West Fraser Timber Co Ltd (WFG) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Company Limited third-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, 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 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, operator. Good morning and welcome to West Fraser's third-quarter conference call. Joining me today is Gerry Miller, our Executive Vice President, Finance and CFO and several members of our senior management team.

We have posted a summary of this presentation on our website at www.WestFraser.com for those of you who would like to follow along on that.

Yesterday, we reported third-quarter net earnings after discontinued operations of CAD45 million compared to CAD63 million in the previous quarter. The lower earnings in the third quarter reflect significantly lower prices for lumber and plywood compared with the second quarter.

EBITDA during the quarter was CAD109 million and cash provided from operations was CAD116 million. As a result of our strong cash generation of CAD410 million through the first three quarters of the year, we ended the quarter with a net debt to capital ratio of just 6%.

Our strong balance sheet and cash generation has allowed us to pay down our operating line, commit to a more normalized capital program for the next 12 months of at least CAD150 million in our Wood Products division and double our quarterly cash dividend from CAD0.03 to CAD0.06. Gerry will more fully discuss the financial position of the Company in a few minutes.

Before that, I would like to make a few comments on the Company's Wood Products and Pulp and Paper divisions. Starting with Wood Products, our Lumber division produced EBITDA of CAD49 million in the quarter compared to CAD75 million in the second quarter. The reduction in EBITDA is primarily due to a 16% decline in SPF lumber prices versus the second quarter and a 34% decline in southern yellow pine prices. As a result of the more precipitous drop in southern yellow pine prices, are US Lumber division was a significant drag on earnings in the quarter.

Our Canadian Lumber division operated virtually full capacity while our US operation operated 75% of capacity reflecting the higher cost structure in several of our mills and the collapse of southern yellow pine pricing, particularly for wide widths in the quarter.

In Canada, our well-capitalized and efficient mills performed well. In addition, we benefited from strong exports to Japan and China during the quarter. Shipments to China have been particularly strong and have supported stronger SPF pricing in the North American market.

The beetle epidemic in the interior of BC has pretty much run its course. Most of the mature pine in the central interior is dead or dying. In those mills in which we are processing predominantly dead pine, our lumber recovery, productivity and grade outturn continued to suffer. Our mill personnel have done a fantastic job of adapting to the decline in wood quality through equipment modification and improved processing techniques.

Cold weather in parts of Alberta last winter has temporarily retarded beetle activity in some of our operating areas giving industry and the provincial government more time to attack the affected areas. Subsequent to the end of the quarter, the US government requested consultations with Canada relating to stumpage [charts] for beetle-killed timber in the BC interior. If the dispute is not resolved through consultations, either side may require that the dispute be referred to arbitration.

Last week, we reached agreement with the United Steelworkers of Canada on a new four-year contract covering most of our unionized mills in BC. The ratification process is currently underway.

Our Panel division performed well in the third quarter, producing EBITDA of CAD20 million and an EBITDA margin of 18%. Our plywood mills operated at full capacity. Plywood prices declined significantly towards the end of the quarter as US producers shipped more heavily into the Canadian market due to the continuing weakness in the US housing market and the strengthening Canadian dollar. Our MDF and LVL operations continued operating on a reduced basis reflecting the significant oversupply in these markets.

Our Pulp and Paper division operated at full capacity during the quarter and benefited from continuing strong pricing for BCTMP and NBSK. We built some excess pulp inventory early in the quarter due to reduced purchases from China, but sales volumes have improved recently and we anticipate bringing our inventories into line in the coming weeks. Global pulp inventories are in good shape and while prices have declined recently, we expect them to stay reasonably strong in the coming months.

Most of the closure costs of our Eurocan operation are now behind us. We are in the process of selling whatever equipment we can and should sell all remaining product inventory by the end of the year.

Looking forward, we believe Wood Products markets will remain depressed for the foreseeable future due to the overbuilt housing market in the US. However, the growing strength of the Chinese market, combined with our low cost structure and our commitment to invest significant capital in our facilities in the coming months, will, we believe, allow us to outperform the industry.

In addition, the continuing strength of the pulp markets and the improving cost structure of our kraft pulp mills will drive further earnings improvements in this division. Now I will turn it over to Gerry to discuss our financial position.

Thanks, Hank and good morning, everyone. For the quarter, we earned CAD45 million after discontinued operations on sales of CAD707 million. EBITDA in the quarter was CAD109 million, representing an EBITDA margin of 15%. Sales, EBITDA and earnings were lower in the quarter compared to the second quarter, mainly the result of lower prices for both SPF and southern yellow pine lumber.

Our EBITDA and EBITDA margins this quarter compared to the previous quarter were lower in the Lumber segment, similar in our Panel segment and higher in our Pulp and Paper segment. Our lower consolidated EBITDA and earnings compared to the second quarter are partially the result of higher selling, general and administrative expenses, which relate mostly to an increase in share-based compensation costs.

The change in share-based compensation costs was $18 million in the quarter compared to the previous quarter, an expense of CAD8 million in the third quarter and a recovery of CAD10 million in the second quarter. The higher expense in the current quarter relates to an increase in our share price, which closed the quarter up 15% from the beginning of the quarter.

Interest expense was slightly lower from the previous quarter as average debt levels were lower in Q3 than in Q2. Also, one of our three rating agencies, Standard & Poor's, increased its debt rating to BB+ in September. This rating increase only marginally reduced our interest expense in Q3 as the rating change was made late in the quarter. The change will reduce the future borrowing rates and standby charges on our operating line.

In the quarter, we recorded a foreign exchange gain on our long-term debt of CAD11 million. The gain is the result of the strengthening of the Canadian dollar by nearly CAD0.035 from the beginning of the quarter to the end of the quarter and the translation effect on our US-denominated $300 million debt.

The income tax rate in the current quarter was slightly higher than in the previous quarter, mostly due to the earnings mix across the various jurisdictions in which we operate. The resulting diluted earnings per share after discontinued operations was CAD1.04 in the quarter compared to CAD1.46 in the second quarter. Diluted earnings per share for the three quarters of the year was CAD2.95.

Our earnings from continuing operations resulted in a positive cash flow from operations of CAD79 million in the quarter, down from CAD130 million last quarter. Working capital was reduced in the quarter providing cash of CAD38 million.

Maintaining optimal working capital levels remains a key focus across our Company. In the quarter, we increased our dividend to CAD2.5 million per quarter. In the current quarter, we invested CAD10 million in property, plant and equipment. This compares to about CAD6 million in capital investment in the second quarter. In September, we announced an additional capital that will be directed to strategic profit improvement projects in our lumber business over the next 18 months. This capital is in addition to the green transformation capital that has been allocated in our Pulp and Paper business.

Overall, we generated CAD113 million in the quarter from continuing operations. From discontinued operations, the closure of the Eurocan mill and the associated linerboard and kraft paper business. We generated CAD6 million from a reduction of inventories and the collection of accounts receivable. The closure of that operation is proceeding as planned with the expected total cost of the closure to be less than the guidance we provided in Q4 2009. In addition, we are moving on selling various assets at the site and these asset sales will continue through next year.

On the balance sheet, with our positive cash flows, we have been able to increase our cash balance and reduce our net debt position. At the end of the quarter, the net debt to capitalization ratio was approximately 6%, down from 12% at the end of the last quarter. And as I mentioned earlier that one of our rating agencies, Standard & Poor's, increased its debt rating from BB flat to BB positive near the end of the quarter. This upgrade puts our rating by each of the three rating agencies one notch below investment grade where our credit rating was before the downturn. Hank, I will turn it back to you.

Okay, that is it from us and operator, we will now be ready to take questions.

(Operator Instructions). Richard Skidmore, Goldman Sachs.

Good morning, Hank. Hank, can you talk about the capital spending program, how much of that is targeted to the US South lumber operations specifically, increasing capacity there to potentially offset reductions that may come out of BC in the future?

Yes, Rick, so the capital that we kind of announced in September was reflective of our confidence that these cash flows were going to allow us to make capital decisions partway through the year rather than waiting till our normal December annual capital review. So we are going to be spending around CAD125 million -- we have approved at the Board level about CAD125 million of capital to be spent in BC, Alberta and the US South. I can't give you a breakdown on the percentages in each area, but they are high payback items. On trend earnings or trend lumber prices, these would be two year or less payback items and they are going to be -- there is going to be some spent in all three of those operating areas.

Okay. And then maybe just along those same lines, how do you see, Hank, the industry or specifically West Fraser's lumber capacity in the beetle-impacted region changing over time and what would be the timeframe that you think that that starts to actually happen in BC?

Well, I think it is -- the recession has already caused it to happen fairly significantly in BC, but based on future lumber prices, it is hard to predict the shelf life of the dead and dying pine, but we are getting closer to a fairly significant downfall. And that could happen over the -- within -- it could begin happening maybe in five years and proceed over a 5 to 10-year period.

Okay, so the standing timber that is dead and dying in BC, some of that at least can still be utilized for anywhere between 5 and 10 years and any meaningful step-down in lumber capacity probably happens in that 5 to 10-year timeframe as opposed to the zero to five-year timeframe?

Yes, that's right.

Okay, great. Thanks, Hank.

Pierre Lacroix, Desjardins Securities.

Yes, thank you, good morning. The first question I have is on China. Can you give us what is the breakdown of Chinese shipments in the quarter, what is the approximate percentage of your shipments that are going to China?

Well, we shipped about roughly 15% of our production, Canadian production offshore to Asia. And it is probably somewhat more than half of that would be China. Japan and China are two big markets and more than half of that would be China.

Okay, good. And Hank, maybe you can give me some indication, how is the pricing situation going for China? What is different from North America on the pricing side?

We are selling predominately low grade and there is not a significant difference in pricing in China versus our North American markets.

And the pricing strategy, is it determined on the weekly basis, on a daily basis? Is it quarterly or is there any kind of concept like that?

Well, it is different for different customers, but it would be all of the above probably.

Okay. Thank you very much.

Benoit Laprade, Scotia Capital.

Thank you, good morning. Just a follow-up on Pierre's question, can you compare this quarter's shipments to China from last quarter and from the same quarter last year?

I can. They are up significantly, certainly up significantly from the quarter of the previous year and up significantly from the previous quarter in this year as well.

And is there anything in particular driving that?

Is there anything what?

In particular that is driving that change specifically in Q3? Is it a particular effort on your part? Is it the market that is changing over there or what is the catalyst there?

I think it is just an increasing acceptance of SPF over in that market and the ability of the -- the economy is moving ahead and I just feel -- I think they are getting more comfortable buying from us, using our product and I guess that is the only thing I could say.

Thank you.

(Operator Instructions). Richard Skidmore, Goldman Sachs.

Thanks. Maybe just to, Hank, follow up on that last question. Is the increase in volumes to China related at all to the amount of lower quality lumber that you are producing because of the beetle kill?

I don't really know the answer to that, Rick. We are not selling all of our low grade to China obviously. I just think the economy is going well over there. Their factories are geared up and they need our wood.

Maybe another way to ask this is are you seeing any change in lumber demand aside from the normal US housing impact because of quality issues of the lumber itself coming out of BC into the US such as the US customers are buying less from BC because of the beetle kill?

No, we haven't noticed that.

Okay. Maybe just shifting topics to the pulp markets, can you just talk a little bit more, or if Ted is there, talk a little bit about what you are seeing currently in the China markets both on the kraft and BCTMP pulp side.

I don't think Ted is on the phone.

Hank, I just got on the line.

Sorry about that. I guess we all have to listen to Ted then.

Thank you, Hank. On the BCTMP side, we have seen demand come back. Demand has been very strong in the last 45 days. But again, NBSK, NBSK is fairly stable at this point in China. So I think our outlook at least for the short term is fairly strong.

And do you get the sense that the Chinese, that they have - that it sort of stepped out of the market in the first part of the year, that this is back more towards a normal level and that it is sustainable or is there something that -- there has been some discussion that maybe there was just some timing of some shipments leaving North America to China that caused the most recently reported data to show China volumes up materially relative to August or are we just seeing that September volumes are much better than August into China?

Yes, I think basically our view on it is that, in the Chinese market, they really took a bit of a pause through the first say two months of the third quarter and now they have been back much more active. So whether that will carry on for the next several months, we can't say, but I would say for the last two months or so, it has been fairly back to normal.

Great. Thank you.

Paul Quinn, RBC Capital Markets.

Yes, thanks. Good morning, guys. Just a follow-up question on China just so I have got this. You are saying exports to Asia is 15% of I guess almost 840,000 board feet of lumber and China would represent just over half of that. So essentially if I do the math, it's somewhere -- Chinese shipments are about 6% of your total shipments?

That's probably roughly correct, yes.

And when you describe it as significant increase over last year, what is significant? Is that 10% to 15% growth? Is that a 30% growth?

Into Asia, it is 50%.

50%. Okay. And then just on -- Hank, you mentioned the improving cost structure of the kraft mills. I want to be able to try to model that in. How do you see suggest I go about that? What are we talking about in terms of the improvement? Is it a 5% improvement on cost?

Ted, why don't you cover that?

Thanks, Hank. Well, I don't think we usually get into detailed data on our individual pulp mills, so really can't go into that much detail, Paul. But I think a significant amount of the improvement in the quarter was in our kraft pulp business. I guess I will leave it at that.

Okay. And I guess a question, maybe you can answer in a general way. Do you see the cost improvement at your kraft side continuing over the next four quarters?

Well, I think that is our expectation. I think a big part of it is -- I think you saw that in our record production and we expect that to carry on, definitely.

Okay. And then just maybe a question, I guess back to you, Hank. Just on capital structure, you have now got a squeaky clean balance sheet once again. Do you start -- you have opened up sort of the Company wallet for some CapEx expenditures. Do you start to fill confident about further growth opportunities at this point?

Well, I think just like probably everybody else, we have no idea what the future holds in terms of the US economy. So we will continue to be, I would say, cautiously aggressive in terms of our capital spending. So our number one priority is to continue to invest in our existing operations and certainly, we are interested in strategic opportunities and we just have to look at whatever comes along on an individual basis.

Great. That's all I had. Good quarter. Thanks, guys.

Thank you.

(Operator Instructions). There are no further questions registered at this time.

Okay. Well, thank you, operator and thanks, everybody, for joining our call and we will be around all day if anybody wants to follow up on anything. Thank you.

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