West Fraser Timber Co Ltd (WFG) 2008 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Company Ltd. third quarter 2008 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 are subject to various risks and uncertainties. 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 through our website or through SEDAR and is 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, Chairman, President, and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Thank you. Good morning and welcome to West Fraser's third quarter conference call. Yesterday we reported a loss of $2 million or $0.05 per share. EBITDA for the quarter was $77 million or 9% EBITDA margin. Our operating earnings reflect an improvement compared to the second quarter as log costs have dropped and prices for lumber, line of work pulp and news print improved. On a year to date basis, the benefit of lower log costs and these improved prices was largely offset by a stronger Canadian dollar. In these challenging times, we produced free cash flow of $76 million in the third quarter and $127 million on a year-to-date basis allowing us to carry out required capital expenditures while paying down $133 million in debt. The severe downturn in the US housing market continues to adversely affect our solid wood results. Production curtailments in the summer months resulted in some strengthening in SPF lumber prices but we saw a sharp decline late in the quarter.

Although benchmark Southern Yellow Pine lumber prices remained fairly steady for the quarter, we saw demand for water dimensions fall off which reduced our mill nets. Log costs have come down both in Canada and the US compared to 2007. In the US, we've experienced some production curtailments associated with log shortages caused by poor weather and lack of reasonably priced logs. Plywood and MDF prices held steady quarter over quarter. Our mills generally ran well during the quarter. In response to the very difficult market conditions and as previously reported, we reduced our lumber production on an annualized basis by 435 million feet in Canada and 327 million board feet in the US or roughly 13% of our overall capacity.

Our Alberta MDF and LVL operations continue to operate at reduced rates. Our British Columbia sawmills continue to feel the effects of the deteriorating quality of Mountain Pine Beetle wood through declining lumber and grade recovery.

Our pulp and paper divisions performed reasonably well in the third quarter. EBITDA was $45 million, producing an EBITDA margin of 16%. Our heat and craft pulp mill took its annual maintenance shutdown in September reducing production by approximately 14,000 metric tons in the quarter.

The most remarkable thing about the third quarter is how much has changed since it ended four weeks ago. Over the past four weeks, lumber and pulp prices dropped substantially. Demand continues to weaken for these products. The rapid devaluation of the Canadian dollar versus the US dollar has mitigated these price declines somewhat, but it appears as though pulp prices will go to cash costs or below which will then provoke a supply response. Line board news print have held up better but if history's a guide, we expect price deterioration in those products as well.

The tremendous uncertainty and volatility in global financial markets makes forward planning very difficult. Under current circumstances, further curtailments are required in the lumber, pulp and panel business to stop this steady price erosion and move the industry back above cash costs. At West Fraser, we'll continue to evaluate each of our operations to determine the correct operating scenario given the expected pricing environment.

As I've said before, our management and employees are very focused on cost control. Our plants are for the most part modern, efficient and technologically advanced. The average tenure of our management team is over 20 years so we have as a group been through very serious recessions before. And finally, our balance sheet's in good shape and we have significant credit facilities available to us. The foreseeable future is difficult to predict but I believe we are well positioned to weather the current storm and prosper when the economy turns up again.

Finally, I want to remind you that several weeks ago we announced the pending retirements of three key members of our senior management team. Martti Solin, our Executive VP and CFO, Gary Townsend, President of our Solid Wood division; and Bill Legrow, President of Transportation and Energy. We've been planning for these retirements for over two years. And I'm happy to say have strong and experienced internal talent to replace our three retiring VPs. Martti will be speaking in a minute has been our VP-Finance and CFO for over 20 years. He's been a key member of our senior management team and our primary connection to the financial community. We will obviously miss his wisdom, judgment, experience and friendship when he leaves. Gerry Miller, who is currently our Executive VP of Operations will assume Martti's role of Executive Vice President of Finance and CFO on January 1, 2009. Gerry's a chartered accountant and has held a number of senior positions since he joined West Fraser over 20 years ago. As many of you know, Rodger Hutchinson, our VP and Corporate Controller will be working closely with Gerry in his new role. Rodger has been with the Company for 14 years so you can count on the continuation of a strong and experienced financial team at West Fraser going forward. I'll now turn to it over to Martti Solin.

Thank you, Hank, good morning. We know investors and analysts compare the current period to the immediate and previous period rather than the same quarter last year as required. Our second quarter itself had lower value use of items such inventory evaluations which make a meaningful comparison quite cumbersome.

Having said that and as Hank already also alluded to it, in today's fast moving, or perhaps more to the point quickly deteriorating financial and business conditions even our third quarter results represent to a large extent the relevant information as today's conditions are vastly different from just two to three months ago. A startoff to qualify a few figures.

The FX loss for the quarter was a $0.26 and the gain on asset sales $0.07, also these figures are obviously after tax. Taking these items into account, the so-called adjusted profit for the quarter was $0.14. Hank already mentioned the exchange rate issues.

Some of you may recall that for the space at $0.01 US changed in FX represents roughly $20 million annualized pretax cash flow. That calculation assumes that selling prices for the products will remain unchanged. That assumption does not hold true today in products like lumber and pulp where Canadian producers represent a significant part of supply. Some of the currency gains have been lost at prior pricing and therefore, the currency benefit is significantly less.

Every company defines free cash flow slightly differently. Our definition is after tax cash from operations after working capital changed these, less business maintenance capital expenditures and dividends and before asset sale proceeds and before acquisitions. As Hank already stated for the quarter, we had a positive free cash flow of $76 million and for the first nine months $127 million. Which has helped us to virtually eliminate current borrowings. The short-term borrowings we have on the balance sheet relate to our US operations.

We are acutely aware that under current business conditions, which Hank described, the free cash flow duration is not likely to be as robust as what we have had so far this year. We recognize that the strong free cash flow was achieved in part by restricting capital spending as we have often said, capital needs to be spent to maintain the high level of our activity of our operations. Having said that, we are pleased that our balance sheet remains in good shape when we are going into the winter months which require a buildup of log inventories.

In these difficult times, access to liquidity is survival factor, recognizing this important issue we approach our bank and syndicate late in the summer to adjust our permanent package as well as to request a permission to increase the size of the committed facility from $600 million, to $700 million. The banks granted that request and after the covenant to eliminate interest to EBITDA maintenance tests for as long as our debt to capitalization ratio remains below a certain level. In these unusual times, one cannot take anything for granted. However, I believe it is fair to say that our covenant package should allow our pass through access of revolving lines at all times.

We are also satisfied that our banking syndicate which is made up of some of the strongest banks anywhere will continue to have access to capital and will meet their funded requirements. Terms of our long term debt repayments we have $150 million due in October 2009 and $100 million in March 2010 both launched in Canadian dollars. A significant reason for carrying such a large committed line which expires March 2012 is to potentially use that facility to fund repayments in the event other funding sources will not be available in a timely basis.

Finally, you might ask some of us which issues will keep us awake at night. In my case, I can say that at my age, there issues keeping me buzzing, but let me (inaudible - highly accented language) just on one issue. We worry a great deal about our customers and their customers' ability to pay the bills. In other words, trade credit issues. We have seen an increase in defaults which so far have been minor but remains a major concern. We also worry about our customers' ability to open letters of credit in our oversees (inaudible) sales. Having said that, our own access to liquidity is the key factor going forward.

As Hank said, I will be retiring at the end of the year. I obviously wish I would have been able to retire under more upbeat financial conditions. I know that my retirement does not change West Fraser's commitment to manage its affairs conservatively when required and look for opportunities when appropriate. I want to thank all of you for the cooperation I have had with you over the years. With this, I believe Hank and the rest of us are available for questions. Operator?

Thank you. We will now take questions from the telephone lines. (OPERATOR INSTRUCTIONS) Thank you for your patience. The first question is from Richard Skidmore of Goldman Sachs. Please go ahead.

Good morning. Thank you, just a clarification on the FX impact. That was a CAD$0.01 Canadian change equal to CAD$20 million, Martti?

It's a $0.01 US, changed 3%, C $20 million Canadian in our pretax EBITDA or cash flow.

Okay. And then, Hank, you mentioned that there was some concern about some of the other paper grades that you -- where prices have been stable but potentially if history's a guide, you might see them start to move lower. Have you started to see any erosion in the prices for news print or liner board?

I think not yet but like I say, going into a recession, those are certainly not recession proof rates, no question about it. They've always fallen before.

Then just lastly, maybe going back to Martti for a second, just on the covenants can you just elaborate maybe a little bit more on what those might be? Are they EBITDA to interest covenants, debt to capital covenants?

The key to debt to capitalization which we think is at the level that's under most normal conditions say we shouldn't have a issue with. And if that's for whatever reason is being breached, then a interest to EBITDA covenant is overlaid as well.

Okay. Then just maybe lastly, your total liquidity, if you were to sum all of those pieces up, your current availability?

It's a very close to the maximum available. We haven't initiated the $100 million ex of which we have a right to borrow under the current agreement. I mentioned at the end of the quarter, we were very close to debt free on a basis on the current. We are very close to today $600 million and potentially an additional $100 million if we so wish.

Thank you and best of luck to you, Martti.

Thank you, Rick.

Thank you. The following question is from Richard Kelertas of Dundee Securities. Please go ahead. Your line is now open. Please go ahead .

Yes, Martti. We're going to lie awake at night knowing that you're not there, but we know Gerry's got things well in hand. Just wanted to just cover off quickly in terms of the lumber operations, you mentioned that you've got 13% of your total capacity that you've taken down. With the change that's happened so far in the markets do you anticipate that that number's going to increase dramatically or did you anticipate what was coming over the last four or five weeks and you're basically in line with what you expect for this year and next year?

I think, Richard, we evaluate, yes, I mean I don't think that we expected price erosion as significant as it has been over the last few weeks. Obviously, we just look every day, every week at our operating strategy. I can't give you any indication as to what we might do but things are changing dramatically and so we're just going to continue to evaluate and do what we think we have to do when the time comes.

Where has the biggest weakness come? Has it come from the wholesalers? Obviously that's probably where it is or the retailers or is it pretty well equal right across the board?

I don't really know, Richard. From our point of view, we do have a sales VP on the phone. Chris, would you like to answer that?

Hi, Richard it's Chris. I think it's across the board but I think the retail community's really struggling. I mean, it's no secret people like stock are having a very difficult time. It's really difficult all around.

Right. Also now just on the paper end and board and pulp side, we heard Canfor Pulp indicate that they expect that downtime will probably be something they'll have to deal with but that the higher cost producers will be the ones that will have to take it. Do you expect that you're going to be able to weather the storm here obviously with prices in free fall in China, it's going to spread obviously. We're expecting prices to be off anywhere from $150 to $200 in 2009. Have you been able to get your overall costs of production down to where you can compete with Canfor Pulp in that regard? And depending on the grade obviously?

Well, I can't really answer that specifically, Richard, but I do believe we've made good progress throughout our system in costs and productivity. I think that we have a very good cost structure in many of our operations, but again, just like in our lumber operations, we are going to evaluate the pricing, both pricing and demand for the product, on a daily or weekly basis. We're just going to have to make decisions in every one of our lines whether it's panels, lumber, or pulp and paper based on economics. I can't give you any specifics on that right now.

And just a final question on the yield on the recovery that you were talking about. Have we seen a further deterioration in the recovery rates in your sawmills in British Columbia from the time we went out to see your operations in March/April?

Not really. Its deteriorated significantly. It had deteriorated significantly up to that point in time. We haven't seen any real deterioration since then. Again, it's, I don't think any of us really have any experience as to what the future holds there. I think it's very important that the investment community continue to understand that this is a challenge we have to face.

Thanks very much. We'll see you on the golf course, Martti.

Yes.

Thank you.

Thank you. The following question is from Daryl Swetlishoff of Raymond James. Please go ahead.

Thanks. Good morning, guys. Stumpage rates in the B.C. interior were down quite a bit. Can you comment on log price trends in the other areas that you operate?

Well, log price trends are going down in, certainly in British Columbia and the US South, but in the US South, there's pressure from, or has been anyway, pressure from the pulp industry on the smaller logs. So that's kind of kept kind of a -- kept some pressure on log prices there. But we expect, I guess our expectation would be log prices, we'd expect to see a reasonable weakness in log prices given the declining demand for logs as a result of, I mean, lumber production is going to have to continue to fall to try to match the decline in consumption in North America. So I would expect to see a further price erosion in log prices.

That's logical. Hank, given the currency moves and resulting changes in the cost structure what's your sense of the willingness for some of your US competitors to curtail operations rather than make losses?

I think certain stances are different for everybody, but first thing I'd say about the FX is it might be $0.77 or $0.78 today, but given how fast it fell, I mean, we're not certainly planning for it to be here for very long. It fell very quickly. As it relates to the US, there's some advantages that they have down there closer to market, et cetera. S, and also in a very bad market like this, the FX doesn't necessarily, I mean, prices for SPF lumber, which is what we make up in Canada, obviously, prices likely will fall to reflect the advantage that we get on the exchange rate.

Thanks for that. I'd also like to wish Martti, the best of luck in retirement. It's been a pleasure dealing with you over the years. Thank you.

Thank you.

Thank you. The following question is from Stephen Atkinson of BMO Capital markets. Please go ahead.

Good afternoon. Or good morning. In terms of capital expenditures, have you -- is there any guidance you can give us for next year?

Well, I think the advantage of having invested heavily in technology and modernization over the years gives us some breathing room. So I think that we have an opportunity to restrict our capital significantly in '09 if market conditions stay the way they are now. Our maintenance CapEx is maybe 50 million or $60 million. We can quite easily do that we think. So we basically are planning for the worst. Very low CapEx but we'll certainly be ready to spend on high payback items if we start to see some glimmer of hope out there.

There was an $18 million translation adjustment I guess relating to the US assets. Would there be a repeat in the fourth quarter?

Stephen, if, Rodger Hutchinson can make a comment on that.

Stephen, what that is, is that's the translation of our US operations self-sustaining operations so that $18 million goes directly to shareholders equity through cumulative other income, does not go through the income statement. Whether there will be a repeat or not depends on what the exchange rate is at the end of the quarter. The way we sit now there would be a large amount if the quarter was to end today at a $0.77 exchange rate. As I say, depends what the exchange rate is at the end of the quarter.

Are you able to tell us the gross amount of the US investment?

I just don't have that figure in front of me right now.

It will be identified on the balance sheet I guess?

No, it's not.

Okay. And okay. I guess I was going to ask about wood costs in the Southeast and the regions you are harvesting. I think you touched on it a bit. I was trying to get a bit of color on that.

Well, I can say I can't really add anything, Stephen. That drop is sometimes, we're in nine states down there. It's a little different by region. But in general, log costs have not come down just as they have in Canada.

So they're coming down in the fourth quarter?

No. I mean, in the fourth quarter, we don't see any particular, I don't think we see any particular further drop in Canada. It may be marginal. In the US, some of it's going to depend on the demand from the pulp mills for the small size and with pulp prices dropping off, we might see some easing up on demand down there.

Thanks a lot.

The following question is from Paul Quinn of RBC Capital Markets. Please go ahead.

Thanks. In your press release, you mentioned diversifying your lumber markets and increasing shipments to Asia. Can you quantify that, how important is that to you?

Well, we do continue to try to look for markets outside of North America and we're active and we've been active in Japan for a long time. We're working hard to open up markets in China as are our competitors and so we continue on that stream. But relative to the North American market, those are not big markets, and they're kind of incremental for us at this point in time.

So in terms of the year over year growth, shipments in Asia, how would you quantify that?

Chris, do you have any comment on that?

Hi, Paul. It's Chris. We're up in Japan. We've increased our market share there. In China we're up threefold but it's starting from a very low base so it's still not a significant number.

Just on the, in terms of plywood now that it seems like either plants are burning down or closing, you guys make up about two-thirds of Canadian capacity. I would have sort of expected prices to maintain themselves a little bit better given your position. Does that surprise you or is it just the fall-off in the Canadian market?

I think we're seeing the effects of the recession in the US and the Canadian market as well, but housing starts are down marginally in Canada, and I mean it's -- you can't really comment any more than that. The plywood market's going follow the housing market. Chris, do you want to comment on that?

Paul, I would just add that we are moving into the winter which is traditionally a very slow time for plywood and I think that's obviously affected pricing as well.

In terms of Hank, you mentioned the commodity prices offsetting the drop in the Canadian dollar. Do you see a lag there? Is that an immediate impact? Or is that a quarter lag? What do you see?

Well, again, I'd defer to Chris who deals in the market every day. It's obviously not going to be a direct correlation but Chris, I mean, can you comment on that?

Sorry, Paul. I missed the question. Could you repeat that?

Yes, sure. Just on the, Hank was mentioning the offsetting commodity price drop when you have a Canadian dollar dropping as what we're seeing in the market, just whether you're seeing a lag and how long that lag is?

Yes. We're seeing -- it's pretty directly tied. It appears to me the prices for our -- for lumber specifically Canadian lumber is dropping almost as quickly as the exchange rate is.

Great. Just last question for Martti, just knowing that you're leaving the firm at the end of the year, just wondering if you're going to be selling your West Fraser shares?

No, sir, I'm a strong believer there will be good times coming up in a few years time. So I'm going to hang on to all my holdings.

Thanks very much, sir. Pleasure doing business with you.

Thank you, Paul.

(OPERATOR INSTRUCTIONS) The following question is from David Edelstone of Equity Research. Please go ahead.

Yes, hello. I just was curious to know with the acquisition of the Stuart Lumber and the Warehouser CFL this year. Is there any more rebalancing of the B.C. interior that you foresee for your operations?

Okay, so any more rebalancing? Not quite sure I understand the question but fundamentally, I think that, our strategy is to when opportunities arise to try to solidify our timber base given the fact that there's going to be a significant annual cut downfall sometime in the future related to the Mountain Pine beetle. So the two potential acquisitions that you're talking about, Stuart Lake and (inaudible) are reflective of that effort by us. We're also, by the way, trying to sell a small timber quota as well. We're just trying to solidify the base around the operations that we see have long-term futures for us.

That just is clear. Regards to the $4 million of asset sales listed on your report, does that include the mass floor cycle that was sold?

No. It doesn't. It included some of the real estate sales we have from the time when we owned the (inaudible) building supply business and some other items. So it's a combination of a number of items.

I guess finally, just do you see with the January 1, implementation of the Russian raw log export tax, do you see any coming down the pipeline as a benefit to any of your operations in terms of pulp or lumber?

Well, I guess our sense would be that if it really comes through it's going to make it more difficult for the Europeans to access the fiber and if that happens, there could be somewhat of a shortage over there. And that can, on a global basis, it could only be of benefit it would seem to me.

Thank you.

Thank you.

Thank you. There are no further questions registered at this time.

Thank you, operator.

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

Thank you.