically, U.S. sawmillers allege that most Canadian producers are subsidized through two mechanisms. In the first place, public or Crown lands in Canada comprise the vast majority of timber supply in the key lumber producing provinces of Quebec, Ontario,Alberta and British Columbia. In these provinces, governments set the cost of timber, known as stumpage, on the basis of administrative calculations rather than on pure market-based transactions. In the second place, many of these provinces restrict the export of logs (even between provinces), and it is argued that these restrictions lower the cost of logs to lumber producers in those provinces. We believe the former argument about subsidy is without merit, and the latter is important only in certain locations (e.g. the B.C. Coast). Nevertheless, U.S. trade laws permit U.S. producers to petition the Department of Commerce to impose countervailing duties and antidumping regulations to offset these alleged subsidies. The most recent round of this ongoing dispute came to a tentative conclusion on March 21, 22 when the U.S. Department of Commerce issued its Issues and Decision Memorandum related to its investigation into the merits of the U.S. case against Canada. In this decision, the Department levied a countervailing duty of percent along with anti-dumping duties ranging from 2.26 percent to percent for specific companies, with an all others rate of 9.67 percent. Henceforth, softwood lumber shipped from Canada into the United States will carry an ad continued on page 2 Hancock Timber Resource Group High Street, Boston, MA

2 US levies 29 percent import duty on softwood lumber from Canada continued valorem import duty of 29. percent (with some variation among companies due to variations in the anti-dumping duty). The U.S. International Trade Commission reviews the Department of Commerce decision on May 6, and, if they agree with the findings, the results become binding. Canada may appeal this decision to the WTO but the appeal process is lengthy (one to two years), and these tariffs would stay in place pending WTO review. It is also possible that some other solution to the U.S. claims might be negotiated at any point during this period. General Economic Effects The disputes over softwood lumber exports from Canada into the United States are longstanding, and some form of managed trade has been in place for most of the past 2 years (indeed, the current dispute is known in the Department of Commerce as Lumber IV ).As a result, a considerable body of economic research has developed around the issue, and the impacts of various trade measures are well understood. There are four general impacts of an import duty on Canadian softwood lumber: ❶ the price of lumber in U.S. markets rises, but by less than the amount of the duty because consumers use less lumber when prices are higher, ❷ the price of lumber in the Canadian market falls as Canadian suppliers shift volume out of the United States and into Canada, ❸ profits to U.S. producers rise since they enjoy higher production levels and higher output prices. The increase in profits is less than the amount of the duty because some of the increase in lumber prices is transmitted into higher timber prices, and ❹ U.S. timber prices rise as a result of higher lumber prices and expanded U.S. lumber production. These adjustments also give rise to a host of secondary adjustments. For example, higher lumber prices in the United States encourage an increase in non-canadian imports these have increased 35 percent to 1.4 bbf since 16, the date the last trade dispute was resolved through the imposition of a quota on lumber imports from Canada.The remanufacturing (wood furniture, doors, windows, etc.) industry will move across the border to enjoy lower Canadian lumber prices, but much of their (duty-free) output will be shipped back across the border.the value of Canadian logs that can be exported into the United States will increase. Higher lumber prices will encourage substitutes wooden I- beams for large dimension lumber; steel studs for wooden studs. Over time, one would expect these adjustments to mitigate the advantages for U.S. producers and erode the positive effects of the duty on U.S. timber prices, but all of them take time. Quantitative Impact on Timberland Investors Given the complexity of the market adjustments to the imposition of the lumber duty, it is difficult (perhaps foolhardy) to estimate the implications for timberland investors. But, here we go. In the short run, the main impact of the duty will be to make Canada, especially the higher-cost mills in British Columbia, the marginal supplier to the North American lumber market. Short-run lumber demand is inelastic, so most of the duty will be passed on to consumers in the form of higher prices. By assuming full pass through, we can estimate the maximum possible impact on timber prices. Spruce-Pine-Fir lumber (the kind of lumber that most of Canada produces) currently trades at about $3/mbf.The duty would therefore add about $/mbf of cost to Canadian lumber supplied to the United States. Pre-duty production costs in British Columbia were about $5/mbf below those in the US Inland West, the pre-duty marginal supplier (RISI 22). If all the increase in marginal production costs was transmitted to lumber prices, they would increase by $4/mbf (see chart on page 6). Applying a lumber recovery rate of 1.57 per mbf for southern pine lumber producers, the maximum impact on southern timber prices would be about $9 per ton. continued on page 6 2 Hancock Timberland Investor Fourth Quarter 2

3 Quarterly Average Regional Composite Prices: Softwood Sawtimber Stumpage US$ per MBF $1, Pacific Northwest Export Pacific Northwest Domestic $8 Northeast New Zealand Export $6 $4 $2 $ Sources: Log Lines, Timber Mart-, New Zealand Ministry of Forestry and HTRG analysis Figure 1. Regional Softwood Sawtimber Stumpage Prices Softwood sawtimber prices fell again fourth quarter, ending the year at levels not seen since the early 1s. In the Pacific Northwest, export prices were especially soft, falling 21 percent over prices last year.a similar story for New Zealand export sawtimber dropping 3 percent from last quarter s level, and down 34 percent over last year. Weak demand in Japan combined with the strong US dollar continues to keep prices down. Domestic sawtimber prices remain soft, despite healthy domestic demand for housing. Lumber supply from Canada, Europe, Australasia and America have remained strong, holding domestic lumber prices and in turn, timber prices, down. Quarterly Average Regional Composite Prices: Softwood Pulpwood Stumpage Per Ton $4 $35 $3 $25 $2 Pacific Northwest Northeast Sources: Log Lines, Timber Mart- and HTRG analysis Figure 2. Regional Softwood Pulpwood Stumpage Prices Pulp prices in the Northeast and Pacific Northwest fell hard fourth quarter, with annual average drops of 17 and 53 percent respectively. ern pine pulpwood prices also moved down albeit more softly, with a 3 percent decline over last quarter. $15 $1 $5 $ Regional Timberland Values Per Acre $2,5 Figure 3. Timberland Prices $2, $1,5 $1, $5 $ 87 Source: NCREIF Pacific Northwest Northeast The anticipated drop in timberland values owing to lumber and timber price declines in 2 was realized fourth quarter as timberland values fell in all regions compared to year-ago levels.values dropped 3.7 percent in the Northeast, 1.7 percent in the and just under 1. percent in the Pacific Northwest. It should be noted that most properties in the NCREIF Timberland Index are appraised at year-end as opposed to during the year, making fourth quarter values the most robust measure for the year. Hancock Timberland Investor Fourth Quarter 2 3

4 Timberland Enterprise Value per ern Equivalent Acre Per Acre $1,2 $1, $8 $6 $4 NCREIF ern Timberland Index Timberland Enterprise Value/ ern Equivalent Acre Figure 4. Public Market Timberland Value In the wake of its merger with The Timber Company, Plum Creek dominates our estimate of public market timberland valuation. Its strong yield-driven valuation and favorable tax treatment have buoyed the TEV/SEA index. Private timberland has been trending downward, as asset values adjust to lower lumber and timber markets, and as it did in the mid-1s, Plum Creek may narrow the valuation gap between private and public timberland markets. $2 Sources: NCREIF and HTRG analysis $ EBITDDA Multiples for Privately Traded Timberland Northeast Pacific Northwest Figure 5. Timberland Pricing Multiples ern timberland pricing multiples continued upward fourth quarter. ern timberland managers may be deferring timber harvests in anticipation of a rebound in prices.this decreases current EBITDDA levels and increases the multiple. Price to earnings ratios in the Pacific Northwest and Northeast fell as expected fourth quarter, as timberland values fell in these regions. Sources: NCREIF and HTRG analysis Timberland Investment Performance Indexed: 1(1)= NCREIF Pacific Northwest NCREIF All-Region S&P 5 Index NCREIF NCREIF Northeast S&P Forest Products Index T-Bill Figure 6. Timberland Returns (1-2) Public equity traditionally responds quickly to general economic conditions and the rising expectations for economic recovery fueled equity markets fourth quarter. The S&P 5 Index returned just over 1 percent fourth quarter, almost fully recovering from third quarter losses Sources: NCREIF, Ibbotson and HTRG analysis 4 Hancock Timberland Investor Fourth Quarter 2

5 Timberland Investment Performance Indexed: 14(1)=1 2.5 NCREIF All-Region S&P Forest Products Index Securitized Timberland Figure 7. Timberland Returns (14-2) The S&P Forest Products Index shadowed the performance of our Securitized Index expectations of an economic recovery in the first half of 22 and warm weather in the fourth quarter spurred the housing market and strengthened lumber markets.. 1. Sources: NCREIF, Ibbotson and HTRG analysis.5 Securitized Timberland Performance Indexed: 14(1)= Deltic Crown Pacific Plum Creek U.S. Timberlands The Timber Company Source: HTRG analysis Index 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ 3/1/ 6/1/ 9/1/ 12/1/ Figure 8. Hancock Securitized Timberland Index As with the TEV/SEA index, the Hancock Securitized Timber Index is now dominated by Plum Creek, post its merger with The Timber Company. Plum Creek s gains following the merger pulled the HSTI up for the quarter, and Deltic Timber continued its good performance.these two companies now comprise more than percent of the Index on a market capitalization-weighted basis. U.S. Timberlands and Crown Pacific struggled as the market remained uncertain about their fate. Crown Pacific has sold timberlands and closed lumber mills to reduce its debt load, while U.S.Timberlands continues to search for alternatives to its current structure. Hancock Timberland Investor Fourth Quarter 2 5

6 US levies 29 percent import duty on softwood lumber from Canada continued It is unrealistic to expect that this full value would be passed back to timber because: lumber consumption will decline in the face of higher lumber prices, adjustments discussed earlier. But, for a period of time, the softwood lumber duty should have a positive impact on timber values and timberland returns. Literature Cited: Resource Information Systems Inc. (RISI). March 22. AgFirst Forest Products Seminar.Atlanta, Georgia. higher-cost sawmills will enter the market, and loggers will move to more distant and difficult sites to obtain the additional timber. All of these adjustments capture some of the value that would otherwise go to landowners. Nevertheless, with southern pine sawtimber stumpage currently trading at about $4 per ton, if even half the potential value flowed back to the stump the impact for timberland owners could be significant. Over time we expect that this benefit will be eroded by the market North American Softwood Lumber Average Variable Costs (Del. to Chicago, 2 $US/MBF) Costs $35 $32 $3 $28 $25 $2 $15 $1 $5 Sources: RISI % U.S. Canada East 1% Pre-Duty Cost Post-Duty Cost 2% 3% U.S. West Coast British Columbia 4% U.S. Inland West 5% Canada East U.S. 6% Percent of Total Supply 7% British Columbia 8% Short-term Demand U.S. West Coast % U.S. Inland West 1% Research Team Clark S. Binkley, Ph.D. Chief Investment Officer cbinkley@hnrg.com Courtland L. Washburn, Ph.D. Director of Economic Research & Investment Strategy cwashburn@hnrg.com Mary Ellen Aronow Forest Economist maronow@hnrg.com Timothy Fritzinger Financial Analyst tfritzinger@hnrg.com Hancock Timber Resource Group is a division of Hancock Natural Resource Group, Inc., a registered investment adviser and wholly owned subsidiary of John Hancock Financial Services, Inc. 22 Hancock Natural Resource Group, Inc. NOTES: Figure 1. The composite price for southern sawtimber is based on quarterly average Timber Mart- published prices for pine sawtimber and chip-n-saw stumpage. Pacific Northwest prices are derived from quarterly average Log Lines published prices for whitewoods and Douglas-fir with internal analysis of logging costs for stumpage calculations. New Zealand export prices are based on New Zealand Ministry of Forestry quarterly average published prices for Radiata unpruned A, J and K sort export logs with internal analysis of logging costs for stumpage calculations. Northeast sawtimber prices are calculated from internal analysis. Figure 2. Pulpwood composite prices are derived from quarterly average Timber Mart- published prices for southern pine pulp wood stumpage, Log Lines published whitewood and Douglas-fir pulp logs with internal analysis of logging costs for the Pacific Northwest, and HTRG analysis of Spruce/Fir pulpwood in the Northeast. Figure 3. Regional NCREIF timberland market value per acre is derived by dividing the total regional market value at quarter end by the number of acres reported in that region. Due to the small sample of property in the Pacific Northwest in 17 and 17 Q2, these values were back cast from 17 Q3 with quarter-end appreciation returns. Market values for Northeast timberland were re-estimated for the period 19Q4 through 19Q3 to adjust for what we believe to be an anomalous property included in the NCREIF database during those quarters. Figure 4. Timberland Enterprise Value per ern Equivalent Acre (TEV/SEA) for five timber-intensive publicly traded companies compared to southern timberland values per acre calculated from the NCREIF database. TEV is a quarterly estimate based on total enterprise value (total market equity + book value debt) less estimated value of processing facilities, other non-timber assets and non-enterprise working capital. SEA uses regional NCREIF $/acre values to translate a company s timberland holdings in various regions to the area of southern timberland that would have an equivalent market value. Figure 5. EBITDDA multiples are calculated using NCREIF timberland value per acre at quarter end divided by a trailing four-quarter average NCREIF net income per acre. Figure 6. Total quarter-end returns to timberland based on the NCREIF database. Northeast returns prior to 14 are based on the John Hancock Timber Index. Additional adjustments were made to return calculations in the Northeast for the period 19 Q4 through 19Q3 to adjust for what we believe to be an anomalous property included in the NCREIF database during those quarters. This re-calculation in the Northeast results in a re-calculated All-Region NCREIF return series during the same period. Ibbotson Assoc. database was used for S&P 5, U.S. T-Bill and S&P Forest Products quarter-end returns (dividends reinvested). Figure 7. Total quarter-end returns to securitized timberland based on internal analysis. The Securitized Timberland Index includes Plum Creek (PCL), Crown Pacific (CRO), U.S. Timberlands (TIMBZ), Deltic (DEL) and The Timber Company (TGP) (dividends reinvested). Figure 8. The Hancock Securitized Timberland Index (HSTI) uses a base-weighted aggregate methodology (similar to that used to construct the S&P 5) to calculate a market capitalization-weighted value for five publicly traded timber-intensive forest products companies. Base weights were readjusted for the emergence of new companies or at the beginning of each year. Dividends are not reinvested. The companies included in the HSTI have no investment relationship with the Hancock Timber Resource Group. References to expected investment performance in this newsletter are based on historical information and are based on management's projections. Potential for profit as well as for loss exists. 6 Hancock Timber Resource Group High Street, Boston, MA