West Fraser Timber Co Ltd (WFG) 2007 Q2 法說會逐字稿

Good morning ladies and gentlemen. Welcome to the West Fraser Timber Company Limited second-quarter results 2007 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 upon forward-looking statements.

I would now like to turn the meeting over to Mr. Hank Ketcham, President and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Thanks. Good morning and welcome to West Fraser's second-quarter 2007 conference call. West Fraser had a second quarter loss of C$14 million or C$0.33 per share versus a loss of C$5 million or C$0.12 per share in the first quarter this year. EBITDA which is defined in our news release, was C$28 million for the quarter or 3% of sales compared to C$41 million or 5% of sales for the first quarter. Martti Solin will review the financial results in more detail later in the call.

Low lumber prices continued to be a major challenge for us as our lumber business recorded an operating loss of C$26 million for the second quarter compared to a loss of C$40 million in the first quarter this year. Operating earnings for the second quarter include the results from the 13 U.S. sawmills we acquired on March 31. Although the operational performance of the new U.S. mills was as we expected, low lumber prices resulted in operating losses from these operations.

Both the SPF and Southern yellow pine benchmark prices were slightly higher in the second quarter at US$259 per thousand and US$283 per thousand respectively which was up from US$254 per thousand and US$263 per thousand in the first quarter. The slight U.S. dollar price increase for SPF lumber was more than offset by the stronger Canadian dollar.

Reduced U.S. housing starts resulted in lower demand for lumber products which has led to excess supply. Announced production curtailments and mill shutdowns by some lumber producers will decrease supply somewhat but it is not expected to be enough to significantly improve pricing which is projected to remain depressed for at least the balance of this year.

West Fraser's lumber production volumes increased in the second quarter to 1.4 billion feet from 994 million feet in the first quarter. This is entirely due to the added production from the new U.S. mills.

Deteriorating log quality due to the mountain pine beetle continues to negatively affect lumber production, lumber recovery and grade recovery at our B.C. lumber operations. West Fraser and others in the industry are working closely with the B.C. government to identify ways to address potential economic concerns related to the mountain pine beetle infestation. This includes ensuring that the most current information related to the impact on operations is factored into stumpage determinations and that the log grades introduced in 2006 accurately reflect the potential of mountain pine beetle affected logs.

In Alberta, West Fraser is shifting its harvesting activities into pine stands that are at a higher risk of infestation. There is some indication that cold weather may have slowed down the spread of the infestation although further surveys are being undertaken in order to substantiate this.

Operating earnings of the panel business for the quarter were down to C$3 million from C$4 million in the previous quarter. While MDF prices were higher in the quarter, plywood and LVL prices were lower as were LVL production and shipments.

The second quarter results for our pulp and paper business were significantly weaker than we expected. The operating loss from the Company's pulp and paper operations was C$16 million compared to operating earnings of C$11 million in the previous quarter. The stronger Canadian dollar, extended maintenance downtime and unanticipated production issues and weaker newsprint prices all contributed to the decline.

In the quarter we took annual maintenance downtime in each of our Hinton and Cariboo Northern bleached kraft mills and at our Eurocan linerboard and kraft paper mill at Kitimat. The shutdowns at our Cariboo and Hinton mills were as planned. The shutdown at Kitimat planned for 18 days in June was extended because of a failure of the effluent line at the mill. In all, the Eurocan mill was down for 30 days including 10 days in July.

Our mechanical pulp and newsprint businesses continue to operate well. In addition to the stronger Canadian dollar, newsprint earnings were affected by a continuing decline in pricing. Obviously our NBSK results are not where they need to be. At our Cariboo joint-venture mill, in both the quarter and the first half, we have had some operating reliability issues that resulted in lost production and higher production costs. Our share of the production losses in the quarter was approximately 3500 tonnes. Mill personnel are addressing the issues and we expect to see better operating results in the future.

At our Hinton mill, we are in the final stages of the restructuring plan that we announced in March of '06. The restructuring involves the closure of the wood room and downsizing pulp capacity by shifting all production to an upgraded single line. The wood room was closed in December and the mill is now operating substantially on residual wood chips. In the first half of '07, the old pulp machine ran about 50% of the time. Our intention is to permanently close this machine in the third quarter.

The upgrade of the newer pulp machine was completed in May and to date we are pleased with the startup. By the end of June, the machine was running at or above 85% of its design capacity. We expect to meet the target production of 1000 tonnes per day by the beginning of the fourth quarter.

Our production costs in the first half of the year have been higher than expected due to higher fiber costs and higher-than-anticipated costs associated with the startup. With the restructured mill, we expect annual production to be about 350,000 tonnes.

The most significant pulp and paper issue in the second quarter was the operation of our linerboard and kraft papermill at Kitimat. On June 11, we took the mill down for its annual maintenance shutdown. On June 21, the pipe carrying effluent from the mill to the effluent treatment system failed. As a result of the failure, the startup of the mill was delayed 11 days while a temporary bypass was established. The cost of the temporary bypass, the permanent repair to the effluent pipe and the lost production will total approximately C$10 million, of which approximately C$2 million is reflected in the second-quarter results. The balance will be reflected in our third-quarter results. For the first six months of '07, total production at the Kitimat plant was approximately 30,000 tonnes less than production for the first six months of '06.

In the past four years, we have made significant progress at Eurocan increasing productivity and reducing production costs but the two major problems we have had this year, the poor operational performance in the first quarter relating to the startup of the turbo generator and the effluent type failure, have been significant setbacks. We are working hard at getting this operation back on track.

Martti Solin will now discuss the financial results in further detail.

Thank you, Hank. Good morning. I would like to start by making some comments on the segmented results for lumber since this is the first quarter when we saw the expanded U.S. lumber business. Although we will not segregate our U.S. and Canadian lumber results, we will give you some guidance so that you will have a better ability to gauge our future results.

We now have 15 mills both in Canada and in the U.S. In Canada, we have produced roughly 4 billion feet or about 270 million per mill. Presently we are producing almost exactly half of that in the U.S. You will note that we are giving you both production and segment separately for Canada and the U.S. in our MD&A. The inclusion of the U.S. lumber capacity will change the individual line items when expressed per thousand board feet. The sales, cost of sales and admin will be higher but offset by lower freight and depreciation charges.

As a general observation, we can say that the exchange rate is a great equalizer. With a current strong Canadian dollar, the per thousand results in U.S. are not a whole lot different from the results of our Canadian mills.

It is too early to report on synergies. All we can say that we are pleased how the integration has progressed and how the operations are going. We are very comfortable that our synergy target can be met.

Let me now comment on a few items in our statement and try to give you a simplified variance analysis on our results. There is nothing unusual in our balance sheet. The reduction in inventories is mostly the seasonal shift in log inventories as well as some reduction in lumber inventories. Proceeds from the inventory reductions repaid some of the operating line borrowings.

Let's move to the earnings statement. Just to clarify the accounting treatment of the Kitimat pipe failure, the prevailing accounting rules do not permit to accrue expenses not yet incurred. Accordingly, out of the estimated total cost of about C$10 million, C$2 million is included in the current quarter and the balance estimated as C$8 million should be in the third-quarter results. The C$8 million represents both the cost of repairs as well as a loss contribution as a result of production loss. The nature of this event is such that it is unlikely to result in insurance recovery.

The SG&A going forward should be around C$30 million per quarter, not C$20 million we had in the first quarter, which included one-time credits. Other expense is a net figure in which the exchange loss in trade receivables of about C$16 million and the difference being various other gains and losses. The tax recovery of about C$21 million is a mixture of recovering at the higher rate than the current rate and nontaxable amounts.

Foreign exchange gains and losses as well as other income makes the comparability of results from one period to the next somewhat difficult. I know each of you have your own views on this but my simplistic approach is to take operating loss of C$37 million, add interest expense to that, C$10 million, and tax effect all that at a statutory rate of 34%, giving us a loss of C$31 million or C$0.72 per share.

This completes my comments and we are now available for questions.

(OPERATOR INSTRUCTIONS). Richard Skidmore, Goldman Sachs.

Good morning, guys. Just wanted to follow up on the U.S. lumber operations and now that you have been in there for a quarter and as you look to the synergy goal that you have, any view on how the operations are running? Ultimately how you think that synergy goal is going to play out going forward? Do you think it could be accelerated? Do you think it could be larger, smaller? Any color on that would be great.

Well we have been running the operation now for a quarter and we are very pleased with the reception we are getting from the entire employee group down there. It has been very positive. The mills are running as well as we had expected. We did set a good production record there this month -- last month, excuse me. And we are actually very encouraged by what we are seeing there. We think there is lots of upside potential.

In terms of synergies, we are convinced we are going to get the synergies we have announced and I think that if we -- it is a little too early to tell whether you know what the -- if there is further upside or not but we'll certainly report on that if we find it.

And then just secondly following up on a question or a comment that you made about the lumber recovery rates being impacted by the beetle, logs or the log quality deteriorating, can you quantify sort of the impact that that is having on your operations up there in British Columbia?

No, it's year over year, quarter over quarter; it is relatively marginal at this point in time. But it is a -- it is certainly noticeable and the wood is significantly drier that we are bringing into these operations so it affects you and it does affect production because it breaks up in the mill more than it has in the past and that causes recovery and grade issues. So I don't think I can quantify it any more than that.

Thanks, Hank.

Patrick Yung, Raymond James.

Good morning. Following up on the U.S. lumber question, what are your thoughts in terms of input costs going forward for the rest of the year?

Input costs I think going forward for the rest of the year are going to be roughly the same as they were in the first half of the year, not significantly different.

Okay. That's fair. And a second question is you had an inventory write-down C$18 million in the first quarter. Did that -- was there a reversal of that in the second quarter and if so, how much of that was in there?

We consumed the logs which -- where the write-down took place so we got in second quarter the benefit of that C$18 million so that is all there was to it.

Okay. That's fair. And the final question is on your pulp assets, it seems like the assets are a bit of a distraction to you guys. And if so, do you see current favorable pulp markets as an opportunity to maybe divest some of your assets in that group?

Well I wouldn't call them a diversion. I would call them a work in progress. As you may recall in acquiring the Weldwood assets, we took on the Weldwood pulp mills, Hinton and Cariboo, and I guess we have had them for a couple of years and it is our job to really squeeze performance out of those operations. Obviously we haven't done that to date but we've got a strong program going on in Hinton which we think is going to significantly improve that operation. Quite optimistic about what can happen there as we wean the mill from a significant amount of roundwood to residual chips. We have been able to rationalize operations there.

We are going to be shutting down the old pulp line which is a high-cost pulp line. At Cariboo Pulp, it is a good operation but obviously as I mentioned earlier, we have had operational difficulties. We don't expect those to be ongoing. And at Kitimat, I think that is the one operation that I think everybody including us in this operation continue to be frustrated with. We have made good progress over the last couple of years as I suggested but setbacks seem to come more frequently there than we would like.

We've got a strong management team. We think we have put -- we think we have made the proper investments in that plant to make it an operation that can give us stability. And on top of all of that, we got into this business because a viable pulp industry in the interior is required in order to consume the residuals; 50% of the log ends up in these pulp mills generally. So we are -- we have got to get these operations performing the way they should perform.

All right. Best of luck in your efforts and that is all I had.

Thank you.

Don Roberts, CIBC World Markets.

A couple of questions. On -- stumpage seems to be up again just for the formula. You'd mentioned about some of the specific changes that the provinces is entertaining on the formula to better reflect I guess the value on the beetle wood. Could you give us a little more color there? And you know, I assume that we haven't seen these reflected yet and if they are going to come in, a sense of timeframe and magnitude?

Well I am going make a quick comment and then I'm going to ask Wayne Clogg to be a little bit more specific. But there is -- you know the timber resource in this province is changing dramatically and it is questionable as to whether the timber pricing system properly reflects that and it is very important that our provincial government understand and recognize the deteriorating quality of their timber as they make policy. Wayne, do you want to add to that?

Sure, Don. I think you know that last year the provincial government made a couple of major changes to the stumpage system. They went to market, the market pricing formula. They also changed log grades, eliminating what we used to call grade 3 which was a dry log. And instead they tried to account for the loss in log value at the stage where the timber is cruised and appraised. So that was a major change.

And I guess what we are saying, Don, is that you don't always get these things right on the first shot. And there is a lot of technical detail goes into that to the appraisal side of it and there are some definitions around log grades that we think have to be continually looked at to make sure that they reflect what is actually happening with those logs in our mills.

Okay. So it is just part of that original -- you are essentially tweaking the changes that were put in before, it sounds like? And what is your sense in thus far the response from the U.S. coalition on these changes?

I don't have any sense on that. I don't think we're talking about any changes that have taken place, we are talking about a system that we are just encouraging the government to make sure that as they -- that the system reflects, the system in place reflects, accurately reflects the quality of the log we are buying. And we can't predict what effect will be in the future. And I have no idea what -- this doesn't relate to the coalition in my point of view. It relates to accurately pricing the wood.

Just the right implementation of the current system?

Correct.

You had said -- just focus on the U.S. operations. Did you get hampered much in the quarter with the wet weather in the south on getting wood out?

Yes, we did have -- we did lose some time at one of our mills in Texas and I believe that probably we did have some problem getting some logs in but I think the only time we lost was about four or five days in one of the Texas mills.

Okay. And lastly with regard to the beetle impact in Alberta, what specific sort of the location? Is it Hinton which is most adversely affected down the road do you think? Or which are the ones could you give us some guidance on?

I will ask Wayne to answer that.

I think you know, Don, that there was quite a large flight of beetles out of B.C. into the Peace River country in Alberta last year. Those beetles affected areas up in Grande Prairie. We had no beetles on the Hinton FMA from that and a few scattered in through the AMC and Blue Ridge FMAs. As Hank mentioned, there was some significant mortality this winter. It is not widespread. So it is in pockets but somewhat encouraging that if the province continues with an aggressive control strategy that perhaps once in awhile we can have some support from Mother Nature in Alberta.

But most of the operations including ours in the east slopes area there have significant areas of mature pine and the strategy in Alberta that the government is following is to try and, as Hank said, focus on bringing that inventory of pine down by shifting operations into mature pine.

Okay. Good. Thanks so much.

(OPERATOR INSTRUCTIONS). Mark Bishop, RBC Capital Markets.

Thanks very much. Hank, there is a line in your report I just wanted you to elaborate on that you are working with the government to develop a response to deal with the non-sawlog material. Just wondering if you could elaborate on what your discussions might be with either Hydro or the government and where you see this initiative going and maybe at what pace?

Well, you know, there is more wood being left out in the bush and that is because there is more of a log is -- no longer makes lumber when you bring it in so it is being left out there. And the government's interest is in finding ways and industry's interest as well is to find ways to utilize that waste. So the government is going to put out -- is going to put out a call for energy proposals, bioenergy proposals. We don't know the timing on that. I think the government is working very hard on formulating the proposal.

We are also as I am sure many other companies are looking at what our options might be and, you know, analyzing the potential for us to participate in making power out of the waste left in the bush and out of the dead standing pine trees. So I don't know the pace that this is going to happen but I think everybody is working pretty hard on it.

Okay. Great. So at this point you don't have any sort of initial capital plans focused in that area?

No.

Second question, just on your fiber supply for the B.C. operations. Quarter to quarter, did you change the level of the whole log chipping that you might have needed to do and do you see it changing in the second half? It sounds like you may be going the other way at Hinton.

We are not really doing any whole log chipping in British Columbia.

Yet. I will just jump in on that one, Mark. We are doing a bit of whole log chipping in a couple of our operations for external sale. So we are still in balance on residuals but there is a demand right now for whole log chips so we are taking advantage of that and doing some whole log chipping.

And that is flowing back into your sawmill performance?

Yes.

And just a question on the softwood. Any update on the arbitration, the timing of a decision we might see and a determination of what might happen with the retroactivity of the export tax?

I don't have any insight on that. Our Company believes very strongly that the agreement as written is the agreement that both countries need to follow. And it is our view that the agreement as written clearly, clearly supports the position that Canada has taken.

What kind of timing do you think we will see the arbitration ruling?

I don't have any idea on that really.

Okay. Any update on the CapEx for the U.S. mills or are you still going with a maintenance scenario at this point?

Yes, it is a maintenance scenario, probably a little less than we had originally planned. We haven't spent that much so far and I think our original plan was C$25 or C$30 million. I don't think we will spend that this year.

Okay. And your total CapEx was 7. Could you just again confirm what your expectations are?

I think we will end up somewhere in the C$160 to C$175 -- C$160 to C$175 million range.

Great. Thanks very much, Hank.

Paul Quinn, Salman Partners.

Yes, thanks. I just want to circle back on your discussions with the B.C. government on stumpage changes because of the mountain pine beetle. I am having a hard time understanding how you can ask for a break when you can't quantify the cost increase or the value drop. Is there a study done on the association level that would be able to quantify that so you would be able to have a legitimate case in front of the government?

Paul, I will tackle that one again. First of all, we are not talking about changes as far as changing any systems. What we are talking about is trying to work within the system we have. As usual, there is various joint committees working at the scaling level and at the appraisal level and yes, there are -- the government is trying to work with agencies like Forintek to try and quantify some of the impacts in the mill. It is somewhat of a chase because as you do the studies and implement it, the wood continues to deteriorate. So we just want to make sure that the factors that are used recognize what we are actually experiencing in the mills.

Okay. So essentially through no major changes in the current systems, but what do you expect with further iterations of MPS that stumpage should drop over time?

Yes, that is the way the system works.

Okay, thanks.

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

Okay, thank you. I should add for full disclosure, I had forgotten to mention the B.C. Coast is on strike and we do have one sawmill that operates on the Coast. It is our Terrace sawmill which operates one shift. It is on strike. It has no material impact on the results of the Company.

So thank you very much for joining the call and we will be around all day if there is further questions or clarification you want to follow up with. Thank you. Goodbye.

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