West Fraser Timber Co Ltd (WFG) 2007 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Timber Company Ltd. fourth-quarter and annual 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 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, Chair, President, and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Thank you. Good morning and welcome to West Fraser's 2007 fourth-quarter conference call. I'm going to assume you've read our news release, so I won't repeat the figures. The way I look at the results, we lost $73 million in the fourth quarter. That is the operating loss plus interest expense, all before taxes. These results include a $10 million write-down of the quarter ending lumber and log inventories based on expected lumber sales values.

Our reported loss of $2.9 million was after taking into account an income tax recovery of $67 million including $30 million related to a tax rate reduction. We had positive EBITDA in the quarter of $7 million. These very poor results reflect a strong Canadian dollar and dismal lumber prices. Our mills generally ran well during the quarter, although curtailments at some of our lumber mills resulted in reduced production.

With respect to our operations, I would like to first focus on our lumber business. SPF lumber prices continued to fall during the fourth quarter and that trend has continued into 2008. Although the average southern yellow pine 2X4 price stabilized during the quarter, our U.S. operations suffered because of weaker prices for wider dimensions.

The Canadian dollar began the quarter near par but rose to almost 10% above par before settling back to par at the end of the quarter. This has created extremely difficult conditions for us. The overall impact of these levels has to be considered in the context that we had an $0.86 dollar at the beginning of 2007.

Log prices in British Columbia and the U.S. South have not responded to the dramatically reduced sales environment. In B.C., we are processing pine beetle killed logs almost exclusively, which has affected production volumes as well as lumber grades and recovery factors resulting in lower revenues. In response to these conditions, we have implemented production curtailments at our Canadian operations, which to date represent approximately 425 million board feet on an annualized basis.

In addition, we just announced lumber production curtailments at our U.S. operations totaling 350 million board feet on an annualized basis. By the end of the quarter, we had achieved the $23 million of synergies on a run rate basis that we had previously announced for the newly acquired U.S. mills. We need to upgrade a number of these mills to improve productivity and efficiency. Unfortunately in the current environment, we are not generating sufficient cash to undertake these improvements.

As we've previously said, we will not see any turnaround in North American lumber markets until either the housing markets absorb the current excess unsold homes or there has been a significant reduction in lumber production. As a result, we think 2008 will be another very difficult year for the lumber business.

We're expecting a decision shortly in the arbitration of the softwood lumber surge dispute. We continue to believe that the Canadian position will prevail. A recent positive development for us was the opportunity to acquire additional timber tenders in the Kamloops area. These tenures will help offset some of the loss of harvestable timber caused by the mountain pine beetle infestation and should benefit our operations at Chasm, 100 Mile House, and Williams Lake in the long run. This acquisition is subject to various regulatory approvals and we are expecting completion some time in the second quarter.

Moving to our panels division, our plywood business continues to do well as it benefits from the continued strength of the Canadian housing market, although average benchmark prices have recently shown some weakness. Results from our LDL business continued to be poor, reflecting the state of the U.S. housing markets, while our MDF results have been adversely affected by the strong Canadian dollar.

Our pulp and paper division had mixed results. Our two mechanical pulp mills and our Caribou Crown pulp mill all operated very well and produced strong results. The Hinton NBSK mill has still not achieved our production targets, although we are getting close. High fiber costs continue to be a challenge at this operation.

The Kitimat linerboard and kraft paper mill operated well during the quarter, although the strong Canadian dollar continued to erode 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 quarter. The scope of this downturn is unprecedented and we are very focused on cash preservation and maximizing efficiency. However, we continue to make capital available to projects which will significantly improve our business such as the Kamloops tenure purchase.

The combination of continued poor markets and high log costs will significantly affect the first-quarter results as the seasonally high log inventories will have to be written down to lower values to reflect the lower lumber prices.

Our integrated model has reduced the severity of effects of this downturn, although our lumber business has grown significantly in the past few years so we are proportionately more exposed to lumber prices than in the past.

Although when times are this difficult it's hard to measure our product and geographic diversifications should continue to benefit us. We have reduced lumber production response to the current difficult market environment and we will continue to assess our operating strategy as circumstances change. I want to reiterate that we are very focused on operational excellence and cash preservation.

Martti Solin will now discuss some financial issues.

Thank you, Hank. Good morning. In these difficult times, I would like to focus on issues such as liquidity and financial flexibility in general, which relate to balance sheet strength and the availability of or access to funding.

To get started, let's look at our cash-flow statement for the quarter and the year a little more closely. The fourth quarter was a very difficult period by any measure, as Hank just highlighted. After working capital -- after working capital which reflects the seasonal work inventory buildup, we had a $17 million use of funds from the operations. On top of that, we spent $15 million for capital improvements and paid our regular quarterly dividend amounting to $6 million for a total use of cash about $38 million before one-time items.

Our annual results are somewhat more difficult to digest, as non-cash working capital included a couple of one-time items related to the annuity refund. If we deduct $312 million related to the special charge in taxes, it means that for the full year of 2007 we generated roughly $75 million from operations and spent $[107] million in capital and $24 million in dividends. That means that we had a negative free cash flow of about $56 million last year. Again, all these figures are before one-time gains and other items.

These [declines] from operational and cash needs that we may be faced with going forward. In addition, we have debt maturing in 2009 totaling $150 million and another $100 million in 2010. Even without any of the refinancing, which always is a possibility but which is subject to debt market conditions even for investment-grade borrowers like West Fraser, we believe we have sufficient access to funding.

As you may recall in 2007 as a part of the U.S. sawmill acquisition, we entered into a five-year committed revolving loan facility for $600 million. We believe that the [systems] of this committed facility is very important in these difficult times. These types of financing facilities contain certain covenants. We do not anticipate any issues with the [covenants] and expect to be able to utilize our facility as we may require.

As we have told you earlier, we have agreed to acquire certain timber tenures in the Kamloops area. Our revolving facility will be used for this and any other purchases or (inaudible) which should we make any in the future.

We ended the year with a 25% debt to capitalization ratio. In the event these difficult times continue throughout 2008, the ratio will inch up, but we would not expect it to go up by more than a couple of percentage points.

Finally, let me comment on an important accounting issue that is the asset impairment issue. We have very carefully reviewed all the assets to determine if the future cash flows are sufficient to recover the carrying value of those assets. As required by the accounting rules, we have also tested in fact twice during 2007 our goodwill for impairment. We have concluded that none of our assets met the accounting test for impairment, nor did the goodwill which we carrying in our balance sheet. We recognize that these assessments are highly influenced by underlying assumptions. For as long as these difficult times continue, we will periodically test for impairment using then available best information for future cash flows and other assumptions required to complete such tests.

We are now, operator, available for any questions which you may have.

(OPERATOR INSTRUCTIONS) Mark Bishop, RBC Capital Markets.

Just a couple of questions. First, Hank, if you could address the downtime that you say you've taken or will be taking through 2008? I guess that's a 2008 annualized measure of 425. Is that strictly taking off certain shifts or are you actually taking curtailments at certain mills for a period of time?

We have taken shifts off. We have a mill that's completely shut down. That is kind of it, Mark. In Canada and in the United States, which we announced yesterday, those would be again primarily a reduction of hours.

Sorry, the Canadian mill, is that the Terrace mill that you earlier announced as down?

Yes.

The valuation of the tenure that you purchased, is that still something that you are not prepared to disclose?

That would be correct, thank you.

Just on that strategy, I assume given Martti's earlier comments that this is something that you will continue to pursue given your concern over the fall down in terms of purchasing additional tenures in the northern interior as well?

Yes, it is something that all the companies are doing to sort of high timber base. So we and others will be doing that, I'm sure.

The valuation of those additional acquisitions will be disclosed depending on who the vendor is? Is that fair?

That would be right, yes.

You mentioned the -- and I don't think you mentioned it in your comments opening the call but the concerns over rail. I'm just wondering if you could maybe give us a little bit more insight into where you are today with that issue and what if any remedy you might have, how you are dealing with that issue?

I think rail service has been an issue for all of us, or many shippers certainly in the forest industry for a long time. The service is spotty. It raises our costs at the mills and certainly that is very difficult when there are no margin in the mills already. So I think the shippers are working together to discuss things with -- with the railroads and I think there's legislation passed that will allow shippers to possibly work more effectively to address these issues in the regulatory environment as well.

Do you see any near-term capacity relief in terms of improved access to cars in the next two quarters or so? Not that you necessarily need it.

Yes, you'd certainly think that with the reduced production there would be no car supply issues at all. But there seem to be. So -- but hopefully that will improve as time goes on.

Okay, you had a comment in the release regarding your exposure to the potential surge decision and I guess I was under the impression that previous reports had indicated you had a run rate I think it was around $9 million a quarter or so exposure and there was an incremental decision and it looks as if you'd indicated the total 2007 exposure would only be about $15 million.

Yes, $14 million we said -- and you are right, Mark, we have recalibrated that calculation, that $14 million looks like a good figure.

Okay, was that a change in your view of how the actual surge was calculated then, or --?

No, I think it was just internally we just had calculated a little more accurately. It doesn't reflect a change how we calculated it. There is no policy change in that.

But obviously a better number. Just one last question regarding your market mix in the lumber side or your customer mix. Are you at a rate now that's heavier to the box store DIY segment of the business than you've been throughout 2006 and 2007?

Well, in Canada, our sales or marketing strategy hasn't really changed. In the U.S., we are probably somewhat more heavily exposed the U.S., but that's because of the products that we make in the markets down there. So I wouldn't say there's any particular change, no.

Hank, when you say in Canada, I assume you are referring to the marketing strategy from the Canadian assets into the U.S. Is that correct?

Yes.

So you are actually not more heavily exposed to box stores? I just -- I was thinking that perhaps the strategy to be little heavier to the DIY in the current environment where the builders have taken off so much volume? Maybe they don't actually -- you don't see any benefit in one segment over another at this point?

Let's put it this way. If there's been some change in strategy, I don't know about it, Mark. I don't think we've changed at all.

I'm not suggesting a change in strategy, but I'm just wondering where you are seeing the opportunity to maybe smooth out or improve your demand levels in the trough here. So you're not seeing any reason to increase your focus on the DIY segment in 2008?

Not currently.

Okay, great. I'll turn it over. Thanks very much.

Stephen Atkinson, BMO.

What is the CapEx for this year and for next?

For '07 --

No, for '08, sorry.

For '08. Well I think it will probably be in and around where it was in '07, Stephen, but certainly we've got lots of places to spend money, so we are going to be very, very careful. But we have projects that we can hop on to if things improve during the year. Right now our view is that we're certainly not going to do much more than we did in '07.

Okay, but you -- I guess if you have high return projects, then you would do them. Otherwise I would just assume CapEx the same as for 2007.

Yes.

Okay, and the profit improvements, I guess those would be more directed in the U.S., would they?

You mean capital that we could spend to improve profits?

Yes, or just the whole idea that typically when you acquire assets, usually you beat your synergy target, if I may be so bold.

Well, I don't know. Sometimes. We've got lots of our good projects in Canada and the United States, so we will just go through the list of mills and where their highest return is, most strategic place to spend and that is where it will be. But like I say, we don't expect things to get significantly better in 2008, so I don't think we are going to be releasing a lot of new capital.

Okay, in terms of the wood cost, I assume the cost of the beetle wood would be relatively flat. Would that be a good assumption?

A reasonable assumption. I will let Wayne Clogg maybe speak to that.

The stumpage system that we have enacted in B.C., Steven, does recognize deteriorating quality of the timber. So our wood cost has declined in B.C., but we've had a corresponding impact on our mills as well.

Okay, so I should assume relatively flat, then?

Well, I guess what I am saying is both sides of the equation are moving.

I'm sorry, yes, you are right. Relatively flat in terms of margin and just as a price change. How about U.S. sales?

Well, the U.S. sales has been a bit of a challenge. I mean log prices have come down, but 2007 pulpwood prices were very strong. There were low inventories at the pulp mills and weather conditions were not favorable. So the pulp mills chewed into the lower end of the saw up profile and we're challenging prices there. Similarly, at least earlier in the year, plywood prices were strong and plywood producers were certainly bidding up the price of larger logs.

So our overall price of logs did come down, but we weren't completely in charge of the market there if you get what I'm saying.

Okay, would there be any benefits with the new tenure? (multiple speakers) the three mills? With the Kamloops tenure, yes, sorry.

Well, our acquisition was primarily aimed at long-term fiber security for our facilities there. As Hank said, we are anticipating at some point an adjustment of (inaudible) cuts in the interior because of mountain pine beetle.

Okay, and in terms of the maintenance given that you are expensing now, how does the first quarter compare with the fourth?

In terms of maintenance --

Maintenance expense, yes, or the amount of maintenance you are going to do.

It shouldn't be any difference. The only significant kind of fits we get on maintenance are in our pulp and paper operations. That is the only variance on kind of over year and those happen in later in the spring at our big kraft mills.

Okay, so that's more of a second quarter event.

Yes.

Okay, thanks.

Patrick Yung, Raymond James.

Some of my questions have been answered, so I only have one on liquidity. In terms of the credit lines, are there any covenants that may prevent you from drawing them down in the future?

We don't believe so. They are certain covenants and assuming that the type of scenario we're talking about we don't, but it is evolving well so it never can be a, say, black and white, but we don't expect.

Are there more in terms of balance sheet type of covenants or coverage covenants?

Coverage.

That's helpful, thanks. That's all I had.

Robert Trout, Goldman Sachs.

Just a general question for you. I know you gave your outlook for 2008 with respect to housing that you don't really see any improvements, but looking I guess past 2008 into 2009, the consensus seems to be pretty -- consistent that it will be around $1 million or under for '08, but there's a lot of disparity I guess as far as when people see the inflection point. So I am just wondering if you could maybe give us your view on what level of starts we need to be at in the U.S. to get back to normalized pricing for lumber and/or profitability?

There's two sides to that equation. How much production, how much production is coming out and will be out and will a stay out that changes what you need in housing starts? So it's really difficult for us to say, but certainly significantly more than the starts we are at today. I know that is not very helpful, but I can't tell you that we've been great predictors of the future. So we think there's quite a bit of production out of the market.

Okay, do you think it's like a 1-5 kind of number? Assuming that not a whole lot more production comes out?

The supply and demand thing, so it's -- we don't know.

Okay, thank you.

Paul Quinn, Salman Partners.

A couple questions. Just on the tenure you acquired from Weyerhaeuser, I know you don't want to give a specific price, but maybe a direction from sort of the amount or the values that the B.C. was giving you back on the timber take back compensation? Are we seeing tenure in B.C. higher than that amount?

I don't think we are really in a position to talk about that right now.

Okay, in terms of the curtailments that you spoke about for the $425 million in Canada, is that taken throughout the year in 2007 or is that weighted to Q4?

All of the -- the big curtailments for us anyway, the sawmill that is shutdown, actually went on strike in the summer. We just didn't start it up, so that's been for awhile. A couple of the large curtailments were in December and the rest of them are in January and February and they are basically indefinite.

Okay, in terms of -- I'm just trying to understand the curtailments in the U.S. South, I'm seeing sort of the southern yellow pine prices at a premium almost $100 year-to-date to the SPF, but you are reporting that. I haven't looked at the wides but the wides are causing you to grieve. Are you tracking that at that premium that we are seeing at least in what's reported on the 2X4s?

Well, the premium doesn't -- the 2X4 price really doesn't mean anything to us. It is the sales mix you have at the mill and the wide widths are very depressed. So basically for us the mill [mat] is lower than historically you would expect.

Okay, in terms of -- you mentioned the Quesnel sawmill still hasn't sort of achieved the $600 million. Can you give us a run rate for what it's running at right now?

It is probably running at -- in the last short period of time, 85% maybe. While we're talking, I'll just make sure of that.

Just wondering if there's been a change in CapEx strategy? Historically you guys have been pretty consistent on your CapEx spending, whether the times were good or bad. You know, in terms of a percentage of D&A, it's been pretty consistently somewhere in the 90%. Is that a change just because of the downturn is so severe right now?

Yes, it is a change. Our company has never experienced anything like this before, nor I think has the industry. This is just -- it is a brutal situation where prices have fallen not only below cash, but there were shutdown points for a large part of the industry and so we have always in virtually every previous downturn, we have been able to maintain our relatively normal CapEx. This is different. It's just a bloodbath out there.

All right, in terms of just the asset impairment, because you guys brought it up, I guess the keys or the assumptions going into that. Can you sort of give us an idea as to just specifically on the B.C. assets what you are impacted by the mountain pine beetle, is there -- did you put in a harvest rate reduction assumption in there?

Paul, we may not get into kind of a detail, say, we don't want to go into it. It is a very comprehensive look at all the aspects coming from prices to exchange rates to run rates, so all those factors go into it.

Paul, kind of more recently, the Quesnel sawmill is really running in or around 80% of capacity.

Great, that's all I had. Thanks, guys. Good luck.

Sean Steuart, TD Newcrest.

Just a couple of questions, guys. Hank, wondering -- I know you don't give the lumber recovery factors out, but if you can give us an idea of over the past year the declines you might have seen in your LRF as far as processing the beetle kill wood? And the second question I had was on the quarter-over-quarter improvement in pulp and paper costs, just wondering if I'm right to assume that's mostly productivity improvement at Kitimat following through from the problems you had earlier in the year there?

on the first question, our LRFs are I don't think significantly different than last year, but we have made improvements in the mills. It is kind of hard to -- we had different log sizes and so forth. It's kind of hard to directly equate LRF to the beetle kill. We know that it is having a significant effect, but where you can more accurately see the effect of this is on our grade outturn and grade outturn is down significantly in our B.C. operations.

Okay, that's helpful. Yes on the pulp and paper side, just wondering if our assumption that most of the quarter-over-quarter improvement in unit costs is attributable to Kitimat?

Kitimat had a reasonably good month, but one of our kraft pulp mills also did extremely well and our two mechanical pulp mills did very, very well as well.

Okay, great. Thanks, guys.

Don Roberts, CIBC World Markets.

Hank, really two questions. I guess most observers have been I think generally puzzled by the lack of permanent closures as well as curtailments in the industry, the lack thereof just given how cash negative things are at. I would think that maybe -- has been kind of a puzzle -- I'm just really for you guys I would -- [Indian] issue as a whole I would say but you used to talk for you guys. I would expect this to be showing up partly in terms of a build in inventories of the lumber at your sawmills.

Could you give us a sense on where your inventories are at now some of your key mills like Quesnel and where sort of compared with where they would normally be at?

We have actually been able to move our lumber. Our inventory builds are largely due to lack of rail service. We do have a bit of an inventory build in one operation because -- not because of anything other than we are modernizing the planer but that's it. We are generally able to move our lumber.

And you sense that through -- I'm sure the customers have already clearly brought down their inventories, but are you seeing it through some of the earlier stages as a distribution channel that there has been any build? What is your sense on that? Is that empty rate from customer back to mill?

My understanding from our sales guys is that the cupboard is pretty bare.

Okay good. Your observations in terms of why we haven't seen the closures is like most folks being cash negative? What is a (inaudible) exit that we are missing he?

I think a lot of us -- speaking for West Fraser -- we are less, in a declining market I think we always are surprised at how bad it gets. So I think we are always a little behind the eight ball in terms of how bad it is going to get. So maybe we always react a little late. I don't know. But this has been unlike previous downturns, in my opinion. You know, so many operations are operating so far below the level that makes sense for any of us. It's hard to say. We have -- everyone of us has different strategies and we think we are seeing significant downtime now. Certainly we're taking it and so I think there's going to be a reaction in '08.

Okay, a second question (inaudible) a little bit earlier on Sean's question about the beetle issue, this is really the first call in which you actually seem to emphasize more the grade next fall down here, which has been a potential source of concern. Could you give us a little -- sort of help in the quantification of this for example, when we break down the percent of premium product that you got (inaudible), number two standard and better, where was it sort of historically, where do you see it falling down? And then also perhaps how much more do we [see in] the economy grades than you had before? Because this is really key I think on this margin squeeze.

Don, we have talked about grades. I believe we have talked about grade fall down in the past as it relates to the mountain pine beetle. I mean it is obvious to anybody who walks through a mill that the stuff breaks up and deteriorates as it goes through the process. In terms of quantifying, I'd prefer not to do that. I would just say that the two and better grades are -- in B.C. are in the beetle zones -- are declining and certainly that means that economy is -- the lower grades are going up.

Okay, thank you.

(OPERATOR INSTRUCTIONS) Mark Bishop, RBC Capital Markets.

Hank, just a follow-up -- really trying to understand what message we should be taking away from your investment strategy for 2008. Obviously the investments in tenure are more defensive in nature and look like there will be other follow-on investments of the same sort in the northern interior. But let's assume that it is in the range of tens of millions of dollars. Clearly that is capital that you are not spending in the U.S. on the U.S. sawmills.

Should we be looking at that as if you are really perceiving that your U.S. operations will not be as profitable or as successful even in this environment as your B.C. mills and that you are not prepared to invest any more until you see substantial improvement there? Just trying to help understand what the message really is that you are sending.

Earlier in the year, the U.S. operations did better than the Canadian operations. As I think I mentioned, the U.S. operations do have the benefit of certain things. They don't pay export tax not subject to the variability of the dollar. But I think most importantly the swing in the U.S. operations this year has been the significant break from benchmark pricing down there which is the result of significant lower prices for wide widths. We are not quite sure why that has occurred. We expect it to come back to a normalized basis and so what we have down there is we think a good business model.

Pricing has changed in a way we had not anticipated. But we expect that to come back and we have got -- I don't want to be -- leave the wrong message. We are still squeezing stuff out of the mills that we have. We would not go into any of these mills and just spend capital before we have squeezed out the operational efficiencies that we think we can get. So we have gotten within the first year of owning it, we haven't even owned for a year. We got the synergies that we announced, $23 million. We got them on a run rate basis.

We are getting more, so certainly that means the next step is to start to improve the facilities from a capital point of view. But I think that they are going to be good assets. They are good assets. They need like some of our Canadian mills, they need capital spend on them and we're just going to have to figure out when we have the cash, we are going to spend the capital, but not before.

Yes, just struggling with sort of what looks like maybe a shift in timing and I guess also what the message that you previously sent on thinking that given that you have the lowest cost mill system in the B.C. interior that you would always have the availability of wood over anybody else and that you weren't all that worried about accessing fiber in the future. So anyway, I just still -- a little bit confused on that message.

Excuse me, I am a little confused on the question, but I must say, we just on one comment you made, I don't think we've ever said that we have the lowest cost assets in the B.C. interior. We believe we have modern, efficient assets, but the B.C. interior has a bunch of efficient operators. So our issue is in the past we generally have the capital through a business -- through a course of a year and not significantly alter our CapEx. This downturn is significantly worse and so we have had to significantly reduce it.

I don't know if that answers your question. As it relates to picking up timber, you've got to look at -- on a CapEx in a mill, if you -- you can always do that next year if you want, if you don't want to do it this year. On a timber opportunity, you don't have a second shot at it. You've got to go for it.

Right. I certainly see it's opportunistic. Just one last question. If you could just remind us again on your dividend policy and if there's any circumstances that you see a reduction or at least a temporary elimination of that dividend?

We review the dividend policy at length at every Board meeting and we view -- we have to take everything into account in terms of -- we forecast what we believe a likely scenario our cash flows are going to be in the future and we make the decision on that basis.

Okay, thanks very much. Good luck for the quarter.

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

Okay, I appreciate you all joining us. Thank you very much. Goodbye.

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.