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A Brief Warning About a Troubled REIT

Every income investor and their mother love a good REIT. With their potential for big yields and dividend growth, that’s hardly surprising.

So let Potlatch Corporation (PCH) serve as a good reminder that not all REITs are created equal

Potlatch specializes in acquiring, managing and maintaining forests, with the dual intent of harvesting the trees for wood products, then planting and renewing its forests through responsible stewardship.

It currently controls approximately 1.6 million acres of timber, with holdings in Idaho, Minnesota, Wisconsin and Arkansas.

Through its wholly owned subsidiary, Potlatch TRS, it also operates real estate development and sales business.

In addition, the TRS subsidiary runs six manufacturing plants to convert all that raw timber into practical wood products like lumber, plywood and particleboard.

With a turnaround in the housing market becoming more of a reality, it only makes sense that outfits like Potlatch are seeing an increase in investor attention.

Since the first of the year, shares in Potlatch Corporation have been on a steady rise, up about 18% on the year.

And the company pays a decent dividend of $1.24 annually, or roughly $0.31 per share per quarter, representing a yield of about 2.6%.

Despite the rising share price and serviceable yield, there are reasons for investors to keep their distance…

All the Sign of Trouble I Need

First, there’s the not-so-small matter of the company’s debt…

Potlach has approximately $526 million outstanding, pushing its debt-to-equity ratio to 2.52 – well above the industry average of 0.92.

Second, there’s the also not-so-small matter of the company’s valuation…

Potlatch shares are trading right up against their 52-week highs. At $47 a share, that gives Potlatch an astronomical price-to-earnings ratio of 44.

Given the mounting debt and high valuation, it’s no surprise that institutional investors have been drawing down their positions.

In tandem with the exodus, analysts have unleashed downgrades, landing recommendations squarely in the “neutral” to “sell” territory.

On top of it all, even insiders are liquidating shares. Over the last six months, there have been nine separate insider sales against only one purchase. Hardly a bullish sentiment.

However, what bothers me most about Potlatch – and why you should ignore it completely – is that it severely cut the dividend in 2011, from $0.51 to $0.31.

Nothing inspires less confidence than a dividend cut. And that’s all the sign of trouble I need.

Safe investing,

Tim Diering