West Fraser Timber Co Ltd (WFG) 2007 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Company Ltd. third-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 our risk factors in our annual MD&A, which can be accessed on our Web site or through SEDAR, and as supplemented by our quarterly MD&As. 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.

Thank you. Good morning and welcome to West Fraser's third-quarter conference call. I have got a number of senior managers, both in Quesnel and here in Vancouver, also on the phone with me.

I am going to assume you have read our press release, so I will not repeat the figures. The way I look at the figures, we lost $48 million in the third quarter. That is the operating loss plus interest expense, all before taxes. This result includes $33 million to write down the quarter-ending lumber and log inventories based on the period-ending lumber sales values.

These are disappointing results, reflecting the high Canadian dollar and dismal lumber prices. I would like to point out, though, that our mills generally ran well during the quarter.

With respect to our Lumber division, the average lumber price for the quarter and the average exchange rate do not really tell the story. The current SPF price in U.S. dollars is around $220, some $40 below the average for the third quarter. Similarly, the Canadian dollar strengthened almost $0.08 from the third-quarter average. That is what has created the dismal conditions we are experiencing. In addition, processing almost exclusively pine beetle logs in BC has affected production volumes and costs as well as lumber grades, resulting in lower revenues.

Our new sawmill in Quesnel continues to progress in its startup, although we will not achieve full production by year-end, as we had hoped. Last week, we announced the temporary closure of our sawmill in Terrace. The current market conditions just do not justify the operation of this mill.

Our U.S. mills continue to make good progress in reducing operating and administrative costs. We are well on the way towards achieving the $23 million of synergies we had previously announced.

It is obvious that we will not see any turnaround in lumber market conditions until the housing market absorbs the excess inventory of unsold homes or there is a significant reduction in lumber supply. As a result, we think 2008 will be another difficult year in the lumber business.

The arbitration process in the softwood lumber surge dispute has now commenced, with parties filing their positions. It looks like a ruling could be released in the spring of 2008. West Fraser continues to believe strongly that the Canadian position is what the parties intended and therefore will prevail.

In our Panel division, our plywood business continues to do well as it benefits from good domestic demand. Our LVL operation felt the effects of the poor state of the U.S. housing market, resulting in reduced volumes and prices, while our MDF results have been adversely affected, primarily by the strong dollar.

Turning to Pulp and Paper, for the most part, we were pleased with the performance of our Pulp and Paper business during the quarter. Our two mechanical pulp mills and our Cariboo kraft pulp mill all had record or near-record production levels, leading to strong results. The Hinton NBSK mill is still working through issues relating to its downsizing. As a result, we have not yet achieved our production cost targets for this mill.

The Kitimat linerboard and kraft paper mill operated very well following the completion of repairs to its (inaudible) line in early July. The extra downtime and related expenses of about $8 million hurt its results. The continuing weakening of the U.S. dollar more than offset any pricing gains in our various pulp and paper products during the year.

In conclusion, during these difficult times, we focus on cash preservation. We are limiting our capital expenditures in each of 2007 and 2008 to less than $150 million. However, we continue to make capital available to projects which will significantly improve our cost position.

Our integration strategy is paying off as we continue to be, on a net trading basis, self-sufficient in terms of by-product chip supply for our pulp and paper mills. Our product and geographic diversification should continue to benefit us. Our lumber production is now roughly 50% in British Columbia, 35% in the U.S. South and 15% in Alberta. We believe this gives us a good platform going forward.

We continue to believe that most of our sawmills are low-cost, but we are continuously assessing our operating strategy to ensure that we are operating in a mode which insures the best results for the Company.

Martti Solin will now expand on a few financial issues.

Thank you, Hank. Good morning. I'll be brief. Let me start by updating for the Canadian exchange rate change effect our operating results. The guidance we can confirm that each $0.01 change means approximately C$20 million in pretax annualized operating earnings terms. Accordingly, the $0.05 change for the third-quarter would have meant C$25 million operating earnings reduction, assuming no product price changes.

As a rough rule of thumb, we can say that exchange gain on long-term debt translation is reduced by a loss of roughly 50% on a gain in translating U.S. dollar-denominated working capital items. In other words, we recorded at $21 million gain on U.S. debt, which was offset by $10 million loss on U.S. denominated receivables and other working capital items. This loss has been shown under the other income and expense. That line is net of various income expense items.

As Hank mentioned, we wrote down our lumber and log inventories to net realizable values to reflect lumber prices and the exchange rate at the beginning of October. The lumber inventory write-down was $14 million and the log inventory write-down was about $19 million. Most of the inventory write-downs relate to the Canadian operations, as the inventory levels in the South are significantly lower.

Our SG&A for the third quarter reflects a reversal of $5 million relating to the incentive payments, as well as a share option expense recovery of about $4 million. These items have not been allocated to the business segments and are shown under corporate in the segmented report.

From a cash generation and liquidity perspective, we remained in good shape. Our current cash flow met our operating and capital requirements. In a couple of weeks, we will have a $145 million debt repayment due, which payment will be made, at least initially, from our $600 million committed revolving loan facility.

These comments complete my comments here, so we are, operator, now available for the questions from the analysts.

(OPERATOR INSTRUCTIONS) Richard Skidmore, Goldman Sachs.

(technical difficulty)

Don Roberts, CIBC World Markets.

Hank, a couple of questions. First of all, from the results we see the overall EBITDA numbers. Could you give us a little more of the breakdown on the relative EBITDA between the Canadian and the U.S. operations?

On a unit basis, they're not all that dissimilar. Probably that is the best I can do for you. They are relatively close.

Relatively close, okay. Right now I know that the chip prices are a function of the formula, but if we look at sort of regional chip prices, they looked pretty low in BC vis-a-vis other regions. Any thought with regard to changing the structure of the formula on the chips?

Not really, Don. Most of it is internal and so we do not want to subsidize either side of the transaction, lumber or pulp, so we're trying to calculate market prices in the regions and charging that amount.

Okay, when we're looking at the SLA, could you refresh us, again, in terms of the outlining the ability to switch options down here to the one with the lower cap?

In other words, go from option A, which we do in D.C. and Alberta, to option B and I think we have an opportunity to do that, to make that decision. It is not our decision. It is the provincial decision and I think it is three years from the signing of the agreement, which I think would be about two years from now.

You sort of look in the current situation -- if you had to make that decision now, would you probably sort of support that moving towards the other option now or what are your thoughts?

I would just reiterate what our company said all along. This country should be operating on one platform and in our view, the case brought by the U.S. was a subsidy and dumping case, which translated into a duty. In our view, this country should have and would be better off with a common duty negotiated across the country and we still strong support that. It is the only way for fairness to prevail throughout this country.

Okay, just lastly, one quick question for Martti. You mentioned about the sort of passive hedging strategy with U.S. dollar debt. Has there been any other changes in hedging strategy or policy for the currencies?

No, it is, as you know, it's tough to think about the current U.S. dollar debt at these particular levels, but we have not made any -- we do not, say, as a rule, hedge by using hedging instruments.

Yes, okay. Thank you.

Mark Bishop, RBC Capital Markets.

A couple of questions. Hank, just back on the agreement, I think you mentioned that it is two years before we can see a transition to option B. Do you see another scenario that potentially could play out and that the U.S. could actually decide it wants out? I believe both sides need to indicate that, but given that it looks like the Canadians are currently dumping, is there a danger that the agreement gets canceled and we see another round of at least anti-dumping duties placed in the Canadian industry, maybe timed around the same time as we start to see the markets recover?

I guess I would say that our company, anyway, never felt this was a perfect deal. There are issues I think that both sides feel are somewhat unresolved, but this is a long and arduously-negotiated trade settlement between the United States government and Canadian government and we would expect that both sides would respect the agreement, number one. And would respect the mechanisms put in place to solve disputes within the agreement. So that are strongly held position.

So this arbitration I guess will be the first test of that theory?

Yes.

Okay, and just -- I know it is probably looking too far down the road here, but given that you and I guess your other larger competitor still have capital plans for sawmills in the interior that obviously are dealing with the beetle, if you look out a couple of years, three to five years, I would expect we're going to be running into situations where we have mills that are in the same region, one of which of two mills may end up needing to be shut down. So I would imagine that we may see an inefficient allocation of capital. Is there any opportunity for the companies in the interior to start looking at tenure swapping in advance of when the real impact of the downdraft of the AAC cut occurs to optimize capital planning now?

Well, I guess that is a good question, but our view is that, you know, at least in our company, we're going to try to figure out what the future holds, whether it is five or ten years out. We're going to do our best to allocate capital in a way that gives a return to our shareholders.

I can't judge over the next few years how all that is going to shake out, but we are going to be very, very focused in our company of making the right capital allocations and I also believe that the acquisition of Weldwood two or three years ago gives us a very, very strong platform to -- from which to do that.

Okay, just on the U.S. mills, I think, Hank, in the initial comments you indicated that you're going to keep capital below $150 million. Has that -- has your perspective changed on the pace at which you plan on spending capital at the U.S. mills or is that program at this point still -- I know you have not specifically outlined what the capital is, but have you slowed it back from your initial plans?

No, we have not slowed it back from our initial plans, but our initial plans did not require much capital. We feel there is a lot of low-hanging fruit, at least from transferring from the previous owner to the method by which we kind of run mills, and so we have been very satisfied that we are making good progress with limited capital expenditures. Once we have kind of gotten through that process, then we have to look hard at capital at some of those mills.

Okay, great. Just on the synergies, the $23 million, it sounded as if you've gotten a long way into those. Are you on track for a faster completion of that than I think you initially outlined three years?

No, I think we're definitely on the line for a faster completion of that.

Great, okay. Then just finally, I don't know this is a question for you, Martti, or not, but if you could give us a little bit of a outline of your downtime at the Pulp and Paper operations for the next couple of quarters.

Marty has asked me if I would answer that. In the next -- we took our major downtime at all three of our major pulp mills, pulp and paper mills, in the second quarter. As you know, at Kitimat it extended into the third quarter, the first two weeks of July. That is why Kitimat's results are not reflecting a better -- reflecting the great production that they had for the rest of the quarter. Fourth quarter and first quarter of '08, we do not expect any significant downtime at any of our facilities.

Okay, so second quarter '08 is really the first -- next scheduled maintenance outage?

That's right.

Okay, great. Thanks very much.

Sean Steuart, TD Newcrest.

A couple questions, guys. Hank, you touched on plywood markets in Canada and how strong they were and that obviously contributed to some good margins at the Panel segment. Can you talk a little bit about your outlook there? I guess some of the strength we have seen in pricing is supply related and how long you see the market staying as tight as it is right now?

Well, I think that it depends on -- partly it depends on how long the Canadian lumber or housing markets is buoyant, which it is. That is really driving the good results we're seeing in our Canadian plywood shipments versus the bad results we're seeing in our U.S. lumber shipments. That is what's driving it. Sure, there has been some capacity withdrawal, but there is also a significant encroachment coming from OSB and nonetheless, plywood prices have held.

So I guess we just go quarter by quarter and we're not seeing a significant deterioration at this point in time. But you know, we worry about substitution and we worry about a weakening housing market out there.

Okay, and then second question for you, Hank or Martti. In light of the S&P downgrade a couple of weeks ago, can you guys comment on your commitment to retaining investment-grade status and I guess how important is it to the strategy going forward?

Yes, we are very commitment. We have been, we continue to be very committed to be investment-grade. A borrower -- it just shows up in the times like we have today in the capital markets. It is certainly an advantage of having the investment-grade rating. It is going to obviously require us to continue to maintain the kind of conservative financial policies we have maintained and we're committed to do so.

Okay, that's all I had. Thanks, guys.

(OPERATOR INSTRUCTIONS) Robert Trout, Goldman Sachs.

It is Bob in for Rick Skidmore, actually, today. I just wanted to talk a little bit about the Canadian dollar. If you guys could just clarify, you may have touched on it earlier in the prepared remarks, what the actual sensitivity is either pretax or after-tax.

Yes, I mentioned that the pretax impact is a $0.01 is a -- $0.01 is on a pretax basis, say, C$20 million change in operating earnings.

That is pretax, again? I'm sorry.

Pretax, yes.

Okay, thank you.

There are no further questions registered at this time -- I'm sorry, we do have one more question from Paul Quinn, Salman Partners.

Just a question on the $150 million CapEx. Any -- can you give us a breakdown as to where you're going to spend that in terms of geographic indications? Is that 50-50 Canada/U.S.?

It would be more in Canada than in the U.S., for sure, but I could not really give you a breakdown. We're going through our capital process right now, Paul, and I think it's premature to kind of give a better breakdown than that, but it will be more predominantly in Canada than in the U.S.

Okay and just secondly on log values in the BC interior and I guess soon to be Alberta, with them coming down significantly because of the mountain behind beetle, do you see stumpage tracking that value coming down? How do you reconcile that?

I'm going to ask Wayne Clogg, our Senior VP of Woodlands, to answer that.

The target rate, or they call it the average market price, dropped in October to 11.14 a cubic meter, which is lower -- I look back to the FRBC bump in mid-'90s and I think it is about the lowest that it has been since that bump. So you have to go back to 2003.

There is potential for it to drop further because of the lagging effects of market pricing, so we may see some further declines in this winter and then there will be a new MPS equation next July and it is kind of crapshoot, Paul, to know what is going to happen then. But I think we're getting close to bottoming out in BC.

In Alberta, we have been on minimum stumpage there for quite some time, so we continue to be on minimums. We're about at the bottom there in Alberta now.

Just so I understand, you are happy with the way the BC interior stumping is tracking falling values?

I did not say that. No, it is coming down, but I think our results and others show that it could come down further.

Okay, thanks guys. Good luck.

A follow-up Mark Bishop, RBC Capital Markets.

Just two quick follow-ups. Wayne, I understand that there will be a transition to full MPS from the hybrid model. Could remind us again what the timeline is for that and what you see as the major implications when that does get implemented?

I guess I will look at what we have heard. There has been an indication that the Province is looking at an MPSA, full MPS, by July '08. I do not think that is necessarily a hard deadline, but it is something that they're looking hard at. The main implication I think is that MPSA takes away the kind of averaging of different timber stands in the interior and it takes away the water bedding of log grades. So if, for instance, in the beetle zone, is there is a high percentage of pulp grades, those would not waterbed to other regions.

Okay, great. Hank, just a question, again, maybe a bigger picture question on lumber markets. I know the North American market is by far the most significant, but are West Fraser's efforts right now at trying to diversify your lumber markets, whether it is Asia or elsewhere? Do you see any opportunities for even marginally improving opportunities in those markets?

Well, we ship to Japan, have done for many years. We have people there that really try to root out as much sales activity as we can get. We're certainly active in China, although that is a market that really, in my view, does not have the -- it is so minor that at this point in time, I think we just continue to work away at that market hoping that gradually we can develop some real opportunities there. But they are not their right now and our view is that the North American market is the market that is going to be our, by far, our predominate market in the future. And our job is to make sure that we continue to focus on that market and do the best we can supplying it and getting our costs down.

Okay. And currently, the way you're going to markets, given your customer mix, you are happy with that structure? Do you see any changes in terms of the component going into box stores versus the wholesalers or are you going to continue to go to market the same way you always have?

We have no intention, no plans to change that. We talk about it all the time. We're quite satisfied with our approach at this point.

Great, thanks very much. Good luck in the quarter.

Thank you. There are no further questions registered at this time, so I'll return the meeting back to you, Mr. Ketcham.

Thank you very much for joining us and I guess we'll talk to you in a quarter or so. Goodbye.

Thank you. The conference has concluded at this time. You may disconnect your telephone lines. We thank you very much for your participation and have a great day.