West Fraser Timber Co Ltd (WFG) 2011 Q1 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Company Ltd. first-quarter 2011 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 or through SEDAR, and as supplemented by our quarterly MD&As. Accordingly, listeners will 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.

Thank you, operator, and good morning. Welcome to the first-quarter West Fraser conference call.

Yesterday, we reported earnings of CAD20 million on sales of CAD687 million. While these earnings are substantially lower than our fourth quarter earnings, our EBITDA was only slightly lower than the previously quarter. Jerry Miller, our CFO, will discuss our earnings more fully in his report.

From an operational standpoint, the Company performed very well in the first quarter. Our lumber mills ran at full capacity in Canada, and production was up 9% over the previous quarter. Our US lumber mills ran at 75% of capacity, up from 70% in the fourth quarter, and production was up 8% versus the previous quarter.

Log costs remained relatively flat quarter-over-quarter in both Canada and the United States. Benchmark SPF lumber prices were 10% higher in the first quarter and southern yellow pine prices were 14% higher compared with the previous quarter. However, after adjusting for a 3% increase in the value of the Canadian dollar, SPF prices expressed in Canadian dollars were up only 7%.

The lumber market strengthened in the first quarter of the year due to supply constraints, continued growth in Chinese demand, and low inventories throughout the supply chain. However, prices began to erode towards the end of the quarter as a result of more supply coming on the market. The US housing market remains extremely depressed, which continues to inhibit a sustained recovery of lumber prices. On the positive side, spending on home repairs and renovations continues to increase, as does spending in the industrial and commercial sector.

In addition, demand from China continues to grow impressively. In the first quarter, approximately 30% of our Canadian SPF lumber was shipped to Asia, up from 20% in the corresponding quarter in 2010. We anticipate continued strong growth in this market, as long as the Chinese economy remains healthy.

Lumber shipments were 11% below production in the quarter. This was due to transportation problems caused by extreme weather conditions in many regions of North America, as well as weakening lumber demand towards the end of the quarter. Production in our panel division was up about 5% during the quarter, while pricing was up 2% for plywood and down 2% for MDF. We shipped virtually all of our plywood to the Canadian market. During the past year, US plywood producers began shipping into the Canadian market due to both the lack of demand in their home market as well as the weakening US dollar, which makes their product more competitive in Canada.

We continued to process significant volumes of dead pine trees in many of our British Columbia sawmills. In many cases, up to 80% of the logs have been infested by the mountain pine beetle. This causes reduced grade recovery, reduced lumber recovery, and reduced productivity. Our people have done a great job in adapting to this new reality by investing in new machinery and technology and by modifying many of our operating procedures. We are hopeful that some extreme cold weather events in Alberta this past winter, combined with a more aggressive approach by the Alberta government and industry in combating the beetle in that province, will continue to retard the spread of the beetle in Alberta.

We are currently embarked on an aggressive capital spending program throughout our company. Over the next 18 months, we'll spend about CAD230 million on our lumber mills in Canada and the US. In addition, we'll spend CAD88 million of Green Transformation funds on high payback energy projects in our craft pulp mills. Of course, we'll closely monitor market conditions and will [spin] some projects if markets continue to deteriorate. We have a very strong balance sheet that allows us a lot of flexibility, and we intend to keep it that way.

The BC industry is continuing to work with our federal and provincial governments in response to the arbitration case filed against Canada by the Department of Commerce under the 2006 Softwood Lumber Agreement. We believe Canada has a strong defense. The current timetable indicates the arbitration hearing will commence late in February 2012.

Our Pulp and Paper Division performed well in the quarter. Production was on target at each of our mills, and we continued to make good progress on our cost reduction efforts. Prices for beech craft pulp and BCTNP were down 2% and 3% respectively in Canadian dollars versus the fourth quarter of 2010. However, while MBSK prices are up 4% in Canadian dollars compared with the year ago quarter, mechanical pulp prices are actually 17% lower. This reflects pricing pressures on BCTNP caused by over capacity in the hardwood craft market. MBSK pricing, on the other hand, continues strong due to low global softwood craft inventories. The pricing gap between softwood craft and hardwood craft and mechanical pulp is at historically high levels.

In May we'll take our caribou pulp joint venture craft pulp mill down for a 12-day maintenance shut, which will result in about 5,000 tons of lost production for West Fraser.

Looking ahead, we continue to be optimistic about increasing lumber demand in Asia. In order to benefit from this increasing demand, we need to work with our transportation suppliers to ensure we have the capacity to move these higher shipments. We don't foresee much improvement in the North American lumber markets until some supply comes off the market. This has proven to be a slow and painful process in the past, but we believe we're not that far away from a demand supply balance.

The strong Canadian dollar will continue to be a challenge for us, which means we must redouble our cost control efforts. Yesterday, we announced our intention to qualify through the Toronto Stock Exchange to permit us to buy back our shares under certain circumstances. There are several steps that we need to take in order to qualify and we will formally announce when that process is complete. Our goal is to have the option of purchasing our shares back if we feel they are undervalued and it is the best use of our excess cash.

I'll now ask Gerry Miller to comment on our financial statements.

Thanks, Hank, and good morning, everyone. We have fully transitioned to reporting our financial results under the new International Financial Reporting Standards. With these new reporting standards, you will see some changes in the presentation of our prior results. With the transition from the previously accepted accounting principles to IFRS, we have made several adjustments to our equity, totaling approximately CAD195 million. The details of the adjustments are fully disclosed in Appendix B to the quarterly financial statements.

Earnings for the quarter from continuing operations were CAD20 million or CAD0.44 per share on a diluted basis. Discontinued operations in the linerboard and craft paper business that we shut down early last year contributed a loss of CAD1 million in the quarter. In the quarter, we generated EBITDA of CAD80, million which is slightly lower than the CAD81 million we generated in the previous quarter. We generated a significantly higher EBITDA in our Lumber segment, but this was offset by slight reductions in both our Panels and Pulp and Paper segments and a higher equity-based compensation expense experienced in the quarter.

Excluding equity-based compensation expense, EBITDA would've been CAD106 million in this quarter compared to CAD100 million in the previous quarter. The higher equity-based compensation expense is mainly the result of the significant increase in our share price in the quarter, an increase of 28%. We used a Black-Scholes valuation model to value outstanding options, and the market price of our shares is a significant factor in that valuation.

Accordingly, the significant increase in our share price in the quarter resulted in a large increase in the equity-based compensation expense. If we were to calculate the equity-based compensation expense for the second quarter based on the closing value of our shares yesterday, reflecting about a 10% decline from the beginning of the second quarter, we would estimate a recovery of this expense of approximately CAD10 million.

Selling, general, and administrative expenses totaled CAD27 million, which is a decline of about CAD2 million from the previous quarter. Interest expense was approximately CAD5 million compared to CAD6 million in the last quarter of 2010, mostly as a result of lower stand-by charges on our unused credit facility. The exchange gain on long-term debt of CAD8 million is the result of the strengthening of the Canadian dollar compared to the US dollar. The value of the Canadian dollar increased nearly CAD02.5 in the quarter, resulting in this gain on our 300 million US dollar-denominated long-term debt. Other expense of CAD4 million relates mostly to a foreign-exchange loss on our US dollar-denominated accounts receivable.

Our income tax provision of CAD14 million is at a higher than expected rate of about 40%, largely because the majority of the expense relating to the equity-based compensation is not deductible for tax purposes. In the quarter, we recorded a loss of CAD1 million from discontinued operations compared to income of CAD15 million in the previous quarter, which included a gain on the sale of equipment at the closed [Urican] site.

In the quarter, we used about CAD56 million of cash to fund our operations. During the quarter, we paid in excess of CAD60 million in income tax, mostly in respect of our 2010 earnings, in addition to installments in respect of our expected 2011 income tax liability.

We also built our Canadian log inventories, as we do each year at this time. The payment of our income taxes and the investment in our break-up log inventories were the most significant uses of cash from operations in the quarter.

Cash used in financing activities was fairly normal in the quarter. There was a small repayment of an operating loan, and we paid interest on our outstanding debt. In the first quarter, we increased our dividend back to the level established before the 2006 recession and the 2008 financial crisis. We believe that providing a modest dividend to our shareholders is appropriate.

In the quarter, we invested about CAD20 million in plant and equipment across the Company. In total, approximately CAD12 million was invested in our Pulp and Paper business, almost all of which will be funded through the Federal Green Transformation program. In the quarter, we received reimbursement of CAD8 million toward this total under the Green Transformation program.

The balance of the capital spent in the quarter relates mainly to our Lumber business. You will recall that in December we announced a CAD230 million capital program that will be directed mainly to improving our Lumber business. This capital program is intended to take place over the next 18 months. While the first-quarter investment under this program is relatively small at about CAD8 million, we expect that capital investment will ramp up quite dramatically over the next few quarters.

All in all, we used CAD80 million cash in the quarter, the majority of which related to our income tax bill for 2010 and the buildup of our breakup log inventories.

At the end of the quarter, we had cash balances of about CAD80 million and a very small balance on one of our operating lines. Our available liquidity, including our cash and our credit facilities, was approximately CAD540 million.

Our debt to capitalization ratio was 12% at the end of the quarter, up slightly from the year-end ratio, due mainly to the income tax payment and the seasonal log inventory buildup.

Subsequent to the end of the quarter, two of our rating agencies, Moody's and Standard and Poor's, changed their outlook on our company. Moody's improved their outlook from negative to positive, and Standard and Poor's improved their outlook from stable to positive. The current ratings of our three rating agencies on West Fraser are DBRS, double-B high with a stable outlook; Moody's, BA-1 with a positive outlook; and S&P, double-B-plus with a positive outlook. We will continue to look at -- to work, as we said in the past, to earn back an investment grade rating for West Fraser.

With that, Hank, I'll turn it back to you.

Thank you. And I guess we -- Operator, we'll now open it to questions.

(Operator instructions.). We do have a question from Bill Hoffman with RBC Capital Markets. Please go ahead.

Hi, good morning. I wondered if you could talk a little bit about the shipments of lumber over to the Asian markets. You were talking about how it had moved up to about 30% in the first quarter and I just want to get a sense of what you see might be the potential for opportunity for you all this year, what you're getting on realizations in those markets right now, and how it's helping you to balance, obviously, your own system.

Bill, we're quite positive about our ability to continue to ship at that rate and possibly even higher -- probably even higher -- as long as the transportation system allows us to do that. So we're working very hard in that respect. Sales realizations are not dissimilar to what we're getting in North America, and I guess on the whole, this has been a great new market opportunity for us and the rest of the industry, and we don't see any reason right now why it won't continue to grow.

So like when we see spot prices moving around and dropping like they have in North America, is that pulling the pricing of your export markets down as well?

I mean, I don't want to get into it specifically, but as I said, fundamentally over time, prices are not significantly different between the two markets.

Okay. And just a second question is for Gerry -- just in a capital spending program, you talk about the lumber ramp-up. Can you just give us an idea of where you expect the second and third quarters might go relative to the first?

Bill, I think it was pretty light in the first quarter. I think we'd probably look at -- I think we've said in the past that maybe about CAD160 million for the year would be plan, and we would kind of ramp up that over the next couple of quarters.

Okay, great. And just a last question -- in the Pulp side of the business, you did talk about the weakness in the BTTMP side. We realize that that was the start of a machine over in China, and I just wonder, I guess theoretically, that's supposed to begin to get integrated into paper assets on the same site. Can you just give us an outlook on how you see the balance in those markets right now?

Well, the hardwood craft and mechanical pulp side supply definitely exceeds demand at this point in time. Our view is, as I said, the imbalance -- the gap between softwood craft and hardwood craft prices is significantly higher than historical averages. So something's got to change there. I guess that's all I have to comment on that.

Okay. Thank you.

Thank you. The next question is from Alex Ovshey with Goldman Sachs. Please go ahead.

Thanks, good morning. Hank, could you just talk about the key end uses for your mechanical pulps and then also the key end uses for the craft pulps and whether or not there's an opportunity for customers to switch from the craft to the mechanical once given the historical premium between the prices?

I'm going to let Ted Seraphim answer that question.

Good morning, Alex. I think fundamentally, this price gap's been going on now for about nine months, and if things have not switched by now, we don't really anticipate significant switching in the near term. Longer term, if it continues, customers are going to look for ways of obviously having the lowest cost option, but at this point, we're not seeing a lot of switching, and demand for MBSK continues to be strong due to the end uses that its going into. And I don't want to take too much time to get into that, but the other aspect has been, as you may know, the high prices of dissolving pulp has also created significant demand for MBSK. So as we look at the near term, we don't see a lot of change.

Okay, that's helpful. And then just shifting to the lumber demand out of China, this will be a tough question to answer, but I think it was about 2 billion board feet last year. I think there's some out there espousing that it may be as much as 4 billion board feet that goes to China this year. But if you think about a longer term, three to five years out, Hank, what do you think is the right way to think about what the incremental demand out of China may be for lumber over the next five years, if you have a view on that?

Well, if you kind of just look at the trajectory over the last five years, you'd say it's going to be continuing significant growth, but I can't really project out, but I do believe that if the economy in China continues to operate the way it's operating now, we just continue to grow to gain market share over there, and I don't see any reason for that to stop. So I can't really say -- I couldn't predict on where this is going. All I can say is 30% of our Canadian shipments are going there now, up from virtually nothing five years ago. So with the growing economy, the urbanization, we just see that continuing to grow.

Great, thank you.

Thank you. The next question is from Rick Skidmore with Goldman Sachs. Please go ahead.

Good morning, Hank. Can you just talk to when you might see a step-change in log availability in BC for either both West Fraser and/or the industry?

Well, it would be -- West Fraser and the industry, it's going to happen at about the same time, and we think that we're going to start to see some significant change five to six to seven years from now.

So over the next couple of years, you wouldn't anticipate much in the way of change and log availability for you?

No.

Okay. Gerry, can you just comment on how we should think about the share price sensitivity of share-based comps? So a dollar change in West Fraser share price is equal to x-million in your share-based comp?

Rick, it's about CAD1.6 million.

Okay. And then, Hank, just maybe coming back to Lumber just for a second, you mentioned some additional supply coming back in the first quarter or supply increasing. From your vantage point, did that supply come on from idle capacity restarting, or was that just from competitors or yourselves running existing capacity a bit harder?

I think both. I think that some idle capacity has come on. Some hours have been added in mills that had reduced hours, and there's definitely production creep as people get new technology into their mills.

All right. Thank you.

Thank you. The next question is from Daryl Swetlishoff with Raymond James. Please go ahead.

Thanks. Good morning, guys. Hank, just to follow on the Asian story, we heard a lot of noise about the ability for, or the potential for, incremental lumber shipments to help rebuild Japan after the devastating earthquakes. Can you comment on what you see the opportunity for West Fraser is near-and long-term there?

Well, in Japan, we've been a long-term large supplier of the Japanese SPF market, and that's going to continue. With respect to the disaster that they've gone through, and are still going through, I really can't comment on what that's going to mean to increased lumber shipments. We don't really look at it that way. Our job is to be there, ready if they need anything. Plywood shipments will probably increase somewhat, but we haven't seen any significant change up to this point in time. It's probably too early, but like I say, the industry has done a great job, the BC industry, in contributing to the disaster relief. And we've got the lumber if they need it, and we'll be ready to supply them.

Thanks. So the rest of my questions have been asked and answered. I'll turn it over.

Thank you. (Operator Instructions). The next question is from Sean Steuart with T.D. Newcrest. Please go ahead.

Good morning, everyone, just a couple of questions. Gerry, I'm wondering if you can talk on the costs we saw in Q1. I guess the unit cost of both the sawmills and the pulp mills were a little bit better than we expected. Can you just talk about the progress you made toward productivity improvement, offsetting input cost pressure, and what you're expecting on the input cost pressure side over the next couple of quarters?

Well, I think cost is -- that's what we do. That's West Fraser, and we really try hard to keep our unit cost in check. I think fuel is something -- if oil prices go up, we're going to have to work hard at offsetting that, various transportation and other costs. As far as logs go, the majority in Canada -- anyway, the majority of our logs are in inventory, and I think for the next couple of quarters, we've already got that in place. So I think going forward, we work hard at it every day, and we're going to continue to focus on keeping our costs as low as they can be.

Okay. And the second question is for Ted. Ted, I was just hoping you can expand a little bit on your comments on softwood pulp markets. I guess, anecdotally, we've heard that spot prices in China have come off a little bit. West prices still went up in North America and Europe in April. We've had good stats on the mill inventory side and shipment side. Just wondering if you can talk a little bit about what you're expecting for prices through the summer here?

Sure. I think your first -- I think you've almost answered your question when you look at -- inventories are extremely low. You're talking about the spot prices in China. I think they're off CAD30 or CAD40, but the reality of it is that if China decides to back off a little bit, particularly through the maintenance shutdown period, I don't personally think that we'll see a significant impact on pricing. China is not as important to softwood craft as they are to the mechanical grades. So near term, we see things as being pretty strong and pretty balanced right through the next three to six months.

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

Thank you. The next question is from Paul Quinn with RBC Capital Markets. Please go ahead.

Yes, thanks. Good morning, guys -- a couple of questions. One, we've seen a material drop in lumber prices with the increase in the Canadian dollar and just wondering if there's a change at West Fraser in terms of operating rates going forward in the Q2 and the rest of the year?

Well, I think we look at that all the time, Paul, and currently we have no plans to alter anything. Our job is just to continue to drive costs down, but obviously, as you recall, if we get back into a situation like we were in in '09, we and everybody else are going to have to make some serious adjustments, but we don't foresee that at this point in time.

All right. In terms of transportation costs, what have you seen there? Is that coming up with the price of oil and diesel, and specifically transportation costs to Asia?

Yes, oil is driving up transportation costs for sure, yes.

Well, I guess just a clarification on cap-ex for 2011, Gerry, you mentioned 160. That's 160 plus the Green Transformation program?

Yes. And the 160, I mean, it's going to be a matter of how we roll out the spending, but that is in addition -- or the Green Transformation is in addition to that.

Okay. And just lastly, you guys sell a lot into -- well, historically have sold a lot into US homebuilders. What are you seeing on the customer side there? Are they reporting sort of a bust of the spring home buying season, or in certain markets, is it a lot better than sort of what I'm seeing?

I think we're probably all seeing the same thing. We don't see any -- maybe some regional markets are doing a little bit better, but fundamentally, we're not seeing any improvement in the new home building down there.

Okay. Thanks, guys.

Yes, thank you.

Thank you. The next question is from Pierre Le Quo with Desjardins Securities. Please go ahead.

Yes, thanks. Just on the balance sheet side, you have a strong balance sheet and good cash flow levels, so you invest in cap-ex. You're now talking of buying back shares eventually. Where the acquisition teams fits into your strategy, do you have a lot of time for that these days or how should we look at it?

Our strategy is no different than it's always been. We have to balance -- basically, we've always said we want to always operate with a prudent balance sheet, which we intend to continue to do. If we drive strong cash flow, some will be applied to cap-ex. That'll be our first priority on high payback items. Our second priority will be on building shareholder value however we can, whether it's in some form of acquisition or, in our case, share buyback. I mean, we now have another tool, and our job is to create shareholder value, and those are the three elements by which we can do it.

But if you look at the market these days, do you find the market more attractive than it was, or how do you position yourself with the current market conditions?

You mean the economics?

Or the acquisitions, yes.

You mean the market for acquisitions? Is that what you're asking, Pierre?

Yes.

I can't really comment on that. We don't view it any different than any other time. If an attractive opportunity comes along, we'd certainly look at it, and that's exactly what we'd do today.

Okay. Just a couple of small questions on the startup of some of idle capacity -- can you provide or do you have an idea of where that capacity is coming from on the original basis? Is it more on the West Coast, given the Asian, or do you see that on US South or on the East side as well?

So where idle capacity might start up, I think there's idle capacity all through the system, and so it can start up all over North America, it seems to me, very nicely.

Okay. So general -- the final one, on the plywood side, you mentioned that there might be some demand coming from Japan. Can you specify how much of your capacity is certified for the Japanese market?.

Probably most of it's certified. We have three mills, and I think we have two certified and probably have the third one certified fairly quickly.

Okay. Thank you very much.

Thank you. The next question is from :Robert Duncan with Canaccord Genuity. Please go ahead.

Earlier in the conference call, there was a discussion about log availability, and you talked about significant changes occurring four to -- five to six years out. Can you characterize the word "significant" in terms of size and amounts?

Wayne Clogg will answer that question for us.

Good morning, Robert.

Good morning.

That's a very difficult question to answer, and the reason is that it depends very much on utilizing dead and damaged pine. So recently, the province has reset the allowable cut in two supply areas, significant ones, in Prince George and in [Cornell], and they've essentially maintained the cut at the level that the industry was using the volume for a period of up to 10, but there's a very strong caveat there, that that depends on a very heavy utilization of dead pine. The ability to use dead pine is not just a physical thing, but it's an economic thing. So it depends very much on lumber market conditions, the ability to use all of that dead wood. So what we're looking at is that given reasonable economic conditions, it's likely that we're looking at a five-to-10 year horizon to be able to utilize that resource. But we can't forecast today, Robert, what economic conditions will look like six years from now, for instance.

But then, again, near the beginning of the conference call, you talked pine -- 80% of your pine was infected, which is obviously reducing grade and it's reducing, as you said, lumber recovery. So while the logs are available, the quality and the quantity of lumber is already beginning to deteriorate; is that correct?

Yes, and as Hank said, our folks in the mill level are working very, very hard to push back on that, to continue to be able to recover product and keep our quality up.

Great. Thank you very much.

Thank you. The next question is from Alex Ovshey with Goldman Sachs. Please go ahead.

Thanks. I have a few more questions. One, as you look at the housing market, I think it's a lot easier to make the case for the multi-family units to recover a lot quicker than single family, given the vacancy rates are a lot more closer to normal than multi-family. So the first part of the question is, Hank, based on what you're seeing in the market, would you agree that we're more likely to see a recovery in multi-family occur before single family? And then the second part of that question is, if this does occur, how does the recovery in multi-family impact your businesses?

Well, I think you're right. I think that likely we're going to see a higher percentage of multi-families than single families over the next little while, and of course, on a unit-per-unit basis, more wood is used in a single family. So that would be more helpful if the ratio was in reverse, but that's just a fact of life. And so that's going to be the way it is for a little while until we bleed off all of this excess housing inventory that we have down there, but I think you captured that correctly, and that's one of the reasons how the housing market -- or why lumber prices continue to be depressed.

Okay. Is there any rule of thumb to think about how much lumber would be used for a single-family unit versus a multi-family unit, or is it too difficult to be able to think about it that way?

No, there is a rule of thumb. I can't tell you it right off the top of my head.

Okay. I'll try to find that out.

I'll tell you what, we'll get that to you.

Okay. I very much appreciate that. And then secondly, as you think about some of the other end uses for lumber, repair and remodel, industrial end uses, any noticeable change in the demand for those end uses at this point?

For repair and remodel and industrial?

Yes, just what your customers may be saying the trend may look like over the next year or so?

I can't say specifically, but it is trending up.

Okay, great. Thank you.

That concludes today's Q&A session. I would not like to turn the meeting back over to Mr. Ketcham.

Well, great. Thank you, and thank you all for attending, and we'll talk to you on our second-quarter conference call. Appreciate it very much. Bye.

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