West Fraser Timber Co Ltd (WFG) 2010 Q1 法說會逐字稿

Good morning, ladies and gentlemen, welcome to the West Fraser Timber Co. Ltd. first-quarter 2010 results conference call. During this conference call we will be making certain statements about potential future developments. These forward-looking statements are intended to provide reasonable guidance to investors, so the accuracy of these statements depends on a number of assumptions and is 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 and uncertainties in our annual MD&A which can be accessed on our website or through SEDAR and as supplemented by our quarterly MD&A. 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.

Okay, thank you, operator, and good morning, everybody. Welcome to West Fraser's 2010 first-quarter conference call. We've posted the highlights of our first-quarter results on our website for those of you who'd like to follow along.

We've experienced quite a remarkable improvement in lumber prices since the fourth quarter of 2009. Combined with improved pulp pricing West Fraser recorded its first quarterly profit since 2008. Earnings for the quarter were CAD19.4 million or CAD0.45 a share, EBITDA was CAD103 million and our EBITDA margin was 15%. Earnings from continuing operations, which excludes the costs associated with the closure of our Eurocan operation, were CAD34 million or CAD0.79 per share.

We believe we can now see the light at the end of the tunnel in terms of the deep recession our lumber industry has suffered through since late 2006. But housing starts in the US are still near historically low levels and we believe that it will be a long and bumpy ride before new home construction returns to a level that supports the long-term demand of about 1.6 million housing units per year.

Nevertheless, after three years of industry wide downsizing, supply and demand currently appear to be in close balance. As a result our wood products business performed well during the quarter. This division produced CAD6 million of EBITDA with a margin of 16%. Lumber prices during the quarter were up 31% in both Canada and the US, as a result sales and shipments were strong. As a result of the strong lumber prices our lumber export tax will drop by 5% in May in B.C. and 7.5% in Alberta.

We operated our Canadian business at 95% of capacity during the quarter. We started up a third shift at our Hinton, Alberta sawmill in March, this startup went very well. All of our mills ran well during the quarter and our costs were down significantly. At quarter's end we were virtually at full capacity.

Our lumber inventories are in very good shape and we believe we have sufficient logs at our Canadian mills to run at full capacity through the spring break out period. Our US sawmills ran at about 55% of capacity during the quarter due to weather-related log supply issues.

Our panel division also ran well during the quarter; EBITDA was CAD11 million and our EBITDA margin was 11%. Our plywood mills operated at full capacity and plywood prices were up slightly over the fourth quarter. Our MDF business continues to operate at about 65% of capacity. Production and shipments were good at both plants but prices were somewhat lower than the fourth quarter.

Our pulp and paper division produced EBITDA of CAD39 million with an EBITDA margin of 19%. Pulp prices continue to increase and the supply/demand fundamentals are currently very good. Our kraft pulp business did not meet its production target in the quarter due to several operational problems at our Hinton pulp mill. Shipments were strong however and our overall pulp production costs were lower than the fourth quarter.

As you know, our Eurocan linerboard mill was shut down in January. We recorded a loss from discontinued operations of CAD15 million for the quarter. We expect our total closure costs for this facility not to exceed CAD65 million of which we've accrued CAD50 million to date.

West Fraser received CAD88 million of green transformation fund credits from the federal government. We've identified good payback projects for these funds and will begin some of these projects in the first half of the year. The Mountain Pine Beetle epidemic continues unabated in B.C., but through operational improvements and management focus recovery and grade outturn has remained at the same level for several years.

We expect lumber markets to remain solid for at least the next couple of months. However, we expect the improved pricing to encourage some of the curtailed capacity to come back online following the Spring breakout period. This will dampen prices as the new home construction market is still weak. But we do believe that the worst is over in our business and that we will see gradually improving price fundamentals as the housing market begins to improve later in the year.

We expect strong pulp pricing to continue at least through the third quarter reflecting strong buying from China and extremely low world pulp inventories. While it's too early to predict the end of the housing recession, our modern facilities, low cost structure and strong balance sheet will allow us to be more aggressive on capital spending this year while continuing to reduce our debt.

The past three years have been the most difficult period in memory for our industry, but I believe that West Fraser has emerged a stronger and even more competitive company than we were going into this recession. I'll now pass it over to Gerry Miller, our Executive VP and CFO.

Thanks, Hank, and good morning. Earnings from continuing operations were CAD34 million on sales of CAD688 million compared to earnings of CAD8 million on sales of CAD570 million in the fourth quarter and a loss of CAD80 million on sales of CAD558 million in the first quarter of last year.

Below operating earnings, interest expense was slightly higher in the quarter compared to the previous quarter as a result of higher borrowing costs associated with our credit facility amendment despite the fact that our total borrowings were lower in the current quarter than in the previous quarter. Compared to Q1 2009 interest expense was only slightly lower despite our lower borrowing levels and due to higher current borrowing costs.

In the current quarter we recorded an exchange gain on our long-term debt. The gain is a result of the stronger Canadian dollar and the translation effect on our US dollar denominated senior notes. In the previous quarter we also recorded a gain on the translation of the US dollar debt as the Canadian dollar strengthened. In the first quarter of last year we recorded a loss because the Canadian dollar weakened in that quarter.

Other was an expense of approximately CAD8 million in the quarter compared to income of CAD1 million in the previous quarter and income of about CAD8 million in the first quarter of last year. In the current quarter we experienced a loss on derivative financial instruments of approximately CAD4 million relating mainly to a pulp contract.

As well, we recorded a loss on the translation of our US dollar-based accounts receivable as the Canadian dollar strengthened. In the previous quarter we also recorded a loss on the translation of the US dollar accounts receivable and the pulp contract, but that was offset by a gain on US dollar foreign exchange contracts.

Other income in the first quarter of last year was mainly the result of translation of the US dollar accounts receivable with the weakening Canadian dollar in that quarter. Included in operating earnings is selling, general and administrative expenses that totaled CAD38 million. The increase from CAD28 million reported in the previous quarter and the CAD23 million recorded in the first quarter of last year relate almost entirely to equity-based long-term compensation expense of which there was two components.

The first is an expense that we must record on the increased value of stock options that are outstanding. The increased value relates directly to the increase in our share price. In the past many quarters, including the first quarter of last year, this was a negative expense as our share price declined.

The second component relates to recording an expense for share units that were granted in the quarter as part of long-term compensation. Under the accounting rules a significant expense is recorded at the time the units are granted, even though the redemption of these units is deferred for three years. As the majority of these expenses was recorded in the year -- in the quarter, sorry, the impact in the subsequent quarters will be less significant.

As previously mentioned, discounted operations relates to the Eurocan mill which was closed in January. The loss from discontinued operations includes approximately CAD6 million after tax for contract cancellation and other costs associated with the mill closure. The balance relates to the sale and delivery of linerboard and kraft paper out of inventory, as well as the ongoing costs at the site including salaries, insurance, property taxes and similar costs.

The remaining inventory in accounts receivable at March 31 totaled CAD53 million. This should be substantially liquidated by the end of the third quarter. Cash flows from operations after working capital reflects the significant improvement in earnings in the current quarter. You should note that we no longer include the cash flows from the discounted Eurocan operations in the detail of the cash flow statement.

In the quarter we prepaid the term note which was due in March; the repayment was made out of cash on hand and by accessing our credit facility. In the quarter we had capital expenditures of CAD28 million, the majority of this was for the timber we acquired from Weyerhaeuser. Overall, if you exclude the long-term debt repayment and the change in the operating loan, we generated approximately CAD40 million in net cash in the quarter.

We remain focused on our balance sheet, especially on investment and working capital. Over the past several quarters we significantly reduced our working capital and we are committed to manage our future investment in working capital aggressively. The total net debt of the Company at the end of the quarter was approximately CAD450 million, down from approximately CAD500 million at the beginning of the quarter. Of the CAD450 million, approximately CAD300 million is long-term. The debt to total cap ratio at the end of the quarter was 22%.

In our last conference call we discussed the amendment to our credit facility where we agree to provide security to our lenders. In the quarter we substantially completed that process. The agreement with our banks is that security will fall away as we regain our investment grade rating. With that, Hank, I'll turn it back to you.

Okay, thanks, Gerry. I just want to close by saying that as North America's largest lumber producer, with among the most modern and efficient plants in the industry, we look forward with confidence to fully participating in what will eventually be a very strong up cycle for our business. With that, operator, I'll turn it back to you for questions.

(Operator Instructions). Pierre Lacroix, Desjardins Securities.

Thank you very much. Just one quick here, it's about your hedging strategy given the fact that you may expect the second half of the year to be under pressure on the lumber side. Are you active in the future market right now?

Yes, we are active in the futures market now and we have been for some period of time. It's not a significant portion of our sales, but we do participate in it.

In terms of the percentage of your total sales, can you give us somewhat of a proportion in which you are involved right now? And what is the normal proportion give or take? Is it between 5% and 10% of your volumes and are you at 10% or is it something like that?

No, no, it would be under 5%; it's minimal.

Minimal, okay. Thank you very much.

Paul Quinn, RBC Capital Markets.

Hey, guys, thanks very much. I had a couple questions on just overall market supply and demand, especially in lumber and panels. Just on the supply side it looks like -- I understand your US operations were running 50% capacity in the quarter. What's the expectation going forward here?

Well, they're running at 55% in the quarter, Paul. And the expectation is as logs start coming in we're going to ramp up as much as we can. But we still will be running some of the mills at -- on 50- or 60-hour work weeks until we see that this lumber pricing is fully entrenched and that we can continue to buy logs at a reasonable price. So, we'll go substantially above 55%, but it will be a little while before we get to 100 I think.

Okay. So in terms of shoving the yellow pine prices which we saw up significantly over the quarter, a lot of that's due to the curtailments that you and everybody else took?

Yes, we anticipate that a lot of the operators down there were having the same log supply problems as we were. So I think that played a big factor in supporting prices.

Okay. So for modeling purposes should we think like 70% or 65% for Q2 and then sort of holding at that level going forward?

Yes, I think 70% would be a good number.

Okay, great. And then just on the demand side, what's your expectation of the US home buying program? Has that been a big factor in the marketplace for a recovery in the US housing market?

Well, I mean, all I know is what I read in the papers and they say it has been. I wouldn't be qualified to say that. But all I know is we've had a pretty significant price spike this quarter. So probably had something to do with it.

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

Thank you.

Alex Ovshey, Goldman Sachs.

Good morning and thanks for taking my question. Just several housekeeping questions. Can you just help us with guidance on how to think about amortization expense and capital expenditure for 2010? Is the first quarter a good run rate to use?

Yes, I think so, yes.

Okay, so then amortization of about CAD200 million?

Thereabouts.

And then in the lumber segment, I think in the press release it said that the business benefited from a CAD10 million log and lumber inventory valuation adjustment. Just help us understand how to think about that number going forward. What would be the drivers that may change that up or down in the second quarter?

Well, I think the majority of our inventory now is at cost, so I wouldn't expect there would be much of a change other than if market should substantially decline.

Okay, helpful. And just on the pulp markets, can you just talk to how you see your order book in China? Especially in the context of the recent March data where volume shipments to China were down 48% year-over-year albeit against tough comp. How do see your order book in China today?

I'll ask Ted Seraphim to answer that, he's our VP of Pulp.

Yes, I think when you look at the order book going forward; first of all, inventory levels worldwide are extremely low. I think when you look at what happened in China in the first quarter, shipments were down. But I think that's a combination of two factors. We believe China went into the year with higher than normal inventories. And then with the situation in Chile and just an overall tightness in the market the allocation of volume to that market was reduced as well.

So, as we look at China going forward for the next quarter or so we expect demand there to be relatively strong, they're going to need to rebuild their inventory. So we're pretty confident as we look at the next three to six months. And I think the inventories speak for themselves in terms of what the order books look like. I think you'll see continued full order books for the next little while.

So, would it be fair to say you'd probably see some sequential recovery off of the March number or --?

Yes, we should, but I think that's -- it's just a forecast.

Helpful. And just one last question on lumber. Can you just remind us what the capacity profile for lumber in Canada and the US is?

Overall capacity is 5.5 billion feet, 3.5 billion feet in Canada.

Okay, great. Thank you very much.

Thank you.

Bill Hoffmann, RBC Capital Markets.

Good, thank you, good morning. Gerry, just wonder if you could talk a little bit about this CAD88 million of green transformation funds and also maybe what your overall capital spending targets are going to look like this year?

The CAD88 million green transformation, of course that needs to be spent by the end of March 2012. And we have projects in the Q4 for that at various levels of approval and we're proceeding on that. As far as our other capital, I think we're kind of in the range of CAD90 million to CAD100 million overall and we were CAD28 million in the first quarter. So the remainder as we see it today would be for the balance of the year.

Does that CAD90 million to CAD100 million include any of this green transformation funding as well?

No.

Okay, so that would all be on top. And then for those kinds of projects, do you have to submit your expenses as you go through the projects, how does that work?

I think the process is that we have to get approval from NRCan initially. And then we as we spend we submit and we get reimbursed in the following month or couple of months after the expenditures or after we spend the money.

Okay, thanks. And then just a final question. One of the things you mentioned was just because of wet weather in the South, is trying to rebuild log inventories down there now that things have started to dry out a little bit. Can you just talk about working capital cash uses to rebuild that inventory down there?

Well, I don't think that -- the inventory levels in the US are not like they are in Canada at this time of year. So, I don't expect that there's going to be -- we'll have to invest some working capital, but I don't expect it to be too, too large.

Okay, thank you.

Sean Steuart, TD Newcrest.

Thank you. Good morning, guys. A couple of questions. You've got a bit of pulp downtime planned for the second quarter on the maintenance side. Just wondering if there is any thought to potentially deferring some of that downtime to Q3 maybe to just take advantage of the better pricing through the second quarter. Is that possible at this stage or are we too far along in terms of that downtime schedule?

Sean, no, we're too far along. So we're going to take the downtime in the two kraft pulp mills this quarter and we just -- and we have taken a little bit of downtime at our -- one of our mechanical pulp mills in April. So that will all be -- we'll get that all out of the way this quarter.

Okay. And then a follow-up question on the US South Mills, I guess a lot of the downtime was related to the wet weather and just not being able to get the logs. But we also heard some anecdotal reports of transportation issues as well. Was that something that hindered the operating rates at all this quarter or was it more just the wet weather?

It didn't hinder the -- there are some transportation issues down there, but it has not hindered our operating rates.

Or your ability to ship it I guess at the end of the day.

You've got to work really hard to get it shipped, but we are getting it shipped.

And, Gerry, can you comment to the relative margin differential between the US sawmills and Canada this quarter?

No, I don't know -- that's not something we disclose, Sean.

I thought I'd try. Okay, thanks, guys.

Teresa Lee, Sionna Investment Managers.

Can you remind me what the marginal cost of lumber is and the breakeven for the industry?

It's Gerry. I don't know that we know what the breakeven is for the industry. And --

Or maybe just I guess what the marginal cost for lumber for the industry would be?

No, don't -- don't know. I think people are operating at all kinds of different rates, so I'm sure that things are not that normal at this point. So wouldn't know.

Do have a sense of how much new capacity would be expected to restart given the stronger lumber prices?

That's another hard one. It's a matter of whether you can get logs and what the price is and whether you have a crew to come in and operate your mill. So again, I think it's one that there's no answer to; we just don't know.

Okay. And longer-term, where should CapEx be for -- I know your CapEx is lower than normal because of the downturn. But where would CapEx be in the long term?

We've traditionally kind of been CAD150 million, maybe a little higher. As a company we're fairly aggressive on capital spending when our cash flow is good because there are always lots of projects to do in this business and we like to be on top -- get out front and do them.

Okay. And just one final. I just want to circle back on the hedging question. You said you were under 5% hedged. What is the actual corporate hedging policy?

Well, we have several relating to it, whether it's product or whether it's FX or natural gas for that matter. But we really don't -- we don't participate in hedging in any large way in any of those areas. We've always taken the approach that we'll go with the market. So it really is not a very large exposure.

Okay, great. Thank you very much.

Thank you.

Daryl Swetlishoff, Raymond James.

Thanks. Good morning, guys. Just one question. Hank, can you tell me what West Fraser saw in the fall that gave you the confidence to go out and build the logging inventories necessary to run at the kind of operating rates that you did in Canada in the first quarter?

Well, we start -- you have to make your commitment on your log inventory really in December. And we looked at our -- we looked at our operating returns and so forth and we just felt that we had a good opportunity to make a margin in the spring and if you don't make that decision in December you're hooped. And so that's what we did. And I think it's turned out to be a very good decision.

No question. Oh, maybe one more question. On the shipments to China, Gerry, what was the percent you guys shipped to China with respect to your offshore shipments this period?

This is Chris McIver who runs our sales.

Yes, it would be about 5%, probably about 5% for the first quarter.

And percent total offshore would have been?

About double that.

About double that. And would that have changed from last year this time much?

Yes, we were up in the first quarter to China, but not our other offshore.

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

Richard Skidmore, Goldman Sachs.

Good morning, Hank. Just a couple of follow-up questions; first on the pulp downtime. Ted, if you could maybe quantify how many tonnes you'd expect to take down in the second quarter?

Yes, I think about 15,000 tonnes on the NBSK side and about 20,000 tonnes on the BCTMP side.

And then maybe bigger picture, Hank, is -- for Hank and Gerry, as you look at your balance sheet and strategy coming out of the trough perhaps of the housing cycle, although it might be a slow recovery, lumber prices are up. Hank, how are you thinking about strategically the opportunities in front of West Fraser and your balance sheet and how you deploy capital as you go forward over the next year or two?

Well, I think for the first time in our history we have really had to substantially scale back our capital spending. We've never really had to do that in recessions before; that just shows you the depth of this particular really depression in our industry. So we've just got a lot of stuff that has high payback projects that we should have been doing throughout this recession, but we were focused on our balance sheet.

So, we've got a good strong balance sheet now, I think we've really got our feet under ourselves. So, we've got a long list of stuff we're going to do internally in this company to really position us both in Canada, but more importantly in the US to really get those plants in first-class shape. In Canada we're in pretty damn good shape right now. But there's always stuff to do and we're going to be doing it.

And, Hank, when you look at ROIs on those types of investments, how would you quantify the range that you would see in those projects? Is it high teens? Is it a 20% to 30% kind of percent ROI on those investments?

Yes, we've got some -- yes, 20% to 30%.

Okay, great. Thank you.

Chris Damas, BCMI Research.

Yes, I had a couple of questions on the surge penalty on US exports. In 2010 were Alberta producers, including yourself, triggering the surge? And secondly, why do you do that? Is it because the 7.5% more is the cost of business? And thirdly, if the export tax goes to zero does that mean the surge disappears, the surge tax penalty?

Well, 2010 -- we operate -- yes, if you can make more money in surge than by curtailing, then you would do that, that's the cost of doing business for sure. And if the export tax goes to zero then you don't go into surge.

There's no more surge?

No.

Great. And just one last one. Could you comment? There's a Swedish paper union strike, it's kind shutting down a couple of mills in Europe. Does that affect you guys? And when is Hinton going to get rid of its problems?

Well, on the first question, I think when you have an extremely tight market like you do, any disruption has some impact. So for sure it has some impact. Hinton has made substantial progress over the last two or three years; we've spent a fair bit of money restructuring that facility. We've got a really good management team there. We had a couple of extraordinary boiler-related issues there, but I think fundamentally that plant is steadily moving into steady-state good operation.

Does it ship to Europe?

Some.

Okay, great. Thank you very much, gentlemen. Great quarter.

Thanks.

(Operator Instructions). Lidio Mancuso, Equilibrium Capital.

Hi, good morning. Just a couple of areas here. Hank, you talked about logs having been in short supply this winter in the US. How did that affect log costs down there?

Log costs have been pretty good down there. Let me give you a little color on that -- Wayne Clogg who runs that area.

As somebody mentioned earlier, there was severe weather, one of the worst in memory for our guys down there, continuous rain. And that affected log supplies across the South and it affected log supplies for every sector. And with low lumber prices until recently, ourselves -- all we could do is hold our price. And if we weren't able to get the logs we needed then that was the end result.

The paper mills have a much higher cost of shutdown, so they were just about prepared to pay what it took to get the fiber to run their plants and that was difficult for us to compete with. So it was a tough winter and inventories are still kind of recovering now as the weather has improved.

Okay. So that's -- so going forward, as things open up there, do you expect your log costs down there to be any different going forward say into the second and third quarters?

Well, there is upward pressure. I mean a number of the land owners just simply withheld their wood from the market when log prices were very low. So, we expect upward pressure on prices. But as the paper mills have been able to replenish their inventories, we believe that that will moderate the upward pressure on log prices. So, I don't know if that's helpful.

Can you quantify what that upward pressure might be?

No, it's really difficult to tell; it's very regional and we really haven't -- because of the weather and because of the shortage of logs, we really haven't been able to see what prices will do in a more balanced market between supply and demand. So I think we're just going to have to see what happens in the summer. But we are seeing landowners more interested in bringing wood forward and putting it on the market. And there's still a fair amount of capacity that's been closed down there. And that reduces the amount of demand. So we've just got to see how it balances out.

Okay. And what about in Canada, the log costs in Canada? How are those going to -- with lumber prices up here, how are those going to be affected going forward?

Well, I think this has been such an extraordinary downturn, as Hank said, Canadian producers have driven their log costs to very low levels by reducing the business that they're hauling, deferring costs where they can, all of those kinds of things. So there will be upward pressure as well in Canada if the recovery is sustained. But certainly we will be doing everything we can to hold the line on cost increases. Stumpage in Canada, both in Alberta and B.C., is tied to lumber prices. So eventually higher lumber prices will translate into increases in stumpage.

Right. And is that like a fourth-quarter phenomenon or is that even a 2011 impact?

Well, each province has a different formula. In B.C. the lumber price is about a five-month lag to where it's reflected in stumpage. So we would see, for instance, the July stumpage reflect lumber prices in February, March, April. That being said, there are some changes being proposed by the B.C. government in July and it's early in the game to forecast what -- how that's going to translate.

Okay. And, Gerry, just a question on this -- you talked about this reforestation liability. You had mentioned that in the fourth quarter as well. And it's not clear where that reforestation benefit accrued to. Was it in the panels or was it on the lumber side?

This was last year, so third and fourth quarter. And it would have been mostly to lumber, it was a little bit in the panels but mostly lumber.

So when you say that for your panel segment in the first quarter you had an adjustment to reforestation liability in the fourth quarter, how much of that benefit -- what was that benefit in dollars in the first quarter for panels?

There was no benefit in the first quarter; the benefit was in the fourth quarter. Because what we did was we went through our annual look at the liability and we made the adjustments -- they were last year.

Yes, and how much was that in the fourth quarter, what was that benefit in the fourth quarter?

In panels?

In panels, yes.

I think it was a couple million dollars.

A couple million. And so was there a benefit -- and there was a benefit on the lumber side as well. How much was that?

I think it was -- I'd have to go back and look, but I think it was around CAD15 million.

CAD15 million on the lumber side.

Something like that. Yes.

So the lumber segment benefited not only from the CAD10 million that related to inventory valuation adjustments, but also that CAD15 odd million that related to -- that related to the reforestation liability in the fourth quarter in lumber.

Last year, yes, yes. It would have -- yes, we reduced the accrual last year and it was a benefit last year.

Right. Yes, okay. Okay, that's fine.

Great, thanks.

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

Okay, Operator, thank you very much. And thank you for joining our conference call. And we'll talk to you in the second quarter. Thank you, bye.

Thank you, gentlemen. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.