Potlatchdeltic Corp (PCH) 2018 Q2 法說會逐字稿

Good morning. My name is Ian, and I will be your conference operator today. At this time, I would like to welcome everyone to the PotlatchDeltic Corporation's Second Quarter 2018 Conference Call. (Operator Instructions) I would now like to turn the call over to Mr. Jerry Richards, Vice President and Chief Financial Officer, for opening remarks. Sir, you may proceed.

Thank you, Ian, and good morning. Welcome to PotlatchDeltic's investor call and webcast covering our second quarter 2018 earnings. With me in the room are Mike Covey, Chairman and Chief Executive Officer; and Eric Cremers, President and Chief Operating Officer.

This call will contain forward-looking statements. Please review the warning statements on our press release, on the presentation slides and on our filings with the SEC concerning the risks associated with these forward-looking statements. Also, please note that a reconciliation of non-GAAP measures can be found on our website at www.potlatchdeltic.com.

I'll now turn the call over to Mike for some comments, and then I will cover our second quarter results and third quarter outlook.

Thanks, Jerry. Good morning. This was our first full quarter since we closed the Deltic merger in February, and the integration has met or exceeded our expectations by nearly every measure. The merger was strongly cash flow accretive given the strength of the lumber market. We generated $94 million of adjusted EBITDDA in the quarter with the Wood Products contributing $52 million. Our lumber market went on a historic run in the second quarter due to a variety of factors, which have been well documented. The Random Lengths Framing Lumber Composite peaked at a record $582 per thousand board feet in June and has started to pull back as we expected. However, we do not expect pricing to collapse. Industry fundamentals remain strong with capacity utilization rates around 90%. Bottlenecks and transportation logistics exist but are easing, and single-family housing starts are in line with expectations. The repair and remodel segment continues to be robust, and fire season has started in British Columbia and the U.S. West. For these reasons, we believe our Wood Products segment is well positioned to continue to deliver strong results for the remainder of the year.

Even though lumber prices have been declining for the last 7 weeks, our average price for July was about 2% higher than the average lumber price we realized in the second quarter. We expect our average lumber price for the full third quarter to be just over $500 per 1,000 board feet or about 3% lower than the second quarter.

The strong lumber market has also translated into higher Northern sawlog prices since over 2/3 of our Idaho sawlog harvest is indexed to lumber prices. Index log volumes to be delivered through mid-August will reflect the higher lumber prices that existed through the first part of June. Resources third quarter EBITDDA will increase significantly relative to the second quarter due to seasonally higher harvest volumes in addition to the strong Northern sawlog prices.

This was our first full quarter of operations on the Deltic timberlands. This is reflected in Southern harvest volumes that were 64% higher compared with the first quarter. Our Southern Resource team is also making good progress identifying management practices that will reduce cost or increase growth rates. Examples include planting genetically advanced seedlings, fertilization and developing site-specific treatment plants.

Our Real Estate segment had another solid quarter, closing on the sale of just over 11,000 rural acres. As discussed on the last earnings call, second quarter rural sales included a $7 million sale of land near the Boundary Waters Canoe Area in Northern Minnesota. This represents about 1/5 of a larger multiyear option involving the conservation fund and state and federal agencies that use conservation funding to secure land approximate to the Boundary Waters Canoe Area. Total sales could add up to 40,000 acres over a 5-year period if all the purchase options are exercised.

Regarding the integration of Deltic, I'm really pleased with the progress that we've made in just a few months. Our annual synergy run rate was $40 million at the end of June. Mill production levels have increased and harvesting has ramped up. In addition, Deltic is treated as a REIT effective with the merger close, and most of the corporate overhead synergies have been realized. In some cases, headcount rationalization will not be complete until year-end when accounting, payroll and other systems are all consolidated. Overall, we're off to a great start and we are well on our way to achieve our goal of increasing annual cash available for distribution by at least $50 million by the end of 2019.

By the end of the fourth quarter, we will complete the earnings and profit purge associated with converting Deltic to a REIT. Recall that amount is estimated to be approximately $250 million and we'll be paid 20% in cash and the remainder in stock. Our dividend payout ratio is expected to be around 50% of cash available for distribution for the year, excluding the cost to achieve synergies. The board will revisit our dividend late this year once we have more visibility in the markets, progress on our synergies targets and special distribution. Our thinking about share repurchases has also evolved in considering the recent weakness in our share price. We plan on reviewing a share repurchase authorization with our board near the end of August.

We are well positioned to benefit from the improving U.S. housing market. I'm excited about PotlatchDeltic's prospects for 2018, which is shaping up to be an extraordinary year.

I'll now turn it back to Jerry to discuss the quarter and then we'll take questions.

Thanks, Mike. I'll start with Page 4 of the slides. Adjusted EBITDDA was $94.2 million in the second quarter, which is $29.5 million or 46% higher than the first quarter. The second quarter includes results from Deltic's operations for the full period compared to only 39 days in the first quarter. As Mike mentioned in his comments, the combined operations benefited from a historic run in lumber prices in the second quarter.

I'll now review each of our operating segments and provide more color on the strong second quarter results. Information for our Resource segment is displayed on Slides 5 through 7. The segment's adjusted EBITDDA was $43.7 million in the second quarter, which is $6 million higher than the first quarter. We harvested 378,000 tons of sawlogs in the North in the second quarter. This was down seasonally from the 449,000 tons that were harvested in the first quarter due to spring breakup. Northern sawlog prices increased 19% on a per ton basis in the second quarter. This increase reflects the effect of higher lumber prices on indexed sawlog volumes and seasonally lighter logs due to lower moisture content.

Turning to the South. We harvested 1.1 million tons in the quarter, which is up 64% compared to the first quarter. Most of the increase was a result of a full quarter of harvest on the Deltic timberlands. In addition, logging conditions were good in the second quarter compared to the extraordinary wet conditions in Arkansas in the first quarter.

Our Southern sawlog prices were 8% higher in the second quarter compared to the first quarter. The volume and price of hardwood sawlogs were both better than we assumed in our forecast. While the price of Southern pine sawlogs by product type remain flat quarter-over-quarter, there was a higher mix of more valuable large diameter logs from the Deltic timberlands.

Logging haul cost were $5.4 million higher in the second quarter compared to the first quarter. This was due to solely to the net increase in the segment's harvest volumes. Forestry cost were higher seasonally in the North.

I'll now shift to Wood Products, which is covered on Slides 8 and 9. This segment's adjusted EBITDDA was $51.5 million, which is up $22.5 million or 78% compared to the first quarter. Our average lumber prices increased 11% from $465 per thousand board feet in the first quarter to $517 per thousand board feet in the second quarter. Lumber shipments increased 55 million board feet to 259 million board feet in the second quarter. This was lower than the 275 million board feet that we anticipated shipping in the second quarter. The shortfall was primarily due to truck and rail shipping challenges. We expect to catch up in the second half of the year and still plan to ship just over 1 billion board feet of lumber for the year.

Cost of sales for the lumber mills increased due to the higher shipment volumes. Adjusted EBITDDA related to our 2 panel mills increased $1.5 million due to inclusion of Deltic's MDF plant for a full quarter. The MDF plant is benefiting from the replacement of press chains and a press belt that Deltic completed in 2017 and ran at 87% utilization in the quarter. Improvement in the MDF plant's contribution was not included in our $50 million synergies target.

I will now cover our Real Estate segment on Slides 10 and 11. Real Estate's adjusted EBITDDA increased $4.3 million in the second quarter. As discussed on our first quarter earnings call, we closed on the sale of approximately 8,000 acres of nonstrategic timberlands to a conservation entity for $900 per acre in April. Including that transaction, we sold a total of 11,571 acres of rural land in the second quarter. We believe there are solid rural Real Estate opportunities on the former Deltic timberlands and listed the first Deltic rural properties for sale near the end of June. Sale of Deltic Real Estate is not included in our $50 million synergies target.

In the Chenal Valley development business, we sold 13 lots at an average price of $74 per lot in the quarter. Lower average price per lot reflected a higher mix of our smaller Wildwood lots this quarter. Lot sales were heavily weighted to the fourth quarter once development of the next cycle of lots is completed.

Turning to synergies and operational efficiencies on Slide 12. Excellent progress against our targets has occurred since the merger closed in February. As Mike mentioned, we are at a run rate of $40 million at the end of June and remain confident that we will achieve a run rate of at least $50 million in 2019.

Shifting to liquidity highlights presented on Slide 13. We ended the quarter with $125.7 million of cash. We also have $379 million available on our revolver. As a reminder, we plan to distribute $50 million of cash to shareholders as a special dividend in the fourth quarter. This is to complete the conversion of Deltic's timber operations to REIT status. We are also evaluating other uses of cash, including a dividend increase, paying down our 7.5% debt maturing in 2019, reinstituting a share repurchase plan, investing in additional high-return projects in our mills, acquisitions and accelerating contributions to our pension plan to take advantage of the higher 2017 income tax rates.

Capital expenditures were $13.1 million in the second quarter. We are accelerating some deposits to lock in delivery of equipment related to high-return 2019 projects. We expect that capital expenditures will be in the range of $50 million to $60 million for the year.

S&P upgraded our credit rating to BBB- investment-grade earlier this month. Their press release cited strong demand in pricing, timberland coverage, high margins and conservative financial policies as reasons for the upgrade. We are now investment-grade rated by both S&P and Moody's.

Before I comment on our outlook, I want to point out that we are no longer providing EBITDDA and CAD guidance now that we have a full quarter behind us as a combined company. As a reminder, guidance was provided solely to help with model calibration while there were a lot of moving pieces with the merger. The assumptions embedded in our third quarter outlook are included on Slide 14. We expect Resource adjusted EBITDDA to be up significantly in the third quarter as harvest volumes reach their seasonal high point for the year. We expect Wood Products' adjusted EBITDDA in the third quarter to be comparable to slightly higher than the second quarter. This assumes that increased lumber shipments will exceed the effect of slightly lower lumber prices. We estimate that real estate's third quarter adjusted EBITDDA will be about half of the amount generated by the segment in the second quarter. We anticipate selling significantly fewer rural acres due mostly to the lack of large conservation sales in the third quarter. In addition, most of the development lot sales are planned to occur in the fourth quarter.

The corporate expense run rate is expected to be $11 million per quarter for the remainder of the year. The increase in the corporate run rate reflects an adjustment to the bonus accrual rate due to our strong results. This year has been tremendous thus far. We expect third quarter 2018 adjusted EBITDDA to be meaningfully higher than second quarter 2018. This is primarily due to a seasonal increase in our Idaho harvest volumes, higher lumber shipments and our expectation that lumber prices will settle at historically strong levels.

That concludes our prepared remarks. Ian, I would now like to open the call to Q&A.

(Operator Instructions) Our first question is from the line of John Babcock from Bank of America Merrill Lynch.

Just want to quickly step in. Could you clarify the guidance? I think I missed that on kind of wood and resources for 3Q.

So in terms of adjusted EBITDDA levels, John?

Yes, exactly. Yes.

Yes. So Q3, we have seasonally higher harvest volumes in Idaho. So we think resources, adjusted EBITDDA will be meaningfully or significantly higher than the second quarter. And then for Wood Products, we have a pretty meaningful increase in shipment volumes. So we think that will more than offset a slight decrease in lumber prices. So there, we think it's either Wood Products is either comparable or up slightly.

Real Estate is about half of what it was just due to fewer conservation sales in Q3.

Okay, appreciate that. And then I was wondering if you could kind of talk about the lumber market now. You guys don't seem to be expecting much of a collapse in lumber pricing from here. I just want to get a sense for kind of where inventory levels stand at both the mill and distributor levels. And also what else you're seeing that might help us get a better sense for where the lumber market is going from here.

This is Eric, John, and our sense of it is that out on the dealer networks, inventories are relatively low levels. What you saw was a really strong lumber price run up in the second quarter. We think credit limits were pushed for those dealers trying to buy lumber so they probably didn't put a time in inventory. You are starting to see the inventory pressure come off a little bit as some of that wood is now coming down from Canada, was trapped up in Canada earlier in the year. So some of that pressure is starting to come off. But our view, and I've read it in 3 or 4 different places now, is that inventory levels are pretty low out in dealer inventories. Now when it comes to the mills, I mean, I would say things are probably at typical levels. There were transportation issues across the industry in Q1 and Q2 where a lot of those pressures have now eased. I know we've seen that in our own business, so I would expect inventories at mills to be at relatively typical levels.

Okay. And then next, I was wondering, and this doesn't seem to have a direct impact on you per se, but I was wondering if the trade situation, kind of the back and forth with China is having any impact on kind of the confidence that your customers are having or perhaps more related even to your business. Any commentary you can provide there will be helpful, but I realize the impact may not be too significant.

I think it's relatively insignificant at this point outside, of course, the tariff situation if Canadian lumber continues. But that's largely not been mentioned in any of the commentary by administration.

Okay. And as far as your customers, I mean, do they seem pretty confident still at this point?

Yes, absolutely.

Yes.

And our next question is from the line of Collin Mings from Raymond James.

First, just following up on John's question. As you think about the decline in lumber pricing again over the last 1.5 months or so, what would you attribute to normal seasonality versus some sort of shift in underlying fundamentals?

Well, our guess, Collin, is that lumber prices ran up in the spring and roughly 1/3 to half of that was due to transportation issues down in Canada. So those issues are now more or less behind us. Some of that wood is still flowing across the border, but some of that price run is going to get given back here. I think what you're really seeing at this part is just psychology at play. Once those prices started to roll over, if you are a dealer and you had any kind of inventory, you stayed away from the market until you thought lumber prices were -- had bottomed. And lumber prices are still falling. We think there may be a little bit more to go here before prices do hit a bottom. But at some point in time, it comes back to fundamental supply and demand. With dealer stocks light and with homebuilding continuing to be pretty robust albeit the most recently announced numbers are weak, still the trend is in the right direction. Demand for lumber remains robust. And so we think pricing will find a floor here and get back again. So I hope that answers your question, but that's how we characterize the price run up and then decline.

No, that's very helpful color there. Maybe moving just to the fire situation. Just have any of the fires in Idaho impacted your ownership yet? It looks like most of the activity is a little bit further south, but just an update there. And even if not directly impacted, has there been any indirect impact on operations in Idaho?

No. So the fire risk in North Idaho today is currently rated as moderate by the district fire wardens. And with the rating scale of low, moderate high and extreme, we're still at moderate. We've had a couple of small fires in our Idaho ownership, less than 1 acre in size. But they've quickly been extinguished and no merchantable inventory was burned up. So, so far, so good. Most of those fires you've mentioned are in Central and in Southern Idaho. So, so far, we've been spared. Now we think we probably got about 2 more weeks to go before the fire wardens tell us that they will kick up the rating on the fire possibilities to high from moderate. We still got a couple more weeks to go so, so far, so good. And to answer your second part of your question is now we really haven't seen any secondary effects from the fires that are in the Western half of the U.S. and B.C. so far.

Okay. All right. And then just one last one and I'll turn it over. Just again in the prepared remarks, you went through a lot of the capital allocation discussions you have or plan to have with the board. Clearly, share repurchases maybe on the margin are becoming more attractive given the pull back in the stock, dividend, a lot of flexibility there. But just as you think about the timberland acquisitions, and I know we've discussed this in prior calls, but maybe just an update there, Mike, from your perspective of thinking about growing the timberland footprint. It looks like on the cash flow statement, maybe there was just a nominal amount of timber purchase activity during the quarter. But just maybe update us on that front, given the growing cash balance.

Well, we'd certainly like to grow the footprint of the company in areas that are geographically adjacent to where we already have a footprint in the Central U.S., South and in the Northwest here in Idaho. As you know, that's challenging to do with very few properties currently on the market in Alabama, Mississippi and Arkansas. It's also hard to find returns that are attractive in those Southern markets at the current kind of price level of timberlands. Northern Idaho has been the more attractive place for us to find some small acquisitions. I think we've bought about 25,000 acres last year as kind of bolt-on. But it's been -- there's been a shortage of timber properties on the market and is still something we can try to do and think that we can have some advantage with these bolt-on acquisitions.

Our next question is from the line of Gail Glazerman from Roe Equity Research.

Just going back to the lumber outlook and assumptions. Is it just that your assumption is that pricing is going to stabilize and probably rebound by the end of the quarter? Or are there some timing lags where you've locked in higher pricing that we should think about? And can you maybe give a little more detail on how that flows into your Northern log pricing in the quarter as well? Just a little bit more color on what you're expecting there.

Yes. So Gail -- so this is Eric. We always sell our lumber anywhere from 2 to 4 weeks out into the future. So when prices peaked in June, we didn't feel the immediate effect of that because -- until mid to late July, let's say. So we're always selling forward our lumber so that there's a lag effect from when lower prices that you see actually affect our business. So we have prices gradually coming down over the course of the year. We'll finish the year, frankly, at prices that were higher than where we started the year in Q1. So there will just be a slow, gradual softening of demand as we move through -- a slow gradual decline in price as we move through the back of the year, but still at prices that are relatively high resulting in very high margins for our Wood Products business. So I guess -- does that answer your question on that part?

Yes. And I'm still just trying to get my head. I mean, random length composites are something like $90, which is obviously a far cry from what you're doing. Are there kind of grade differences that you're performing significantly better than that?

Well, we were very much in line with random length's Q1 to Q2. Random lengths was up, I think, 12% and we were up 12% to 13%. So we've been in line with random lengths. Now there are differences between our business and our product mix versus random lengths. So at any given quarter, you will see deviations between the 2. But for the most part, we're going to track random lengths. Now as it relates to Northern sawlog prices, yes, 70% of our sawlog production in Idaho is indexed to the price of Western lumber. So you only got to drill in Western lumber prices to find out what's going on with Northern sawlog prices. But what I can tell you in this most recent quarter, our Northern sawlog prices were up 19%. The random lengths index was up 13%, so there is a difference between the 2 of about 6%. And that was really entirely due to the density issue of wood. As we get into the summer months, wood dries out so it's lighter. But we sell it on a dimensional basis or an MBF. So the price per ton looks like it's going up when it may actually be flat.

So one additional piece of color I'll throw out in terms of the lumber price effect on our outlook. As we mentioned on the call, we're no longer providing explicit EBITDDA guidance. But with lumber prices running to a higher level in Q2 than we anticipated, that correction that we talked about in last quarter's call is coming from a higher peak, if you will, or higher level. Which means that when you look at our internal forecast that we have for the rest of the year, lumber price averages are about 10% higher than what was built into the outlook that we had when we like set for last quarter's earnings call. So that record is down so we just pencil that through. That represents probably $25 million or $30 million additional EBITDDA for Wood Products, just for that segment.

Okay. And last quarter, you talked about small bits and pieces that were starting to add up to maybe $5 million to $7 million of incremental synergies. During your script, you mentioned specifically a couple of things that were in your initial synergies, MBF and HBU. Are those things additive to that $5 million to $7 million that you cited last quarter? Are they part of it? And is there any sort of update on kind of what upside to the $50 million you may see just given how you performed so far?

Yes. So Gail, we said $5 million to $7 million last quarter. I'd tell you that our number is probably $8 million to $10 million. These are annual run rate synergies. We're not there with the $8 million to $10 million yet. We're probably about halfway there with these operational synergies, so they're starting to flow through the P&L. And they touch virtually every area of the business. I just saw one the other day that we're going to save, I don't know, $200,000 a year on franchise taxes because we now have fewer subsidiaries filing. So individually, they're small, but collectively, they add up to a lot. And we are making great progress on capturing those synergies.

Okay. And then just one last one. Any sort of update, any new investments in your wood basket in the South that we should be looking for?

In terms of competitors and mills and whatnot?

Yes.

No, I think that there's at least 12 new mills that have been announced that are not yet operational. And collectively, they amount to something like 4 billion board feet a year, driving 15 million to 20 million tons of increased log demand in the South. But I think all those are well-publicized.

I think the most kind of exciting market that we have in our wood basket is in Alabama. We've seen several new mills either built or announced there, including GP, Talladega, which will start this fall as well as Westervelt has announced a sawmill, which hasn't been cited yet. All those are in the central Alabama wood basket, which is very advantageous for us and we're starting to see signs of an improving market for pine logs there.

Yes. And just to Mike's point, so on that central Alabama area where you have 2 rivers, [Taikiki], Talladega, we just saw a $3 a ton price jump here very recently in Southern Yellow Pine sawlogs as people see the increased demand coming.

And our next question is from the line of Ketan Mamtora from BMO Capital Markets.

My first question, has the relative attractiveness of further growth in Southern timberlands versus sawmill investments or sawmill M&A changed in your view at all? I know you've mentioned in the past that things -- Southern sawlog pricing in your wood baskets will take some time to recover. You're also a net buyer of logs in the South. Has that changed how you think about those 2 pieces of your business in the long term?

Not really, Ketan. We continue to focus on expanding and improving the mills that we own. And we've got attractive capital investments, particularly in the 3 Southern pine mills and the MDF plant. We'll focus on that rather than any standalone M&A activities. We'll continue to focus on timberland opportunities as a timber REIT, but we'll grow the Wood Products business kind of internally and organically rather than expand it.

Got it. And do kind of further investments in sawmills, whether it's M&A, mostly focused on M&A, complicate your REIT status in any way? Or do you have enough room -- enough headroom on that count?

We're fine to focus on our capital investments in our existing mills, and it's almost practically unlimited in terms of what's practical and how much we want to put into those. A stand-alone Wood Products acquisition, just to go by standalone mills, certainly, we'd have to flush that against our REIT test and evaluate. We have plenty of headroom as we sit today.

Got it. That's helpful. And then just a couple of clarification questions. Jerry, as you move from Q2 to Q3, how does this density issue play out in Northern Idaho log price? It seemed like it was about 6% to 8% in Q2 versus Q1.

Yes. So Ketan, it's Eric. The impact is about another 3% lighter. So you should -- all things equal, you'll see about a 3% price rise from the density issue in Q3 versus Q2.

Another 3% increase. Okay, got it.

Well, logs continue to dry out in Q3 as you get into August and September and July can be pretty hot in Idaho.

I see. That's helpful. And then typically, when you move from Q3 to Q4, how does that play out historically?

It goes the other direction. You start to get snowfall. It gets cold outside. The logs get denser. It's probably a 4% to 5% the other way.

Got it. And then you mentioned earlier in response to one of the questions that your Northern Idaho timberland sawlog pricing is linked to Western lumber pricing. Is it divestment composite? Or is it the specific rate within that? How -- is that something you would be able to tell us?

No, it's broken down by species, Ketan, so it's really quite complicated. I mean, we just -- our view is you could start with an estimate of what's going to happen in Northern sawlogs by looking at random lengths. If you want to get a little bit more accurate, you can compare it to the WWPA lumber index, which is a Western index. And then if you really want to get accurate, you really drill into what's going on with Hem-Fir and Doug fir.

Because I'm noticing that the inland Hem-Fir pricing has held up significantly better than either Southern Yellow Pine or even Western SPF, so I was just curious whether your contracts are more skewed towards Hem-Fir than kind of the broad index.

Yes, you got it. I mean, you also have to take into consideration, cedar is a part of the mix, too.

And our next question is from the line of Chip Dillon from Vertical Research.

If you could, first, talk a little bit about the land basis, it looks like maybe on the Real Estate sales, it was a little lower than what we might have thought in the second quarter. And how do you see that on the land sales that you expect in the third and fourth quarter?

Chip, this is Jerry Richards. So you are correct in terms of the trend of land basis you saw. In the second quarter, we had the 8,000 acres sale, conservation sale in Minnesota. And Minnesota has the lowest land basis of any of our land sales. So that's why Q2 was lower. When we guided or in my comments, I mentioned 30% will be the land basis in Q3 and then it probably stays somewhere near that ZIP Code in Q4.

Okay, that's helpful. And you also gave some very good -- I think Eric mentioned the -- just doing the math on the lumber prices versus your assumptions. But as we -- $25 million to $30 million additive to Wood Products, but also, could that also have a little topping up in resources given the indexing you have in Idaho? And would you add another $5 million for that?

Yes, I think that's fair, Chip. I mean, somewhere in that $5 million to $10 million range will be the corollary effect in -- based on the index sawlogs.

Okay, okay. And then last question, just for who wants to take it. It seems like with the stock having come in from January with everything else tied to housing, of course, and building and your comments about the Southern timber situation, would you see buying back stock as incrementally more positive or, I guess, preferable especially versus buying timberland in the South at this point given what you're seeing in terms of the returns offered on deals?

Chip, I think it's fair to say that buying our own stock back at these price levels, which are at a significant discount to most analyst estimates and NAV, is more attractive than buying a fully priced Southern timberland at, call it, $2,000 an acre that has embedded in that price is an assumption that over time, Southern pine sawlog prices are going to have to increase to make that justified. So I think at these levels, we'd be more satisfied buying our stock in timberland and we're going to discuss that with our board in the next quarter.

And I guess, one more quick one, if I could just jump in. I know Deltic's former chairman is consulting with the Chinese based companies, Sun Bio, in Arkansas. And I don't know if you have any thoughts that are, maybe because you're on the ground there, regarding the permitting process that they face. I understand that they have not gotten a clean air permit and sort of what does that involve? Just keeping in mind that on one hand, we haven't seen a virgin mill permitted in 30 years. On the other hand, maybe there haven't been that many tried.

Well, we've had conversations with the delegation in Arkansas, including the governor about how helpful it would be to have another paper mill in the state from a standpoint of a market for pulpwood to continue investments in forestry in the state and employment. I think the administration in Arkansas is extremely supportive of the Sun Paper project. I can't imagine that they're going to hold up the permit process, but these things take time. So we continue to be hopeful and optimistic that the Sun Paper plant gets built.

And our next question is from the line of Mark Weintraub from Buckingham Research.

Appreciate all the color, and I just want to follow up. So you indicated given the strength in lumber pricing that could add $25 million, $30 million versus your prior guidance on outlook in Wood Products and maybe another $5 million, $10 million on the resources side. Are there any other variables of significance, be it from costs or anything else that you would think you'd want to highlight given that you didn't actually give -- well, that you want to highlight at this point?

No, I think we've covered them, Mark.

The biggest wildcard is really can we ship -- we'll have a significant increase in shipments from Q2 to Q3 as we catch up. It's a matter of making sure that we execute on that and we're well on track to do that.

Yes. Transportation issues have -- were the real boogie man in Q2. Rail and trucking were challenging everywhere, virtually everywhere. And what I'd tell you is a lot of that pressure has now come off as we move into late July, August.

Okay. So it's fair to say that if we take your prior guidance and add order magnitude $30 million, $35 million, recognizing things can always play out a bit differently, that's a reasonable starting place from your perspective?

Short answer, Mark, is yes.

Okay. And then I'm really curious as to what the relative profitability at the sawmill is in the West versus the South. And what implications, if any, that might have in how pricing dynamics play out if we continue to have pressure. Because I imagine in the South, the sawmill is making a ton of money still. Whereas in the West, given much higher log costs, maybe they're not making that much money there. I'm just curious as you -- as how you were seeing that.

Yes, Mark. I think it's fair to say that Southern mills at $40 ton logs are making lots and lots of money right now compared to Western mills that are paying, who knows, $80, $90 a ton for logs. So yes, I think Southern mills are a lot more profitable than Western mills. Now that being said, Western mills are still making pretty good margins at these high prices.

Okay, fair enough. And are you seeing any -- I guess, we're getting the new capacity coming on in the South, which, over time, might tend to equalize these things out. Are there any other dynamics that work, which are working to arbitrage this -- what looks to be an unusually large differential in profitability from one region to the next?

Well, what you are seeing is that Southern Yellow Pine is gradually taking market share from other species across the U.S.

In lumber.

In lumber, yes. You're starting to see Southern Yellow Pine find its way into California. We've seen it in Denver. We're starting to see it up in Canada in the Lake States.

It's being exported to China.

It's now being exported to China. So you are seeing some dynamics. It's just natural supply and demand at play here, taking advantage of really cheap Southern Yellow Pine logs.

Okay. And just one small one. I think you've mentioned in terms of potential uses of capital, pension contribution in reference taking advantage of 2017 income tax rates. I was just a little confused by that. Maybe if you could just clarify.

You bet, Mark. So not to get too far in the leads, we have until September 15 to make a voluntary contribution to the pension plan. And the IRS rules allow us to actually deduct that on the 2017 tax return, which will be at the higher corporate federal rates.

And our next question is from the line of Steve Chercover from D. A. Davidson.

So first of all, going back to the subject of lumber contracts, given your view that lumber stabilizing in the futures are way down, I'm sure it's not really of interest right now, but is there a level where you'd start to lock in more volume?

Yes, Steve. What I would tell you is the principal party that we do our lumber hedging with, has told us they've got enough risk on the table for the year, so they don't want to offer anymore contracts. So we're not looking to hedge any lumber production for the back half of the year.

Okay, got it. And then switching gears. I understand that Q4 is when we'll see the bulk of the lot sales in Chenal Valley. Are you targeting the small kind of local builders? Or are there any national builders that are on the radar?

Those are -- that community in Chenal Valley has traditionally been local builders. Little Rock is kind of a tertiary market for the larger national homebuilders. So it's always been more local.

Got it. And then finally, with respect to the repo, I expect the board will authorize it later -- well, not in July but in August. But are you capable of actually acting on that prior to the E&P purge?

Yes.

Okay, because I assume you'd want to get the share price up there so, I guess, for lack a better word, diminish the dilution, is that correct?

Yes. I mean, when we look at share repurchases, Steve, I mean, would be based on what we think the relative uses of cash and potential return is. So I'm not sure that we see a direct tie with the E&P purge.

And our next question is from the line of Paul Quinn from RBC Capital Markets.

Just a question on timberland transactions. I know you guys are still integrating Deltic but probably is still active in the marketplaces, even on marketplaces they're inactive in. Just wondering why -- from your perspective, why do you think that there is so few transactions or so few properties for sale out there right now?

Paul, I could only guess. I really don't know the answer to it. If I'd speculate that if the team knows and others that hold a lot of property that may come on the market due to the fund life of their investments, if they see an opportunity -- or if they see maybe timberland -- timber prices, Southern Yellow Pine timber prices are going to improve in the next 18 to 36 months, that's a window that causes them to wait and hold property from the market thinking they'll get more money. I really don't know the answer. That's all I could think of.

I'm scratching my head, too. Just maybe on lumber side, when you guys are thinking about CapEx budgets of the various deals given the variability or the profitability maybe based off region and cost and value, how big is that as a consideration between investing something in, say, a Northern sawmill versus a Southern sawmills?

Yes. So Paul, whenever we go to make a capital investment in our mills, we don't look at spot pricing. We use lumber pricing, averaging, multiple years, 5, 6, 7, 8 years on average. So we're never looking at spot pricing to rationalize our CapEx. And we're always looking for returns that are probably, I would say, at a minimum in the 10% range. But often, we'll go up into the 20% to 30% range. We're going to install a new auto grader at our Ola sawmill that we just picked up in the Deltic merger. It's, who knows, $3 million, $4 million project and it's going to have the 30% IRR attached to it, I would imagine, using average lumber prices going back 7 years or so. So I don't know that we really think of capital investments in our Northern mills versus our Southern mills any differently. We use kind of the same approach and methodology for each.

Okay. Would it be safe to say that you've got more opportunity for capital investment at the Southern mill, especially at the Deltic mills just because you've reinvested in your Northern asset over the last, say, 5-plus years?

Oh, yes, absolutely. That's correct. And there's an abundance of Resource. We're little bit more constrained on Resource in some of our operating areas in the North, whereas we don't have that issue in the South.

Okay. Have you guys found like a limit to the amount of capital machinery that you can put into a mill before it really affects the operations, i.e., you might want to stagger some projects at one so you -- former Deltic mill just because it's -- doing all this work really hinders the production and flow?

What I would say, Paul, is that we've definitely seen a real tightening in equipment vendor community for installations into our sawmills, improved capacity or productivity or cost. So some of the projects we're looking at now won't go in until 2019. We just put a deposit on one that won't get installed until 2020. We're putting a new stacker in at our St. Maries mill. So these -- the market has tightened considerably and lead times have lengthened considerably, and that's happened over a very short period of time. That being said, we're constantly trying to uncover new opportunities and get after them just as quickly as we can.

Well, you raised an important point. Maybe given the profitability of lumber right now, even though prices have come off, everybody is making money and some mills making lots of it. Therefore, everybody, I would suspect, is incentivized to add capital. Is that going to be the constraint going forward just on the equipment side and the installation?

Yes. I think for the next 2 or 3 years, I mean, the U.S. South is -- got the world's highest sawmilling margins right now. There's no reason why capital shouldn't continue to flow into that wood basket. And the issue is those lead times are now pushing 2 to 3 years. Well, where is the economy going to be in 2 to 3 years? Fed's raising rates and who knows? But it's a -- it's becoming more and more of a gamble. Put it that way.

And especially, Paul, with companies like Comact and others that are building turnkey brand-new sawmills, they're focused on those opportunities more than they are one-off projects to put a great earnings on the stand-alone mills. It's just hard to get their attention understandably.

Ladies and gentlemen, I'm afraid we're out of time for questions. I will now turn it back to the presenters for any closing remarks.

All right. Thank you, Ian. And certainly, thank you, everybody, for your interest and focus on PotlatchDeltic. We'll be available for questions almost as soon as this call ends here.

Ladies and gentlemen, this does conclude PotlatchDeltic's second quarter earnings call. We thank you greatly for your participation. You may now disconnect.