Growing Money on Trees

12/02/2009 9:29 am EST


Ryan Irvine


Top Chinese timber producer Sino-Forest has lots of room for expansion, writes Ryan Irvine in KeyStone's Small-Cap Stock Report.

Sino-Forest Corp. (TSX: TRE) is a Canadian-listed, commercial forestry plantation operator located in the People’s Republic of China. As of June 30, 2009, [it] had 434,000 hectares of trees under management and over 900,000 hectares of trees available to be acquired under five long-term master agreements. The company’s principal businesses include the ownership and management of forestry plantation trees, the sale of standing timber and wood logs, and complementary manufacturing of downstream engi­neered wood products.

We were pleased with Sino-Forest's third quarter numbers, which met or slightly bested Street esti­mates. Management remains optimistic about the outlook [for] China’s forestry sector and demand for wood fibre due to the posi­tive effects of China’s stimulus plan, which called for further infrastructure development, rebuilding of Sichuan [after last year’s earthquake], and building of low-income housing for rural areas.

Log prices have rebounded since [the beginning of the year] and again showed a gradual, steady recovery [during the third quarter]; however, management continues to anticipate that prices will not reach the overall 2008 levels until the end of 2009. It appears the company is well-positioned to benefit from the central government’s goal of doubling fast-growing, high-yield plantations to 13 million hectares by 2015.

Overall, Sino-Forest reported another strong quarter despite weak prices in most commodities, including logs, during the global economic downturn. The company has sustained its track record of produc­ing growing, profitable financial results due to the positive effects of China’s economic growth and its flexible business model, which allows the company to sell wood fibre either as standing timber or as harvested logs. When log prices are relatively weak, management can defer the sale of harvested logs in favor of the sale of standing timber, which has been generating consistently attractive gross margins per cubic meter.

While it is an industry leader in commercial forest plantations, Sino-Forest only has a 5% market share in China. This leaves the company with strong opportunities for growth long term. With the stock now [above $18], on a valuation basis, Sino-Forest is no longer as cheap as it was at the $8.80 level on our January recommendation, but with a trailing [price/earnings ratio] of around 13.19x and a forward-looking [P/E] in the range of 11.71x, it is not exactly expensive, [either].

Despite the recent rally and return of confidence in the markets, we believe the markets broadly have gotten ahead of themselves and are due for a period of consolidation or correction. As such, we maintain our near-term rating [of] “Hold” on Sino-Forest [for the short term]. We believe in Sino-Forest long term and continue to rank the company as a buy, as it is an excellent way to play the long-term infra­structure boom in the Chinese market. We believe that [in] three to five years, its shares [could] be significantly higher than where they are today.

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