West Fraser Timber Co Ltd (WFG) 2013 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. second-quarter 2013 results conference call.

During this conference call, 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 is supplemented by the Company's quarterly MD&A. Accordingly, listeners should exercise caution in relying upon forward-looking statements.

I would now like to turn the meeting over to Mr. Ted Seraphim, President and CEO. Please go ahead, Mr. Seraphim.

Thank you. Good morning. Joining us this morning is our CFO Larry Hughes and a number of our senior management team.

West Fraser earned CAD109 million or CAD2.54 per share in the quarter. Adjusted earnings for the second quarter were CAD107 million or CAD2.49 per share as compared to CAD103 million in the first quarter. EBITDA in the quarter was CAD178 million or 20% of sales as compared to CAD141 million in the first quarter.

Our lumber business generated CAD125 million in EBITDA, a decrease of CAD21 million from the first quarter. We produced 1.3 billion board feet in the quarter, roughly similar to our production in the first quarter. We have increased our lumber production compared to the first half of 2012 by approximately 150 million board feet.

As I mentioned during our first-quarter results call, the increase in production is primarily due to the acquisition of the Edison Mill and the fact that some of our capital projects are up and running in the US South. Lumber prices dropped substantially during the second quarter from the highs achieved during the first quarter.

High lumber prices in the first quarter reflected increased demand as US housing construction improved. In addition, our first-quarter results were affected by weather-related Canadian railcar shortages and most producers undershipped their production. As shipping limitations were overcome in the second quarter, supply gradually outpaced demand, resulting in a decline in average pricing of approximately 14% from the first quarter.

Our earnings were also negatively affected by higher purchase log costs at our Canadian operations. We have a significant capital plan in our lumber business for the remainder of 2013 and we are in the process of commissioning one of the mills curtailed since 2008 located at McDavid, Florida. We expect that the mill will restart on a one-shift basis before the end of 2013.

Construction is also progressing on the rebuild of our Edison sawmill and it is expected to begin production late in 2013.

Our panels business generated CAD10 million in EBITDA, a decrease of CAD8 million from the previous, from the first quarter. Plywood markets were under significant pressure due to a weaker Canadian housing market as well as inventories destocking in the quarter. As a result, the average plywood price declined 17% compared to the previous quarter.

Our pulp and paper business generated CAD31 million in EBITDA, an increase of CAD23 million from the first quarter. Improved earnings this quarter reflected improved NBSK prices, a weaker Canadian dollar and higher income from selling power under our Alberta power purchase agreement.

In addition, despite the scheduled two-week maintenance shutdown at our joint venture Caribou pulp mill, we generated improved results in our NBSK business as the operating performance at both the Hinton and Caribou Mills improved from a difficult first quarter.

Although the US housing recovery continued in the second quarter with housing starts in North America running at a rate of approximately 200,000 units higher than the first half of 2012, the increase in North American production has outpaced the growth in lumber demand. To the end of April 2013, North American production increased by 8% compared to the same period of 2012 or approximately 4 billion feet on an annualized basis this year.

Lumber and plywood pricing have improved during the first half of July. Nevertheless, we are still very early in the recovery of the housing market and, as such, we should expect some volatility in lumber and panel markets through the remainder of the year. We expect prices of our pulp and paper products to remain similar to the second quarter as the current global excess supply of pulp is likely to persist.

With this, I will turn the call over to Larry Hughes.

Thanks, Ted. And thanks to everyone joining us today. Please refer to the advisory contained in our quarterly MD&A concerning our use of terms such as EBITDA, adjusted earnings and adjusted basic earnings per share.

As Ted indicated for the second quarter, we reported earnings of CAD109 million or basic earnings per share of CAD2.54. The table on page 3 of our MD&A describes and quantifies several non-operational items which affected our results. If we adjust the CAD109 million earnings to subtract the CAD12 million recovery related to equity-based compensation and add back the CAD11 million loss related to the translation of the US dollar denominated debt, the result on an after-tax basis is adjusted earnings of CAD107 million, or adjusted basic earnings per share of CAD2.49 for the quarter.

The equity-based compensation recovery reflected a weakening of the Company's share price over the quarter and a loss on the US debt resulted from a weakening of the Canadian dollar against the US dollar in that period.

On a similarly adjusted basis, results of this quarter were similar to those of the previous quarter with adjusted earnings of CAD103 million and adjusted basic earnings per share of CAD2.42.

From an operating earnings and EBITDA perspective, our lumber and panels results declined from the previous quarter, but our pulp and paper results were much better as prices improved and income from power sales made a strong contribution. Our defined-benefit pension plans are revalued as of the end of each quarter and the result this quarter was an actuarial gain of CAD77 million or CAD58 million after-tax.

This actuarial adjustment will fluctuate with changes in long-term interest rates and return on plan assets. For this quarter, the gain was due to an increase in the applicable discount rate, which was partially offset by lower-than-anticipated earnings on the plan assets. Cash generated by operating activities during the quarter after working capital changes was CAD256 million, which included the seasonal reduction of the log inventories at our Canadian solid wood operations.

Capital expenditures for the quarter totaled CAD74 million, bringing our total to date for this year to CAD123 million. We are projecting capital expenditures for the total year to exceed CAD300 million, which will include approximately CAD100 million related to power production projects.

Our balance sheet remains strong with a net debt to capital ratio of 5%.

I would like to make one clarification. In our news release we indicated that stumpage increases were set for this quarter for BC and Alberta. This is correct with respect to BC, but a stumpage increase for Alberta is dependent on future lumber prices and so, although we expect an increase, it is not technically set at this time.

That concludes my comments and, Operator, we are prepared to open the lines up for questions.

(Operator Instructions). Daryl Swetlishoff, Raymond James.

Good morning. First question. Ted, in your opening comments, you mentioned that purchase log costs were higher in the quarter. We noticed in our model that log costs in general were higher. Could you give any color on any other cost buckets that you saw?

Well, I think log costs for the prime -- we are talking about the number side of the business, obviously. But log costs -- and again our R&M and our labor costs are up as well because we are spending a tremendous amount of money on dust control in the Company. And so that has been a significant focus for us as well also. And then the [electricity] costs were somewhat higher than the previous quarter as well in our Alberta operations.

That's helpful. Thank you. Are you seeing much log cost inflation in the US South at this point?

No. It has been very muted until now.

Just switching gears a bit. Your Pulp segment, how are the pulp mills running today?

Today. Actually our basic [P&P] Mills and our Alberta newsprint mill, they run very solid day in, day out and they are much simpler processes. In terms of our NBSK mills, Caribou, we did have trouble there in the first quarter. We have to fix something during our maintenance shutdown, but that mill has been running very well since our maintenance shutdown in May. Sorry, in April. I apologize.

And Hinton, as I've said many times, we want to see it run well for a year before we get really excited about it. But that mill has been running quite well for the last couple of months.

And lastly, Ted, can you give us a bit of color on what West Fraser is seeing in the Chinese lumber market? And maybe a bit of a -- how you expect shipments to that market to evolve in the next few months.

Sure. Well, I think first of all, we have seen fairly robust demand over the last few weeks. And with the drop in lumber prices, the Chinese have definitely come back into the market so we expect demand to be quite strong over the next quarter in China.

That's exciting. Thanks. I will turn it over.

Paul Quinn, RBC Capital Markets.

Just a question. You piloted higher-than-expected power realizations in Alberta. Maybe you could quantify that.

We don't quantify those things. But, I think, power prices in Alberta, I think those are -- I think the full price in May was [hitting] on the CAD200 megawatt range. So obviously May was a strong month for us. So I think that is about all I am prepared to share on it.

But it was a strong quarter for power, but not that unusual. The first quarter was just very unusually poor. So the second quarter was maybe more typical of what we would normally see in that period of the year on an annual basis.

Then just on lumber realizations which is, I think, where I was low for the quarter. Just trying to understand that. I understand the log -- the lag with some of your market prices as prices are moving up. And obviously there's lag on the way down. Does that explain all of it or is there a little bit of a mix shift within the quarter?

No, I think it is primarily really lag, Paul. (multiple speakers). No.

And then the last question Daryl asked on cost. And if you looked at costs going forward, I mean I have got your cost up 13% year over year which is significant. And I can understand the dust control mitigation efforts and some of the log price inflation that you are seeing in the Canadian operations. What's your expectations on cost going forward? If we look out a year.

Well, as we look at the main elements, the most critical element is really our log cost, primarily in British Columbia. And so as we see those going forward -- for example in July, BC stumpage increased somewhere between CAD5.00 and CAD7.00 cubic meters. So, again, that is dependent on the market for both logs and also depending on where lumber pricing is going.

So, we expect log costs to go up in British Columbia. We expect that our costs in our -- from an operating standpoint will likely start to stabilize. Because we are getting a tremendous amount of capital throughout the lumber business in the Company. And when we do that, naturally, our costs go up. Our R&M goes up and over the next year we are optimistic that we will see some of that revert back to normal. So I think the main issue is really around log costs.

Great.

In BC.

Right. Thanks for the help. Best of luck.

Okay, Paul. Thank you.

Sean Steuart, TD Securities.

Good morning. A few questions. Larry or Ted, maybe you can give us an idea. The restart of the McDavid sawmill, what sort of capital are you looking at for that restart?

Well, I think actually to get the mill started up, the capital is very modest. But to make that a successful mill longer term we are going to be spending some capital there. But it is CAD10 million to CAD15 million.

Okay. And it is a 200 million board foot mill on a full shift basis. Is that right, Ted?

Yes on a two-shift basis it will be in that area. Maybe just slightly less.

Okay. And thoughts on potentially starting up your other idle sawmills in the South.

Well, from our perspective it really comes down to two things. Markets and priorities for our spending. So we have got tremendous amount of capital that we are spending in the US. So we decided to start up McDavid because the capital involvement isn't significant and we feel fairly comfortable about the wood basket in that area.

So we have got one more mill down at [Folkston] and we continue to evaluate that. But at this time we don't have any plans to start it back up.

And, Ted, I guess, broader perspective on Capex plans. Even with higher spending this year, you are going to transit -- you have an overcapitalized balance sheet now and it continues to improve even with higher Capex. Can you speak to, I guess, what you see in terms of further fast payback opportunities across your asset base and how you balance that maybe with acquisitions going forward.

Sure. I think in terms of capital, I think when we sit down and talked with investors and analysts over the last quarter or so, I think, whether it is Larry or myself or others, what we are really saying is we have a significant amount of catch-up capital due in the Company. And we have got tremendous -- we have got a lot of power projects and a number of other things we are working on.

So our view is our run rate for capital is about CAD150 million to CAD200 million a year and we are going to significantly exceed that this year.

We have got -- we are going to exceed that probably in 2014 and 2015 as well. So I think we have got a pretty robust program over this year and the next two years, probably somewhere in the order of CAD800 million plus or minus on a three-year basis.

Okay, that helps. And finally, and I will let you go, can you give us an update of where things stand with respect to new labor agreement negotiations? I think you had some expiries happening this year.

Yes, I think we have some labor agreements expiring in British Columbia in terms of our solid wood business. We are not the first ones up to the plate. Canfor is in negotiations right now and we expect that we will be talking shortly after Canfor completes negotiations.

Got it. Okay. Thanks. That's all I had.

Stephen Atkinson, BMO Capital Markets.

Good morning. In terms of the energy projects we are talking about CAD100 million going forward still to be completed. Is that correct?

Well, we have four projects that we are in process of building and so two of them are two energy projects that are two BC sawmills at Fraser Lake and Chetwynd and when we announced those we said that was CAD90 million in total. Those need to be completed by midyear next year. We have got our large joint venture project, our joint venture Alberta use print mill. That is a 63 million megawatt gas-fired engine power producer. And that will start up mid-fourth-quarter.

And then we have got a biogas project that will be starting up, I think late next year, early the following year at Slave Lake. So, as Larry said, it is CAD100 million this year but there will be still more spending next year.

And I am assuming the (technical difficulty) biogas project is probably your least profitable, if I may put it that way?

No, I think we believe it will be a good project. Again, it is a CAD40 million project of which CAD15 million of it was through support of Alberta and federal government. So, no, it will be a very good project for us.

Great. And do you have any tax losses or what is your position with regards to tax losses in the US and in Canada?

It's Larry. And good morning. At year-end, we indicated that we had CAD335 million of loss carryforwards. And I think if you refer to the notes, our tax note in the financial statement, you can see what we have been recognizing. So that will give you an indication of where we are at with those tax losses.

That's great. Finally, on Hinton, I know that sometimes it runs well and sometimes not as good. Are you able to give me color on the second quarter, how it went?

Yes. I think first of all, your comment sometimes it runs well, sometimes it doesn't, I think our view on it is slightly different. And that is, we did a very large capital project there in late 2011. And it was really around the pulp (technical difficulty). And we had trouble making that run. That pulp (technical difficulty) is running very well now. So the issues we had in the mill in the first quarter and that spilled over into the early part of the second quarter, more around the front end of the mill. And there were some issues in the digester and a few other areas. If we (technical difficulty).

typically since we pulp that, no. So I think we are fairly optimistic. Let's call it guardedly optimistic that we have got most of our issues behind us. But again, this is a kraft pulp mill and things do happen and we are working very diligently on preventive maintenance there.

So our goal is to make sure that that operation is as stable as the rest of our operations. So, we have got lots of work to do, but I feel like we are moving in the right direction.

Obviously you are going to improve the harvest supply with the lumber expansions in Alberta so that can I assume once you're finished that this would be a first quarter (inaudible) mill. Certainly for Canada.

That is our expectation, for sure.

That's great. Thanks so much.

(Operator Instructions). Mark Kennedy, CIBC World Markets.

Good morning. I have a few questions I wanted to get a little further clarification on. So, first of all with your comment there about CAD800 million of Capex over the next three years, is that total Capex or is that discretionary Capex?

I don't quite follow your question. But it is really our total. And that is really a ballpark figure. Depending on markets, cash flow, and -- these are projects that we see in front of us (multiple speakers) continue to look for more projects.

So it really comes back -- this is primarily payback projects. We still have CAD30 million to CAD50 million a year of maintenance capital that we have to spend so everything over and above that is payback.

All right. That is helpful. And just on the stumpage issue in BC. You are saying you are seeing stumpage costs go up CAD5.00 to CAD7.00 a cube here on July 1.

How does that formula work? Given the pullback in pricing, do think you see any stumpage relief as you move out into the latter part of this year or early part of next year? Or is this sort of generally going to be more of a one-way train?

No. I think that given where lumber markets are today, if they stay where they are today, we will see some relief in the fourth quarter.

It is about at least a three-month lag or so?

That is correct, yes.

Okay. But it is my understanding the way the formula works though as far as the increases, you get the biggest increases in July every year. Is that right?

I think, to give you the best answer, we have got Dave Lehane who is our VP of Woodlands. And I think maybe Dave could give you a more detailed answer than I could if that would be helpful.

Sure. That would be great.

Good morning, Mark. I think as you are pointing out that BC stumpage system is updated in two ways. And once a year the regression or the formula is updated based on bidding behavior in the BC timber sales program. And that update occurs on July 1. And in addition to that, there is a market update every quarter.

So, what we saw on July 1 was a combination of a new equation as well as an update based on lumber markets.

So we saw an average in the interior of CAD5.00 to CAD7.00 increase. And that lumber market is based on a three-month average with a two-month lag. So, when you look at -- look forward to October 1 there will be another adjustment in October. And our outlook based on market is that we will see in BC a stumpage decrease across the interior.

Okay. Yes that's very, very, very helpful. And then a question, Ted, coming back to your mills in the US South. Can you give us an update as to -- would you say you are now --? I think you have got, what? 13 now soon to be 14 operating sawmills there and would you say that half have been updated at this point or how far are you in terms of their modernization programs?

Well, first we have 14 sawmills in the US. Then with McDavid starting up we will have 13 running. so 13 out of 14.

And then, in terms of our capital spending, by the end of this year we will probably be around two thirds completed in terms of the capital we are spending. And our goal is to have this completed largely by late 2014 or early 2015.

And then in terms of the US market [town] you are seeing now, are you seeing stronger takeaways in the last month kind of thing relative to where we were earlier in Q2? And also if you can give any color as to where you think the inventory levels and the distribution system are there as well.

Well, I think in terms of the market we have seen a pretty positive increase since late June in the marketplace. Futures, July futures are around -- they closed around CAD290 and September futures today are around CAD330. That cash market is up about CAD35 from late June. And what we are seeing is in terms of -- and again, the data in the lumber market is, as you know, in terms of inventories is not as clear as it is in, say, pulp and other grades. But fundamentally we do think that inventories are moving in the right direction and we are relatively optimistic.

But again, we still believe we are early in this recovery. So we do believe there is going to be bumps ahead as we look at the remainder of the year.

Right. Thank you.

David Elstone, ERA Forest Products.

Hello. Just wanted to -- not to belabor the stumpage question, but when you -- when we have the increase of [CAD5.00 to CAD7.00] (inaudible) on July 1, is that -- will you feel the impact in that quarter or how does that filter through based on your producing of logs?

Dave, do you want to answer that question?

Yes. And certainly the CAD5.00 to CAD7.00 is an average across the interior. And that will be -- that will move depending on mix and haul distance and operating area. And it is -- it is in place for log deliveries from July 1 and it will also, if you look at our results, be somewhat muted by inventory.

So it will be more of a filtered process, not immediately you won't see the full impact in Q3 there.

That's right.

Okay. And just to look at your log cost in general just based on the BC mid-tier forest, based on your log prices in Q1 -- or in Q2 the trend is a jump of about 20% before that stumpage increase. Do you anticipate that long cost to -- that trend to continue and what is the drivers behind that -- these -- the jump in delivered log cost?

There's a number of factors and, certainly, there are rate pressures. We have a good mix of contractors. The contractors are under pressure for labor costs and labor availability and that flows into rates. And that is not a big number. But it certainly has an impact. We are seeing in certain parts of BC aggressive bid behavior in the private woods sector. And we are also starting to see increases in stumpage. So I think we have seen a big increase in log costs and over time I think that is going to flatten.

Is there any impact from the beetle with regards to the beetle having an impact on the cost? Or —?

I think in terms of for this call, if you would like to have more detail, maybe you should just give us a call afterwards. But generally speaking, again for our Company both 45% of our production is in British Columbia. We are very focused on what is going on here in British Columbia, but what gives us comfort is one we are spending money and investing our notes in British Columbia and secondly we have got a significant exposure in Alberta and the US South. But BC will be a challenge. There's no question as we manage supply.

But ultimately it is very difficult for us to predict where log costs are going to be going here because a lot of it has to do with the behavior of our competitors as well as ourselves.

Certainly. Perfect. Thank you.

(Operator Instructions). There are no further questions registered on the telephone line at this time. I would now like to turn the meeting back over to Mr. Seraphim.

Again, thanks to everybody for participating. And if you have got any further questions we are available to answer them through the rest of the day. And enjoy your summer and hope we will talk to you in a few months. Thank you.

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