West Fraser Timber Co Ltd (WFG) 2006 Q4 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber fourth quarter results conference call. During this conference call, we will be making certain statements about potential future developments. These forward-looking statements are to provide reasonable guidance to investors but the accuracy of these statements depends on a number of assumptions and is subject to various risks and uncertainties. These statements are not guaranteed by the company and actual outcomes will depend on a number of factors that could affect the ability of the company to execute its business plans, including those matters described under risk factors in our annual MD&A, which can be accessed on our website or through SEDAR. Accordingly, listeners should exercise caution in relying on forward-looking statements. I would now like to turn the meeting over to Mr. Hank Ketcham, Chairman, President, and Chief Executive Officer.

Thank you. It is Hank Ketcham and Martti Solin here in Vancouver and various members of our management team on the call both here in Vancouver and up in some of our mill locations. Some of them may participate in the Q&A at the end of the remarks. Obviously you have seen our results and they reflect a very bad quarter for lumber prices and lumber markets, and that certainly has been reflected in our earnings.

To recap our results for you, we had earnings of $296 million or $6.87 a share for the fourth quarter of 2006, compared to a loss of $8 million or $0.19 a share in the previous quarter and earnings of $9 million or $0.20 per share in the fourth quarter of '05. For the full year, our earnings of $398 million or $9.23 per share compared to earnings of $108 million or $2.49 per share in 2005. The fourth quarter and 2006 results were affected by several items including a duty refund of $387 million plus $50 million in a related interest which resulted from the settlement of softwood lumber dispute.

With the duty refund removed from the results, West Fraser's EBITDA would have been $40 million or 6% of sales for the fourth quarter. This compares to EBITDA of $53 million or 7% of sales for the third quarter of '06. Several other unusual items were reflected in our results and Martti will talk about these later.

In our solid wood division, EBITDA excluding the duty refund was $1 million in the fourth quarter of 2006 compared to a loss of $10 million in the previous quarter. This improvement was due primarily to lower log costs in the quarter, partially offset by lower lumber prices. In addition from October 12 of '06, the company's lumber shipments to the U.S. have been subject to a 15% export tax, compared to an approximate 9% duty charge in the third quarter of 2006. Benchmark SPF 2X4 prices averaged U.S. $245 per thousand board feet in the quarter compared to U.S. $278 per thousand board feet in the third quarter of '06.

Lumber production was down at our mills in the fourth quarter at 910 million board feet. This compares to 1.1 billion board feet in the third quarter. The lower production numbers were primarily due to the sale of two sawmills, which Martti will talk about, lower production from our Quesnel sawmill as we made the transition to a new 600 million board foot capacity facility. Power outage along the West line affecting several of our mills in the third quarter -- excuse me, in the fourth quarter, and some marginally lower LRF and grade recovery problems as it results to the mountain pine beetle.

The new Quesnel started up in the end of October '06, but we're not expecting to reach full capacity until the end of this year. The company's panel operations generated EBITDA of $5 million or 5% of sales in the fourth quarter, compared to $16 million or 13% of sales in the third quarter. This reduction was due to lower shipment volumes and higher production costs. Various operating issues resulted in lower production levels at plywood operations while MDF production was reduced in the quarter due to market-driven product mix changes.

For pulp and paper, EBITDA was $42 million or 16% of sales. This was a $9 million decline from last quarter and was due primarily to higher furnished and natural gas costs and reduced pulp production and shipment volumes. Our pulp production was lower due to restructuring at Hinton Pulp, which I will talk about in a minute. Our shipments were lower due to a softening of the BCTMP markets and the buildup of NBSK inventory for the Hinton Pulp restructuring.

The restructuring at our Hinton Pulp mill is proceeding and will be completed by June. It includes shutting down our older pulp machine and upgrading the remaining pulp line. We also shut down the wood room at Hinton and have switched to residual chips for most of our fiber. Annual capacity at the mill will be 350,000 tons when the upgrade is completed. We are expecting this to result in an improved cost structure and increased competitiveness.

At Eurocan Pulp and Paper, we have installed a new turbogenerator which can produce up to 25% of the mills power requirements and will result in substantial cost savings. This project was scheduled to be completed in late '06 but was delayed until early this year. The change at the Hinton and Eurocan should result in improvements for us in this segment of the business later in the year.

Other issues that continue to be a concern include the spread of the mountain pine beetle, the management of the softwood lumber agreement, chip inventories, and the CN rail strike. With regard to the mountain pine beetle, timber supply analysis conducted by outside consultants using government of B.C. inventory data, indicate a decline in timber harvest level sometime between 2015 and 2020 for the North Central region of the Province. Our ability to utilize this beetle killed pine resource will depend on how quickly the wood deteriorates and the provincial policy framework surrounding mountain pine beetle harvesting and pricing.

We are seeing an impact of the mountain pine beetle at our sawmills and our lumber recovery factor and grade. We continue to upgrade and operate our mills in a manner that reduces the effect of processing such logs. Alberta experienced a significant beetle blight in 2006. We should know this summer whether the infestation is intensifying there.

West Fraser is adjusting harvest plants to focus on pine stands that have been identified as being of high-risk of infestation. Harvest levels in the Province are expected to increase in order to salvage attacked pine and reduce the volume of pine risk of attack.

On the pulp side, reduced production at non West Fraser sawmills that supply us with chips is having an impact on chip inventories and prices. Where economically feasible, some whole log shipping of pulp wood is being undertaken at our sawmills and through 2007 we will continue to look at sources that can supplement our residual chip supply.

Since the softwood lumber agreement was implemented on October 12, 2006, numerous issues regarding its operation have come up. We've been working with the industry associations, the provinces, and the federal agencies to find an effective resolution process, but this has proven difficult. We hope that industry and our governments can work in a collaborative fashion to protect our interests under this agreement.

Starting in mid-January, rail service levels deteriorated significantly, due mostly to severe winter weather. The current CN strike has dramatically worsened this problem. At the beginning of the strike, CN announced a plan to maintain service levels at 65% normal levels. This week, the situation has deteriorated and service levels and car supply have been reduced to about 25% of normal. Product is building up rapidly at the mills and inbound raw materials are becoming a problem. We are diverting whatever we can to truck and other railways, but with our remote location, this is very costly and the volume is small.

Government needs to take whatever steps necessary to be in a position to react if this is not resolved on Monday by the CIRB hearing. Although we do not expect strong results for 2007, primarily because of the continued lower housing starts in the U.S., we are taking the steps necessary to be well-positioned when the markets and prices improve. One of the major initiatives we took was in late November, when we entered into an agreement with International Paper to purchase 13 southern yellow pine sawmills in the U.S. South. This strategic acquisition, which is scheduled to close in the first quarter of '07, will increase our lumber production capacity by 1.8 billion board feet. It also enhances our geographic, fiber, and product diversification, while reducing our exposure to foreign currency volatility and any future trade issues with the United States.

Now I will hand it over to Martti for a more detailed look at the numbers.

Thanks, Hank, and good morning everybody. Let me start by saying that during my time as the CFO, which is long as you know, I have never had a quarter like this one to start out. My brief comments are here to help you understand a little better what happened during this last quarter of 2006. First of all, let me remind you and direct you to see our website for more information. We have now filed our audited financial statements and MD&A already at this early stage.

So in terms of the results, obviously the duty refund was the main event in this quarter. We received a gross refund of C$470 million using the exchange rate at the time of the receipt of refunds. Since 2001, our cumulative duty expense using then prevailing exchange rates was C$547 million. The difference, i.e. C$75 million, is a cumulative effect of a strong Canadian dollar. To put it in other words, we paid duty deposit in U.S. dollars and received the refund in U.S. dollars, the Canadian dollar difference being a C$75 million between those two payments.

As everybody knows, we had to pay that 18.06 special charge to the Canadian government, which in our case totaled $285 million and we received interest on deposits of $50 million. And the net impact of all these items is a $280 million gain or $6.70 per share, as Hank said. Because of the pending U.S. South acquisition, which is scheduled to close end of March, we have kept the duty proceeds invested in U.S. funds to hedge our purchase price of U.S. $325 million. The gain in holding U.S. cash amounted to approximately C$11 million, and is included in other income.

The other items of the C$25 million other income item is made up largely by normal a translation gains or trade receivables. The segments or the other major issue during the quarter was the sale of our approximately 90% ownership of Babine and Decker Lake sawmills for net proceeds of about $79 million, resulting in both on a pretax and after-tax basis of a gain about $22 million or $0.50 per share.

In addition, we completed in Alberta a minor divestiture for proceeds about $2 million. Just to help you to understand the difference in our production levels over Q3 to Q4, Babine and Decker Lake sales represents in rough numbers $50 million reduction in Q4 production. As Hank mentioned, the quarterly conditions for lumber were and continue to be very difficult and as already mentioned on an EBITDA basis the quarter-over-quarter lumber sales improved by $11 million, reflecting in our part our policy of writing down not only product inventories to market, but log inventories to net realizable values.

Just to give you a little guidance for the Q1, this new year in the periods like now when we build log inventories and assuming that lower lumber prices will last through the quarter, this accounting policy will result in reduced earnings compared to what otherwise would have happened.

Just to complete my comments, I will comment on our Quesnel sawmill. As Hank mentioned, this new mill started operations during the quarter. We have not capitalized any startup losses in respect to this mill other than expenses related to training and like, which amounted to just over $1 million in the fourth quarter. The amortization of the new mill will commence when we reach about 80% of the expected production and the old Quesnel mill is now at the end of the year being fully amortized, so that is all I had.

I believe we are now available for comments if you have any.

(OPERATOR INSTRUCTIONS) Mark Bishop, RBC Capital Markets.

I have got several questions, but I will ask two and get back in the queue. Hank, you talked at a very high level on issues with respect to the SLA, and I am just wondering specifically where we are I guess with both the federal government and the U.S. on the interpretation of the search calculation.

I think I will let Bill Legrow who handles the file for us answer that.

As far as on the Canadian side of the border is concerned I think we have got that situation straightened out with the federal government. The search calculation will be done without considering the adjustment that was the center of that controversy. I guess it now remains to be seen whether or not the U.S. will challenge that through the softwood lumber committee. The softwood lumber committee is having its first meeting late this month and we may find out then.

Okay, so no indication yet from them?

No.

The second question is with respect to, Hank, your reference to the pine beetle. I'm just wondering -- I know it is a big topic and you're going to continue to get asked similar questions, but first is there any way to quantify perhaps year-over-year what the impact would have been on the change in your recoveries because of the beetle? Whether that is in LRF terms or in the cost per thousand?

In some of our BC mills, not all, but in some that are most directly affected by mountain pine beetle, there has been a marginal reduction in LRF. We are assuming that relates to the mountain pine beetle, but it is not scientific and there has been a marginal reduction as well in our grade percent. That is partly as well due to smaller logs being harvested as we go into the mountain pine beetle stands and away from some of our more traditional areas. So I think this is something that is just going to play out over time and I think we are all learning as to what the effects are going to be in the future. So I can't give you a better answer than that.

Okay, I guess part two then maybe you can't either, but in the context of your response, how do you think about capital going forward at your BC interior mills? Presumably if the problem gets worse you need to spend more capital to keep productivity recoveries the same, but is that the approach you would want to take if we have a declining resource?

I think first and foremost we believe we are going to have a vibrant industry in the interior, although downsides at some point but vibrant and real competitive, so we're going to continue to follow our normal course when there's everything we do relates to paybacks. And if we can calculate paybacks that are attractive, we are going to invest the money, but we are certainly going to be aware of regional issues and again that is all I can say. Our job and I think the whole industry's job is to make the investments to be able to properly process the resource, whether it is mountain pine beetle or not.

So in terms of looking out, say, the next two years on capital in those B.C. mills, then should we assume that you are essentially aside from the Quesnel investment, no change in the level of investment?

Well, we do have a capital budget that is approved for this year and we do not see any change in it and I can't tell you what two years our capital budget would be.

Okay, so what is the capital budget for '07?

Roughly $200 million. Of course we look at those -- that is approved roughly, but we look at every project before we start and reanalyze it.

And that of course excludes any capital you might be spending at the IP mills?

No, that includes it.

Okay, that's good. I'll get back in the queue.

Don Roberts, CIBC.

Three questions. First of all, Hank, just a housekeeping one. Could you just clarify which individuals in particular are behind the selling on the Ketcham investments and the Tysa investments for estate purposes?

Ketchum investments and Tysa investments are selling.

Okay, but is this yourself or is it other members, just for clarification?

No, it is the families, basically it is all of us together.

All together, okay.

I want to stress here that as it said in that -- this has no relation to anything other than some estate planning issues as the first generation ages. The family is still as committed as ever to this company and to the people who have built it up for us.

Great, yes. I just wanted to sort of hear it from your lips. Second point, your observation on the beetle issue and looking out using sort of the provincial government data say in the falldown more in 2015, 2020 at least in the North Central region, are you really focusing here on the allowable cut numbers or is this fine-tuning it really to look at economic supply?

I'll tell you what, why don't I let Wayne Clogg, our VP of Woodlands, answer that question.

First of all, the supply information is based on a study that was I guess carried out under the auspices of COFI to look at supply going forward. We have been taking that information, and added our best estimates of demand levels to look at how supply and demand will sort of meet over the next decade or two. And, as Hank said, on the raw numbers we do not see a decline in supply occurring until sometime between 2015, 2020. Then you can do finer work to see exactly when that is happening. I think what you're alluding to is, that's fine, but can you still use that wood profitably? That really has two components. One is your ability to actually make quality lumber out of the product, and we are doing work in our mills and so on to stretch that out. The other component, and maybe the more important one is the economic viability of it. As Hank alluded to in his opening comments that has everything to do with the policy framework with the government, which includes pricing of the timber, the issues around waste and so on. So I think you can see what I'm saying. That wood is there and we can find the technology to use it, but the economics has everything to do with it.

Isn't the ministry is still -- they're not going to be doing their timber supply review until next year for the Prince George area, so this -- isn't it dated information that we're basing it on?

No, it is actually quite current information. It is using the same inventory data but it was done for each of the affected timber supply areas and then aggregated. I believe the information is available on the COFI website.

Okay, that's great. Thanks a lot. Just last question, Hank, quickly could you give us a sense -- I know you don't focus primarily on it, but what is the tone right now that you're seeing out in the Asian markets, and I'm thinking both for lumber and plywood? Any change in tone?

Still pretty strong. Demand is, has been stronger, but I'll tell you what. Let me ask Chris McIver, who knows it better than I do, he is our VP of lumber sales.

Thanks, Hank. Yes, I think it is actually very strong still, particularly in Japan. But we have seen a slowdown and we think that a lot of that is related to their year-end, their March year-end and the inventory issues. But we believe that Asia will remain strong. The non-Japanese market there has been very strong for low grade.

On the plywood side?

We do very little plywood in Asia. That business is effectively gone to the Chinese and the Indonesians, so we don't see that changing really.

Okay, great. I will get back to the queue. Thanks.

Daryl Swetlishoff, Raymond James.

A few questions. First could you give us a bit more color on what you're experiencing with the Quesnel ramp up, Hank? How is the ramp up going today?

Again, I could, but we have much more experienced people on the phone, so this one I will toss to Gary Townsend, who is our vice president of wood products and in charge of that product.

We are presently running at about 50% of our new mill target, and we are seeing a gradual climb up, a startup curve. We don't see any problems with any of the major equipment in there. It's simply to get the bugs out and get it running. The production levels are nearing now the production levels of the old mill and by the end of the quarter for sure, we will be past that and into new levels, so we don't see any problems with the equipment we have in place and we should be, we will be fine.

That's great. Would that mill be cutting what percent beetle wood currently and what do you expect it to be cutting when it is steady-state?

Oh, I don't know. Wayne, do you know what percent is in there right now?

It is a high percentage. We have pine beetle and spruce beetle in the Quesnel TSA, and TSL, so I would say off the top of my head it is 80% plus.

How would that compare to your overall B.C. interior mountain pine beetle percentage?

Probably slightly higher. We have high concentrations in Quesnel and Fraser Lake, so they would be the highest percentage of beetle cut.

Just turning gears a little bit, what would chip prices currently that you're experiencing with B.C. interior? If you had to hazard a guess, what would you peg chip pricing at?

Sorry, what was the question?

What is chip pricing right now in the B.C. interior?

I think they're roughly $70. It is Gerry Miller, by the way. Roughly $70 a ton FOB sawmill, roughly.

Thanks for that. Last question, Martti, your release says you paid about a 15% export tax. What was the exact dollar amount in the quarter that you paid export tax?

$16.8 million, it is in the P&L if you look up, so that is after the October 12 period, so it is all disclosed there in the P&L.

$16.8 million?

$16.8 million.

Right, thanks. That's all I had, I will turn it over. Thanks very much.

Sean Steuart, TD Newcrest.

A couple questions. First, can you Hank, expand a little more on MDF markets? You touched on some mix issues this quarter. Maybe just a little bit more detail on what you saw and why it hit the volumes so severely.

I know it is going to sound like I don't really know anything about what's going on, but we do have experts sitting in the room and since others have answered, I thought I am going to ask Zoltan Szucs, who runs that division, to answer that question.

Really what happened in the beginning of the fourth quarter, the market hit a brick wall and it has been in a freefall for most of the quarter. Which followed a very strong buildup of purchasing, purchase activities during the second and third quarter, when many of the customers were on allocations. It seems like some of the import board that was coming to these shores did not during the second and third quarters, and that buildup had very strong interest in the product and activities and prices. With the housing starts turning, the fourth quarter was quite a different story. That said, the prices were not as severely affected as the volumes.

Martti, just a question. Quarter-over-quarter increase in accounts payable was pretty significant, even excluding the income tax payable that you have on the refund. Is there anything in there that would explain the big jump?

Yes, there is that special charge is included. I believed it is $122 million because there is also something we on special charge we collected on behalf of IP on (indiscernible) board duties, so that is included in payables.

Okay, that's great. Thanks a lot.

Rick Skidmore, Goldman Sachs.

A couple questions. First on the rail issue, can you just talk to how that might impact your production in the first quarter of '07 and is this going to be a longer-term issue? How long has it been sort of 25% of the rail cars coming in?

Let me give you a broad answer and then our transportation VP, Bill Legrow, will give you the specifics. We have had rail issues prior to the strike, of course, and have struggled to ship our production for quite some time. We got hit by cold weather or the railroad got hit by cold weather in January, which started an inventory buildup in our company. We think that this strike, we hope that the strike is going to be addressed quickly. We are not getting the service that -- we are certainly well below the 65% service that CN felt they could provide, and it is having a serious effect on all of our operations. Bill, you want to be more specific?

In terms of where this strike might go, there is a dispute between the Canadian local and the international that is being heard by the Canadian Industrial Relations Board. That hearing is being rescheduled now for Monday, February 19. Hopefully there will be some kind of a resolution coming out of there. If there is not, I think what you'll see is shippers across the country applying political pressure to have something done about this, particularly here in western Canada. It's not just forest products, but all bulk shippers in western Canada are starting to face pretty severe problems with building inventory and more cars under load. The container terminals here on the coast are plugging up and that impacts the whole Pacific gateway. So I think if it is not dealt with through this Industrial Relations Board early next week, there'll be a lot of political pressure. Anybody's guess what the government might do.

(OPERATOR INSTRUCTIONS) Mark Bishop, RBC Capital Markets.

A couple of follow-up questions, maybe for Chris McIver for the first one. Back on the beetle I'm just wondering what kind of a change you've seen in your ability to generate J-grade? And I guess the flip side of that, are you seeing any receptivity in the Japanese market to accept a slightly less attractive product, which obviously still fulfills the structural needs?

Mark, it's Chris. We are certainly seeing a reduction in our J-grade. We make two products for Japan. One is what we call an export Highline, which does include some blue stain and is otherwise very similar to a J-grade. We believe that hopefully over time the acceptance of that product will increase because our expectation is there will be less white J-grade available. So far they have resisted. It really all depends on how much wood they can get from Europe, to tell you the truth.

At this point have you seen much of a change in your overall volume that you are sending to Japan?

I don't have the exact numbers, Mark, but yes, we have seen a reduction. The fourth quarter was particularly tough for us, but we have made up for some of the Whitewood, the J-grade, with this export Highline, so the overall has not been as significant as it would have been if we can only ship them traditional J-grade.

Okay, thanks. Just switching to the Southeast, just wondering if, Hank, you had any comments on what is happening down in that area with respect to wood supply fiber availability and I guess even sawmill downtime. I guess there is a lot of private capacity down there. Are you seeing things tighten up maybe a little more than we would've expected or what are you seeing down there for the dynamic?

Currently as you know, we only have two sawmills and really a good access to good numbers from two sawmills, so I don't think that is not indicative of probably what is going on down there. The markets are very tough down there, probably for Southern yellow pine probably tougher than it is for SPF right now. You know, wood costs have not declined that much and it is just a real struggle. I do believe that their chips are off and there is reduced production down there, but how much I don't know.

Okay, then just a final question maybe for you, Martti, on the integration efforts. It sounds like you've constructed your various teams. Just specifically on the information systems, I'm just wondering how you are feeling about the ability and the timeline to connect the dots between the Oracle and the SAP system and what the cost of that will be.

I may take the approach Hank has used, ask Rodger Hutchinson who is heading our integration effort to comment on this, if it is okay.

Sure, we are not anticipating any issues in terms of reporting results. We expect the close of the acquisition to be at the end of March. And in terms of costs, we do not have a final number yet, but it will be inside of $2 million we suspect at this point. And we should be done within a year is our expectations.

Okay, great. Thanks very much.

Paul Quinn, Salman Partners.

Just a question on depreciation going forward with the new Quesnel mill expected to come up over 2007. What do you expect or what should we be using for 2007?

Paul, it's Roger again. Probably it will be fairly similar to what it is now, not including our U.S. South Mill. So around $250 million would be a good number going forward.

The question was for the new mill.

Oh, just the Quesnel sawmill?

Yes.

For 2007 we won't be starting to depreciate it until near the end of the year. After that it will be roughly $8 million to $10 million a year.

Okay, and the IT Mills?

Have not determined that yet. Probably around $20 million a year, but we'll determine that once we finish allocating the purchase price.

Just a question on log chip costs. You mentioned $70 a ton, and you mentioned a portion of your chips are whole log shipping. What kind of costs are you seeing on whole log chips and what percentage is it making up of the fiber basket?

It's Gerry Miller. We are not producing many whole log chips at this point. There's some being done in our sawmills and a couple of others, but it is not a very large proportion. The cost kind of varies depending on where you are getting the wood from, so it's higher than residual at this point but it really depends on the region you are getting the logs from.

All right, thanks.

Rick Skidmore, Goldman Sachs.

Martti, just wanted to follow-up on the capital structure as you look at your balance sheets going forward. The $600 million of cash on the balance sheet, you're going to pay out $325 million of that roughly U.S. for the acquisition. That still leaves you going forward more than a couple hundred million dollars in cash on the balance sheet. How should we think about your capital structure going forward and use of the cash going forward?

Rick, first of all just you need to remember that out of the year cash of $600 million we need to pay the special charge which we already talked about just of a hundred million dollars. Then there will be an income tax on the duties, which is another almost $150 million. So that takes a big bite out of it and what is left is a little less than what we need to close the transaction and take into account that we are into the seasonal log inventory buildup time. Having said that, I think the timing of the duty refunds was very fortunate from our perspective in terms of this transaction. And therefore our capital structure will be or capital structure as measured today as a debt to cap will be in the low 20%, say, and we feel at this stage of the cycle very comfortable with that.

Okay, thank you.

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

Again, thank you very much for joining us and I guess we'll talk to you next quarter. Thank you.

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