Rating Forest Investments

Criteria, Definitions, Investors, Read

Understanding the importance of sustainability has popularized an asset class that used to be reserved for the state, churches and nobles. Forest – to be precise its wood – has always served people as fuel, product and building material. Forest has now become the epitome of sustainable investments. The idea of sustainability emerged in a time of crisis and scarcity. Around 1700, the mining industry and livelihood of thousands was threatened in Saxony. The problem was an acute scarcity of timber. The mining industry and smelting of ores had consumed whole forests. Trees had been cut at unsustainable rates for decades without efforts to restore the forests. In Germany, the term sustainability is associated with Hans Carl von Carlowitz. He was raised in and influenced by the aforementioned environment of wood scarcity. He traveled widely in his youth and learned much from the forced discipline of the French minister Jean Baptiste Colbert, who had enacted a forestry reform in France. Carl von Carlowitz’ view that only so much wood should be cut as could be regrown through planned reforestation projects, became an important guiding principle of modern forestry.

In this preliminary article you can learn more about some risks and rewards of buying forests and what you should consider when buying forests. Given the popularity of forest investments, the question arises as to which ratings are available to investors as decision-making aids. The first question to be asked is which instruments can be used by investors to tap into this asset class. The most common investments in forests are shares, direct investments or closed-end funds. Whereas in direct investments investors invest directly in one or more trees on specific areas and leave the management to a service provider, closed-end forestry funds are less individual.

  • A forestry share is a security which securitises a share in a stock corporation whose capital is invested to a large extent in forest property or wood processing. Primarily Scandinavian and North American forestry stock corporations are traded. There are no German forestry stock corporations with significant free float on the stock exchange. Buying forestry shares does not necessarily mean planting new trees.
  • A closed-end forestry fund or closed-ended forestry fund is a collective investment model based on issuing a fixed number of shares which are not redeemable from the fund. Unlike open-end funds known for corporate stock and bond investments, new shares in a closed-end forestry fund are not created by managers to meet demand from investors. Instead, the shares can be purchased and sold only in the secondary market, which is the original design of the mutual fund, which predates open-end mutual funds but offers the same actively-managed pooled investments.
  • Direct investment in forest means becoming the owner of the forest yourself and thus acquiring all the rights and obligations of a forest owner. The investor needs to be able to maintain regular forest care. As a forest owner, you also have certain obligations, since you are legally obliged to ensure road safety. This means that all trees and branches that are located in places with increased traffic – for example on country roads or hiking trails – have to be felled or trimmed as soon as they pose an increased risk for humans. Buying forests also means taking responsibility.

The implications for the rating approaches to these investment alternatives are considerable.

Forestry shares being tradable on the stock exchange at any time are subject to extreme fluctuations in value. The valuation of most listed forestry shares has a history of having fluctuated by several hundred per cent. Such fluctuations in value mean that ratings of these stocks can quickly become out of date. In fact, a buy recommendation can turn into a sell recommendation within a day if the stock market price quickly exceeds the fair value. Most forestry share companies are predominantly wood processors, who are strongly affected by economic fluctuations and thus by fluctuations in pulp or timber prices. Therefore there is a strong dependence of many forestry shares on economic trends.

Direct forestry investments in precious woods, on the other hand, can react better to market fluctuations by postponing the harvest. The trees are left in the forest until the harvest is worth it – they become bigger, taller and more valuable every day. Fuctuations in precious wood prices have historically been significantly lower than those of timber or wood used for pulp production.

In Germany in particular, the very contradictory regulations must be observed. For decades, the German government has not consistently supported wealth creation through property acquisition. Pay attention to the municipality’s right of first refusal. In this sense, there are no secure legal bases for forest investments in Germany, because rights of first refusal can hinder both buying and selling. In addition, the following contradictions must be observed.

The yields generated from a direct forestry investment are generally tax-exempt while the price gains of forestry shares and forestry shares dividends are subject to the almost 30 per cent flat rate withholding tax including solidarity surcharge and church tax. On the other hand, the transaction costs are significantly higher than with stocks. In addition to the purchase price, land transfer tax, notary and fees, which often make up ten per cent of the purchase price, are added, thus significantly reducing the returns for forest investors. Property tax has to be paid annually and wood production in Germany is relatively expensive due to environmental regulations and certifications. In addition to the actual purchase price, there are also other costs when buying a forest which would not be part of the rating analysis of an independent forest rating. For example, you have to include the costs for the notary, usually 1.5% of the purchase price (the percentage can be higher for small areas) and the property transfer tax, around 4% – 6.5% of the purchase price. You must also not ignore the broker’s commission.

As a forest owner, you also have to pay additional costs.

Property tax, accident insurance and, if applicable, contributions from the soil and water associations are to be mentioned here. With the management of the area, the ancillary costs are always offset by possible income from the sale of wood.

Forest areas in other countries offer far higher returns, although buying forest in foreign countries can be difficult for foreigners. It is much easier to hire companies to lease or buy forests or fallow land in other countries, to manage them in order to generate yields for investors. The country rating must be taken into account for every investment abroad. The country rating is used to assess the economic, social and political risk that an investor will be prevented from receiving the income due to him.

Forest investment providers advertise the scarcity of forest. They argue, that the benefits of forestry investments are the growing demand for the raw material wood. Whether there are fewer and fewer forest areas and whether the demand for wood exceeds the supply has to be tested continuously.

Forestry investments are not always socially beneficial, especially when stock corporations and other big companies buy cheap land in foreign countries and perhaps even displace locals, or the price of land for local residents rises immeasurably as a result of land purchases. Forests are not always ecologically friendly. Thousands of hectares with cloned eucalyptus or teak planted in rows are no gain for nature. Many insecticides and pesticides that pollute and destroy the soil and the environment are sometimes used to increase output.

In any case, structurally rich forests with many different tree species offer a better and safer alternative to planted conifer monocultures that are based on only one tree species. Although these grow faster, they are also susceptible to storms, snow, ice and pests. Mixed forests of deciduous and coniferous trees are not only more stable and better adapted to climatic changes, they also allow you to react more quickly to changes in the demand for wood species on the market.

Any forest rating should also pay attention to the age of the forest. Young forests, in which there are only a few old trees, initially require more maintenance. Of course, they can more easily be designed according to your ideas. The young forest will initially generate little income from wood sales through its maintenance. Forests of old age with significantly taller and thicker tree trunks enable an early profit from the logging and sale, but require care for the new generation of trees.

Good soil and suitable tree species mean that larger quantities of wood of better quality can be expected in the long term.

This is likely to be reflected in the cost of purchasing the forest, especially if the seller has had the forest valued by an appraiser. Regardless of the quality of the soil, its location is a decisive criterion for price formation. So it depends a lot on where the forest is located. A forest area near Munich will therefore cost significantly more than a similar one in the countryside in Saxony-Anhalt. The standard land value is derived from the average price of areas sold in the area and, in addition to the special features of the forest area offered, serves as an aid to determining the actual value.

If the forest is well cared for and there is already a lot of high-quality wood to be expected on the area initially, then you should also expect higher costs. In any calculation, bear in mind that there are usually additional costs for managing the forest. So you cannot count the expected cubic meters of harvest one-to-one with the wood prices and use this to conclude the profit. If the area is difficult to access, the wood harvest is also time-consuming. If it is a particularly protected forest, for example in a nature reserve, then management is only possible to a limited extent. The ideal value of these forest areas is all the higher for one or the other, especially if rare animal and plant species live in this forest. You should therefore be clear about your goals in advance and only acquire forest if it fits your previously set goals.

In addition, a forest rating process should include a step in order to check any “contaminated sites”. For example, if the forest is on a former military site, the trees there may have been damaged or the ammunition in the ground has to be laboriously cleared.

All closed-end forestry fund investments have one risk factor: the long contract term. Even with sustainable forestry investments which respect human rights and the environment, the planted trees need lots of time to grow. On ecologically farmed land, they probably take even longer to grow than the fast-growing trees in monocultures, which are harvested earlier, to produce cheap pulp and biomass. During long contract terms, much can happen: companies can fall victim to mismanagement or go bankrupt, the regions in which the forests grow can become politically unstable.

Natural events such as fire, earthquakes, droughts or floods also have a lot of time to occur over the years.

Forestry investment are therefore right for investors in particular if they do not shy away from risks, have the necessary financial means and staying power until the trees generate returns. If you take over a neglected forest that does not promise stability and is therefore susceptible to pests or storms, that does not necessarily mean that it is a bad deal. Careless forest care can have a positive impact on the purchase price and there may be a lot of potential in your future forest. An unkempt forest can be a deterrent, but it is up to the investor to shape and maintain the forest. What possibilities are opening up in the forest and what additional costs have to be reckoned with for any maintenance measures? With almost every intervention in the forest, whether in well-tended or unkempt forests, financial resources are necessary.

Some native tree species have been planted in the wrong locations in the past. This can result in poor growth, instability and increased susceptibility to damage. To select tree species that are appropriate to the location requires a lot of expertise. To increase the stability of a forest and make it fit for the next centuries requires a forestry rating first.

Ecological goals or enjoying forest ownership are important motives for some investors. Because while it has a personal value for some, only the regularly generated income plays a role for others. However, if one compares direct forest investments with other investment options such as stocks, then short-term gains are generally not to be expected. Every rating approach for direct forest ownership has to take this into account. Forest ratings are possibly the ratings with the longest time horizon. Long-term bond ratings – for comparison – usually only refer to a forecast period of four to five years.

Forests give us the sustainable resource wood, which will also be of ever greater importance in the coming generations.

That makes the forest relatively stable as a system. However, for a fast growing return, other investment methods are a better alternative. So buying a forest is a decision that should be made not only for financial reasons, but also for a certain amount of idealism and enjoyment of nature. Forest investors are similar to investors who invest for ethical, ecological or social reasons.

Forest has been in great demand in Germany for a number of years and has often been family-owned for generations. In addition to the forest exchange, there are a few other real estate portals and tender platforms on the Internet that also offer forest. Depending on the respective provider, there may be costs for registration or an application. In some cases, brokers are also placed between the buyer and seller from the outset.

A responsible forest office or an auction houses in the area, the member newspapers of forest owners’ associations for forest pieces on offer or the advertising section of the regional newspapers might provide information on forest for sale. With currently estimated 1.9 million forest owners in Germany, investors are also well advised to ask around in their private or professional environment. The chance that you have forest owners in your circle of friends is quite high.

black camera

A Case of Rating Repair for a Small Publicly Traded Company

Agencies, Analysts, Bureaus, Raters, Read

A small publicly listed company is a company whose shares are bought and sold on a particular stock market even though turnover or total assets are small in comparison to other listed companies. Every big story starts small. Therefore, among small companies there are often also stock corporations with exceptionally high potential for a good share price development. Small businesses can also be great debtors. Well-managed companies can have excellent credit ratings over long periods. Therefore, such companies are attractive to bond investments, provided they have issued bonds.

The internet is full of investment offers. The disadvantage of this information, however, is that it is often written with the interest of selling securities. Many stock market letters testify to how spectacular sounding promise of returns can be advertised to investors. Alternative ways of obtaining reputable information about good companies are therefore of interest.

The following is an example of how an interesting company can be found and analyzed using the database of a credit reporting agency. Thousands of companies worldwide use Creditsafe to grow their business and reduce exposure to customer credit risk. With Creditsafe it is easy to determine the maximum amount of credit to extend to a company based on company information including, payment history, County Court judgments (CCJs), financial stability, credit scores and limits. Credit managers enjoy to be able to access credit reports for companies anywhere in the world.

A database like that of Creditsafe can be used not only in customer and delivery relationships, but also in all other relationships with company stakeholders. The following example shows, on the one hand, which information can give reason to deal with a company in more detail. On the other hand, the example also shows what can be misunderstood and therefore give rise to a rating repair.

Creditsafe allows to search a database of more than 240 million company credit risk profiles to determine the risk when trading with overseas companies. This information is valuable in identifying good quality companies. In particular, companies can also be found that are particularly attractive for their business partners because they have a good credit rating.

For companies in certain industries, a good credit rating is of crucial importance for business success. For example, in most countries around the world, governments apply very strict standards to the companies with which they work. The creditworthiness is checked for each invitation for tenders. The seriousness and creditworthiness of a company that supports governments in the area of security is particularly important.

The following company is a typical example. The listed company (A6T) artec technologies AG from Diepholz / Germany was founded in 2000 by Thomas Hoffmann and Ingo Hoffmann and develops and produces innovative software and system solutions for the transmission, recording and analysis of video, audio and metadata in networks and the Internet. Since 2000, customers have been using the product platforms MULTIEYE® for video surveillance and security, especially in industrial and governmental environments, and XENTAURIX® for media & broadcast applications for monitoring, streaming, recording and analysis of TV, radio and web livestream content. artec offers its customers a complete service (project planning, commissioning, service & support) both for the standard products and the special developments.

The Creditsafe Rating Model is a predictive analysis tool that uses the latest advanced statistical techniques. It combines commercial and other key information, including trade payment information, public information, key financial ratios, industry sector analysis and other performance indicators which provides you with view of a company.

The business credit score measures the likelihood that a business will remain solvent for the next 12 months. But as the executives behind millions of transactions each year are relying on business credit scores to help them answer questions like: Which vendor should we work with? Can we continue to work with this supplier? What kind of terms can we offer them? and How much funding should can we offer them? Business credits scores are much more than that simple definition.

The Creditsafe Rating Model was created by an analytics team who looked at companies that failed over the last 12 months and assessed the commonalities within these failures. They compiled hundreds of variables and looked at the weighting each variable carried along with the impact each variable had on the failed businesses. They then selected a number of variables which were compiled together to create the modules.

The company stands out at Creditsafe with an excellent credit rating. artec technologies AG (DE01958811) is reported with a very good Credit Index of 1.1, a Risk Score of 97 (on a scale from 0 to 100), the best International Score A and an extremely low Probability of Default of 0.06%.

Initially, the good credit rating seems to be confirmed in the balance sheet data. Compared to most other stock corporations in Germany, the company has a high level of equity both in absolute and relative terms. The solid lines in the graph show the comparative values for the 25% and 75% quartiles as well as the medians. Equity is the capital that remains at a company’s disposal after debts are deducted from the total assets.

It is a comparison of the company based on the industry code (primary) with other companies from the same industry. The analysis has been based on the industry code 82 – Office administrative, office support and other business support activities. The Equity Ratio measures the ratio between equity and the total assets of a company.

The Total Borrowing Ratio measures the ratio between debts and total assets of a company. The Debt Ratio measures the ratio between debts and equity of a company. Other key performance indicators measure liquidity, e.g. the Cash Ratio shows the ratio between liquid assets and short-term debts.

The performance indicators determined by Creditsafe include “Capital Structure” and “Liquidity” as well as “Results & Profitability”.

At this point the information must be confusing. No results are reported. This affects the following key figures in the Creditsafe model:

  • Revenue indicates the value of goods and services a company sold within it’s ordinary business activity during a trading period.
  • Pre Tax Profit Is calculated from the operational result plus financial result plus extraordinary result or from the net income plus the net tax expenditure.
  • Net Profit Ratio measures the ratio between operational result and revenue. So it indicates how much the company actually earned with its achieved revenues.
  • Return on Assets indicates the rate of return for a company’s total assets.
  • Return On Capital Employed shows the rate of return for a company’s capital. In distinction from the Return On Assets Ratio , this indicator considers just the long-term capital.

No values are shown for any of these key figures for the company under consideration here, artec technologies AG. Therefore one has to ask about the reasons why there are no values here.

The report of the Deutsche Bundesbank, the central bank in Germany, is also linked on the homepage of artec technologies. Like Creditsafe, this report confirms that the company has a good credit rating.

As part of Eurosystem monetary policy operations, commercial banks can submit credit claims as collateral for refinancing at the Deutsche Bundesbank. For this, the borrowing enterprises must be considered “eligible”. This is checked in a credit assessment conducted by the Bundesbank. Enterprises may also request a credit assessment. In either case, the Bundesbank provides the enterprise with the results of the credit assessment in their entirety. The aim of Bundesbank’s credit assessment system is to estimate an enterprise’s one-year probability of default (PD) on the basis of financial statements as precisely and reliably as possible. For that purpose, Bundesbank uses a statistical methods to select the ratios which, when combined, are best able to predict an enterprise’s PD.

Credit rating grades of the Deutsche Bundesbank and external credit rating agencies authorised in the Eurosystem are related. This is the example of S&P’s credit ratings:

The data input to Creditsafe can easily be checked under the “Documents” tab. This shows that, as expected, Creditsafe used data from the Federal Gazette. German companies are obliged to publish their financial statements in the Federal Gazette. In the case of the artec technologies AG considered here, however, no data on the income statement was published in the Federal Gazette.

The website of artec technologies also offers the reports of three research companies, which offer in-depth analyzes with all other aspects of stock valuation.

The missing income statement in the credit bureau’s report is due to the legal situation for small, medium and large companies. The size classes (Größenklassen) defined in the HGB serve to regulate accounting and publication for incorporated companies (Kapitalgesellschaft). The larger a capital company is, the stricter the requirements for auditing and the more detail required when disclosing the business data. The four size classes are defined in the HGB for accounting law. They are used for corporations, including the GmbH, the UG and the AG. The size classes are also applied to partnerships without a natural person as a personally liable shareholder (GmbH & Co. KG, UG & Co. KG).

In § 267 HGB, four size classes are defined: micro-company, small company, medium-sized company and large company. For each size class, at least two of the three thresholds listed for each class should not be exceeded. The thresholds are as follows:

  • Balance sheet total (Bilanzsumme),
  • Average number of employees,
  • Revenues (twelve months before the balance sheet date).

The thresholds were changed in 2016 with the German Accounting Directive Implementation Act (Bilanzrichtlinie-Umsetzungsgesetz – BilRUG). The size classes are structured as follows:

Determining FactorMicroSmallMediumLarge
Balance sheet total (Bilanzsumme)350,000 EUR6,000,000 EUR20,000,000 EUR> 20,000,000 EUR
Revenues (12 months before the balance sheet date)700,000 EUR12,000,000 EUR40,000,000 EUR> 40,000,000 EUR
Number of employees on an annual average1050250> 250
artec technologies

Small companies must disclose their balance sheet and their notes. The profit and loss account is not mandatory. In addition, the audition requirement is dropped. In the case of artec technologies AG, the information published is part of the company’s follow-up obligations due to its membership of a transparency standard at the Frankfurt Stock Exchange. The obligations result from these obligations, but not from Section 267 of the German Commercial Code.

The shares of artec technologies AG are traded on the Open Market. The Open Market (Freiverkehr) is a regulated exchange market and not an organised market in the meaning of the German Securities Trading Act (section 2 para. 5 WpHG). Unlike the Regulated Market, which is subject to public law, the Open Market is subject to private law. The General Terms and Conditions of Deutsche Börse AG for the Regulated Open Market (Freiverkehr) on Frankfurter Wertpapierbörse (FWB®) regulate the conditions for admission to and the follow-up duties for securities in the Open Market segment. Admission to the Open Market is possible for securities that are neither admitted to trading on the Regulated Market nor included in trading on the Regulated Market.

Issuers and participants in the Open Market are subject to lower transparency requirements than in the Regulated Market. The Open Market segment is therefore an attractive alternative for both young, growth-oriented small and medium-sized companies such as artec technologies AG.

Since all of this information is public, it is advisable to update the information with the credit reporting agencies. Since these credit bureaus have to enter and update very large amounts of data from many companies in their databases, they rely on the official publications of the companies in the Federal Gazette. If the annual financial statements are reported to the Federal Gazette without a profit and loss account, then by default the data from the income statement are not transferred to the credit reporting agency’s database.

Important key figures about the stock corporation can be viewed free of charge on the website of the Frankfurt Stock Exchange. There are also research reports from SMC, EDISON and GBC. Not to be forgotten are the numerous other information tools, such as price information for technical chart analysis and risk indicators such as those from Moody’s, all of which provide information about artec technologies AG and offer investors certainty in their decisions.

Generally accepted, Bayesian statistics is a theory in the field of statistics based on the Bayesian interpretation of probability where probability expresses a degree of belief in an event. For rating systems, this theory says that if information is missing, a judgment should be made more cautiously than if the required information is available. If only the balance sheet and not the profit and loss account are taken into account in a rating, the result may be a poorer assessment. It is therefore advisable to add missing information.

Statistical credit rating models specify a set of statistical assumptions and processes that represent how the sample data is generated. Statistical credit rating models have a number of parameters that can be modified. For example, the event of a default can be represented as samples from a Bernoulli distribution, which models two possible outcomes. The Bernoulli distribution has a single parameter equal to the probability of one outcome, which in most cases is the probability of filing for insolvency. Devising a good model for the data is central in Bayesian inference. In Bayesian inference, probabilities can be assigned to model parameters. Parameters can be represented as random variables. Bayesian inference uses Bayes’ theorem to update probabilities after more evidence is obtained or known.

In our practical case, these theoretical considerations mean that the lack of information can lead to disadvantages in the evaluation. It is more likely that the missing information will result in a worse rating than with full disclosure. In most cases, a better rating is achieved when more information is disclosed.

In the case of a rating agency recognized under the EU regulation on credit rating agencies that carries out a committee-based rating process, however, the lack of information in the case of unsolicited ratings must not be used as a means of pressure on issuers to urge them to commission a rating process. With a credit reporting agency like Creditsafe, however, this case does not matter. The rating is determined purely mathematically-statistically and based on models without involving a rating committee made up of analysts who could make arbitrary decisions. In addition, there is no fee for the rating that could create a conflict of interest. It therefore remains a sensible way to enable a better evaluation by providing more up-to-date information.

In most cases the credit reporting agency provides the assessed company with its own company report free of charge. An application to receive your own report is sufficient with Creditsafe.. The authorization to receive information must be proven by the company’s employee. However, the company is free to refer business partners and investors to the report of the credit reporting agency and the credit rating contained therein. Similar to the reference to the central bank eligibility certified by the Deutsche Bundesbank, such a reference can strengthen confidence in the company being assessed.

The irritation about missing P&L data in the reports of the credit reporting agency about artec technologies can be easily resolved. For this it is not necessary to expand the disclosure to the Federal Gazette. It is sufficient to provide the credit reporting agency with the certified accounts. A form is available for this that simplifies and standardizes the transfer of data. All financial reports can be found on the company’s German website:

However, it can also be advisable to expand the disclosure to the Federal Gazette. Not only Creditsafe, as in the example, but also many other credit reporting agencies, research houses and, last but not least, financial service providers such as banks and insurance companies access the Federal Gazette. In order to fulfill their various obligations, to check the identity of their business partners and to determine the beneficial owner, they need official data.

PALTURAI is the example of a service that is also used by investors and creditors such as banks and insurance companies to examine the situation at a company. For this purpose, PALTURAI analyzes all reports to registration courts as well as to the Federal Gazette. In order to avoid contradicting information and irritations to the detriment of the rated companies, a consistent approach is recommended. The international data flows and interdependencies in the transfer of information worldwide are more complex today than ever before. The task in the context of a rating repair is to bring about the correction in the most efficient way possible.

With a very good rating like the one for artec technologies, the question arises whether the already very good rating could possibly even be called into question through more transparency. The income statement contains additional information that is taken into account when assessing creditworthiness. For artec technologies, the data that cannot be found in the Federal Gazette has now been added. It shows that the creditworthiness is still rated as very good. The company retains its very good ratings.