When it comes to timber companies, location will be a key driver of profitability in the coming years.

Weyerhaeuser Co (NYSE: WY) is easily the most attractive forestry and wood products company in the US. For this storied company, founded in 1900, making money from advantageously situated US timberland is in the grain.

The company operates in four basic units: wood products, cellulose fibers, timberlands and real estate.

The wood products division, which generates about 40 percent of revenue, produces and markets joists used as structural supports, oriented strand board used in walls and floors, and lumber that’s found at any do-it-yourself or hardware store.

Last year, Weyerhaeuser generated $3.1 billion in sales, helping lift the company’s earnings for the first time in three years. The improved performance stemmed from the strengthening construction business in the US. Nearly three-quarters of the company’s production is used in residential construction, with only about 5 percent of its wood products for export.

Making products that are used in everything from toothpaste and newspapers to diapers and bandages, Weyerhaeuser’s cellulose fibers operation generated 24 percent of the company’s revenue. Given the ubiquity of cellulose fibers, this business provides buoyancy to the company’s earnings, even in down cycles, and is typically one of its strongest performers in terms of growth.

While about a third of the cellulose fiber the company produces is consumed in North America, 27 percent was ultimately sold into the ex-Japan Asian market, i.e. China. Another 16 percent went to Japan and 12 percent to Europe, with the remainder sold to other emerging markets.

A major driver of the growth in the fiber division is Weyerhaeuser’s innovation in developing proprietary varieties of fibers, helping to shield it from the extremely competitive nature of the cellulose fiber market. With relatively low barriers to entry, the pulp market sees a fairly steady flow of newcomers, particularly when prices are as high as they are now.

As one of the top 20 homebuilders in the US, the company’s real estate division generated about 14 percent of revenue last year.

The company operates primarily on the West Coast, with smaller presences in Texas, Maryland and Virginia. During bust times, real estate is a serious drag on profits. But with home sales on the rise and the pace of construction picking up, this division should make a positive contribution to profits and perhaps even grow over the next few years.

We’re most interested in its timberlands, though, which typically account for about a quarter of revenues.

The company controls about 6 million acres of timber forest, with about a third of its holdings located in the extremely productive Pacific Northwest region of the US, which primarily produces Douglas fir. The remaining two-thirds mostly consist of pine producing forests in the Southern US, with about 300,000 acres of pine and eucalyptus property in Uruguay.

The Pacific Northwest is the most productive timberland in the US, thanks to its cool, damp climate and typically abundant rainfall. The Douglas fir that dominates the region is also a much higher value wood than the pine typically harvested in other parts of the country.

The fact that it’s the largest timber producer in the Pacific Northwest makes Weyerhaeuser extremely attractive, because the company’s location gives it easy export access to China. This location also leaves it well placed to pick up the supply slack created by lower production caps in Canada, which is typically a key Chinese supplier.

While Weyerhaeuser’s export business currently only generates about 5 percent of revenues, this percentage will increase in the coming years, as Chinese log imports jump an expected 70 percent over the next three years.
Already generating about $80 per acre in annual earnings, the company’s acreage will continue to boost earnings, as global lumber prices catch up with those in the US.

Weyerhaeuser was hard hit during the 2007-2009 recession. During this period, the company’s earnings plummeted and its share price fell from a high of about $60 to a low of $19. Since then, it has given itself a complete makeover, unloading its paper and corrugated packaging businesses and converting itself into a real estate investment trust in 2010.

That transformation has dramatically improved the company’s performance and efficiency, speeding its return to post-recession profitability.

The sale of the company’s underperforming units raised enough cash to allow it to radically reduce its debt load, taking its debt-to-equity ratio down to just 1. With a much lower and still falling level of debt, Weyerhaeuser has plenty of room to increase its divided—currently 68 cents per year for a yield of 2.1 percent—as the US construction market recovers and Asian log demand grows.

Weyerhaeuser’s payouts will likely rise faster than most of its competitors, because of its high level of vertical integration and its control of prime-quality producing forests. The company also enjoys the advantage of processing its own products and using some of that production for its own building activities. As a result, it has a much tighter grip on costs than its industry peers.

With substantial upside potential despite the high price of US timber, Weyerhaeuser Co is a buy under 40.