West Fraser Timber Co Ltd (WFG) 2015 Q2 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. second-quarter 2015 results conference call. During this 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 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. Ted Seraphim, President and CEO. Please go ahead.

Thank you. Good morning, and thank you all for joining us today. West Fraser earned CAD14 million forced or CAD0.17 per share in the quarter. Adjusted earnings for the second quarter were CAD13 million as compared to CAD100 million in the first quarter. Adjusted EBITDA in the quarter was CAD72 million or 7% of sales, down from 17% in the first quarter. Lower product prices were the main reason for the decline in earnings.

Our lumber business generated CAD45 million in adjusted EBITDA, a decline of CAD72 million from the previous quarter. The composite lumber price continued to fall through the first half of May and was down at one point by almost CAD75 from the beginning of the year. There was some strengthening in the market during June, but prices are still CAD40 below where they were at the beginning of the year. Difficult markets were partially offset by improved operations and the early benefits of our capital program. Our second-quarter production was 7% higher than in the first quarter of the year. Our two energy projects at Fraser Lake and Chetwynd were operational by the end of the second quarter.

Our panels business generated CAD21 million in adjusted EBITDA, down CAD5 million from the first quarter. Lower plywood prices more than offset higher shipments in plywood.

Our pulp and paper business generated CAD8 million in adjusted EBITDA, a decline of CAD22 million from the first quarter. Although list prices for NBSK were down only 2% for the quarter, actual transaction prices for NBSK and BCTMP pulp fell further which accounted for approximately 50% of the decline in our results. Major maintenance shutdowns our Cariboo joint venture NBSK mill, and our Quesnel River Pulp plant impacted results as well. Our Hinton pulp mill continues to show improving operational performance.

2015 will be another significant year for capital spending as we complete an ambitious five-year capital spending program in excess of CAD1.3 billion. Over the past nine to 12 months, we started up 10 new continuous kilns, four new planers, two major sawmill upgrades, as well as four major energy projects. While we are at different levels in the startup curve for each project, we are very encouraged by the current and projected improvements in cost, productivity, and revenues associated with each project.

After a poor first quarter, we saw the resumption of the US Housing recovery in the second quarter as US housing starts average 1.15 million units in the quarter. Despite slowing demand in China, our business remained strong in the quarter. We continue to be optimistic regarding medium-term demand for our lumber products in both North America and Asia. An improving US economy supported by low new home inventory should continue to spur new home construction.

Pulp markets are expected to be under continued pressure as we face the combination of new capacities and slowing demand in China. Despite the market challenges we have seen thus far in 2015, we are very encouraged about the future outlook for the Company as we continue to focus on investment in capital and people to ensure that we are driving industry-leading margins. I am very proud of all of our employees and their efforts to improve operations while executing the largest capital program in the Company's history.

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

Thanks, Ted, and thanks to everyone joining us today. Ted and I are making reference to several non-IFRS terms during today's call, and so I would refer you to our MD&A under the heading, non-IFRS measures, for definitions and descriptions of how these terms are calculated.

For the second quarter of 2015, we have reported earnings of CAD14 million or CAD0.17 basic earnings per share. Beginning on page 3 of our MD&A, we identify various nonoperational items, which we adjust from earnings in order to more clearly reflect results from our operations. The result which we refer to as adjusted earnings was CAD13 million or CAD0.16 adjusted basic earnings per share. This compares to CAD1.19 for the first quarter of 2015 and CAD0.77 for the second quarter of 2014.

I am not going to go over all of our nonoperational earnings adjustments, but I will mention the adjustment to our electricity purchase contracts. Beginning in the fourth quarter of 2014, we have been required to record an adjustment for any change in the fair value of our two electricity purchase and sale contracts. And at the end of the fourth quarter of 2014, this reevaluation produced in unrealized loss of CAD2 million. And at the end of the first quarter of 2015, we recorded a further unrealized loss of CAD30 million, mainly the result of projected significantly lower electricity prices in Alberta. As at the end of the second quarter, the outlook for electricity prices had improved, although partially offset by projected cost increases, with the net result being an unrealized gain of CAD18 million. And so on a year to date basis, in 2015, we have an unrealized loss of CAD12 million.

In the quarter, we saw a significant deterioration of SPF in Southern yellow pine lumber prices, which had a significant effect on our quarterly results, including a lumber and log inventory write-down of CAD21 million. These significant inventory revaluations are the result of the sharp fall in lumber prices at a time when log and other costs have tended to reflect the gradual recovery of US housing construction and lumber markets in general.

Lower lumber prices also triggered the imposition of export duties under the 2006 Softwood Lumber Agreement, and we expensed CAD12 million in export duties during the quarter. We have provided more details about these duties in our MD&A. The basic duty rate that not including surge penalties for July, is the highest under the agreement at 15%, which is the first time in three years that the basic -- the highest basic duty rate is applied.

Despite the relatively weaker financial results, there were some encouraging operational results from all three segments as lumber production increased by almost 7% compared to the previous quarter. Our panel mills ran well, and in the pulp and paper segment we continued to see improvement at Hinton pulp mill. There are no scheduled maintenance shutdowns at our pulp mills for the balance of the year. Each of our NBSK mills are scheduled to have five-day maintenance shutdowns in 2016 and each will have a major maintenance shutdown in 2017.

Cash flows from operating activities were CAD194 million as we consumed the seasonal excess Canadian log inventories during the quarter. Capital expenditures were CAD49 million in the quarter, reflecting a gradual slowdown in the pace of our capital spending as we complete several of our energy projects that have been in progress over the past few years. We are still projecting to spend more than CAD250 million in 2015 as we continue to upgrade sawmills in the US and in Canada. Our normal course issuer bid continues to be in effect, but we made no share purchases during the quarter.

We revalue the funded position of our defined benefit pension plans at the end of each quarter, and this resulted in a CAD54 million after-tax actuarial gain this quarter as a higher discount rate reduced the present value of our liabilities, which was only partially offset by a lower rate of return on our plan assets. Our plans continue to be well funded. Our balance sheet as of the end of the quarter remains strong with a 15% net debt to total capital ratio. And, Ted, that concludes my comments.

Okay. Thank you, Larry, and I think we are now ready for questions.

(Operator Instructions) Sean Steuart, TD Securities.

I will start with the pulp and paper segment. I am just trying to reconcile the changes in your unit cost quarter over quarter, Q1 to Q2. You guys gave us detailed downtime tonnage figures for the second quarter. Do you have those figures for Q1 as well, just as I try to reconcile it?

Well, first of all, good morning, Sean. I think we had no scheduled maintenance downtime in the first quarter.

Yes, I guess just with the Hinton hiccups, I am wondering about lost tonnage in Q1 there. But I guess the other question is, it sounds like Hinton ran better this quarter, but in the MD&A there was some reference to maintenance expenses still incurred there. Can you put a dollar figure on that number?

First of all, we don't really comment on it. It is not really material. But, I think, overall -- if you look at our overall NBSK production, it was basically flat from quarter to quarter. And so that can tell you that we have seen improved production at Hinton given we had our major maintenance shutdown at Cariboo.

Okay. Thanks, Ted. And then, it sounds like there is not much scheduled -- or nothing scheduled through the latter half of the year. Is everything running well in the pulp side into the third quarter?

Yes. And actually Hinton continues, it is still early in the third quarter, but we made a step gain in the first quarter and another step in the second quarter, and we are continuing to make a step gain in the third quarter. I mean, we need a long run rate before we feel completely confident, but we are moving in the right direction.

And then, in terms of our major maintenance, it really is our NBSK mills. We had to do some at QRP, but it is not that significant. It is normally four or five days. And we are basically on a three-year major maintenance schedule at Hinton. So the next one will be 2017 in the fall. And every second year comparably. So our next one will be, again, in the spring of 2017, but we have to do minors at those two kraft pulp mills, every year at Cariboo and every year and a half at Hinton. So really nothing until the second quarter of next year, Sean, as long as we run well.

Okay. Thanks, Ted. And then, just one last question and I will get back into queue.

You bet.

Alberta power prices this quarter, trying to gauge the sequential impact in your results. I know it varies quarter to quarter with your -- the agreements you have set up, but can you give us any impression of how much that might have affected Q2 results?

Well, I think it was really not that material. I think, when you look at our evaluation of our power purchase agreements, that is more about the longer-term full price went up. So that was -- that doesn't really reflect what happened in the quarter. It was a pretty -- power prices were fairly low during the quarter.

Okay. I'll get back in the queue. Thanks.

Paul Quinn, RBC Capital Markets.

Just on pulp, following up on Sean's maintenance question. Just because you don't have any major maintenance in 2016, can you ballpark the cost difference between 2016 and 2017, given the major maintenance [in 2017 at these two mills]?

Well, I should probably defer to Larry because I don't think we disclosed this, but I will leave it to Larry to comment on that.

Yes. Paul, we haven't -- we don't give that kind of detail in terms of what specific maintenance costs are, but the minor shuts do not really have a material effect and you see what the major shutdowns can have a significant impact as we saw at Cariboo this quarter.

Okay. So it sounds like more than CAD10 million, but less than CAD20 million.

(laughter) Well, as we said, for Cariboo, the Cariboo and the QRP shut down accounted for half of the CAD22 million decline in the quarter. And Cariboo is a bigger part of it. So that is probably all we are prepared to disclose. We are giving you a pretty good hint there.

Okay. Thanks for the hint. I'm trying to figure out where lumber prices are going forward here. It sounds like the -- I am curious as to what you are hearing from your customers for the back half of the year, but just the customer impact as well as export volumes and then expiry of the SLA, what do you think happens in the balance of the year?

That is a big question, and I think we all have our own views on it. And as we have said many times, we don't spend a lot of time predicting the next quarter or the next six months. And I think about a year and a half ago, we did say until we get to 1.3 million housing starts -- and we don't know if that is the right number, but we have been saying that for a while -- that we will expect volatility. So I think that is all we can say right now is we can expect volatility.

I think customers are trying to figure out how to deal with the expiry of the SLA. But let's remember that we will be in a standstill period from October 12 this year for another year. So I think there is a bit of uncertainty.

In terms of -- and so, really, Paul, I am not helping you with that. I mean, we really don't spend a lot of time predicting where markets are going. Now, in terms of export, our volumes continue to be strong. There is price pressure in China, given the weaker currencies that we are competing with out of Russia and New Zealand, whether it is logs or lumber. But from a demand standpoint, and I think we have been saying this for quite some time, which appears to be contrary to the expectations of some of the forecasters, but we continue to see stable demand in China and our expectation is really [for the same] for the third and fourth quarter this year. So demand standpoint, there are not any big curve balls that we see coming at us. How people manage -- how customers manage markets around the expiry of the SLA is really more to them than up to us.

Okay. And the last question I had, just log inventories in front of your lumber mills, especially in BC, with -- BC and Alberta, with fire season here, is that normal levels? Are you experiencing any issues or --?

We have not been impacted directly by any of the fires. But that being said, our inventories generally are in good shape. We have got one or two mills where they are little bit on the low side. So we are still concerned about what the rest of the summer looks like. But at this point, we are feeling pretty confident about our log inventories overall.

Great, that's all I had. Thanks, guys.

Mark Wilde, BMO.

Ted, I wondered if you could talk a little bit about the other side of the lumber trade equation. You talked about sort of exports to China and elsewhere. What are you seeing in terms of imports coming into North America, especially into the US, given the strength of the dollar?

Well, imports to the US have increased a little bit over the last year, given the currency. But they are still -- I think they are still 15% or so of where they were at the peak. So they are really not material at this point, Mark. So we really haven't seen any real impact on our business in terms of lumber imports. We really do believe that, for it to be material, pricing has got to be well north $400.

Okay. All right. And, Ted, I guess just, you have been in the Southern US now for about a decade. You have invested a lot of capital down there. What have been your biggest surprises about doing business in the Southern US about -- rather than doing business out in Western Canada?

Well, this is one question, I am not sure I can answer that in this call. Fundamentally, not so much surprises, but it is a different way of doing business. I think the best thing that ever happened to us is that we looked at our capital program, probably in 2005 down there, we would have looked at it quite a bit differently than we do today. And so in Canada the mills are large. In the US to be competitive our footprint is much smaller because we want to make sure that we are competitive in each timber grain. So I think that really is the biggest one. And as we have developed our capital program over the last three or four years, we really focused on a bit of a different structure down there than in Canada. Other than that, really no big surprises. I've got to tell you, we are delighted to be down there, and it is tremendous diversification for the Company.

Yes, I guess, typically, Southern US mills have only run one or maybe two shifts. Have you been able to change that at all to kind of move more toward how you operate in Western Canada?

No. We typically run our mills down there -- we are not a one-shift company. We typically run two shifts down in the US, sometimes up to 100 hours. Sometimes a few hours more at one or two mills. But, generally, it is really all based on ensuring that we have got the right workforce and that we are in the right competitive position in the timber grain. I think that is really part of the tradition in the US South. Most of -- we tend -- a lot of the independents are run one shift, but we tend to run -- we run much more hours in the independents.

Okay. Is it fair to say you are still looking for further opportunities in the Southern US?

Well, we are a Company that wants to grow, but we want to be very disciplined about it. And we have a very much of a long-term view. So ultimately, we want to grow in the US, but it really will depend on valuations and our view on our ability to develop [top second or first core sawmills] down there. So we look at everything and there is opportunities that we pass on or opportunities that other companies think are more valuable than us. But we want to continue to grow down there, for sure, because it is the one significant growing timber basket in North America.

All right. That is helpful. Listen, good luck in the second half of the year.

(Operator Instructions) Daryl Swetslishoff, Raymond James.

Ted, West Fraser has been running CapEx at multiples of depreciation for an extended period of time here. As you guys look ahead, through 2017 and 2018, can you foresee a time when you get back to that CAD175 million, CAD200 million run rate?

Yes, I mean, we continue to look at opportunities that, but again, we want to be very prudent about it. We have to earn a good return on our capital. We still have more capital to spend, but I think by the time we get to 2017, I would expect that we will be much closer to our depreciation. And that is -- it's not our depreciation, but kind of our run rate of, Rodger has mentioned many times of CAD175 million to CAD225 million. So I don't think it is too far up there when we will be back to that rate.

Okay. And given that and given some of the returns on the investments that you have had, we see free cash flow improving over this period. What would be some of the priorities for that free cash flow from the management point of view?

Well, I will make a few comments and then I think I will ask Larry to make some as well. But at the end of the day, it comes down to -- that people call balance sheet allocation. And we fundamentally continue to look for ways to improve our existing asset base. And it is not just traditional projects, but it is other projects that add further integrated value to the Company. Five years ago we were not spending money on energy. So we continue to look for new opportunities. And we continue to look for technologies that will reduce our costs and increase our margins. So I think that is really a never ending quest. Of course, we want to grow -- and I mentioned that to Mark. And then, finally, we have the ability to do share buybacks. So those are really the three areas. But Larry may have some further color on that.

Yes. Not much, Ted. Daryl, the internal improvement is our major focus, but we are growth oriented so we want to always have enough dry powder available to take advantage of growth opportunities. Share buybacks, we were in the market a year ago. We took the opportunity there and we have a modest dividend that we consider and our Board considers every quarter the dividend level. But the key thing is that we are not going to get ahead of ourselves. What we have seen is it is a very volatile pricing and still pretty fragile market. So, we are looking forward to managing the balance sheet in the future, but we are going to continue to be quite conservative in our approach. And lastly, I think we will not be shy about carrying some cash on the balance sheet if we think we are going to have opportunities in the future.

Okay. Thanks for that, guys.

Mark Kennedy, CIBC.

First question, Ted, just on the bioenergy front. Do you expect your two ORC plans to start generating a contribution here in Q3, or how should we be thinking about that as we look into Q3 and Q4?

Yes. I mean, we expect to -- we are generating a contribution today and my expectation is we will be at full run rate going into the fourth quarter of the year because we have been through the startup for a little while now and we are very encouraged by the performance of these plans. So, I think we will see a contribution definitely second half of this year.

Okay. And then, just a question on the softwood lumber deal here. I am certainly not holding my breath that you will have a deal by this October, but just curious on your views. Assuming we go into the standstill period, do you think we will have a deal by October 2016?

Well, I don't have my crystal ball with me. But what I can say is that we have assets on both sides of the border. And from our perspective, this agreement has worked well for the US. We are dealing with issues like the federal election this fall so there is a number of issues that are outside of our control. TPP, Trans-Pacific Partnership, which is really taking all the attention of the Canadian and US government. So I think once they start to focus, post election, on our industry, my expectation is there is a lot of goodwill between Canada and the US, both at the government and the industry level. So my expectation is that we have a good opportunity to find a solution over the next 15, 18 months.

Okay. That's fair. Thanks very much.

There are no further questions registered at this time. I would like to return the meeting to Mr. Seraphim.

Well, first of all, thank you, everybody, for joining us. Enjoy the rest of your summer, and I know that Larry and Rodger are more than happy to take any of your individual questions, if you want to give them a call after this. So thank you very much and we will sign off.

Thank you. That concludes today's conference call. Please disconnect your lines at this time, and we thank you for your participation.