How to earn dividends from a forest

ForestThe lure of speculating in commodities is a powerful one for many private investors, as my fellow Fool writer Harvey Jones discussed yesterday. However, this is a high-risk activity that often ends in tears.

Today, I'd like to take a look at a more Foolish commodity-based opportunity whose value generally keeps pace with inflation, requires little effort to develop and can be realised early or late, depending on market conditions. That's right -- timber.
Timberland, not timber
Despite its name, Phaunos Timber Fund Ltd invests mostly in forests, or timberland. The business model is pretty simple and is based around managed forestry: the cycle of growing, harvesting and replanting trees. The timber is sold for building and biomass fuel plants.

Guernsey-domiciled Phaunos was only launched in 2006 and has only been fully invested for the last year or so. It has assets worth nearly $600m, composed of a mixture of wholly owned and partially owned forestry and timber companies, 86% of which are in Brazil, Uruguay, East Africa, China and New Zealand.

Forestry income up 70%
Phaunos published its final results today, revealing a mixed picture. On the upside, revenue from timber operations rose by 70% last year to $18.8m, and land and timber values rose by $22m.

The young age of many of Phaunos' assets means that revenues should continue to increase for several more years as more trees reach "merchantable" age and can be harvested and sold.

The majority of Phaunos' timber is sold into fast-growing emerging markets in South America and China, and the company is positioned to benefit from any eventual upturn in the US housing market -- the US is still the world's largest consumer of logs.

Dividends and discounts
The problem for Phaunos investors is that its share price has remained at a large and stubborn discount to its net asset value -- an average of 37% over the last 12 months. It's recently been trading even lower, at a whopping discount of 46.6% to the June 2011 NAV per share of $1.16.

Today's results revealed a second problem. Phaunos made a loss of $9.5m in 2011, resulting in a fall in NAV from $1.16 per share to $1.04 per share. Failure to return to profit this year could raise a question mark over Phaunos' progressive dividend strategy -- one of the means by which it hopes to reduce its discount.

Phaunos paid its first dividend last year and today announced a 25% increase in the dividend for 2011, providing a yield of 4.1% at today's opening price.

There are plenty of companies around whose business is wood products -- timber merchants, paper and packaging companies and so on. There are far fewer choices when it comes to finding investments that track the value of timberland, especially if you want to restrict your search to UK-listed equities.

One alternative to Phaunos is Cambium Global Timberland, another investment trust that is very similar to Phaunos and trades at a substantial to discount to NAV, offering an attractive yield of 5.97%. Unfortunately, its NAV has fallen every year since 2009, suggesting that it faces the same challenges as Phaunos.

Another possibility is the iShares S&P Global Timber & Forestry . This ETF tracks the 24 largest global companies involved in timber-related businesses, but its remit is broad and includes many companies that produce wood products such as paper. The result is that its performance is closely correlated to general equities and it does not provide a very accurate way of tracking the value of timber plantations.

Of course, you might choose to take a different approach and invest in good-quality companies that sell wood products, like Fool favourite James Latham. Just remember that this does not give you exposure to the underlying asset value.

Wood I invest?
Phaunos founder Liane Luke has spent the last 14 years managing timberland investments exclusively and is in overall charge of the company's investments. Assuming she bought decent forests at a fair price, then I believe that Phaunos should eventually turn into a stable, profitable business.

Phaunos is definitely one for the long term but, along with Cambium, it is worth considering if you would like to track the value of timberland assets through equities.

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