Disclosure – Non-Independent Marketing Communication
This is a non-independent marketing communication commissioned by Foresight Sustainable Forestry. The report has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is not subject to any prohibition on the dealing ahead of the dissemination of investment research.
Much has been made of the impact Russia’s invasion of Ukraine has had on the hydrocarbons sector. That’s understandable given how dependent many European countries were on the former’s supply of oil and gas.
Less discussed has been a similar trend which has taken place in the timber markets. In the year prior to the invasion, Belarus, Ukraine and Russia accounted for a quarter of the global timber supply, according to industry consulting group Wood Resources International. By comparison, the International Energy Agency estimates Russia supplied about 10% of the world’s oil in the same year.
Sanctions and the fact their production is now labeled as conflict timber, and so cannot be certified by environmental bodies, means timber from Belarus and Russia is now inaccessible to many buyers in the West. For obvious reasons, Ukraine is also unlikely to start exporting meaningful amounts of timber in the near term.
As readers can probably infer, the cutting off of a large proportion of the global supply may help support prices in the timber sector. Unpleasant though the reasons behind these dynamics may be, they arguably build upon a number of trends that were already supporting investors in the UK timber industry, like the Foresight Sustainable Forestry (FSF) investment trust.
FSF launched at the end of 2021 and invests in existing forested land or buys other land which is then turned into forestry, a process known as afforestation. The fund can direct up to 50% of its allocation towards afforestation, balanced out by timber cash flow generation from the established forestry allocation.
The trust generates carbon credits from afforestation sites as well and was the first investment company to receive the Voluntary Carbon Market designation from the London Stock Exchange, a certification which shows the trust’s carbon credits have a high level of oversight and verification.
It also means shareholders have the option to elect to receive the value in cash or as a transfer of carbon units to their UK Land Carbon Registry account such that those units can be used for offsetting the balance of company’s emissions that are otherwise impossible to reduce by other means.
With the current afforestation sites estimated to deliver one million voluntary carbon units and there being an intrinsic value creation opportunity from turning marginal farmland in to more valuable timberland, this provides a compelling upside exposure, revenue diversification and development value opportunity for FSF. Indeed, managers Robert Guest and Richard Kelly often refer to delivering successful afforestation development as the ‘engine room’ of FSF’s total returns strategy.
However, the core of the fund’s investment thesis and a lot of the underlying value of the trust and real returns growth prospects rests on UK, European and global timber supply and demand dynamics, with demand forecasted to significantly and increasingly out-strip the available supply in the future.
In the UK, demand for timber is expected to almost double by 2050, according to industry body Confor. The World Bank estimates global demand is set to rise four-fold over the same period. In such an environment, prices are likely to rise and thus make UK timber more attractive to local buyers.
A large part of that is due to quality control concerns and how forests are managed. Research by Dr Andrew Cameron at the University of Aberdeen published in 2021 found that sustainable forests, of the sort FSF manages, constitute 3% of the world’s forested area but produce a third of the world’s industrial timber.
This is due to more efficient use of land but also the management of harvesting cycles. In simple terms, the manner in which forestry investors like FSF manage their sites mean they produce more timber relative to the area of land the forest sits on and they can then harvest timber more effectively to match demand by managing the time cycles it takes for forests to develop.
In contrast, poorly managed sites produce a much lower level of timber relative to the area of land the forest occupies and often end up being cut down entirely. Suppliers are then unwilling to wait for mature forestry to develop again, so they resort to felling trees in natural or semi-natural forests. As an example of how bad this can get, estimates by the WWF indicate more than 90% of timber sourced from certain parts of Brazil may have been illegally produced.
As Dr Cameron notes, growing demand is likely to compound this problem and make illegal logging worse in emerging markets. Robust quality controls and legal enforcement mean UK forestry is far less likely to be impacted. And with the demand for home-grown, sustainable, higher quality goods increasing among buyers, it’s plausible this will benefit producers like FSF.
These supply and demand factors hint at another key part of the investment case that the FSF managers have made. Timber is an input cost affecting many goods sold, which should – in theory – provide some hedge against inflation.
Of course, reality is more complicated and there isn’t always a clear link between the phenomenon and timber prices. Nonetheless, that Robert and Richard aim to deliver annualised returns of 5% + CPI over rolling 5-year periods indicates the managers believe short-term volatility can be smoothed out over the long run.
Returns for forestry have also displayed little correlation with bonds or equities. Indeed, FSF’s NAV increased by 5% during its first year, even as markets saw massive sell offs and inflation hit double digits. Along with positive share price returns over the same period, that suggests FSF is capable of providing some downside protection to portfolios.
Along with those tailwinds of growing demand for sustainable timber and a shortage of supply, that may appeal to investors looking for some diversification in their portfolio which can act as a source of income and capital growth over the long-term.
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