Profitability and Risk Sources in Global Timberland Investments

Profitability and Risk Sources in Global Timberland Investments

Researchers from two forestry consultancy companies and two universities established a cooperation to analyze the profitability and risk sources in global timberland investments. Authors of recently published scientific paper in the Journal of Forest Policy and Economics have examined what are the main factors that influence internal rates of returns (IRRs) in several global timber plantation investment opportunities. In this blog post, Karolina Chudy, MBA a co-author of the study shares with us the main finding of this research and discusses its practical implications.

Are timberland investments worth the risk?

Timberland investments offer competitive returns, inflation hedging and low correlation to other asset classes. Nevertheless, timberland investments, like other real assets, are also exposed to various sources of risk, such as material and environmental risk, timberland supply/demand and fluctuation of land and timber prices. These potential risks could lead to undesirable results if not accounted carefully by the timberland investors. To address these challenges Dr. Rafał and Karolina Chudy from Forest Business Analytics (Poland), Dr. Bruno Kanieski da Silva and Professor Frederick Cubbage from North Carolina State University (USA), Professor Rafael Rubilar from the University of Concepción (Chile) and Roger Lord from Mason, Bruce & Girard forest consultancy company (USA), investigated the risk/return profile of selected global timberland investments. In this blog post, Karolina Chudy, MBA shares with us the main finding of this research and discusses its practical implications.

Karolina Chudy – CEO and Founder of Forest Business Analytics said:

“Usually public think of timberland investments as being relatively risky because of hazards such as wildfire, insects, and disease. If we look historically, losses occurring from natural events are quite low in well-managed forests compared to unmanaged ones. Moreover, effectively de-risked investments in forestry are also done through insurance. On the other hand, some investors consider forestry investments as ones that even reduce risk in the context of diversified investment portfolio since returns on timberland investments tend to run counter to the returns realized through many other types of investments, or at least uncorrelated with stocks.”

She added:

“If you invest in something, by knowing what challenges might lie ahead and how you can be prepared, makes the risk worthwhile.  In such cases, we may talk about managed risk. Thus, in our study, we performed an independent research on timberland investment risks using a consistent approach of Monte Carlo simulation with variation in all the input costs and for timber prices, for various countries, regions, and species combinations throughout the world: loblolly pine in the U.S. Atlantic coastal plain; Douglas-fir plantations in the western U.S.; loblolly pine and eucalyptus plantations in Brazil; radiata pine and eucalyptus plantations in Chile; and pine and oak stands in Poland.”

Main Risks of Investing in Timberland

„Our results have shown that excluding the price of land, biological growth and timber prices were the most influential variables that impacted the IRRs across global timberland investments. In addition, we identified some country-specific factors, such as planting costs (Chile) and management costs (Poland and the U.S.), which should be carefully considered during the investment process – said Karolina Chudy.

Risk and return relationships for global timberland investment opportunities

Authors of the study prepared a figure where risk and return relationships for selected global timberland investment opportunities were marked (figure below).

“First of all, we found that no timberland investment opportunity was located in the IV quadrant, meaning that for a certain level of risk, the investigated timberland investments do not have IRRs of less than 8%. With such level of risk, it may be expected that timberland investments may provide between 8 and 13%, not including land costs, and are mostly focused on investments in eucalyptus plantations in Brazil and Chile. Nevertheless, returns at such levels may be achieved with lower risk if investors decide to invest in pine plantations in Brazil or Chile instead. We also found that for investors who are more risk averse, the returns up to around 8% are possible in the U.S. Pacific Northwest and the U.S. South” – said Karolina Chudy.

She also commented on the results for Poland:

If timberland investments in Poland were an investable alternative, which is not the case so far due to state-owned forestry sector, any investments in oak and pine stands are not recommended yet, given that for the same level of risk, better returns may be achieved in Douglas-fir plantations in the U.S. PNW. However, I think that the situation may significantly change if a smarter approach to cost reduction, especially management costs, were considered. Also, we shouldn’t forget that although results from investments in Poland have shown poor returns, but they presented one of the lowest risks in the same time.”

Take away message

Authors noted that the incorporation of risk components into deterministic discounted cash flow models should assist investors to better understand the risk factors behind the investments. Thus, investors may know what expected returns might be if values of specific factors turn out not to be as assumed at the beginning of the investment, and may know where they should focus in order to improve potential financial results. Based on such knowledge, the management strategies leading to increases in revenues and decreases in costs may be analyzed and introduced into the practice.

Source: R.P. Chudy, K.A. Chudy, B. Kanieski da Silva, F.W. Cubbage, R. Rubilar, R. Lord. Profitability and Risk Sources in Global Timberland Investments. Forest Policy and Economics, Volume 111, February 2020.

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Karolina Chudy – is the Chief Executive Officer at the Forest Business Analytics (FBA), focusing on the supervision of the projects related to timberland investments and forest products markets. Karolina is also responsible for the implementation of comprehensive client service plans for existing and future clients. Before joining FBA, Karolina worked as a data visualization specialist at the European Commission – Joint Research Centre, where she analyzed massive data sets in Tableau software to provide strategic insights. She holds a Bachelor’s Degree in Analysis and Business Administration from the University of Lodz, a Bachelor Degree in International Business from Østfold University College in Norway and a double International Master of Business Administration Degree (IMBA) at EAE Business School and University of Rey Juan Carlos in Madrid, Spain. Karolina also has accomplished the Fundamentals of Alternative Investments program organized by the Chartered Alternative Investment Analyst (CAIA) Association.