West Fraser Timber Co Ltd (WFG) 2005 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Timber third-quarter results conference call. I would now like to turn the meeting over to Mr. Hank Ketcham, Chairman, President and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Good morning and thank you all for joining us this morning. I'm just going to quickly go through some analysis of the results we announced yesterday and upfront say we are not happy with the results; it has been a difficult quarter.

In the third quarter, we had earnings of $18 million or $0.42 per share compared to earnings of $38 million or $0.88 per share last quarter and earnings of $78 million or $1.95 per share in the second quarter of 2004.

Our quarterly results were negatively impacted by the rapid appreciation of the Canadian dollar, by falling prices in most of our products and by increasing energy costs. I want to reiterate what is in the press release that went out yesterday, and that is that we had a gain on three items that totaled $0.83, which is included in our earnings. That is the share option recovery expense gain, actually, of $0.06, an exchange gain on long-term debt of $0.55, and a recovery of future taxes related to the BC statutory tax rate reduction of $0.22. So obviously on an operating basis, it was a very difficult quarter.

I'm going to just go through some divisional results. First of all, in our Lumber division, the plants are all operating very well. We announced the closure of our 50% joint venture sawmill at Red Earth, Alberta during the quarter, which resulted in a $5 million write-down on asset value.

Our EBITDA for the quarter was $52 million or 10% of sales in our Lumber division compared to $108 million or 18% of sales last quarter. And of course, the decline in EBITDA is due primarily to lower lumber prices and the higher Canadian dollar compared to the second quarter, in addition to the Red Earth sawmill write-down.

The benchmark SPF price averaged US$328 for the quarter compared to US$361 last quarter, which equates to about a $55 Canadian price reduction when adjusted for the strengthening Canadian dollar. In addition during the quarter, we reduced our lumber inventory by about 90 million board feet.

An item of note is that the BC government announced during the quarter that effective April 1st, 2006, there will be revisions to the interior log grades for stumpage purposes. The likely results of these changes will be an increase in stumpage charge for dry saw logs, with a corresponding decrease in stumpage charge for green saw logs. This relates to the beetle problem up in the interior of British Columbia. The impact on these possible changes to stumpage rates on our Company can't be determined at this time.

In our Panel division, EBITDA was $14 million or 11% of sales compared to $17 million or 13% of sales last quarter. The EBITDA decline quarter to quarter was due to Canadian mill net declines in both plywood and MDF businesses. Our LVL business continues to be a strong contributor to results in this segment.

In our Pulp and Paper business, EBITDA was $8 million or 3% of sales in the quarter compared to EBITDA of $15 million or 6% of sales last quarter. EBITDA declined from the second quarter even though that quarter was negatively impacted by planned maintenance shutdowns at the two NBSK Mills and the Kitimat linerboard mill.

The decline in EBITDA was due to lower Canadian dollar product prices at all divisions with the exception of our news print vision, which had increasing mill nets. The lower market prices also resulted in finished goods inventory been written down to market values at the quarter end, further contributing to EBITDA decline.

Our joint venture newsprint mill continues to be a solid contributor to results. A couple comments on the pulp and paper market. The markets in the pulp business markets bottomed out in August. Price levels have come up $20 to $30 in the last 30 days. We expect that demand should be pretty robust for the next few months, but we expect that to be somewhat short-lived.

Mechanical pulp demand is strong, driven by the Chinese market. And the U.S. paper market remains weak and is a real concern as we look into 2006.

Linerboard markets hit bottom in August. Capacity reductions have brought the market back into balance and a $30 price increase is in effect for October orders in North America. The outlook for 2006 is more positive for linerboard than for pulp due to the level of consolidation in the U.S. market and our expectation that supply restrictions in this product line will continue.

On the capital spending side, we have spent significant capital in three general areas. First, we have spent a significant amount capital this year on various energy projects to reduce natural gas usage. In addition, we are part way through the capital project on our new sawmill in Quesnel, which we expect to finish in the late summer of 2006.

And finally, we spent significant capital preparing two of our recently acquired Weldwood Mills to move to third shifts, one of which went onto its third shift in late July, the other which will go onto a third shift either late in the fourth quarter or early in the first quarter of 2006. And in addition, we spent a fair bit of capital on productivity improvements in the acquired Weldwood Mills.

Speaking of Weldwood, the integration is going well and according to plan. We continue to confirm our synergy targets which were announced at the beginning of the transaction; that is, we will achieve $80 million of synergies over a three-year period. We are well on track; in fact we are ahead of target on those synergies at this point.

Finally, we haven't yet determined our course of action on the sale of the sawmilling assets as required by the Competition Bureau related to the Weldwood acquisition. We're continuing to look at our options there.

In terms of the U.S. lumber dispute, Canada continues to win the battle at NAFTA, but the U.S. isn't implementing the decision as required by the NAFTA agreement. Attempts to find a negotiated solution have stalled, given the refusal of the U.S. to implement the ECC decision on injury.

The Canadian government has taken the position that the U.S. must respect NAFTA decisions, which are based on U.S. law, and condition any further talks on U.S. compliance. At West Fraser, we support that position and we believe it's extremely import that our industry and government remain resolute in defending our rights under the NAFTA agreement.

And finally, the beetle epidemic in the interior continues to be a concern for us as we look into the future.

I think with that, I will pass it over to Rodger Hutchinson, our Vice President and Controller, who has some comments.

Thank you, Hank. I will just add a few additional comments on the financial statements. On the income statement, included in cost of goods sold for the Pulp and Paper operations is $5 million related to the inventory write-downs that Hank mentioned earlier. After-tax, that is $0.08 per share.

Amortization expense is up $8 million over Q2. $5 million of that difference relates to the joint venture asset write-down, again mentioned by Hank, and the remainder is due to higher amortization of roads and timber during the quarter.

The interest expense is $5 million lower than Q2. Of that, $3 million is related to debt restructuring charge in the second quarter and the balance relates to the impact of the strengthening Canadian dollar on U.S. interest charges.

Other expense for the quarter is comprised of net foreign exchange losses of $13 million on translation of U.S. receivable balances and foreign operations. This was partially offset by a variety of other items, the most significant of which was a gain of $2.6 million on the sale of real estate. On an earnings per share basis, the net impact of these items is $0.16 per share.

The real estate sale included in other income represents the last remaining big box store site from our old retail operations. We still have a number of smaller store sites on the books at a carrying value of about $14 million.

The tax rate for the quarter has been impacted by the $9 million recovery due to the BC statutory rate reduction. In addition, the write-down of the sawmill assets has not been tax affected and we continue to not tax affect the exchange translation impact of the long-term debt. Going forward, a tax rate of 34.4%, after adjusting for exchange on long-term debt, is a reasonable estimate.

On the cash-flow statement, during the quarter we made a scheduled repayment of our US$125 million related to our long-term debt and we drew CAN$100 million from our credit facility. At quarter end, we have $373 million available under our operating facilities.

Hank, that concludes my comments. And, operator, we are now available for questions.

(OPERATOR INSTRUCTIONS) Don Roberts of CIBC World Markets.

Hank, wonder if you would give us a little more color really with regard to the stumpage changes for April '06 -- the drop in that greenwood, the bean trees (ph) and the beetle wood. What again are the orders of magnitude that we are looking at here?

I think there is a concept that the government is floating around, but I couldn't really give you any sense of an order of magnitude because we haven't really had discussions with the government yet that would kind of lend itself to that. We do have our -- is Wayne Clogg on the line?

No, he is not, Hank.

Okay. So he is our Woods Vice President. I was hoping he'd be on hopefully to confirm what I just said, Don. But I can't give you any better information than that.

But the reason that we see the decrease in the greenwood, is this a function just of the waterbed structure?

Yes.

It is? And again, it's definitive that it's April '06. Have they given any signal when they would give -- when you may engage in sort of more discussion where you get more clarity on this?

They have said April '06 and they have not -- we are assuming this is going to happen fairly quickly, but I'm not aware of when that is going to happen yet.

Okay. Thanks, Hank.

Stephen Atkinson of Bank of Montreal.

Thank you. Good morning. Can you give us some guidance on stumpage for the fourth quarter, whether it's going up or down?

I think it is going to go down a couple of bucks in British Columbia, Stephen.

Okay. And what are your options regarding the sale of Burns Lake?

The options regarding the sale -- basically our options are to find, you know, are to --.

Find a buyer?

Find a buyer, that is right.

So the appeal by First Nation basically was rejected?

I don't think -- it has not gone to the point where it is accepted or rejected. But we have been talking to our partners, our joint venture partners up there. As I said, we don't have a firm view as to how we're going to approach this yet, Stephen. It involves discussions with our partners and so forth.

But we are having those discussions. And we do have an obligation to conclude a sale sometime in the next period of time. But we are not under particular time pressure at this point in time.

Okay. In terms of the ruling regarding your duties where some money was supposed to be returned to you regarding anti-dumping, has the U.S. returned the funds or are they appealing or doing nothing?

I'm going to pass that over to Bill Legrow.

Well, the funds have not been returned. Part of that ruling from the Department of Commerce indicated that while they found us de minimus, they weren't going to return deposits paid. So in fact, we appealed that part of the decision back to the NAFTA panel. And we're expecting a determination from that any day, but we haven't heard as yet.

Okay. And can you talk about your energy costs for the fourth quarter versus the third?

For the third quarter versus the second, you mean?

No, the fourth -- like how do you see it going forward?

Oh, man, that is --.

Energy prices have flattened or even moderated somewhat, even in the past few days with Wilma, the last hurricane, hasn't passed back through the Gulf. So oil prices are off a buck or so; gas prices are off a buck or so. We don't think the current pricing is sustainable long-term. So we think we've probably seen the peak and it should flatten out here through the winter.

Okay. Last question. Was there any increase in wood costs in the south following the hurricanes? And would you see it coming back down in the fourth quarter?

I don't think there was any particular increase in our two mills anyway, Stephen.

Okay. Thank you.

Daryl Swetlishoff of Raymond James.

Thanks and good morning. Just had a question with respect to your chip pricing experience. Can you comment on how chip prices changed just quarter over quarter?

I'm going to pass that on to our pulp fellow, Gerry Miller.

Our chip prices are down probably a couple of percent, maybe something like -- maybe 10% quarter to quarter in B.C.

I would have thought they would have come down a little bit more than that with the renegotiation of the formula pricing agreement. Can you comment on your net long or short position on chips? How many chips do you have to buy or are you a net long on chips right now?

I believe we are pretty much even, but I think we are a net buyer by just a little bit.

Okay. And that would explain why it's only a 10% reduction then? I thought interior chip prices were coming down about $30 a BDU?

Well, there is no question that Canfor moved their chip prices down in their formula. Our formula hasn't changed; it has come down as a result of declining NBSK prices.

Okay. So there has been no change in the actual formula then?

Not for us.

Okay, thank you very much.

Just on our log costs, the U.S. south -- I just looked at it. They are up slightly quarter over quarter Q2 to Q3 '05, but we've offset that by conversion gains. And I'm not aware of any particular bump in the log cost increase as a result of the hurricanes. If I find myself to be wrong on that, I will let you know.

Mark Bishop of RBC Capital Markets.

Thank you. Good morning. A couple of questions. First for Roger. You mentioned, I think, the write-down amount was 5 million. Was that heavier weighted to the Pulp and Paper segment or was there a proportion that was in lumber as well?

Mark, the write-down that I referred to -- if you are talking about the inventory write-down --

The inventory write-down.

Yes, thank you. That was all in the Pulp and Paper division.

And what was the amount of that?

Approximately $5 million.

5 million, okay. On the natural gas sensitivity that you included in the note, does that reflect the energy projects that you are in the process of implementing, so that is really still a number that we should be using into '06?

That reflects our current position. Most of the energy projects that we referred to aren't completed yet, Mark. So into '06 our sensitivity will change slightly, but I don't have that figure available right now.

Okay. Just a follow-up question on the stumpage. You mentioned the changes to log rates, hank. Are you expecting to see or is there a potential for a change in minimum stumpage or at least the pine beetle wood stumpage from the $2 level to a much higher level before that April period, perhaps in January?

If there is, I'm not aware of it. I believe this is an April -- I believe the April date is when this is going to come into effect.

Okay. And just a quick question on the Bill 28 progress. Are you expecting to see any resolution or compensation flow from the Bill 28 kickback?

We will see that when we negotiate with the government, yes. But we haven't --

Nothing through your end?

No.

Thanks very much.

Richard Kelertas, Dundee.

Good morning. Maybe Roger, you can talk just briefly about what numbers you would use for non-recurring items in terms of earnings per share. What actually were non-recurring items for the quarter, so we can get a sense of the actual operations without going through all the P&L. What did you classify as non-recurring for the quarter?

Well, Richard, a lot of our non-recurring, they tend to recur.

Yes, by classified. I know sometimes they do recur on a quarter-to-quarter basis for maybe three quarters or two quarters, but let's say that's classified by yourself as non-recurring.

From the press release, certainly the write-down of the sawmill assets at Red Earth of $5 million would be one such item. The share option compensation, I mean, we have that every quarter but you can't really predict what it will be because it depends on the share price. Same with the U.S. dollar-denominated debt. I mean, we've got that translation every quarter; it depends on the foreign exchange rate.

The reduction in BC statutory tax rates, that is non-recurring; hopefully we will get further reductions in future years, but you can't predict those. The other item I mentioned was the exchange loss on translation of receivables. Again, that will change as the exchange rate changes, so it is always there, but the quantum can't be predicted in advance.

You said there were some inventory write-downs as well at the pulp mills?

Yes. $5 million inventory write-down at the pulp mills. That --

That wasn't included in your list here in the press release.

That wasn't included in the list in the press release because that goes through normal operations. It is unusual in the quarter, but when its prices drop, occasionally we will have these inventory write-downs.

Hank, could you talk about the percentage volume of the beetle-killed wood that you harvested for your operations in BC versus green? Do have a breakdown of that?

Well, no. No, because we have mills in so many different regions; some of them aren't affected and some of them are. But in the worst affected mills, we might be 60% beetle.

So no idea, just a ballpark figure overall what you did in the British Columbia on the beetle side?

I might add, Hank, there it is a published average for the interior is approximately 25% in the interior of BC.

Beetle-killed?

In beetle-killed logs.

That you harvested or is that just logs that are available?

That is Fraser. That is a published interior merchant. We would be slightly above that, although we don't have the figures now.

Okay, great. And I don't know if the question was asked, Hank. Any idea of what the government is giving you in terms of indication on what that beetle kill wood stumpage would increase to in April?

No, they are not. And the question was asked and I just don't have an answer, because we haven't had those discussions in detail with the government yet.

What was your stumpage level for the greenwood in the third quarter?

Hank, It's Wayne. Can you hear me?

Yes, I can.

There we go. Sorry, technical difficulties trying to get tied in here. Do you want me to comment on the April 1st changes?

Yes, why don't you introduce yourself first?

Okay. Good morning, everybody. My name is Wayne Clogg and I'm Vice President of Woodlands for West Fraser. And I had technical difficulties being able to speak. So I heard Don Roberts' question earlier, but I couldn't respond to it.

The government in BC has been concerned for some time with the stumpage charges on beetle-killed timber. By regulation, the stumpage currently on beetle-killed low-grade logs is set at $0.25. And with BC stumpage system, which collects a set target rate. The increase in beetle wood in the interior has resulted in quite a shift in stumpage from beetle kill wood to greenwood because of that.

And the government has been looking at different options to address that, and they've announced, as Hank mentioned, that April 1st they will be changing the system, whereby the log grades will be changed and the beetle-killed timber will be appraised through the cruising and appraisal process rather than identified through the degrading process at the scale.

There is, as you can imagine, a tremendous amount of detail that has to be worked through before the impact of that could be known on operators. But obviously, it is going to result in a shift of stumpage from green timber to beetle-killed timber. And within our Company, we have both green timber and beetle-killed timber, so there will be an effect, an upward movement in stumpage in some areas and downward in others. And other than that, we can't really comment on the magnitude, but we are working with government through various committees on the technical details of it.

I was under the impression that the design of this is twofold, to recover some of the $320 million, I think, was the number that the government had gotten from a private consultant indicating that that was the loss in stumpage revenue, I think from end of June 2005 to June 2004.

The other was not to put excessive strain on beetle-killed areas, although it seemed that that is what they wanted to do in the first place, is try and get some of that wood out.

Do you believe right now that the government is going to try and recoup most of that cost or most of that lost revenue, or is it more or less going to be phased in over a two- to three-year period, or do you think they're going to try and recoup almost all of that within a twelve-month period?

Well, what we are being told by government is that their intention is that this change is revenue neutral. So as you know, within the BC system, the system is designed to collect a specified target rate. So as one component of the profile changes, it affects what is charged on the other.

You may know that government introduced an interim change to interior stumpage on August the 1st, so during the third quarter, to partly address what they see as this disparity in stumpage between green and dry wood. So I guess if you're talking about phase-in, we've already seen part of that.

And what kind of impact has that had on your total stumpage costs?

Well, for West Fraser we have done a rough estimate. It is certainly less than $1 a cubic meter across the Company, so a fairly minor impact.

Okay. Thanks very much.

(OPERATOR INSTRUCTIONS) Sean Stewart of TD Newcrest.

Thank you. Hi, guys. A couple of questions. I guess first for Roger. Pulp and Paper cost structure this quarter, even with the inventory write-down, I thought you might have been a little bit better given you didn't take as much downtime this quarter. Could you talk a little bit about what is going on? And obviously, freight costs are way up, but also chemical costs in that division, if that has been maybe a more significant cost component than we might have expected?

Thanks, Sean. I think I'll turn that question over to Gerry Miller, our VP of Pulp and Paper Operations.

Good morning, Sean. On the cost side, I read your piece this morning. And I think you calculated it to be kind of a 1% or 2% decline in cost quarter-to-quarter, and we calculate it to be quite a bit bigger than that, kind of closer to 8 or 9 or 10. And it is because of the shipment numbers quarter-to-quarter and the production numbers quarter-to-quarter, if you kind of go through that calculation.

Yes.

So like I say, I think it is a bigger decline than what you would have calculated.

On the energy side, I mean, with rising or with higher fuel prices in the quarter, I mean it did affect us. But in some of our operations we have been able to reduce the consumption of natural gas especially, and so that kind of offset it. So natural gas is up, there is no question, but it is not up as much as what the price would indicate if you just took the price increase quarter-to-quarter.

Okay, that is helpful. And then just one other question for Roger or Hank. The capital you are spending on reducing energy usage, can you quantify whether it is a percentage number or anything else, how much less energy you expect to consume across the Company once all of this capital is spent? Is that possible?

Sean, it is Rodger. It is possible but we haven't done it yet and I don't have the number. But that is something that I will have available later this quarter.

Okay.

It is also an ongoing process. I mean, we've reduced energy on capital energy project over the last couple of years fairly significantly. This is one year. We are going to have -- I know we will have some good projects coming forward for next year. So we are going to have a continual focus in that area. And we will continue to reduce our cost of fuel consumption we hope.

Okay. That is helpful. Thanks.

Don Roberts of CIBC World Markets.

Thank you. Hank, International Paper is going to be putting out their books on the solid wood operations in the next couple of weeks. Is that something you are going to be looking at -- I know looking doesn't mean you go to the next step. But is that on the radar screen for you?

Well, I mean, Don, obviously in this business everything is on the radar screen. I can't really comment on that particular situation. I know that everybody in the business is probably sitting wondering whether it is on their own radar screen, and that is really all I can say to you -- that we know it is out there and we don't know what we are going to do about it.

Okay. Just thought I would try. Thanks.

Mark Bishop of RBC Capital Markets.

Hank, just another question on strategy. Obviously, the last several quarters you have lamented the fact that you are not in the OSB industry. Looking forward, do you still see an opportunity to participate in that part of the panel segment? And would your interest lie more so perhaps on even greenfield today rather than acquisitions, given valuations? Would there be a preference for one or the other if you had a choice at this point?

Well, I will just give our general basic third quarter lament again so we will get that out of the way. In terms of strategy going forward, I tell you our number one strategy going forward is putting our current assets in a position that we want them to be in -- that is in every line of business we want to drive costs down and make sure that the businesses that we have can operate at the bottom of the market comfortably. That is our primary focus, both on a capital and operating basis.

Strategically, like everybody else, we are looking at all of our options and I couldn't comment on any particular product line or greenfield or whatever. I can only tell you that as in the past, we just continue to look at all of our options.

Okay, great. Thank you.

(OPERATOR INSTRUCTIONS) Kevin Mason (ph) of Equity Researchers (ph).

I'm just wondering if you could address on the U.S. south if you're seeing any -- not necessarily with respect to prices at this point in time -- but with supply, what is happening down there with the hurricane issues and the salvage of the wood down there?

Hank, do you want me to respond?

This would be Wayne again. Yes.

This is Wayne again. The hurricanes did damage some timber, but south of our supply area in Louisiana and Mississippi. So it had no significant impact on our operations. 2005 has been a very favorable year for logging conditions in the south. And as a result, we have good log inventories heading into the wet season, and log prices have declined to reflect the availability of logs. So I guess it has been a good year down there.

I understood that there was a lot of harvesting capabilities and contractors that had been moving into the affected areas. Is that making it more difficult for yourselves accessing wood?

We are still being able to maintain our inventories. So, yes, there are companies that want to get that wood moved quickly while it can, so some contractors are moving into it.

But you haven't seen an impact yet. Do you expect one going forward with the move of everyone towards the impacted areas?

No. I think you know that the bulk of our timber comes under long-term supply contract with one of the major timberland owners down there, so they are obliged to deliver wood.

Okay, thank you.

There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Ketcham.

Well, again, thank you very much for joining us this morning. And Rodger will be around today if anybody has further questions. Thanks again. Bye.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you all for your participation and have a great day.