Money: Five steps to success in Forestry

By Philip MacAlister

The Asian economic crisis has been like a chilling winter for the forestry investment sector, but there are signs the first blush of spring is here.

When Asia's so-called tiger economies went into a tailspin two years ago, forestry, one of this country's biggest export sectors, suffered badly, as did all manner of forestry investment offerings. For most of this time the capital raisers lay dormant, waiting to sprout again.

Now that export log prices are back to where they were before the crisis, forestry promoters are busy advertising on television and in the papers for investors to buy their own forest.
The pitch is always appealing, the numbers look great, but just how good is a forestry investment?

Listed vehicle Nuhaka Forestry Fund, which owns a 2000 ha forest 40km south of Gisborne, provides an example of what forestry can do for you - but it also illustrates some of the potential traps.

It is important to remember that Nuhaka is a reasonably unique structure for investing in forestry, and there are other ways of doing it, including buying, managing and owning your own estate, investing in a listed forestry company such as Fletcher Forests or Evergreen, or buying into a partnership such as those being offered by the likes of Forest Enterprises, Greenplan and Roger Dickie.

Like the trees, themselves each one has individual characteristics and traits.

Nuhaka is a group investment fund that was established in 1974. Its defining characteristics are that it is listed on the stock exchange and it is a group investment fund run under a trust structure, as opposed to a company.

Earlier this month Nuhaka's manager and trustee, Perpetual Trust, announced that it was about to begin a 10-year harvesting programme, which means unitholders will finally receive the fruits of their investment.
Perpetual Trust general manager private client services Ian Taylor says Nuhaka is the first public forestry scheme "of any note" to be harvested.

What did Nuhaka promise 25 years ago, and how did it do?
The original prospectus for the fund outlines two objectives, namely:

* To provide "high capital gain potential as a means of offsetting the effects of inflation on savings".

* To provide an investment which "emphasises long-term appreciation or postponed income while preserving negotiability through stock exchange listing."

If you bought into the fund in 1974 you would have paid $1.02 a unit (the 2c was for brokerage) and each of your shares could now be sold on the sharemarket for $12.40, a $1.06 discount to their net asset backing. On the face of it then the investment looks to have been quite good - at least it has been a positive return.

However, there have been some important lessons which anybody thinking about investing in a start-up forest should consider.

Lesson One


Don't buy for tax reasons.

One of the main reasons Nuhaka was established was to take advantage of the Government's Forest Establishment Grant scheme that was designed as an incentive to plant trees on the East Coast.

The Government of the day was prepared to give annual grants of up to 50 per cent of approved establishment costs. In effect this was, as the prospectus said, "a tax remission in advance and breaks down the effect of accumulating costs over a very long period."

Such an offer is a major windfall for something like forestry, as there are significant establishment expenses in the first eight or so. After that investors have to wait about 20 years until income from harvesting starts. The longer this waiting period is the bigger the costs become.

In Nuhaka's case the Government abandoned the grant scheme soon after the fund was started and it had to find money from elsewhere to help pay for establishment.
The lesson here is simple, salient and applies to all investments - not just forestry.

Lesson two


Take projected returns with a pinch of salt.

The bulk of investments that are offered to the public are sold on projected returns, with the public believing the bigger the better.

Rule number one of investing, though, is that the higher the projected return the bigger the risk.

With something as long-term as forestry the chances of accurately predicting the final outcome are about the same as picking Wellington to be in the NPC rugby finals at the start of the season.

Nuhaka originally projected that the fund would, at harvest, produce a compound earning rate of 14.5 per cent per annum. That is each $1 invested would grow into $28.44.

Its performance has been far less spectacular. The current share price of the fund is $12.40 (compared with a net asset backing of $13.46).

According to Forest Research economist Gerard Horgan, this equates to a real return of about 2 per cent per annum over the past 25 years.

Lesson three


Liquidity is priceless (and worth having).

Liquidity, that is the ability to buy and sell shares easily, is where investors have had a good strike rate with Nuhaka. For instance because the fund has been tradable there have been several opportunities to make handsome returns (or conversely make a loss).

Nuhaka's first 17 years were pretty mundane with the share price rising ever-so gradually from $1 to about $3. The following three years were a bit like puberty when the now-infamous Asian log-price spike drove the value of the shares from $3 each to nearly $18.
From that all-time high in mid-1994 Nuhaka's share price has consistently fallen to a low of $9. From this point the price has risen by more than a third to its present mark of $12.40.

Mr Horgan says this shows "that there are better times to get in and get out."

You could have got out at $16 four years ago and made a better profit than sticking with the fund, he says.
Equally, if you bought into the fund in 1998 at the bottom of its trough you would have struck good returns.
People who buy into the partnerships generally have to stay in for the duration to get the best returns, yet the market for these funds is shallow, and holdings are rarely traded.

Lesson four


Price prediction is pointless.

Nuhaka's share price is useful example of how the forestry sector is highly cyclical and external forces can buffet companies.

Also, it shows that timing of the harvest is also crucial to the outcome of the investment. All greenfields forestry investments speculate about what the value of logs will be two and a half decades later.

Mr Taylor says Nuhaka originally promised a 14.8 per cent internal rate of returns, but the reality is that unitholders who have done the distance will end up with a return of between 9 per cent and 10 per cent.

Lesson five


Expect the unexpected.

One of the challenges of maximising returns in a forestry investment is picking when to harvest the trees. The beauty of such an investment is that once the trees reach a minimum harvest age of about 25, they can be cut down and sold at any point in the future when the manager deems the price is right.

Nuhaka started to prepare for harvest several years ago and raised a loan of $1.5 million to pay for the necessary roading infrastructure, however these plans were put on hold when the Asian crisis struck. As a result, the fund has been paying interest (more than $110,000 in the 12 months to March 31) on the loan.
Mr Horgan suggests the fund "could have done a bit better" if it had sold the trees when the prices were higher. "You only get one chance of getting it right."
Whether the fund makes a "high capital gain" as promised won't be known until the last tree is felled and Nuhaka is wound up.