LAST UPDATE: March 5, 2007
Deltic Timber Corporation is a timber company with 438,000 acres of timber holdings in Arkansas and northern Louisiana.
The company also has a real estate arm, where it constructs residential developments in upscale communities. Although
Deltic has performed quite well in the stock market over the last 2 years (15% CAGR), I feel negative macroeconomic conditions and decreasing revenues will lead to below average performance in the timber industry and for Deltic
Timber specifically over the next 18 months.
SECTOR: Materials
INDUSTRY: Timber
CONTACT: Kenneth D. Mann, Controller
P.O. Box 7200
El Dorado, AR 71731
(870) 881-6432
Web: www.deltic.com
I assign Deltic Timber Corporation an 18-month price target of $38.83. The following are key assumptions underlying my valuation:

The slump in the housing market will continue for at least the next 12 months until excess housing inventory is sold off, which will lead to lower housing starts in 2007.

The materials sector is extremely overvalued right now (approaching historic highs on price to forward earnings and price to book value multiples) and a sell-off in this sector appears imminent.

Labor utilization and materials production index down after local highs, which will adversely affect the sector as a whole.

The following two valuation methods were employed:
Discounted cash flow analysis and multiples valuation analysis.
Each method produced consistent values per share in the $38-$40 range.
BASIC INFORMATION
Current Price:
Market Cap (Mil):
Shares Outstanding:
Average Volume:
Latest Dividend:
60-Month Beta:
EPS:
P/E:
P/E (1-Yr. Fwd):
P/B:
P/S:
P/CF:
$49.45
$613.48
12,415,851
39,013.3
$0.15
0.97
$0.91
54.34
58.2
2.97
4.00
27.68

Investment Thesis
Summary
Company Overview
Introduction
Industry Segments
Woodlands
Mills
Real Estate
Del-Tin Fiber
Macro-economic, Sector, and Competitive Analysis
Macro-economic Analysis
10
10
Sector & Industry Valuation 12
Competitive Analysis of Paper & Forest Products Industry: Five Forces 14
3
3
5
3
3
7
9
1
1
Financial Analysis
ROE
Liquidity
Indebtedness
Valuation Analysis
DCF Valuation
Relative Valuation
Summary
Appendix
16
16
16
17
17
17
18
19
21
2

Deltic Timber Corporation (Deltic or the Company) is a natural resources company engaged primarily in the growing and harvesting of timber and the manufacturing and marketing of lumber. Deltic owns approximately 438,000 acres of timber, concentrated primarily in Arkansans and northern Louisiana. The
Company’s sawmill operations are located at Ola in central Arkansas and Waldo in southern Arkansas. In addition to its timber and lumber operations, the Company is engaged in real estate development in central
Arkansas. The Company also holds a 50 percent interest in Del-Tin Fiber L.L.C., a joint venture to manufacture and market medium density fiberboard. Deltic Timber currently has 481 employees.
1
Deltic derives revenue from four distinct segments: Woodlands, Mills, Real Estate, and Del-Tin Fiber. The
Woodlands segment includes over 6,000 stands of timber spread over 438,000 acres land in two geographic regions. The Mills segment includes two sawmills located within close proximity of the Company’s timber spreads. The Real Estate segment began in 1985 to add value to former timberland properties located west of Little Rock, Arkansans. Del-Tin Fiber is a joint venture began in 1998 to manufacture medium density fiberboard.
The performance of each operating segment is very cyclical and tied closely to the current state of the economy.
Woodlands Segment
The Company owns approximately 438,000 acres of timberland. The timberlands are Deltic’s most valuable asset, and the harvest of this stumpage is the Company’s most significant source of income. Figure 1 shows the breakdown of the Company’s timberland acreage.
Breakdown of timberland acreage
Hardwood forest
Pine plantation
Other
Pine forest
Deltic’s timberlands represent diverse age classes.
The pine forest timberlands are managed on an allage basis and contain timber that is ready to be harvested over the next several years. Pine plantations are primarily less than 25 years old with the majority ranging in age from 10 to 20 years.
Because pine timber generally does not reach saw timber size until it is 20 to 25 years of age, the majority of the pine plantation holdings are not yet realizable nor are they included in the Company’s pine saw timber inventory.
Figure 1: Breakdown of timberland acreage
Deltic estimates the standing timber inventory for
1
Adapted from Deltic Timber Corp. FY2005 10-K
3

each forest tract by utilizing growth formulas based on representative sample tracts and tree counts for various diameters and actual volumes harvested. The Company’s pine saw timber is used in its sawmills or sold to third parties. Products manufactured from this resource include dimension lumber, timbers, boards, decking, and secondary products, used primarily in residential construction. Pulpwood consists of logs with a diameter of less than nine inches. Both pine and hardwood pulpwood are sold to third parties for use primarily in the manufacture of paper.
Timber Growth
Timber growth rate is an important variable for forest product companies since it determines how much timber can be harvested on a sustainable basis. A higher growth rate permits larger annual harvests as replacement timber regenerates. Growth rates vary depending on species, location, age, and forestry management practices. The growth rate, net of mortality, for Deltic’s Southern Pine averages five to six percent of standing inventory per year. Deltic considers a 30 to 35 year rotation optimal for most pine plantations.
Timberland Management
Forestry practices vary by geographic region and depend on factors such as soil productivity, weather, terrain, and timber species, size, and stocking. The Company actively manages its timberlands based on these factors and other relevant information to increase productivity and maximize the long-term value of its timber assets. In general, the Company’s timberland management involves harvesting and thinning operations, reforestation, cull timber removal programs, and the introduction of genetically improved seedlings.
Deltic has developed and operates its own seed orchard. Seeds from the orchard are grown by third parties to produce genetically improved seedlings for planting. These seedlings are developed through selective cross-pollination to produce trees with preferred characteristics, including higher growth rates, fewer limbs, straighter trunks, and greater resistance to disease. However, this process does not involve genetic engineering. The seedlings are planted in all-aged stands or a site is completely replanted in the case of a final harvest of mature stands. During the last two years, about 15,300 acres were planted, primarily using seedlings grown from seeds produced at the orchard facility. The Company actively utilizes commercial thinning practices. Thinning operations consist of the selective removal of trees within a stand, usually a plantation, and improve overall productivity by enhancing the growth of the remaining trees while generating revenues. Deltic also has a cull timber removal program designed to control undesirable, competitive vegetation in its forests and to increase pine growth rates and reproduction. The Company treated over 30,000 acres over the last 3 years under this program.
Harvest Plans
Management views the timberlands as assets with substantial inherent value apart from the sawmills and intends to manage the timberlands on a basis that permits regeneration of the timberlands over time. The
Company intends to continue to manage the timberlands on a sustainable-yield basis and has no plans to harvest timber on an ongoing basis at levels that would diminish its timber inventory. Deltic has harvested over 1.1 million tons of pine sawtimber over the last 2 years.
4

The Company's harvest plans are generally designed to project multi-year harvest schedules. In addition, harvest plans are updated at least annually and reviewed on a monthly basis to monitor performance and to make any necessary modifications to the plans in response to changing forestry conditions, market conditions, contractual obligations, regulatory limitations, and other relevant factors. Since harvest plans are based on projections of demand, price, availability of timber from other sources, and other factors that may be outside of the Company's control, actual harvesting levels may vary. Management believes that the
Company's harvest plans are sufficiently flexible to permit modification in response to fluctuations in the markets for logs and lumber.
Client-Land Management
In addition to managing its own timberlands, Deltic also manages timberlands owned by others under management contracts with one-year renewable terms. This program provided harvest planning, silvicultural improvements, and maintenance work for approximately 62,000 acres in 2005.
Timberland Acquisitions
The Company implemented a timberland acquisition program in late 1996. This ongoing program is designed to enable the Company to continue to increase harvest levels while expandings its timber inventory. Additionally, it will allow Deltic to maintain or increase the volume of logs supplied to its sawmills from its own timberlands, when economically feasible.
The Company intends to continue to focus its acquisition program on timberlands that range from fullystocked to cutover tracts. Unlike other timber-producing areas of North America, most of the timberland in the southern U.S. is privately held, making it potentially available for acquisition. There can be no assurance that timber properties suitable for acquisition will be identified by the Company, or that once identified, such properties will ultimately be acquired by the Company. Deltic formed an acquisition team to implement its timberland acquisition program. Lands considered for purchase are evaluated based on location, site index, timber stocking, and growth potential. Approximately 123,700 acres of strategically located pine timberland have been added since the inception of the program. Individual land purchases have ranged from 20 acres to 21,700 acres.
Land Sales & Leasing
In 1999, the Company initiated a program to identify for possible sale non-strategic timberland and higher and better use lands. Sales totaled 5,254 acres in 2000, 3,315 acres in 2001, 3,418 acres in 2002, 4,130 acres in 2003, 1,150 acres in 2004, and 45 acres in 2005. The Company also generates revenue from the leasing of hunting, oil and gas, and other rights on its timberlands.
Mills Segment
The Company's two sawmills are located at Ola in central Arkansas and at Waldo in south Arkansas, near significant portions of the timberlands. The mills employ modern technology in order to improve efficiency, reduce labor costs, maximize utilization of the timber resource, and maintain high quality standards of production. Logs processed into lumber are obtained from the timberlands and from public and private landowners. The Company selects logs for processing in its mills based on size, grade, and the prevailing
5

market price. The Ola Mill is equipped for maximum utilization of smaller diameter logs, while the Waldo
Mill can process both smaller and larger diameter logs. The mills produce a variety of products, including dimension lumber, boards, timbers, decking, and at the larger Waldo Mill, secondary products such as finger-jointed studs. The lumber is sold primarily to wholesale distributors, lumber treaters, and truss manufacturers in the South and Midwest and is used in residential construction, roof trusses, and laminated beams.
Capital Projects
Deltic has invested significant capital in its sawmills in recent years to increase production capacity and efficiency, decrease costs, and expand the product mix. Major capital projects completed at the Ola Mill over the past several years include: (1) installation of a curve-sawing gang and double-length infeed to improve log recovery, increase hourly output, and expand product mix; (2) the installation of an optimized edger system to increase lumber recovery; (3) replacement of the planermill with a high-speed planermill and automated sorting system to increase mill output; (4) construction of a small log processing system which extracts small diameter logs from pulpwood, thus reducing average log costs; (5) addition of a boiler system and steam dry kilns to increase mill capacity and provide the capability to produce higher value lumber; (6) expansion of log storage capacity to enable increased production as market conditions improve; and (7) primary breakdown redesign and rebuild of the sawmill processing equipment to improve the infeed of logs and overall flow of green lumber.
At the Waldo Mill, major capital projects completed over the past several years include: (1) installation of a curve-sawing gang to improve log recovery, increase hourly output, and expand product mix; (2) installation of a new edger and optimizer to improve recovery; (3) installation of a log optimization system to improve lumber recovery; (4) extension of the green lumber sorter to increase sawmill throughput; (5) addition of finger-jointing and remanufacturing facilities which add value to existing production; (6) construction of a new high speed planermill and automated sorting system that provide the finishing capacity necessary to operate two shifts at the sawmill; (7) installation of a second log debarker in order to further improve hourly throughput capability; and (8) an additional boiler and an upgrade of the lumber drying kilns to increase the mill's lumber drying capacity.
Raw Materials
In 2005, the Company's two sawmills processed 1,210,515 tons of logs, obtained from either the timberlands or purchased from public and private landowners. The timberlands supplied 41 percent, or
499,616 tons, of the mills' raw material receipt requirements, while the mills obtained 86 percent of the
581,242 tons of pine sawtimber harvested from the timberlands.
Various factors, including environmental and endangered species concerns, have limited, and will likely continue to limit, the amount of timber offered for sale by U.S. government agencies. Because of this reduced availability of federal timber for harvesting, the Company believes that its supply of timber from the timberlands is a significant competitive advantage. Deltic has historically supplied a significant portion of the timber processed in the sawmills from its timberlands.
In order to operate its sawmills economically, the Company relies on purchases of timber from third parties to supplement its own timber harvests from the timberlands. The Company has an active timber
6

procurement function for each of its sawmills. As of December 31, 2005, the Company had under contract
84,415 tons of timber on land owned by other parties, including the U.S. Forest Service, which is expected to be harvested over the next four years. During 2005, the Company harvested third-party stumpage and purchased logs from third parties totaling 764,062 tons . Of this volume, purchases from the U.S. Forest
Service represented seven percent. The balance of such volume was acquired from private lands.
As a result of the reduced availability of federal timber in recent years, demand, along with prices, for privately owned timber has increased, and the Company has increased and foresees further increases in its harvesting and purchasing activities from private timberlands. Due to this increased demand and higher timber prices, private timber sources have been prompted to sell their timber commercially. As a result,
Deltic's sources of private timber are many and diverse. The key factors in a landowner's determination of whether to sell timber to the Company are price, the Company's relationships with logging contractors, and the ability of the Company to demonstrate the quality of its logging practices to landowners. As a result, a landowner will be more likely to sell timber to a forest products company whose own land has been responsibly managed and harvested. There is a substantial amount of other private timber acreage in proximity to each of Deltic's sawmills.
Residual Wood Products
The Company pursues waste minimization practices at both of its sawmills. Wodd chips are usually sold to paper mills or Del-Tin Fiber, and bark is frequently sold for use as fuel. Bark, sawdust, shavings, and wood chips that cannot be sold are used as “hog fuel” to fire the boilers that heat the drying kilns. Deltic expects to continue to sell a significant portion of its Waldo Mill’s residual wood chip production to Del-Tin Fiber pursuant to a fiber supply agreement that expires in 2008.
Real Estate
The Company's real estate operations were started in 1985 to add value to former timberland strategically located in the growth corridor of west Little Rock, Arkansas. Development activities began with the construction of Chenal Ridge, the initial, 85-lot neighborhood in Chenal Valley on the western edge of the
Little Rock city limits as of 1985. Since that time the Company has been developing the remainder of
Chenal Valley, an approximately 5,000-acre upscale planned community, centered around two Robert Trent
Jones, Jr. designed golf courses. The first golf course was completed in 1990. Construction of the second course began in 2001, and was opened for play in the summer of 2003. The property has been developed in stages, and real estate sales to date have consisted primarily of residential lots sold to builders or individuals and commercial tracts. In addition to Chenal Valley, Deltic has developed Chenal Downs, located just outside of Chenal Valley, and is developing Red Oak Ridge, in Hot Springs, Arkansas. Chenal Downs is a
400-acre equestrian development with controlled access, featuring secluded, five-acre lots. Red Oak Ridge,
Deltic's first development outside the Little Rock area, is an 800-acre upscale community designed for residential, resort, or retirement living. Also, the Company has disclosed plans for a 1,170-acre, 187 lot, upscale residential development, The Ridges at Nowlin Creek, on a portion of its land holdings located within the Highway 10 growth corridor west of Chenal Valley. A portion of the development is located within the watershed of Lake Maumelle, a principal source of drinking water for Little Rock. Due to this environmentally sensitive locale, the Company's plans included the most modern, and proven, best management practices to create a low-impact development in order to protect water quality in the lake. Even though the local water utility has commissioned the preparation of a new watershed management plan,
7

which supposedly will reflect current scientific principles that would likely be compatible with the
Company's low-impact development plans, in 2005, the utility filed its petition in the Circuit Court of
Pulaski County Arkansas, to condemn that portion of the development within the lake's watershed, and deposited its estimate of just compensation for the land taken. The condemned property includes all of 99 lots, parts of an additional 20 lots, and proposed access to seven lots. Under Arkansas law, Deltic has the right, and has initiated proceedings, to have a jury determine the true amount of just compensation for the taking of the lands, as well as other damages. The trial of this matter is scheduled to begin in 2006. Under
Arkansas statutes, as interpreted by its courts, condemnation proceedings of this nature by a municipal utility do not vest fee simple title to the land until the utility pays the final judgement of just compensation determined in the case. Should the utility decide not to pay the final judgement, possession and full title is returned to Deltic and the utility is liable for damages during the period Deltic is dispossessed of its property, in addition to legal costs incurred by the landowner. The commencement of this action has caused activities at the Ridges at Nowlin Creek development to be postponed pending the outcome of the action.
Should the utility determine to pay the final judgement, the Company will need to further assess the viability of proceeding with development of lots in the development's remaining acreage. (For further discussion, refer to Note 16 to the consolidated financial statements.)
Chenal Valley is one of the premier upscale residential and commercial developments in the Little Rock real estate market. All acreage in Chenal Valley has been annexed by the City of Little Rock. Red Oak Ridge has been similarly annexed by the City of Hot Springs. Both Chenal Downs and the currently suspended
Ridges at Nowlin Creek are located just outside the Little Rock city limits.
Residential Development
Lots were offered for sale in Chenal Valley during the second half of 1986 with closings beginning in 1987.
As of December 31, 2005, 2,586 lots have been developed in 30 neighborhoods and 2,314 lots have been sold, with about 2,086 residences constructed or under construction. When fully developed, Chenal Valley will include approximately 4,500 residences. However, the actual number of residences in Chenal Valley will depend on final land usages and lot densities. The Company has developed lots in a wide variety of market segments. Lot size has ranged from 0.2 acres to 2.25 acres, and lot price has ranged from $25,000 per lot to over $250,000 per lot.
The first phase of Chenal Downs was opened in December 1997, followed by a second phase in November
2000, with 56 of the 76 lots developed in the two phases sold by the end of 2005. Lot prices in Chenal
Downs range from $89,000 to approximately $187,000. In Red Oak Ridge, the first two neighborhoods were offered for sale in late 1998, with a second lot offering in 2005. These neighborhoods offer a choice of either estate-sized homesites, with many overlooking one of two Deltic-constructed lakes, or garden-home lots.
Commercial Development
Commercial development in Chenal Valley began with the construction of a Company-owned, 50,000square-foot office building, which was sold during 2000. Commercial activity to date has consisted of the sale of approximately 245 acres, including 72 acres in 2003, four acres in 2004, and six acres in 2005.
Commercial property sales to-date have consisted of retail store locations, an office building constructed by
8

the Company on a nine-acre site, multi-family residence sites, convenience store locations, a bank office building site, and outparcels surrounding a retail center constructed and owned by the Company. Under current development plans, Chenal Valley would include approximately 750 acres of commercial property when fully developed.
The completion of construction of Rahling Road to Chenal Parkway, a major connector street, in 1998 provides greater access to Chenal Valley's commercial acreage. Located at the center of this commercial property is a Company-owned 35,000-square-foot retail center. The retail center was completed in early
2000 and offers retail space for lease. The center is surrounded by 16 outparcels, ranging in size from 0.2 to
1.8 acres. To-date, 11 of these outparcels have been sold. No commercial acreage is included in the Chenal
Downs or the currently suspended Ridges at Nowlin Creek developments. Red Oak Ridge is planned to include approximately 80 acres of commercial property. Deltic will begin to develop and offer commercial sites as population density increases.
Del-Tin Fiber
Deltic owns 50 percent of the membership interest of Del-Tin Fiber, a joint venture to manufacture and market medium density fiberboard (MDF). The Del-Tin Fiber plant is located near El Dorado, Arkansas.
Initial production began in 1998. The plant is designed to have an annual capacity of 150 million square feet
(“MMSF”), on a ¾ inch basis, making it one of the largest plants of its type in the world.
From the time production began at Del-Tin Fiber in 1998 until the fourth quarter of 2003, both operating and financial performances were below the expectations established at the time that the decision to construct the plant was made. As a result, on April 25, 2002, Deltic announced that Banc One Capital Markets, Inc. had been retained as financial advisor to assist in the evaluation of strategic alternatives for the Company's investment in Del-Tin Fiber. Subsequently, Deltic's management and Board of Directors completed its review of these strategic alternatives and announced the Company intended to exit the MDF business upon the earliest, reasonable opportunity provided by the market. As a result of this decision, the Company's evaluation of possible impairment of the carrying value of its investment in the joint-venture was based primarily upon the estimated cash flows from a sale of the Company's interest during 2003 and resulted in a determination that the Company's investment was impaired as of December 31, 2002. The investment was written off to zero.
Due to the Company's commitment to fund its share of any of the facility's operating working capital needs until the facility was able to consistently generate sufficient funds to meet its cash requirements or Deltic's ownership was sold, the Company recognized losses in Del-Tin Fiber equal to the extent of these advances during 2003. For the year of 2003, such advances approximated the Company's equity share of losses for the plant; accordingly, the investment in Del-Tin Fiber at December 31, 2003, was zero. The Company also continued to utilize its management resources to work with Del-Tin's management and the joint-venture partner to improve operating performance at the plant. As a result of these improvements, on December 11,
2003, Deltic's Board of Directors revised its intent regarding the Company's investment in Del-Tin Fiber and ceased efforts to sell the Company's interest in the joint venture, while continuing to focus on improving operating and financial results of the plant. Due to this decision, the 2003 evaluation of fair value for the investment was based primarily upon the future net cash flows from Del-Tin Fiber's operations over the remaining life of the plant. The estimated fair value from this evaluation indicated that no impairment
9

existed as of December 31, 2003. In 2004 and 2005, the Company recorded its equity share of the operating results of the joint venture.
Medium Density Fiberboard
MDF, which is used primarily in the furniture, flooring, and molding industries, is manufactured from sawmill residuals such as chips, shavings, and sawdust, held together by an adhesive bond. Although the technology has existed for decades, recent improvements in the manufacture of MDF have increased both the quality and consistency of the product. MDF, with its "real wood" appearance and the ability to be finely milled and accept a variety of finishes, competes primarily with lumber.
Production
The plant produced 141 MMSF of MDF in 2005 versus 148 MMSF of MDF in 2004 and 133 MMSF of
MDF in 2003. Prior to 2003, start-up difficulties and operational problems with the plant's press and heat energy system limited production to levels significantly below capacity. The problems with the press were corrected in mid-1999. As natural gas prices escalated during the last half of 2000, the decision was made in late January 2001 to temporarily suspend operations until the heat energy system could be modified.
Following completion of a capital project to modify this system, the plant resumed operations in June 2001.
Rectification of the heat energy system has enabled the plant's operations to increase production levels closer to the plant's capacity of 150 MMSF per year, as market conditions improved. In addition, manufacturing cost per thousand square feet has decreased, as certain variable costs of manufacturing have been lowered and fixed costs for the facility are being allocated to the increased production.
Raw Materials
The Del-Tin plant provides an additional outlet for wood chip production from the Waldo Mill. Pursuant to a fiber supply agreement that expires in 2008, the Company has agreed to sell, and Del-Tin Fiber to buy, substantially all residual wood chips from the Waldo Mill. In addition, Del-Tin Fiber has an option to purchase residual wood chips from the Ola Mill and pulpwood chips, shavings, and sawdust from the Waldo
Mill. During 2005, 2004, and 2003, Deltic sold approximately $3,868,000, $3,890,000, and $4,099,000, respectively, of these lumber manufacturing by-products to Del-Tin Fiber.
Deltic Timber Corp is a timber company within the materials sector of the S&P 500. The two major macroeconomic factors that effect Deltic (and all timber companies) are as follows: housing starts and the growth of GDP. Each factor is examined in detail on the following pages.
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350
300
250
200
Housing Starts
2
The major raw material input in nearly all new home builds is lumber. As a result, forest products companies such as Deltic rely heavily on home construction to drive sales. Furthermore, since lumber is
(essentially) a commodity product, the ability to increase prices depends on supply and demand. Therefore, if demand for lumber increases due to more new home starts, Deltic is able to increase its prices (and subsequently drive its earnings up). In order to determine the impact the housing market has on the price of lumber, a simple regression model was developed which measures the impact that monthly housing starts have on the price of lumber. Figure 2 displays a scatter plot which regresses lumber prices for the last five years against monthly home starts (59 observations).
Lumber Prices Regressed Against Monthly Home Starts
450
Correlation Coefficient = 0.617
400
150
1200 1400 1600 1800
Monthly Home Starts
2000
Figure 2: Monthly Home Starts vs. Lumber Prices
2200 2400
As seen above, there is a strong correlation (correlation coefficient of 0.62) between monthly home starts and lumber prices. This is (as mentioned previously) related to the fact that lumber is the biggest raw material input for new homes. Thus, increased home starts will drive up demand for lumber (and eventually prices). After 2004 and 2005 were the years of the housing boom, and 2006 was the housing bust, it appears that the 2007 housing market will also be sluggish as builders work off excess inventories of unsold new homes. Average quarterly housing starts for 2007 are expected to be 1.62 million units, which is 10% lower
2
Freddie Mac February 2007 Economic Outlook
11

than in 2006. As the excess inventories are sold off, quarterly home starts are expected to increase in 2008 to 1.70 million units, which is still down considerably from the peak years of 2004-2005. Table 2 below gives historic and projected quarterly home starts for a seven year window beginning in 2002.
Historic
2002 2003 2004 2005 2006
1.70
1.85
1.96
2.07
1.80
Projected
2007
1.62
2008
1.70
Table 2: Average quarterly home starts (in millions)
The decrease in home starts should work to decrease the price of lumber in the short term, which will squeeze Deltic’s earnings until demand picks back up.
Gross Domestic Product Growth
The fourth quarter 2006 GDP growth came in well above market expectations, thanks in part to interest rates that are low by historic standards and above-normal labor utilization rates and strong contributions from consumer spending and net exports. The consensus GDP growth target for 2007 is 3.1%. However, I feel inflation concerns coupled with defaults in the sub prime loan market will likely cause the Fed to raise the
Fed Fund Rate (even though the market is currently pricing in a decrease in the Fed Funds Rate), stunting
GDP growth to below expectations and adversely effecting Deltic Timber Corp.
Sector Valuation
The materials sector is the smallest sector by market capitalization in the S&P 500 at only 3.5%. It is also the biggest gainer to date in the S&P 500, having so far returned 5.33% in 2007. To determine how the sector is trading in comparison with the S&P 500, five key metrics were examined: price-to-forward earnings, price-to-EBITDA, price-to-sales, price-to-book value, and price-to-adjusted cash flow. The results can be seen in Table 3.
Price
Price to forward earnings
Price to EBITDA
Price to Sales
High Low Mean Current
1.02
0.38
0.67
1.48
0.62
0.93
1.30
0.51
0.91
0.91
0.37
0.75
0.76
1.01
0.92
0.91
Price to Book
Price to Adjusted Cash
Flow
1.09
0.37
0.81
0.98
0.39
0.80
1.08
0.86
Table 3: Materials Sector Multiples Valuation Relative to the S&P 500
Comparing the materials to the S&P 500, the sector appears to be very expensive. The sector is trading above its historic mean on all five metrics and approaching its historic high based on price-to-book and price-to-sales multiples. If reversion to the mean occurs, it is likely that the materials sector will underperform going forward. [Note: To eliminate the effect that the technology bubble had on prices in the
12

late 1990s and early 2000s, only the last 4 years of data has been considered for all multiples valuation analysis]
The sector has had the benefit of strong GDP growth and vigorous labor utilization rates. However, a continuing lull in the housing market and a potential rate increase in the Fed Funds rate (as outlined in the macro-economic analysis section) should work to dampen the performance of the sector going forward. All of the above factors lead to the recommendation that the materials sector is overvalued.
Industry Valuation
Deltic operates within the paper and forest products industry, which is traditionally a very cyclical industry in which to operate due to the asset intensive nature of the industry and the high fixed costs associated with maintaining and operating a woodlands and mills company. An examination of this industry using the five key metrics from above (price-to-forward earnings, price-to-EBITDA, price-to-sales, price-to-book value, and price-to-adjusted cash flow) in comparison with first the materials sector (Table 4) and then the S&P
500 (Table 5) was completed. Results follow.
Price
Price to forward earnings
Price to EBITDA
Price to Sales
High Low Mean Current
1.11
0.68
0.91
5.58
0.90
1.64
1.71
0.55
0.81
0.82
0.52
0.64
0.72
2.56
1.69
0.59
Price to Book
Price to Adjusted Cash
Flow
0.67
0.49
0.57
1.06
0.68
0.80
0.65
0.97
Table 4: Paper & Forest Products Industry Relative to Materials Sector
As seen above, the paper and forest products industry usually trades at a slight discount relative to the rest of its sector group, and it’s currently trading at an even bigger discount than usual. However, on four of the five other metrics, the industry is extremely expensive relative to the sector. For instance, it’s currently trading at over two times its historic mean price-to-EBITDA multiple (1.69 compared to .81). It’s also trading substantially above its historic mean price-to-forward earnings multiple (2.56 to 1.64). Taken together, it appears the industry is expensive based on valuation relative to its sector.
High Low Mean Current
Price
Price to forward earnings
Price to EBITDA
Price to Sales
Price to Book
Price to Adjusted Cash
Flow
1.04
8.10
1.56
0.68
0.70
0.36
0.59
0.36
0.26
0.22
0.58
1.62
0.74
0.46
0.47
0.83
0.30
0.67
0.55
2.58
1.56
0.54
0.70
0.83
Table 5: Paper & Forest Products Industry Relative to S&P 500
Finally, to complete industry valuation, multiples analysis was undertaken to compare the paper and forest products industry to the S&P 500 as a whole. As seen in Table 5, it again appears that the industry is overvalued. In three of the metrics (price to EBITDA, price to book, and price to adjusted cash flow), the
13

industry is trading at historically high levels relative to the S&P 500. It would seem the industry has nowhere to go but down.
Summary
The Consumer Staples Sector and Retail Industry valuations support Deltic Timber’s strong sell recommendation. Considering both Deltic’s sector and industry appear considerably overvalued, the stock itself is likely overvalued, too.
Deltic operates in the paper and forest products industry as a low-cost timber supplier. Because lumber is a commodity, Deltic is a price taker. Therefore, Deltic’s ability to earn abnormal earnings depends on constantly improving its production efficiencies to decrease costs relative to its competitors.
A five forces analysis was conducted, in order to evaluate the industry as a whole and Deltic’s place within its industry.
Barriers To Entry (BTE)
Immediate BTEs are relatively high since 1) a critical mass of timber supply is required to obtain economies of scale, which can take decades to achieve (due to slow timber growth rates), 2) fixed costs are high, and 3) specific knowledge of operating a woodland and timber mill is not easily obtainable. Consolidation within the industry is evidence of these high fixed costs, as firms attempt to achieve economies of scale by merging the operations of smaller players into bigger and bigger conglomerates, thereby spreading the fixed costs.
Supplier Power
Supplier power is a neutral for this industry. Hinted at above, consolidation in the industry has reduced the number of players within this industry. Normally, this would allow timber companies to have increased bargaining power over its suppliers. However, at the same time, the suppliers have also begun consolidation, which negates the increased bargaining power of the paper and forest products industry participants. Taken together, neither industry participants nor its suppliers appear to have much in the way of bargaining power over the other.
Buyer Power
Since lumber is a commodity product, a buyer has no incentive to buy from any particular seller. This means that, essentially, switching costs are zero. Also, consolidation of buyers in recent years has given even more power to the buyers in the forestry products industry. Finally, the biggest buyers of lumber are paper manufacturers. The relative ease with which paper manufactures could backwards integrate into timber production increases the power they have as buyers of timber. This is a big negative for participants in the forest products industry.
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Substitutes
There are viable substitutes for lumber, namely steel and aluminum. This decreases the attractiveness of the timber industry, for if prices of timber climb to a level great enough, consumers will switch to aluminum or steel for their needs, when applicable.
Competition
Competition is high within the timber industry as evidenced by tight margins and small returns on equity in the industry. Figure 3 gives the historic returns on equity of the paper and forest products industry relative to the S&P 500.
PAPER & FOREST PRODUCTS E-Wtd (097A) Price 30.08
1997 1998 1999 2000 2001 2002 2003 2004 2005
0.51
0.5
0.48
0.5
0.5
0.45
0.4
0.42
0.39
0.36
0.33
0.4
0.30
0.27
0.4
0.3
0.3
0.3
0.4
0.4
0.3
2006
StockVal ®
2007 2008
0.3
HI 0.49
LO 0.07
ME 0.31
CU 0.30
0.24
0.21
0.2
0.2
0.18
0.2
0.2
0.15
0.1
0.12
0.1
0.09
03-31-1997
12-31-2006
0.1
0.06
RETURN ON EQUITY RELATIVE TO S&P 500 COMPOSITE ADJUSTED (SP5A) M-Wtd
Figure 3: Return on Equity of Paper & Forest Products Industry relative to S&P 500
As seen in Figure 3, the paper and forest products industry historically has returns on equity much lower than the S&P 500 (mean: 0.31::1). Abnormally low returns on equity are one clear sign that competition in the industry is high, again a negative factor for this industry.
Summary
Deltic is a price taker in a commodity industry. Due to the structure of the paper and forest products industry which includes high buyer power, many substitutes, and strong competition, realizing abnormal earnings is very difficult. Deltic’s recent foray into real estate (1995) can be considered an attempt to venture into a sector that will provide a better environment for achieving abnormal earnings. However, this
15

does not seem like a very sound strategy, as both industries are tied very closely to the performance of the housing market, which eliminates the diversification benefit that often comes with entering a new industry.
In order to evaluate Deltic’s financial strength, Deltic was evaluated relative to the 25 companies in its industry (paper and forest products) on certain key financial metrics.
ROE
Perhaps the easiest way to measure a firm’s success, return on equity (ROE) measures the earnings a firm is able to achieve relative to the equity its shareholders provide. In Deltic’s case, ROE had trended up from
2003 to 2005, but in 2006 it dropped off as a lull in the housing market worked to depress earnings. Table 6 below displays ROE for Deltic over the last 4 years.
Year 2003 2004 2005 2006
ROE 4.8% 6.0% 7.3% 5.4%
Table 6: Deltic Timber Return on Equity
It is not enough, however, to look solely at the trend in Deltic’s ROE. It is also necessary to gage how Deltic has performed relative to its peers. The mean ROE for the 25 firms in the paper and forest products industry is 6.45% (market cap weighted), which means Deltic is underperforming its peer group on an ROE basis.
Liquidity
Liquidity measures the ability of a firm to repay its debt. Two key metrics used to measure liquidity are the current ratio (current assets / current liabilities) and quick ratio (current assets less inventory / current liabilities). Comparing Deltic to its peers on these two metrics in Table 7 gives the following results.
Current
Ratio
Quick
Ratio
Deltic Timber
Average of Industry
Peers
1.57
1.59
0.64
0.90
Table 7: Deltic Timber Liquidity Relative to Industry
Generally current and quick ratios above 1 are desirable, but these standards can vary across different industry groups. As seen above, Deltic is basically in-line with the industry average when it comes to current ratio. However, once inventory is stripped out, Deltic’s quick ratio is well below the industry mean and dangerously low (0.64). This means the company could be cash-strapped in the near-term as it attempts to pay back its short-term obligations. Also, from an investor standpoint, it could be an indicator that
Deltic’s management will be more concerned with generating short-term cash, rather than investing in longhorizon positive net present value (NPV) projects, which will hurt shareholder value.
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Indebtedness
To measure indebtedness (or how much debt a firm has in its capital structure), long term debt to total capital is the metric most often applied. This is one statistic where Deltic shines. Deltic’s long term debt currently represents 22.9% of its total capital, well below the industry mean of 44.4%. This implies that
Deltic should have no problem financing its future investments with debt, as the Company has a comfortable cushion currently in place. However, as mentioned in the Liquidity section, the company is currently facing short-term liquidity problems and should shore that situation up prior to taking on new debt.
To value Deltic Timber Corporation, a discounted cash flow analysis (DCF) and relative value analysis were completed.
DCF Valuation Model
A few assumptions imbedded within the DCF valuation (Exhibit 1 in Appendix) are as follows:

Discount Rate used was 8.86%, which is equal to the weighted average cost of capital (WACC) of
Deltic Timber.

WACC assumptions include: 6% market risk premium, 0.97 beta (60-month beta taken from Stock-
Val), cost of debt of 6% (weighted average of interest rates, taken from 10-K), a risk-free rate of
4.71% (yield on 10-year T-bill used as proxy), and a debt-to-equity ratio of 0.34. Calculation of
WACC is included as Exhibit 2 in the Appendix.

Depreciation and capital expenditures would be equivalent as a percentage of sales in the terminal period, which is the case for most mature companies.

Tax rate of 34%, based on historical data.

The terminal growth rate used in the model was 5%, which is based on a conservative estimate of
GDP growth (compare this to 6% GDP growth over last 15 years).

Sales growth in 2007 will be -1%, speaking to the poor outlook for the housing market for the upcoming year. In 2008, sales will pick up considerably, as the real estate market is expected to improve. This spike will then trail off slowly to 5%, which represents the terminal growth rate.
A sensitivity analysis of WACC and terminal growth rate was performed on implied equity value per share, which can be observed in Figure 4.
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Sensitivity Analysis of WACC and Terminal Growth Rate on Implied Value Per Share
Output: Implied Value Per Share
Input: Terminal Growth Rate
38.23
4.25%
4.50%
4.75%
5.00%
5.86%
$103.65
$120.49
$144.90
$183.44
Input: Deltic Timber Corporation WACC
6.86%
$62.30
$67.70
$74.39
$82.87
5.25%
5.50%
$253.43
$419.83
$93.98
$109.17
5.75% $1,322.50
$131.18
7.86%
$43.96
$46.44
$49.31
$52.70
$56.72
$61.60
$67.64
8.86%
$33.65
$35.00
$36.52
$38.23
$40.18
$42.42
$45.02
9.86%
$27.07
$27.89
$28.79
$29.78
$30.87
$32.10
$33.47
Figure 4: DCF Sensitivity Analysis
10.86%
$22.53
$23.06
$23.63
$24.25
$24.93
$25.67
$26.48
11.86%
$19.21
$19.57
$19.95
$20.37
$20.81
$21.29
$21.81
Based on the DCF analysis, Deltic Timber has an implied equity value per share of $38.23. Considering it is currently trading at $49.00, this represents a 22% downside. The above sensitivity analysis allows for multiple scenario evaluation on Deltic’s value. The market appears to be pricing in more growth than the
DCF model does, likely because most believe the housing market will recover faster than I predict is feasible. The appendix contains the full DCF valuation, with projections for income out to 2017.
Relative Valuation
In order to complete a relative valuation of Deltic Timber, five key metrics were observed: Price-to-forward earnings estimates, price-to-sales, price-to-book value, price-to-EBITDA, and price-to-adjusted cash flow.
These metrics were computed on not only an absolute basis but also relative to Deltic’s sector (materials) and the S&P 500 as a whole. First a relative valuation was completed, comparing Deltic to the materials sector. Table 8 below displays the results.
Price to forward earnings
Price to EBITDA
Price to Sales
High Low Mean Current
5.32
1.89
2.93
2.83
1.22
2.02
3.54
2.24
2.88
3.84
2.21
3.06
Price to Book
Price to Adjusted Cash
Flow
1.25
0.77
1.00
3.27
1.52
2.24
0.97
2.82
Table 8: Deltic Timber Multiples Valuation Relative to the Materials Sector (SP-15)
Comparing Deltic Timber to its sector, it is appears to be very expensive. It is trading considerably higher than its average price to forward earnings multiple (31% premium). Deltic could also be considered expensive based on price-to-sales, price-to-EBITDA, and price-to-adjusted cash flow. It is trading basically in-line based on price-to-book value. Overall, based solely on relative sector valuation, Deltic is expensive.
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Price to forward earnings
Price to EBITDA
Price to Sales
High Low Mean Current
4.78
1.64
2.57
2.71
1.35
1.85
3.02
1.79
2.38
3.88
2.04
2.77
Price to Book
Price to Adjusted Cash
Flow
1.28
0.73
0.97
2.67
1.45
1.83
1.05
2.42
Table 9: Deltic Timber Multiples Valuation Relative to the S&P 500 (SP-5A)
Comparing Deltic Timber relative to the S&P 500 as a whole, it appears to again be expensive. On all five metrics (Table 9 above), Deltic is trading above its mean multiple, and in some cases, it is trading well above its mean (price-to-forward earnings and price-to-adjusted cash flow). Assuming multiples revert to the mean over time, Deltic is considerably overvalued based on an S&P 500 relative multiples valuation.
Price to forward earnings
Price to EBITDA
Price to Sales
Price to Book
Price to Adjusted Cash
Flow
High Low Mean Current Target Multiple
71.80
25.60
38.80
19.50
10.90
14.20
4.46
2.78
3.70
2.30
3.56
2.90
58.20
14.50
4.00
3.00
38.80
14.20
3.56
2.90
30.80
17.00
21.30
27.70
21.30
Table 10: Deltic Timber Absolute Multiples Valuation
Target # per share
1.02
2.80
11.10
13.88
1.79
Target
Price
$39.58
$39.76
$39.52
$40.25
$38.02
Lastly, an absolute multiples valuation of Deltic Timber was completed. As evidenced in Table 10, Deltic is trading above its mean multiple on each metric. If a target multiple (assume reversion to the mean) is selected as well as a target per share number, a target price can be computed. Completing this analysis gives a target price for the Company in the $38 to $40 range, which is considerably below the current trading price of Deltic ($49.00), again confirming the strong sell recommendation.
After completing both a DCF analysis and a multiples valuation of Deltic Timber, I reiterate my strong sell recommendation and assign a one year price target of $38.83
, which represents a weighted average of the DCF analysis (50% weight) and the five multiples valuation price targets (12.5% weight each). The catalysts underlying my recommendation are outlined on the following page.
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Recommendation catalysts

A continued lull in the housing market in 2007 will cause a decrease in the price of lumber, further decreasing Deltic’s already slim margins.

This is expected to continue until the excess supply of new homes is sold off, which is not expected to occur until mid-2008.

An expected sell-off in the materials sector will return price multiples closer to their long-run historic averages, further impacting Deltic’s share price negatively.

Increased consolidation in the timber industry will adversely affect smaller industry players (Deltic being one of the smallest) who will not have the size to realize increased economies of scale or higher bargaining power.
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DCF Valuation
03/05/2007
Ticker: DEL
Andrew Givens
Year
Revenue
% Growth
Operating Income
Operating Margin
Interest and Other- net
Interest % of Sales
2007E
151,581
-1.00%
24,917
16.44%
2008E
168,255
11.00%
Terminal Discount Rate =
Terminal FCF Growth =
2009E
186,763
11.00%
30,686
18.24%
34,551
18.50%
2010E
207,307
11.00%
8.86%
5.00%
Forecast
2011E
228,037
10.00%
38,352
18.50%
42,187
18.50%
2012E
246,280
8.00%
45,562
18.50%
2013E
261,057
6.00%
2014E
274,110
5.00%
2015E
287,816
5.00%
48,296
18.50%
50,710 53,246
18.50% 18.50%
2016E
302,206
5.00%
55,908
18.50%
317,317
5.00%
66,251
18.50%
Terminal
2017E Value
Taxes
Tax Rate
Equity Income, net
% of sales
Net Income
% Growth
Add Depreciation/Amort
% of Sales
% of Capex
Plus/(minus) Changes WC
% of Sales
Subtract Cap Ex
Capex % of sales
Free Cash Flow
YOY growth
(4,244)
-2.80%
(4,543)
-2.70%
(4,669)
-2.50%
(4,975)
-2.40%
(5,473)
-2.40%
(5,664)
-2.30%
(6,004)
-2.30%
(6,305)
-2.30%
(6,620)
-2.30%
(6,951)
-2.30%
(6,791)
-2.30%
7,130
34.5%
100
0.1%
9,101
34.8%
370
0.2%
10,160
34.0%
374
0.2%
11,348
34.0%
415
0.2%
12,483
34.0%
456
0.2%
13,565
34.0%
493
0.2%
14,379
34.0%
522
0.2%
15,098
34.0%
548
0.2%
15,853
34.0%
576
0.2%
16,646
34.0%
604
0.2%
22,305
34.00%
20.00%
13,643
18%
17,413
28%
20,096
15%
22,443
12%
24,687
10%
26,825
9%
28,434
6%
29,856
5%
31,349
5%
32,916
5%
37,155
13%
13,188
8.70%
72.50%
82
0.1%
18,190
12.00%
8,723
57%
14,975
8.90%
80.91%
(895)
-0.5%
18,508
11.00%
12,984
49%
16,622
8.90%
80.91%
(1,868)
-1.0%
20,544
11.00%
14,306
10%
18,658
9.00%
81.82%
(2,073)
-1.0%
22,804
11.00%
16,224
13%
20,523
9.00%
90.00%
(2,280)
-1.0%
22,804
10.00%
20,127
24%
22,165
9.00%
-1.0%
24,628
10.00%
21,899
9%
23,495
9.00%
-1.0%
23,495
9.00%
25,824
18%
24,670
9.00%
-1.0%
24,670
9.00%
27,115
5%
25,903
9.00%
90.00% 100.00% 100.00% 100.00%
(2,463) (2,611) (2,741) (2,878)
-1.0%
25,903
9.00%
28,471
5%
27,199
9.00%
100.00%
(3,022)
-1.0%
27,199
9.00%
29,894
5%
28,558
9.00%
100.00%
(3,173)
-1.00%
28,558
9.00%
33,982
14%
29%
71%
Terminal
P/E
EV/EBITDA
Free Cash Yield
923,670
28.1
12.6
3.24%
NPV of free cash flows
NPV of terminal value
Projected Equity Value
Free Cash Flow Yield
Shares Outstanding
Current Price
$135,324
$333,391
468,715
12,260
1.18%
49.00
Implied equity value/share 38.23
Upside/(Downside) to DCF -22.0%
'06-10 Cash/Op's
Cash/Op's % of Sales
156,201
14.3%

Exhibit 2: WACC Calculation
D-to-E 34.0%
D-to-V 25.4%
E-to-V 74.6%
Equity beta 0.97
Market Risk Premium 6.00%
Cost of Equity (using CAPM) 10.53%
Cost of Debt (taken from Balance Sheet) 6.0%
Risk-Free Rate 4.71%
WACC 8.86%
22