West Fraser Timber Co Ltd (WFG) 2011 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the West Fraser Timber Company Ltd. third quarter 2011 results conference call. During this conference, West Fraser's representatives 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 the Company's annual MD&A which can be accessed on West Fraser's website or through SEDAR and as supplemented by the Company's 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, and good morning and welcome to West Fraser's third-quarter conference call.

Yesterday we reported adjusted earnings from continuing operations of CAD3 million on sales of CAD705 million. Our adjusted earnings are a true reflection of how the Company performed during the quarter. Larry Hughes, our CFO, will discuss our earnings in more detail in a few minutes.

EBITDA during the quarter was CAD66 million versus CAD62 million in the previous quarter. The depreciation of the Canadian dollar verses its US counterpart improved our operating earnings during the quarter, but resulted in a greater long-term debt liability due to our US borrowings.

From an operational standpoint, the Company performed well during the quarter, although lumber production declined by roughly 4% due to slightly lower productivity at our Canadian division partly due to the implementation of capital projects at some of the mills and reduced operating hours at our US division reflecting very weak lumber demand and prices. Benchmark lumber prices were 2% higher for SPF and 2% lower for southern yellow pine. This, combined with the lower overall efficiency of our US Mills versus our Canadian Mills, resulted in a significant drag in our lumber earnings.

As we stated in the past, we'll need to continue to spend capital on our US assets to bring them up to the same standard of efficiency that we enjoy in our Canadian Mills. We're in the middle of that process now with major projects underway at several of our Mills. Costs in our lumber division were well-contained compared to the second quarter. However, compared to the third quarter of 2010, Canadian log costs are up 15% while US log costs are down 5%. The significant increase in Canadian log costs can be attributed to increased purchase log costs, higher fuel costs, longer haul distances and a very tight labor market.

Lumber shipments during the quarter were higher than production which has allowed us to keep our inventories at acceptable levels. The mountain pine beetle infestation of BC continues to negatively affect productivity, grade recovery and lumber recovery. The beetle has not reached epidemic proportions in most parts of Alberta at this point, and we are hopeful that continued government industry collaboration, combined with a cold winter will further retard the spread of the beetle in that province. To date we are not experiencing any significant reduction in operating parameters at our Alberta mills.

On November 9, Canada will formally respond to the charges leveled against the BC industry under the softwood lumber agreement. We will vigorously defend our actions and the case will go to arbitration in February. While we are confident of the merits of the Canadian defense we cannot predict the outcome.

Our panel division performed well during the quarter with our 3 plywood mills operating at full capacity while our MDF and LVL operations continue to operate under reduced schedules to match supply with demand. The Slave Lake fire in May adversely affected plywood productivity in the quarter following production interruptions of the Slave Lake veneer mill. Plywood prices and MDF prices were slightly higher verses the second quarter, but lower than last year, by 5% and 8% respectively.

While the plywood market in Canada remains strong, prices continue to be under pressure due to the significant increase in imports from the US, as a result of the weak housing market in that country and the large swing in currency valuations over the last couple of years.

Our Pulp and Paper division also performed well in the quarter. Production was good at all Mills although we continue to periodically curtail productions at our Alberta-based mechanical pulp and newsprint mills when electricity costs reach certain specific levels. At that point the Company makes more money selling electricity onto the grid than making pulp. Electricity-related curtailments resulted in a reduction of several thousand tons in the quarter.

During the quarter mechanical pulp prices increased marginally but are off roughly 12% from the third quarter of 2010. NBSK prices were slightly lower in the third quarter and off about 7% from the same quarter of last year. We took our Hinton, Alberta, NBSK mill down on October 1 for a major capacity expansion and cost-reduction program; It's currently in start-up mode. We are proceeding well in our CAD88 million of green transformation projects which, when completed, will improve production at certain Mills, reduce costs, and improve our environmental performance.

Looking forward, we don't anticipate any improvement in the US housing market for the foreseeable future, but anticipate continuing strong demand for our products from Asia, particularly China. Our third quarter lumber shipments to Asia amounted to roughly 25% of our total lumber shipments. We're concerned about some weakening in the pulp market as inventories are rising and pulp pricing is coming under pressure. In spite of these headwinds, we are confident that our strong balance sheet, our reasonable cash flow and our significant capital spending program will ensure that we remain one of the low-cost producers in the industry. Given our geographic diversification, our low cost structure, our modern and efficient mills and our very strong balance sheet, we are in a good position to continue to weather this 5-year depression in our industry and benefit significantly when markets improve.

I'll now turn it over to Larry Hughes to more fully discuss our financial results.

Thank you Hank and thanks to everyone joining us today. We have a series of slides on our website in the investor relations presentation section that I'll be referring to during this presentation.

Slide 2 contains an advisory concerning our use of terms such as EBITDA, adjusted earnings or loss and adjusted earnings per share. For the third quarter we reported earnings from continuing operations of CAD6 million resulting in basic earnings per share of CAD0.14. Earnings after discontinued operations for the quarter of CAD37 million included the gain from the sale of the Eurocan deep-sea wharf which makes this result not particularly useful as a measure of our operational performance. As shown on slide 3, which reproduces part of note 14 from our financial statement, the diluted earnings per share from continuing operations was negative CAN0.29 per share as a result of the required deduction from earnings of CAD18 million of the recovery on share options. We believe that because of the size and volatility of the share option expense or recovery, the earnings per share on a diluted basis is also not very useful as a measure of our operational performance.

Now for something that is hopefully more useful. Slide 4 reproduces the table found on page 3 of our MD&A which identifies and quantifies several of non-operational items which affected our results. If we adjust the CAD6 million of earnings from continuing operations which excludes the effect of the Eurocan wharf sale to further remove the gains on the long-term equity-based compensation, and the sale of the Terrace sawmill, and then add back the CAD22 million loss related to the translation of US dollar denominated debt, the result is adjusted earnings from continuing operations of CAD3 million or adjusted earnings on a per share basis of CAD0.06 for the quarter, CAD37 million, or CAD0.87 per share for the year-to-date. Note that we have used the basic rather than the diluted weighted average number of shares in this calculation. As Hank mentioned, we believe that the adjusted earnings of amounts more accurately reflect how the Company's operations performed in the period.

Other non-operational items include interest which was essentially unchanged compared to the second quarter, reflecting ongoing low borrowings, a gain on the translation of current US dollar denominated monetary items of CAD12 million compared to a loss of CAD1 million in the second quarter, reflecting a strengthening of the US dollar against the Canadian dollar, and a CAD4 million provision for income taxes compared to CAD6 million in the previous quarter.

The Company's effective tax rate for the quarter was 36.3% compared to the statutory rate of 26.5%. The full reconciliation of the tax rate is included in note 12 of the third quarter income statements, but the key items in the variance were the foreign exchange loss on long-term debt which is taxed at capital gains rates, the equity-based compensation recovery which is non taxable, and a CAD6 million change in the tax valuation allowance.

Under IFRS, we are required to revalue or define benefit pension plans at the end of each quarter with changes flowing through other comprehensive earnings. For the third quarter, the effect of the reevaluation was the charge net of income taxes of CAD82 million and for the year-to-date, a charge of CAD90 million. The actuarial gain or loss will fluctuate with changes in long-term interest rates and the return on plan assets.

Slide 5 is a summary of some key cash flow items. Cash generated from operating activities during the quarter before working capital changes was CAD57 million and after working capital changes was CAD77 million, compared to CAD54 million and CAD115 million in the second quarter, reflecting the reduction in the spring breakup log inventories in Canada during the second quarter.

Capital expenditures for the year-to-date exclusive of green transformation program projects totaled CAD83 million, and we are expecting to spend about the same amount during the fourth quarter. Our balance sheet remains strong with net cash on hand at the end of the quarter of CAD208 million and a net debt to capital ratio of 6%. In the quarter we also renegotiated our CAD500 million committed revolving line of credit to take it advantage of reduced spreads and to extend its term to September 30, 2016.

Hank, that concludes my comments.

Okay, thank you, Larry. We'll now open the call to questions.

(Operator Instructions) Daryl Swetlishoff of Raymond James.

There has been some talk about potential changes to the US building standard codes. I was wondering how that might affect West Fraser with your US-code operations?

Yes, there is an issue down there, and its currently under investigation. The code standards for southern yellow pine are being reviewed, I think its a bit confused right now but I think early in the new year we will have more clarity on what the new standards might be, if they are changed in fact.

Are there any changes that you might make with respect to your MSR capacity just in anticipation or the risk that some of the [dealing] codes do in fact change?

We do have the ability to increase our MSR capacities. That is a possibility, for sure.

The other thing I'm interested in, Hank, is just your bio energy strategy. Could you talk a bit about what your intentions are there, what you've done to date, how much capital you've allocated, and what you expect to get in terms of megawatt's, and how that might fit into the rest of your strategy going forward?

We, like others, I think we've got some great programs underway with our CAD88 million green transformation funding, and the range of projects range from co-gen more electricity to electricity conservation. Some of what we are improved productivity at our mills, and going forward, we do have a small group that is working -- who are committed to building a bio energy business in our company. We are at the early stages there but we consider that to be an area that we're really going to focus on in the future.

Richard Kelertas of Dundee Securities.

Hank, could you give us a little bit more detail and maybe if you can year over year and quarter over quarter, you were indicating that you've seen, and I guess this is stating the obvious, some recovery in yield impact from the pine beetle -- that was going on for a while. Did it accelerate in the quarter for you or did you see it -- or have you made changes to the way you are doing some of your edging and some of your processing that you've been able to stem the tide or has it accelerated for you?

I don't think it is been getting any better. We are constantly working in our mills to find new and better ways to improve the process to mitigate the issues, but the wood is getting drier. Fortunately we were able to start getting into some more greenwood in some of our areas now, so that's what's really mitigating any further decline in the deterioration of the pine. But, our lumber recoveries and our grade recoveries and our productivity continue to suffer. I wouldn't say it's necessarily materially worse in the third quarter versus the second quarter, but it certainly is not improving.

Just switching gears, Hank, maybe you can talk about the wood cost increases. You mentioned that some of it was attributable to your purchased wood program. Can you talk about that? How much of your wood usage in the sawmills for instance was purchased wood versus your own?

The purchased wood is part of the issue, but let me ask Wayne to cover that plug.

We can't give you an exact number of what the percentage of our purchased wood, but in BC particularly, it makes up a fairly substantial part of our guide, it probably varies from 30% to even 50% in some of our mills. I know some of you probably track the interior log market report that is on the administrative Forest website. It is an interesting report to look at trends in purchased log prices, and if I look at July 2010 versus July 2011, the SPF price is showing about an 18% increase. It's kind of instructive to what is happened to the purchase log prices over the last year in BC. I think that is attributable to just increased competition; there's been more mills come on-line, and probably some more optimism in 2010 about lumber prices.

And it could be as well, that maybe in some areas, green wood availability versus beetle kill and purchased wood then is trying to make up for the difference?

Yes, that's certainly part of it.

Can you talk about your fuel costs in quarter over quarter how much they go up for you? Just on a percentage basis?

Again, it's a hard one. We have many different logging operations. Most of our contracts have fuel clauses in them and they vary from division to division. Fuel has certainly been one of the factors that's pressured log costs. The other has been availability of operators for our contractors, and It's not just us, it's across the sector in general. It's been a strong demand for operators from other resource industries like oil and gas, mining and so on.

Have you seen this trend continue into the fourth quarter or is there easing going on?

I would say there's easing. The third quarter is generally when we started our logging operations up in Canada, so negotiations with contractors and that take place in the third quarter, and most of our rates have been settled now as we move into the logging season.

On your crown limits and on the wood you get from the province. Have you -- did you indicate or did you see a substantial rise in the inventory -- sorry in the stumpage charges, or have there been quarter-over-quarter? I suspect because of the setting, you are only going to see year over year. Was it a substantial move for you on stumpage or was it pretty flat?

Alberta stumpage has been flat for some time, and continues to be flat. BC on a year over year basis, if you look at July, 2010 to '11, the effective stumpage rate in BC is up CAD1.82. It would reflect some of that increased purchase cost. July 1 to October 1 is down CAD0.62, so it may have peaked and begun to come back down again.

David Elkstone of Equity Research and Associates.

I just wanted to ask them follow-up on a stumpage question is that shift you've seen over the last year have anything to do with like you mentioned the shift to a harvest of the green timber, or is that just the higher purchase cost and such?

David, it is probably to do with both.

With the southern pine design value change, I guess you have 60 days until January 5 before we will know exactly what the changes will be. Do you see anything happening in the market right now in terms of say inventory management or any other types of coping strategies as people prepare for this eventual design change?

The market in general in the south is very slow right now. We're not sure that, that has anything to do with the design values; it is just a very tough market down there, so I can't comment specifically on to what extent it relates to the design thing.

And just moving over to China. There's been quite a decrease in imported SPF prices to China. Can you just tell us what is happening with what you are seeing for the Chinese market in the moment and what is the next quarter, for instance your loading for November and such?

We think there is still a very solid market over there. It's a growing market. I think that price pressures in the US has affected price pressures in China, and there may be some inventory adjustments going on over there. Fundamentally looking forward, we continue to be quite optimistic about that market.

Paul Quinn of RBC Capital Markets.

Hearing lots of reports of slowdown in lumber exports to China. I hear inventories are building on the docks over there now I hear they are building the docks on this side. Can you comment on that and how long do you expect this slowdown to go on?

As I mentioned a second ago, Paul, we do think there is a bit of a buildup of inventory in China and it is probably working itself off right now. We hope, it's hard to say. Again, I don't know specifically. All I can say is we think that the still strong economy, we think that if there is -- to the extent there's an oversupply of lumber on the docks over there it's starting to work itself off now, we hope, and we think it's just going to continue to grow for us.

I'm hearing it's particularly bad for low-grade. Is that what you're experiencing as well?

It could be a little bit, but I can't give you any specific -- I can't tell you specifically. I think in general it's -- where we might be selling a little bit more 2 and better over there, but again at the current time we think it's simply a question of rebalancing inventories.

Moving onto plywood you complain about the high Canadian dollar increase in the US imports. We saw a lot of change in the Canadian dollar over the quarter. Did you notice any drop in import pressure?

Not quarter over quarter, not significantly, no.

In terms of Eurocan terminal proceeds were CAD40 million. What can we expect on the industrial side? Is that in the same magnitude or is it a fraction of that?

It will be less.

Then on just the Terrace sawmill, that CAD8 million gain. Does that suggest proceeds for CAD8 million, and can you describe the Crown tenures that were associated with that?

All of our Crown tenures in the Northwest were part of the sale which included the tree farm license 41.

Lastly on the BC Hydro, the 2 projects you have on the biomass. That come in the first half of 2014. I guess we have gigawatt hours there; what can we see an incremental revenue or EBITDA generated from that? Is that in the CAD20 million ball park per year?

I guess it's a little too early to be specific on that. All I can say as we were going to get good financial returns out of those projects, good return on the capital.

Stephen Atkinson of BMO Capital Markets.

I'm tying to get a handle on where you're at with the Green Transformation Program. I know it is CAD88 million and you've spent about just under CAD50 million. Can you tell me which projects are being completed and are there any major projects and where they are?

I might actually pass that over to Ted Seraphim.

First of all, all our major projects, they have been announced. Fundamentally, we have 5 major projects, 2 of them are Hinton mill, 1 is a pressure diffuser, the other one is a pulp machine operate. Those will be starting up this quarter. We're just coming out of the Hinton maintenance shutdown. We have a co-gen project at our joint venture Cariboo pulp mill that will be starting up likely second quarter of next year. We have a energy efficiency project our Slave Lake mill that will be starting up late next year, and then we're also putting in a chlorine dioxide generator at the Cariboo pulp mill and that will come in next year as well. Those are the major projects.

Do you expect good returns?

That's correct.

And in terms of your offshore sales, where we've spoke about China, just talking about lumber, of course. What's the situation in Japan?

I think the situation in Japan is basically steady. It continues to be a good solid market for us.

And typically I have been using 10% of sales? Is that fair?

Into Japan?

Yes.

We don't really break it down but I think roughly 30% is going into Asia.

So, excluding the green transformation funding, then what's your CapEx for next year? Or can you give me a ballpark?

No, because we are still in the process of developing our capital plans. We have significant capital that we will be spending. We're kind of halfway through the major capital plan that we announced earlier in the year.

Okay so the CAD250 million in the US [health one], is that the1 where you are halfway through?

Well it's not in the US [health] as the total program was, I think is CAD230 million. Yes, CAD230 million. That's split between throughout our organization.

You are about halfway through, --

By the end of the fourth quarter we'll be about halfway through, I think.

And, in terms of the discussion about the increase in log costs. Are you able to give me an idea of your mix between let's say for a BC, your mix between the beetle and conventional?

Actually to be honest, conventional is the beetle, so no, I can't give you that mix, but it has changed significantly over the last year or so.

Sean Steuart of TD Securities.

On the log cost you mentioned one of the factors was a shortage of equipment and operators, and I take it that's a function of the number of sawmills restarting in the region. Would you qualify that as more of a recent cost pressure for you, or is this something that's been building over the last several quarters?

Part of it is the start up of Mills, but probably the bigger pressure is coming from other industries like mining and oil and gas in areas like trucking where those operators can move easily between industries. So, oil and gas, coal, other mining has been very active, very strong demand for operators, and that's putting pressure on contractors in the forest sector.

Question for Ted. Wondering if you could just give us an update on what you're seeing in China for softwood and mechanical pulp markets right now. Obviously it seems like the sell off in pricing is accelerating a little bit near term. Can you just give us context on what you're seeing right now?

I think just a little background here. The mechanical pulp market really took a hit over the last year and frankly they have been quite stable or the last 6 months. In fact we've got some price improvement as Hank mentioned in the third quarter. Order books are very strong for mechanical pulp and global inventories for that grade are quite low actually. Again, we do have to think about the context of the global pulp market. For NBSK, we know the buyers in China bought significant amount of pulp and the summertime; a lot of that was shipped in September. I think that's why you saw the inventories come down. They've got a lot of product coming over there. There is a slowdown there and as usual some suppliers have bigger inventories than others and we've seen some aggressive price movement by suppliers, but I don't see this as being a long-term thing; I think I see this as a, as Hank mentioned earlier, whether it's lumber or pulp in China, it's an inventory adjustment. We see it right now as a bit of an inventory adjustment and from the West Fraser standpoint our books are in good shape.

Can you confirm that Hinton is the only pulp mill outage for Q4, and then can you remind us again the capacity expansion you will get there? Can you quantify that?

You are correct in the first one, it's our only maintenance shut down and we will not have any major maintenance shutdowns next year. And then in terms of the green transformation program which is getting us energy improvements, we are also getting a capacity increase and that increase is somewhere on the order of 100 tons a day, so that mill will end up being a 1 line mill with production next year we expect to be in excess of 400,000 tons.

(Operator Instructions) Pierre Lacroix of Desjardins Capital Markets

In the press release, you talk about that the traditional margin has been eroded, and that is part of the SPF lumber shipments to China, or sales to China. Can you quantify that at that dynamic a little bit more, please?

Could you just explain that question one more time, Pierre?

In the press release, you mentioned that your margins in the lumber division has been eroded by the fact that you're shipping some more wood, some more lumber to China, so I was curious what was the dynamic beyond that erosion?

The erosion, the major market erosion is southern yellow pine. The spread between the traditional spread between southern yellow pine and SPF is narrowed very, very significantly. I don't -- I'm not sure that the China issue has a significant impact.

We have no further questions registered at this time.

Thank you all for joining us and we'll talk to you in 3 months.

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