Sino-Forest 'angry, stunned and frustrated' at allegations
Comment of the Day

June 08 2011

Commentary by Eoin Treacy

Sino-Forest 'angry, stunned and frustrated' at allegations

This article by Andy Hoffman for the Globe and Mail may be of interest to subscribers. Here is a section:
Muddy Waters Research, a firm headed by U.S.-born Carson Block, has led a devastating attack on Sino-Forest during the past week that has caused the stock to plunge more than 60 per cent and wiped out billions of dollars in shareholder value. Mr. Block has levelled fraud allegations against several Chinese companies listed on North American stock markets during the past year, casting suspicion around the growing list of companies from China tapping overseas markets for capital.

Sino-Forest, however, is a much larger and well-established player compared to Mr. Block's previous targets. It was established in 1994 and recently reached a market value of about $6-billion as investors bought in to the company as a way to play the Chinese economy's surging demand for wood.

Eoin Treacy's view As recently as April Sino-Forest retested its 2007 peak, but concerns about the efficacy of documentation and the reliability of title agreements in China have seen Sino-Forest shares collapse to below their 2008 lows in the last two weeks. As with many companies that do business in China, Sino-Forest's business model is convoluted exposing it to questions about how robust its accounting standards are. It is impossible to know at this stage how accurate Muddy Waters Research claims are. The share extended its decline yesterday but steadied somewhat today in the region of the 2008 lows. A clear upward dynamic, sustained for more than a day or two, would be required to indicate that demand is beginning to return.

Lumber prices broke a five-year downtrend in late 2009. They have been subject to a high degree of volatility over the last two years but have sustained a progression higher major reaction lows. Prices found at least short-term support in the region of $220 and a sustained move above $250 would confirm a return to medium-term demand dominance. The commodity's weakness over the last few months has acted as a headwind for many lumber shares.

Most US and Canadian forest product companies do not have operations in China and should not be unaffected by Sino-forest's travails. A number of companies in the sector have attractive yields which may to help stoke investor interest as prices pull back. This table of lumber shares ranked by indicated yield may be of interest.

Potlatch has an indicated yield of 5.74%. The share has been ranging below the psychological $40 area for the last year and has fallen to test the lower side. It bounced on Friday and while the short-term progression of lower highs remains intact, this is the largest upward dynamic is at least two months. The odds have improved that support building has commenced. If the share finds support above $33 on a pullback, it would confirm the return of demand beyond the short term.

Plum Creek, with an indicated yield of 4.24% and has returned to test the area of the 200-day MA where it has found at least short-term support. A sustained move above $40.60 would break the six-week progression of lower highs and indicate a return to demand dominance.

Rayonier's yield has compressed to 3.33% following an impressive advance over the last two years. It is currently somewhat overextended relative to the 200-day MA and would be best bought following a reversion.

Weyerhaeuser paid a special dividend this year which took its 12-month yield to 9.42%; however its indicated yield is a more modest 2.83%. It has also pulled back towards the 200-day MA and appears to be in the process of finding support.

Canadian listed West Fraser Timber accelerated higher from March and has unwound that portion of its advance since April. It has now returned to the 200-day MA and currently yields 1.17%. A sustained move above C$50 would break the two-month progression of lower rally highs and confirm the return of demand in this area.

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