If there were any residual perceptions about Potlatch Corp. being a wood-products company in a REITs clothing, CEO Michael Covey has been felling them like mature stands of western larch left too long in the asset column.


Covey, who took the reins of the Spokane-based real estate investment trust in early 2006, has become increasingly clear in his message that Potlatchs core focus now is its land and timber resources, and that, while it will continue to push for profitability in its manufacturing divisions, those operations are not the direction in which the company expects to expand in the future.


Timberland had been seen as a tag-along, said Covey at the Global Paper & Forest Products conference in New York in September. Now its seen as the most valuable asset.


He reiterated that in a brief telephone interview late last week, saying, Weve been very clear about that. Were not going to go out and build another paperboard mill.


Potlatch became a REIT in 2006, after years of talk both inside and outside the now 104-year-old company about the need to translate into greater shareholder value the vast timberlands it owns. Under a REIT, income related to timber and real estate sales generally isnt subject to corporate tax. Potlatch shifted its far-flung manufacturing operations, which produce lumber, plywood, particle board, pulp, paperboard, and tissue products, into a taxable subsidiary of the REIT.


Since then, Covey, who is chairman, president, and CEO, has been reinventing the company. While in the past Potlatch was characterized almost entirely by the products it made, today its emphasis is more on the timber from which those products come, and the land upon which the timber grows.


In September, Potlatch announced plans to acquire 179,000 acres of timberland in central Idaho for about $215 million. While the company sees the land as valuable for its timber, the property is situated in the heart of a high-end recreational corridor, and Potlatch plans to study how much of it might bring far greater returns if sold off for second homes and resorts.


Late last month, the company said it was on track to reach its goal of selling 15,000 to 20,000 acres of other land it has identified as nonstrategic to its timber business. Long term, Potlatch expects to sell off 250,000 to 300,000 acres of its timberlands, which now total about 1.7 million acres in Idaho, Minnesota, Wisconsin, and Arkansas.


Potlatch also is boosting harvest levels. Covey says the company hasnt been aggressive enough about doing that, adding that in Idaho, some of Potlatchs standing timber is 70 to 80 years old, and from a financial standpoint, it should have been harvested at 50 to 60 years. Meanwhile, though, the company sees sustainable forestry as a profit center, and is starting to get premium prices for some of the logs and finished goods it sells that it can call green products thanks to certifications it has earned from the international Forest Stewardship Council and others.


Though the REITs emphasis now clearly is on its timberlands, Potlatchs manufacturing divisions have been producing heady cash flow, and the company invested about $40 million last year into its mills and plants to keep them competitive.


The companys third-quarter earnings report, issued late last month, partly reflects the strength of its mills. Potlatch posted net income of $41 million, or $1.04 per diluted share, compared with $25.7 million, or 66 cents a share, in the year-earlier quarter.


Its pulp and paperboard division had a very strong quarter, with high operating rates and improved global competitiveness due to the weak U.S. dollar. Also strong, despite rising pulp prices, was its tissue business, which posted record finished-goods sales. Even its wood-products division, which faced a slump in the housing market and poor lumber prices, generated black ink by focusing on niche markets, including cedar decking and siding.


During the first nine months of this year, the company had revenue of about $1.24 billion, compared with revenue of $1.21 billion in the year-earlier period. The company employs about 3,800 people.


ManufacturingPotlatch operates 13 manufacturing facilities, located in Idaho, Nevada, Minnesota, Wisconsin, and Arkansas.


Though its wood-products division, which makes lumber and panel products at eight mills scattered among those states, has the capacity to produce about 1 billion board feet of lumber and 230 million square feet of panel products each year, the company isnt considered a significant producer in those markets. Potlatch says its able to compete at its relatively small size because of its efficiency and ability to get raw materials in the regions where it operates mills. Its closest mills to Spokane are in Post Falls, St. Maries, and Lewiston, Idaho.


In contrast, Potlatch is a significant U.S. producer of bleached paperboard, which is used primarily for packaging. The company says it has about 12 percent of the U.S. capacity for producing bleached paperboard, with its plants in Lewiston and in Cypress Bend, Ark. Its pulp and paperboard division also produces and sells bleached software pulp for use in making a host of paper products, but is not a major U.S. pulp producer.


Potlatchs consumer-products segment makes a variety of tissue products, mostly for private-label customers. It produces the tissue at mills in Lewiston and Las Vegas. It also has a converting (cutting large rolls into finished products) and distribution center in Elwood, Ill., and tissue distribution centers in Fort Worth, Texas, and Tracy, Calif. The company says it produced 50 percent of the total private-label tissue sold in grocery stores in the U.S. last year.


Though the percentages vary greatly by operation and region, Potlatchs mills buy roughly half of the wood fiber they need companywide, at market price, from its resource division, which owns its timberland holdings, and the rest from other vendors.


TimberWith timberland forefront in Potlatchs focus, the company is boosting harvest levels significantly, though it still defers harvest on a regional basis when necessary due to low prices or weather conditions, as it did last year in Arkansas.


At the New York conference, Covey told participants that about a quarter of Potlatchs Idaho timber is 60-plus years old, and that the company is going to be more aggressive about harvesting such timber to maximize its current value. Older timber grows at a slower rate than younger timber. Overall, the company harvested nearly 36 percent more timber during the first nine months of this year than it did in the year-earlier period.


Potlatchs decision to defer harvest of about 200,000 tons of timber in Arkansas last year turned out to be a good decision, as timber prices there jumped in 2007 by 17 percent, and even higher during the third quarter.


Potlatch also says, however, that it understands the financial potential represented by sustained forestry practices, and will balance its harvesting goals with its desire to maintain sustainability. As of last year, all of the companys timberlands were certified under three different environmental certification programs. Those certifications enable Potlatch to market its logs, and the products it makes from them, to buyers that demand such certified products for green building projects, or simply to be able to say that they use green materials, including pulp for glossy annual reports.


The company says it currently is the only publicly traded forest landowner whose lands are 100 percent certified by the Forest Stewardship Council (FSC), and that means Potlatch can get significantly higher margins for those products compared with market prices. Revenue from FSC-certified products is expected to double this year.


Real estateThe other component of Potlatchs resource segment is real estate, and one of the companys strategic initiatives is to analyze all of its land holdings to determine what property is best to manage for tree harvests, what property isnt well-suited for harvest and should be sold, and what property has an even higher and better use, or HBU, perhaps as recreational property.


The 250,000 to 300,000 acres that Potlatch already plans to sell over the next 10 years dont include whatever land the company decides are either nonstrategic or HBU from the 179,000 acres its in the process of buying in central Idaho. Potlatch is paying an average of about $1,200 an acre for those parcels.


That purchase price helps illustrate how Potlatch expects to reap future earnings from its land holdings in addition to timber harvests. Of the 100,000 to 120,000 acres of land the company already has pegged for sale in Idaho, as much as 70,000 acres is identified as having resale value of $2,500 to $4,000 per acre.


The land Potlatch is buying in central Idaho is near an all-season destination development called Tamarack Resort, where an estimated $1 billion has been invested in recent years.


Potlatch says that companywide, its timberlands include more than 3,000 miles of waterfront property.


Covey said in the September conference that for Potlatch to be interested in a land acquisition, it must be able to contribute immediately to cash flow, and that it must have the potential to be valuable both as timberland and for resale.


We have a fundamental belief that you cant bet the farm that log prices will continue to go up faster than inflation, he said.


The desire to reap rewards from its timber and real estate holdings is more than just a strategy for Potlatch. In order to continue to qualify as a REIT, it must meet certain rules, including having 75 percent of its assets in real estate, getting 75 percent of its net income from those assets, and distributing 90 percent of its taxable income to shareholders each year.


Those rules can, in effect, limit Potlatch in how much it can invest in its manufacturing divisions in the future, and how much it can depend on those divisions for net income.


Contact Paul Read at (509) 344-1262 or via e-mail at paulr@spokanejournal.com.