West Fraser Timber Co Ltd (WFG) 2010 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. second-quarter 2010 results conference call.

During this conference we will be making certain statements about potential future developments. These forward-looking statements are intended 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.

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 risks and uncertainties 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, Chairman, President and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Thank you, operator. Good morning and thanks for joining us. Welcome to West Fraser's second-quarter conference call.

Gerry Miller, our Executive VP and CFO, and I will go over our second-quarter results. We also have certain members of our senior management team joining us on the call this morning. We have posted a summary of our Q2 highlights and financial results to our website which you can access at your convenience.

Earnings for the second quarter were CAD63 million compared to CAD20 million in the first quarter of 2010 and a loss of CAD39 million in the second quarter of 2009. EBITDA was CAD151 million which resulted in a 20% EBITDA margin. All segments contributed to our earnings in the quarter.

The significant improvement in our results can primarily be attributed to relatively strong pricing for virtually all of our products in the first half of the year. In addition, we ran our Canadian sawmills at 98% of capacity throughout the first half of the year allowing us to benefit fully from the short but strong rally in lumber prices in the past two quarters.

As a result of our strong cash flow in the quarter totaling CAD207 million, we were able to significantly reduce our net debt, renew our capital spending program, and pay our regular quarterly dividend. West Fraser is the only publicly traded Canadian forest products company that has paid consecutive quarterly dividends since we went public in 1986.

Our lumber operations performed well during the quarter. Lumber production at our Canadian mills was up 4% versus Q1. Production at our US division improved by 32% versus the first quarter due to drier weather which improved log availability throughout our operating areas. This division ran at about 75% of capacity in the quarter.

Our lumber division EBITDA was CAD75 million compared with CAD66 million in Q1. Our EBITDA margin was 16%. SPF lumber prices were actually down 2% in the second quarter versus Q1 but up 52% versus the same quarter in 2009. Southern yellow pine prices were up 17% in the quarter versus Q1 and up 53% versus Q2 2009.

Even with sharply declining lumber prices towards the end of the quarter, we were still able to maintain our inventories close to our desired levels. As a result of relatively high lumber prices in Q1 and early Q2, the BC lumber export tax rate declined to 10% in May and to 0% in June versus 15% for the first four months of the year. In Alberta the tax dropped from 22.5% in April to 15% in May and 0% in June.

Lumber shipments from our Canadian mills to China increased by 31% versus last quarter. In the second quarter we shipped 18% of our Canadian lumber offshore, primarily to Japan and China. This compares to 15% in Q1 and 12% in Q2 2009.

The mountain pine beetle continues to be a very serious issue for our industry in the interior of BC. The quality of timber continues to decline which has an effect on both grade out turn and lumber recovery.

The beetle has established itself in certain parts of Alberta as well. Industry and the provincial government are working together to aggressively fight the spread of the attack in that province. It's too early to predict whether our efforts to retard the spread of the beetle in Alberta will be successful.

Our panel operations also ran well in the quarter. EBITDA for this division was CAD20 million and the EBITDA margin was 19% versus 11% in the previous quarter. Plywood production was up 8% in the quarter and prices increased 14%.

We experienced a fairly serious fire at one of our MDF mills in the quarter which resulted in 23 days of downtime at that facility. As a result MDF production was down by 2% for the quarter. MDF prices were up by 13% in the quarter.

In our pulp and paper division EBITDA was CAD49 million versus CAD40 million in the first quarter. Our EBITDA margin was 22% versus 19% in Q1. Pulp production was down 9% in the quarter. We lost 36,000 tonnes of production due to regularly scheduled maintenance downtime at three of our pulp mills. Benchmark pulp prices were up 13% in the quarter and 54% versus Q2 2009.

As we have reported previously, we have been awarded CAD88 million of green transformation fund credits. We have approved certain high-payback projects for these funds and will approve good-payback projects for the remainder of these funds in the coming months.

Our Eurocan linerboard and kraft paper mill were closed in the first quarter of the year. We are in the process of disposing of the assets and cleaning up the site. The major expenses for this operation are behind us.

Lumber prices have declined sharply from the levels achieved in the second quarter. Housing starts are still at very depressed levels and the inventory of unsold homes in the US is very high. Until the housing inventories work down to more normal levels we should not expect a sustained improvement in lumber prices.

Chinese pulp demand is weakening and this will cause pulp prices to be under pressure in the third quarter. Worldwide pulp inventories are still quite low so if the world economy continues to improve we could see renewed strength in pulp pricing in the not-too-distant future.

Now I will turn things over to Gerry Miller to discuss our financial results.

Thanks, Hank, and good morning. I will refer firstly to the earnings statement. Sales increased 12% from the previous quarter with sales in each of the three segments recording increases as a result of higher prices and increased shipment volumes.

Selling, general, and administrative expense was CAD17 million in the quarter compared with CAD38 million in the previous quarter and CAD28 million or CAD24 million in the second quarter last year. The reason for the large swing is mainly related to our equity-based compensation plans which, as a result of changes in our share price quarter to quarter, resulted in a large recovery this quarter compared to a large charge in the previous quarter.

We incurred an exchange loss on long-term debt which results from the translation of our $300 million US-denominated debt being translated at a lower valued Canadian dollar at the end of the current quarter compared to the beginning of the quarter.

The majority of other income in the quarter relates to a foreign exchange gain on accounts receivable. In the previous quarter we had a CAD4 million foreign exchange loss on accounts receivable as well as a loss on a pulp hedge contract. In Q2 last year the loss was mostly foreign exchange on accounts receivable.

Discontinued operations relates to the closure of the Eurocan linerboard and kraft paper mill. Earnings from discontinued operations in the quarter relate mostly to the sale of inventories with some minor adjustments to the shutdown costs.

At the end of the quarter we had sold the majority of our finished product Inventory; what we have left almost all is held for customers who have made commitments to purchase. This should all be liquidated in the third quarter.

As far as the closure costs are concerned, we are not seeing anything at this time that would result in an increase in our previously estimated closure costs. We are in the process of negotiating the sale of selected assets and we expect that we will make progress on these asset sales in the next couple of quarters.

I will turn now to cash flow. Cash flow from operations was CAD213 million, including CAD83 million from working capital which was largely the drawdown of our breakup log inventories. Cash flow in the quarter allowed us to repay essentially all of our operating loans.

Capital spending was CAD5.5 million in the quarter. You will recall that we received CAD88 million in credits under the Green Transformation Program as Hank said. These credits can be used to fund qualifying capital projects in our pulp and paper mills.

To the end of the quarter we have two projects which have been approved by Natural Resources Canada and we have two that are in the approval process. A significant portion of our capital spending in our pulp and paper segment this year and next will be funded from this program.

Cash from discontinued operations relates mainly to recovering the working capital accounts receivable inventories that was invested in the Eurocan linerboard and kraft paper business. Overall, after dividends and capital spending we generated about CAD207 million from continuing operations and an additional CAD25 million from discontinued operations for a total of approximately CAD230 million in the quarter.

At the end of June our net total debt was approximately CAD235 million resulting in a debt-to-capital ratio of about 12%. The next significant debt maturity is 2014. At the end of the quarter our available liquidity was CAD690 million.

With that, Hank, I will turn it back to you.

Okay, thank you. I think we are now ready for questions, operator. So I will turn it over to you.

(Operator Instructions) Richard Skidmore, Goldman Sachs.

Good morning, Hank and Gerry. Can you -- maybe, Gerry, just a couple of quick questions. The tax impact on the translation of long-term debt, is that done at a zero tax rate? Just trying to get an after-tax number.

It's about 14% we use for that calculation.

Okay, great. And maybe Hank can you just give us an update on what you are seeing currently or maybe Ted is there to give us an update on what he is seeing currently in the pulp markets and how you think the pace of the price decline might evolve in the third quarter?

Okay. I will let Ted, who runs our pulp division, answer that, Richard.

Well, I think the overall situation is still fairly tight when you look at world inventories. At the end of May they were 27 days and [soft it was] 22 days, but primarily in China there has been a significant slowdown in buying. And I think for certain grades and companies that are significantly focused on that market they are under more pressure than those that are selling their products on a global basis.

So I think globally we are still seeing fairly balanced markets but prices are going to decline. In terms of the rate of decline, it's not something I would really like to comment on it at this point because it's -- we are taking it one month at a time really.

And maybe, Ted, on the Chinese are you seeing them with -- do you have any visibility on the end-market inventories or inventories in the channel to kind of give any indication of how long the buyers' strike might last there?

Well, I think just to provide some perspective purchases of pulp in China are down this year. They are probably down 25% if you look at all grades. So that I think gives you a pretty strong indication that inventories are rather low in China.

So I think we should anticipate that they will be coming back to the market within a few months, that would be my expectations. I can't expect that they will stay out of the market for too long.

Okay. And then maybe just, Hank, shifting back to the lumber business for a few minutes. How do you see the lumber business in the third quarter given the pullback in pricing? Are you still generating cash in the lumber business at current prices and volumes?

Yes, but we do believe that, as I said, there is no fundamental reason to believe that there is going to be any strength in the market in the next little while for sure.

Great, thank you.

Paul Quinn, RBC Capital Markets.

Thanks. Good morning. Actually a pretty strong quarter; it's surprising so congratulations on that. Just a question on grade mix in offshore markets, is that primarily low grade for you guys or can you give us a rough percentage breakdown?

It's primarily low grade, yes. Well, sorry, it's primarily low grade in China. In Japan it's high grade.

So just focusing on China, are we talking like 80% low grade, 20% two and better?

That would be a good mix, maybe even higher.

Okay. And then if you could, you mentioned the Green Transformation Program, two approved projects. What are they and can you give us sort of a dollar amount? And what are the two in process, just so we have some background on that?

Well, I don't want to get -- we have got CAD88 million to spend; we will spend it. And so when you look at our capital program, we are going to spend -- we have got a balance sheet that will allow us to spend a good amount of capital this year and next. And that is -- so you add CAD88 million to that so we have got a pretty strong capital program going forward.

In our pulp division it's going to be primarily spent in our two kraft mills and some in our mechanical mill. In our mechanical mills they are going to be relatively high payback items and we have got three approved.

We have got two approved and the paybacks are, as Hank said, very good. Sorry.

So maybe you could -- what areas of the pulp mill are you focusing on, is that energy or is that environment?

They are mostly -- Paul, this is Gerry. They are mostly energy projects.

Okay, that is all I had. Thanks, guys.

Thank you.

(Operator Instructions) Pierre Lacroix, Desjardins Securities.

Thanks. Just wanted to add some clarity on the inventory level that we had at the end of the quarter at CAD235 million and that level is pretty much the lowest level of the last several years which had an impact, obviously, on the working capital [ratio].

What do you see in terms of the level going forward for that? And by the same token you can maybe comment on the direction of the working cap for the rest of the year. And is there any relation with the Eurocan being closed and that inventory no longer being on the balance sheet?

Pierre, this is Gerry. You are right; the inventory levels are rather low. Part of that is the fact that we have shut down Eurocan and liquidated inventories. That is part of it and of course, too, we have been focused over the last -- very focused over the last many quarters on working capital.

So with -- as far as what the working capital levels are going forward it's going to depend largely on how we are operating and what the cost of getting inventory in it is. But we are intent on keeping it -- our investment in working capital as low as we can.

I see. Do you have any target there in terms of total working cap versus sales or something like that?

No.

No? Okay. Thank you very much.

Daryl Swetlishoff, Raymond James.

Good morning, guys. These questions probably are more for Wayne, Hank, but on the beetle you made some comments. Recently I have heard the Ministry of Forest a couple of times talk about shelf life and some of the recent work they have done where they think the shelf life could be longer, perhaps as long as an average of 12 years, and that the infestation on the mature pine is less than they originally expected.

Do you have any -- what is West Fraser's view on this?

Daryl, Wayne is not on the call so you are going to have to listen to me. But throughout the region you can see different -- shelf life is going to depend on primarily on lumber price because we are seeing serious deterioration, some more -- worse in some areas than others. But grade percent is declining, LRF is declining, productivity is declining, so what keeps you in the game in these logs is lumber price.

I don't think I could predict the shelf life really, but we are dealing with some pretty old wood right now in our mills. It is having a significant impact throughout the organization.

Just with the -- I was up north recently and I was taken with how dry it is. On the lands that you operate what is your sense of the condition of the forest, especially with respect to as we enter the fire season?

Yes, I know it's very dry. It's very dry up there and we have been very lucky up to this point in time not to have any serious problems. I think again, like every year, hopefully we will get some rain one of these days.

Okay. Okay, thanks, Hank.

Jonathan Lethbridge, CIBC.

Good morning. I was just wondering if you could provide some color on the pricing dynamics affecting the spread between southern yellow pine and SPF.

Well, I guess the only anomaly -- like there is kind of a regular price difference which relates to freight and so forth. But the anomaly in the second quarter basically was that there had been a serious shortage of timber availability to our mills in the US South kind of in the first quarter. And that related primarily to very, historically wet weather down there; just couldn't get into the bush.

Also the pulp mills were stocking up on logs because they also were short, so they were buying saw logs in many cases that would normally come to us. So there was a significant shortage, lots of mill down time and so, there was a southern yellow pine price spike in the second quarter just to reflect that shortage. But that has come back into line now.

Okay. So there is no -- there is still -- there is no changes in terms of substitutability between them?

No, not really.

Okay. The other question I had was just on the pulp side and what you were seeing in terms of pressure on the BCTMP pulp.

Well, we are seeing pressure on BCTMP pulp because there is significant -- because there is pressure on hardwood kraft. So there is real pressure on BCTMP prices right now.

Okay, thank you.

Sean Steuart, TD Newcrest.

Good morning, guys. Just one question. Hank, wondering if you can speak to the margin differential in terms of profitability on the lumber you are shipping to China versus what you are getting in the typical North American market.

I think the margin would be very similar.

Okay. As you said, it's primarily low grade stuff so you are still getting good margins on that?

Yes. Well, when you say we are -- we got reasonably good margins in the second quarter. It was a little different in the third quarter.

Okay, that is all I had. Thanks.

Richard Skidmore, Goldman Sachs.

Hank, if we could just maybe spend a little bit of time on the lumber business for a second. How do you see the mix of your business as you go forward over the next one to two years with regards to how much comes out of the US South and how much comes out of Western Canada given the pine beetle situation?

Well, at full capacity I guess the only way I can answer that is at full capacity we are about 2 billion feet in the US and 3 billion feet in Canada. So we would expect that to be the mix.

So as you go forward over the next couple of years you wouldn't expect that the beetle kill would -- reduces your capacity in Canada over the next couple of years? You will be able to run pretty full up there, again assuming that demand is there?

Yes, I mean -- yes, whatever fall down you get you try to make up with throughput. So currently that is what our plan would be, yes.

And then just, maybe just asking a follow-up to that is as you think about the margin, the profitability differential between Western Canada and the US South and the declining productivity in Western Canada, do you see those crossing over at some point where the US becomes more profitable on a per unit basis as you go forward? And are you close to that level such that you would be ramping up production in the US South relative to Western Canada?

Well, let me just put it this way. The mountain pine beetle is affecting productivity but we are improving our productivity because we are making capital investments and every year trying to offset the effect. So I think that we are still doing a pretty good job in Canada.

Our job in the US is to -- I mean we have quite a few assets there that we have not modernized yet so we are going to be spending capital there to improve productivity there as well too. But I -- Canada is still a good business for us and our job is to really start to improve our US operations, many of which have not had capital spend on them for quite some time.

Lastly, does that capital spend in the US South -- as you look out over the next couple of years do you have visibility on when that starts to take place or is it more a function of your profitability or is it a function of the demand coming back in the US?

With respect to when do we spend the capital?

Correct.

We will start spending capital in the second half of this year, but we will -- I mean we are not out of the woods yet in terms of this recession in our industry. And so we are going to be very careful to make sure we have a strong balance sheet but at the same time we will be spending whatever capital we can while maintaining a strong balance sheet.

Thank you, Hank.

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

Thank you, operator. Again, I have nothing further to add so thank you very much for joining us. We will talk to you in a quarter. Bye.

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