Cautious approval for a treeless Fletcher Forests

By PAM GRAHAM

Analysts are initially positive about the shape of Fletcher Challenge Forests without its trees, but the jury is out on whether its share price will perform.

Fletcher Forests plans to change its name and expand processing and distribution assets after selling forests by the end of the year.

It hopes stopping "farming" in favour of "adding value" will find favour with investors, ensuring a share price that better reflects the book value of underlying assets.

The exercise raises the profile of the "leftover" assets, which analysts are putting more work into valuing.

The plan, which faces a competing proposal, is to return $1 a share to shareholders from the forest sale, leaving assets worth 42c a share.

The share price at $1.22 on Friday was less than the $1.42 because of concerns about execution of the plan and the company's ability to cut overheads to match its new size.

Analysts' reports in the wake of the forest sale news last Monday were generally positive.

"The current share price suggests it is the cheapest operating company in the world," said Arthur Lim, of Macquarie Equities.

He said a pure play processing company was attractive if you assumed there was plenty of wood and no need to own the source of it.

Fletcher breaks its processing assets into the markets it serves, with a North America group that earned $9 million in 2003 and an "Asian and other" group that contributed $20 million.

The assets serving North America are the sawmill and mouldings plant in Taupo, and it is argued having the site targeted at one market is a good business model.

The new company owns 50 per cent of American Wood Mouldings and 33 per cent of Empire. Both are distribution businesses supplying the two largest home-improvement chains in the US.

American Wood Mouldings contributed $14 of earnings in 2003 and Empire $2 million.

The company has said talks about a venture with a Danish furniture-maker are advanced, with the investment required less than $20 million and likely to be in the Taupo area.

Fletcher Forests says the assets left over have a book value of $234 million, or 42c a share.

That is equal to 5.2 times the $45 million the assets earned before interest, tax and depreciation in 2003. The multiple of 5.2 is at the low end of a range of international comparisons.

Lim takes a conservative view of the ability to cut costs, so slashes $6 million off the 2003 ebitda (earnings before interest, taxes, depreciation and amortisation) to get $39 million and ebit of $24 million.

That ebit gives earnings per share of 4.3c and a price-to-earnings ratio at the current share price of 5.3 times. That is cheap. He argues eight to 10 times would be more appropriate.

Weighed against that has to be years of disappointment investors have endured from the sector and whether the separation of forest ownership from processing will change that.

ABN Amro's latest valuation using the method of discounting estimated future cashflows values the combined company at $1.30 a share, again less than the $1.42.

The share price of $1.22 means the market values what is left over at 22c a share. The question is whether the separation will change that.