West Fraser Timber Co Ltd (WFG) 2015 Q3 法說會逐字稿

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. third quarter 2015 results 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 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, Mr. Seraphim.

Thank you and good morning, everyone. Thank you for joining us today. I've got Larry Hughes and most of our executive group with us today, either in Vancouver or on the phone. First of all, West Fraser earned CAD56 million, or CAD0.67 per share in the quarter. Adjusted earnings for the third quarter were CAD38 million as compared to CAD13 million in the second quarter. Adjusted EBITDA in the quarter was CAD82 million or 8% of sales, about CAD10 million from the second quarter. Stronger panel and pulp results offset poor lumber markets.

Our lumber business generated CAD26 million in adjusted EBITDA, a decline of CAD19 million from the previous quarter. We experienced a significant slowdown in lumber demand from China over the summer, which further contributed to weaker market dynamics. We have experienced improved lumber demand from China over the last month or so. Lumber markets are improving, but we still expect volatility as US housing starts slowly recover. Our panels business generated CAD29 million in adjusted EBITDA, an increase of CAD8 million from the second quarter. Higher plywood prices and stronger MDF results contributed to improved earnings.

Our pulp and paper business generated CAD25 million in adjusted EBITDA, an improvement of CAD17 million from the previous quarter, substantially due to improved production at our BCTMP and NBSK mills. We're starting to experience ongoing improvement in production at our Hinton mill as we benefit from improving reliability. Production per day at the mill is up approximately 8% from last year, and we expect production to continue to trend upwards over the next few quarters.

I'd like to quickly comment on the expiration of the softwood lumber agreement. As you know, West Fraser supported an extension of the agreement. Nevertheless, this is a government-to-government negotiation. With the Canadian federal election behind us, we expect that the SLA will be an important area of focus for our federal and provincial governments. On October 30, we will complete the acquisition of Manning Diversified. We are very pleased to welcome Manning to the West Fraser family. Manning Diversified has a strong culture that will fit very well with ours, modern facilities, and a very high quality timber base.

Finally, I'd like to let you all know that West Fraser is celebrating our 60th anniversary this year, and we've enjoyed celebrations in many of our communities this year. The values that this Company were built on are clearly evident today with our employees and their families. 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. For the third quarter we reported earnings of CAD56 million or basic earnings per share of CAD0.67. In the quarter we had several significant nonoperational items which affected our results. These are shown in the table on page 3 of our MD&A.

If we adjust the CAD55 million recovery related to equity-based compensation and the loss of CAD25 million related to the translation of US dollar-denominated debt, as well as the negative CAD17 million fair value adjustment to the power agreements, the result on an after-tax basis is adjusted earnings of CAD38 million, or adjusted basic earnings per share of CAD0.46 for the quarter. The equity-based compensation recovery reflected a decrease in the Company's share price over the quarter, the loss on the US debt resulted from a weakening of the Canadian dollar on a period ending basis, and the negative adjustment to the value of the power agreements reflected a weakening of the Alberta electricity futures market.

On a similarly adjusted basis, results of this quarter improved compared to those of the second quarter of 2015, when we achieved adjusted earnings of CAD13 million and adjusted basic earnings per share of CAD0.16. From an operating and adjusted EBITDA perspective compared to the previous quarter, our lumber results declined while our panel and pulp and paper results improved. Adjusted EBITDA margin for lumber declined to 4% from 6% in the previous quarter and 18% in the same quarter of 2014. For panels, adjusted EBITDA margin reached 20%, up from 15% in the previous quarter and equaling the 20% achieved in the third quarter of 2014. For pulp and paper, adjusted EBITDA margin improved to 11% from 4% in the second quarter and 5% in the third quarter of 2014.

Cash generated by operating activities during the quarter after working capital changes was CAD89 million. During the quarter we repurchased and canceled just under 1.1 million common shares at a cost of CAD60 million. Under the normal course issuer bid, which expired in September 2015, we purchased a total of just under 1.4 million common shares at a cost of CAD78 million. We have renewed the normal course issuer bid for another year and have the ability to purchase up to 4 million common shares, or approximately 5% of our total outstanding shares.

Capital expenditures for the quarter totaled CAD51 million, bringing our total for the first three quarters of 2015 to CAD169 million. The rate of capital investment has slowed with the substantial completion of several of our energy related projects and some adjustments in the timing of some of our sawmill upgrades. We are projecting a total capital spending for the year in the CAD200 million to CAD225 million range. After the end of the quarter we successfully extended the maturity of our committed revolving facility to September 30, 2020.

Our balance sheet remains strong, as we ended the quarter with a net debt to capital ratio of 17%. We expect to complete the Manning acquisition later this week by drawing on the revolver. And Ted, that concludes my report.

Great. Thanks, Larry, and we're ready to open it up for questions.

(Operator Instructions). Mark Wilde, BMO Capital Markets.

Can you, first of all, just help us with what's going on in China right now? You said in the last month or so it sounds like you have seen volume pick up again, so I wondered if you could just break China apart. What's underlying demand doing? And just how much pressure are you seeing from more Russian wood or New Zealand logs or whatever coming into the market?

Yes, you know what we'll do is, Chris McIver, who manages our sales, is on the line, so maybe I'll ask Chris to comment on that. Because we've got some folks over there right now, so I think he can give you a pretty up-to-date flavor. Chris, can you comment?

Sure. Thanks, Ted. Yes, it's been a really interesting ride the last, call it six months; most of this year, actually. I think a couple things happened. Early on pricing dropped month after month after month, and a lot of our customers ended up with higher-priced inventory than they generally would've liked, and were having trouble moving it. At the same time, there was some financial issues going on in China. That tightened up credit, which put pressure on them on opening letters of credit, which is really important for us to get the flow of business working.

If you put all that together, and really it severely constrained the business for two or three months. And that was really through the month of September. And we've really seen a pretty good rebound in both volumes and interest in China, certainly the last month and going forward for the next couple of months, for sure. We are seeing a bit of a shift from construction to more what I would call R&R and furniture related activities, as well as some of the business moving from the traditional tier 1 cities to the tier 2 and tier 3 cities. So, it's still not where we want it to be, but it's much improved from where it was.

How do you guys deal with that? Are you reallocating export volume into the North American market? Are you looking for other export markets? How do you manage that?

Yes, firstly, it's difficult. A lot of it has been low grade product, and we have shifted an awful lot of that to North America. You could see that in our low grade if you -- low-grade returns in the US have been dramatically hit by that. And as we see the things recover there, then I think you're going to start to see returns be more normalized going forward. So yes, we've shifted product all around. And we've done things as far as production as well.

Okay. All right. And then, Ted, I wonder if you can just comment on any changes you've seen in competitive behavior with the expiration of the SLA. I know in the weeks leading up to the expiration, it seemed like volumes from Western Canada into the US had fallen off quite a bit. And I didn't know -- I assumed that that was people just holding back until the SLA expired and they could ship in duty-free.

Well, I don't really know if that's the case, at least for large companies. We can't manage our inventories that way. We've got to ship our product every day. And so, from our perspective, we really haven't seen a shift. I think it's more -- and maybe, if you'd like, Chris can expand on it -- but I think it's more from the market side. The brokers and the distributors, who I think in the US were just sitting on their hands trying to figure out what was going to happen. And I think that's why we've seen an improvement in the markets the last little while. They were not carrying very high inventories, so -- at least that's my understanding.

So I think that it's really more of the behavior of the buyer side than at least companies like West Fraser. And just to further add to Chris's comment about how we're dealing with China, there are things we can do around recovery and grade in terms of how we manage our mills to reduce our production of low grade -- low-grade production as well, so that had a bit of an impact on our third-quarter results as well in terms of our production.

Okay. And then just one last one for me right now. Could you just talk a little bit about plywood prices? Because it has really surprised us. We follow the pricing in the trade papers and a lot of those indices were down pretty sharply quarter to quarter, second quarter into third quarter. And you guys held up really remarkably well.

Well, it seems like this call is moving to mostly about markets, and I think I'll have Chris add onto my comment. But again, the weakening Canadian dollar helps us a lot, because we sell almost all our plywood in the Canada market. So I think if you're looking at the US market, you may be seeing things a little differently in Canada. But I don't know, Chris, if you want to expand on that at all?

Yes, Ted. Mark, I would just add there is a definite separation between Canadian plywood and southern yellow pine. And Canadian plywood prices have held up much better. And there's always a lag effect on pricing. Pricing has weakened a little bit at the end of the third quarter, and that of course shows up in the fourth quarter, not so much in the third.

Okay, all right. That's helpful. I'll turn it over.

Paul Quinn, RBC Capital Markets.

In your MD&A you disclosed the Manning acquisition for CAD66 million, plus working capital. Maybe you could give us a couple more financial metrics around that acquisition?

Well, first of all, good morning, Paul. As you know, we always disclose all the information you'd like us on acquisitions. That's a bad joke. But fundamentally I think that acquisition was CAD66 million with normalized working capital over and above that. And I guess the other key metric is that we expect, with some debottlenecking and actually the current owners, who will shortly be the previous owners, were working on that. And some small capital at the front end of the mill.

And so with that, we expect that we'll be able to get the mill up to 130 million feet of production. It's a very modern mill, it's a very good timber supply. And if we look at the financial metrics, we've got five other sawmills in Alberta, so we have a pretty good understanding of what it takes to be successful in Alberta. We are very delighted to have that mill in the West Fraser family.

Well, I imagine it's quite a good mill, given the high cost on a per unit basis.

Yes.

So maybe you could give a trailing 12 months EBITDA. Maybe that would be helpful.

We don't disclose on individual mills, Mark -- I'm sorry, Paul.

Okay. Then just moving on to log cost inflation, what you are seeing there in Canada and the US. Is that still coming up quite a bit in Canada versus flat in the US?

Yes, I think in terms of the US, we saw some increases in the first quarter, but it's really been quite, on average, quite flat since then in terms of log costs. And in Canada we are looking at a 5% year-over-year increase from 2014 to 2015. That's how we see that for our Canadian business.

Okay. And just on Hinton, you outlined the 8% improvement in productivity. I guess that's per day. What is that benchmark compared to your other half interest in Cariboo? Are you closing the gap there or is there still significant room?

Well, I think from a financial standpoint, Hinton is the one that has the big impact on us for two reasons. One, we own 100% of it. Two, the gap from where that mill should be and where it was, was pretty significant. We still think we've got significant room to improve production there. We've had some very strong months that are significantly higher than that 8% improvement. So, Hinton is where -- will have the biggest impact on our financial results.

Cariboo, that mill has typically run closer to plan. We've had a few issues this year, we've had a few challenges, but nothing really material. So we don't have significant concern about that mill. And actually our view towards Hinton today is a very positive and we're pretty encouraged about where we're going with it.

So for planning purposes we should continue this 8% improvement, would be on the conservative side then?

Our expectation is that we are going to surpass our quarterly production from the third quarter into the fourth quarter, and continue to see upside in production there.

That's good. And just lastly on SLA, because you guys mentioned it. Expectations going forward here?

Well, I think first of all, as I said, it really is a government-to-government negotiation. And I guess we're probably the first ones out of the blocks, so I think it's important that we comment on it. I think the fact that we didn't get an extension is probably due to multiple reasons, but one of the big reasons was the federal government shut down this summer because of the election. And so now with the expiry, as everybody knows, we're in the standstill period. And I do believe that there's interest on both sides of the border to find a solution here.

And we're still waiting for our Trade Minister to be announced, but really I think that's hopefully November 4. And our expectation is that, at least at some point later this year or very early next year, we'll see the Canadian and US government engaged and see if we can find a solution here. But I think there is -- I think both sides of the border are motivated to find a solution here.

That's all I had. Best of luck, guys.

Sean Steuart, TD Securities.

A couple questions. You ran your BCTMP pulp mills full out again in the third quarter. We continue to see prices, in US dollar terms, roll over fairly steeply. Are you guys close to a point where you'd consider taking any market downtime at those operations, as some of your competitors have?

Well, I think the best way to answer that question is we have an excellent BCTMP business. And if you look at history, if you look at over the last 5, 10 years, West Fraser runs at a much higher operating rate than the competition. And we expect with our cost structure and the capital we've invested in our BCTMP business for that not to change. So, not that we would ever comment on curtailments, but I can tell you we are very focused on running all our pulp mills at 100%, and don't really see that changing.

Okay. The next question is just on sawmill M&A opportunities. Ted, just generally, what's the opportunity set look like, both in the US South and Alberta now? It felt like maybe some of the easy opportunities have transacted already. What's the deal flow look like from your perspective?

Well, I think every company has a different view towards M&A, and I think ours is very much not on -- we're not primarily focused on growth. We're primarily focused on acquiring great assets with strong timber bases, and hopefully with some synergies with our current asset base. So, from our perspective, we don't look at every opportunity out there, so we've been very selective. I can't really comment on what's out there in the pipeline.

I would imagine, though, that given the -- what's happened in the lumber markets over the last few months, that the expectations on the seller side may be changing. But from that perspective, it's really hard for us to say where this is going to go. As Larry mentioned to me, foreign exchange is having an impact when you look at US acquisitions. We continue to look at things, but we are really focused on mills that fit well with West Fraser. And Manning really fit well with us. We are the largest lumber producer in Alberta by a significant margin. This is the third sawmill we've bought in Alberta in the last couple of years. We've modernized four out of our five saw mills, so Alberta is really core for us.

Understood. Okay, that's all I had, guys. Thanks very much.

(Operator Instructions). Daryl Swetlishoff, Raymond James.

Sean asked all my questions, but maybe I'll ask a follow-up. Just on the pulp segment, we were a bit surprised by the quarter over quarter -- how much better you did. You lost CAD8 million EBITDA in the second quarter. Is that mostly -- if we just look at the second quarter and into the third, is the improvement mostly related to performance improvements in Hinton?

Well, first of all, we went from positive CAD8 million EBITDA to CAD25 million, Daryl.

Right.

First of all, good morning. But in terms of -- I mean, really, we had some struggles with our BCTMP business in the second quarter as well. As you can see, our production is up by about 14,000 tonnes at our two BCTMP mills. We also had our major maintenance shutdown, even though we take 50% of the costs [out of the] Cariboo in the second quarter. So I think when you look at Cariboo shutdown, BCTMP running better, and Hinton running sequentially better in the third quarter. Those are probably the main contributors to our improved results.

Okay. And looking at Manning, so Manning is the second recent data point we've seen where a BC major has paid around CAD150 a cubic meter. Do you think that's an accurate reflection of the value of Canadian AAC going forward?

Wow, that's an interesting question. I think as we look at Alberta, that's probably a reasonable way to look at it. But over and above that, you've got to look at quality of the mill. And I was just up there -- Larry and I were just up there with our operating VPs two weeks ago, and it is a spectacular mill. It's one of the cleanest mills I've ever seen. They spent a lot of capital. They've got an energy system in there. They've got a very modern drying with their kilns. They put a new -- a major planer upgrade in there a few years ago. They put in a new line in the sawmill at the front end of the sawmill a few years ago.

So they spent a lot of -- it's a really well-capitalized mill. So, to say CAD150 a cubic meter on wood on its own, I don't think that would be the right way to look at it. It's probably the combination of great timber base and an excellent mill. And I guess the last thing I want to add, I said it in my comments, but I really do want to reinforce this. When we walked into that mill I felt like we were walking into a mill that West Fraser had owned for many years. We're really delighted at that operation. And we realize that you will view this as a premium price, but we got a premium asset. We're very excited about it.

Thanks for that, Ted.

Mark Wilde, BMO Capital Markets.

Yes, just a couple of follow-ups. Ted, any thoughts on how you guys see the housing market as we move toward 2016?

Boy, I was going to throw this to Chris but I don't think it's fair, so I'll take a shot at it. Really it's the forecasts; our forecasts are as good as yours.

Yes. Mine aren't worth much.

Well, there you go. So yours are probably worth a little bit more than ours. But we actually did a fair amount of work on segmenting lumber demand this summer. We did a fair amount of work as a company, and I think fundamentally I feel like at multifamily, you look at repair/remodel, you look at all the uses for lumber, the one area that sticks out that we need to see material improvement in is single-family housing.

And we also need to see a housing number -- and we've been saying this for a couple of years, so I think we're starting to sound like a broken record -- but we really believe that if we see an incremental, say, 200,000 housing starts in the US -- that's, on average, 2 billion feet of demand. And if you look at further growth in the other uses, those are the things that we think are what's necessary to see a robust, strong, sustained up market.

And whether that's next year or the year after, we're not sure, but we do believe it's coming. And our medium-term view of the lumber business has not changed at all. But in terms of picking the time and the number, I'd rather pay for your -- I'd rather hear what you have to say about it, maybe offline one of these days.

Okay. Just two other things. One, do you have any visibility on your log costs in the southern US for 2016? Are you starting to buy stumpage or contract for logs right now?

Not really. We tend to be in the market just about every day. As you know, it's more of a day to day, week to week, month to month market. But we really don't see any material pressures, on average, in terms of log costs. So this year is -- we've been flat for really on average for two quarters. So I think we're either going to be flattish or potentially maybe just up a little bit, but we don't really expect a lot of log price inflation in the US, though, for 2016.

Okay. And the last question I had is for Larry. Larry, we missed your inventory charge by quite a wide margin this quarter. I wondered if you could give us some help in thinking about how that inventory charge or inventory adjustment moves for West Fraser going from a quarter to quarter basis.

I'm going to ask Rodger Hutchinson, who's here with me, to respond to that one.

The inventory write-down, Mark, mostly related to the lower grade of -- lower grades of lumber, utility and economy lumber. And there was a dramatic price decrease at the end of the quarter compared to the quarter before. So essentially that's what drove the inventory write-down.

Okay, so really just a function then of the proportion of your business that's kind of low grade, coming from the interior, and the drop that we saw in that market in the third quarter?

Yes.

Yes.

Yes, quarter to quarter comparison, right at the end of the quarter, Mark. And since then we have seen some recovery in prices, so it shouldn't be as much in the fourth quarter. Knock on wood.

Okay. All right, sounds good. Good luck in the fourth quarter, guys.

Paul Quinn, RBC Capital Markets.

I thought because you're so good at answering the questions, I thought I'd throw a couple more at you.

Okay, Paul (laughter).

So the first one was just the contribution from your two BC bioenergy plants. They were fully commissioned. What was the contribution in the quarter, ballpark?

Sorry, which plants are you talking about? The --.

Fraser Lake, Chetwynd?

Right, okay. I think you should assume no contribution for this quarter. Just minimal. And they are still ramping up, and we're going to see a contribution by the end of this year, as well on the biomethanation plant. We look for a contribution by the end of this year.

Okay. And then you mentioned CapEx coming down from where we had it. What's your expectation for 2016? Are we at a run rate CapEx now for West Fraser?

Yes, that's a very good question. We're doing our plan right now, Paul, and I'd expect that we might come in a little higher next year. We're staging a little bit more. We're trying to make sure that some of the current capital projects, we let the folks get those running and get our feet on the ground in some of the areas. And then we will go back. So it's possible that we'd be slightly higher in 2016, but we'll have a lot better view of that at the end of the next quarter, or this quarter.

Okay. And then just lastly on China. The expectation for volumes this year, is that going to be flat to 2015, or are you going to be slightly down due to the weakness we saw in Q3? And then how do you think about that market for 2016 and 2017? Is that going to hold up or are we going to see a decline?

Yes, so you want us to compare this year to last year. To the first two quarters we were, I believe, a little bit higher than 2014. But I think as we look at this year we will be down. And a lot of it depends on the next couple of months, but as Chris says, we've got pretty strong order files. And in terms of our outlook as we look at China, I think the BC Interior shipped around 3 billion feet or a bit more to China last year. It will be a little bit less than that this year.

We can't truly forecast what's going to happen, but we still expect China to be a significant buyer of lumber from British Columbia. So I don't know what the numbers for next year, if it's less, it might be 10% or 15% less, or it could come back. We've seen this in other commodities where we've had experience in China. Part of this could be demand, but the other part of it, as Chris mentioned, is a number of these distributors are getting weeded out through the challenging market that we've had for the last few months.

So this may be actually a good thing, where we get to a bit more stable distributor base. And hopefully we can see demand rebuilding there. And we're very focused on developing the China market, and so we do see it as a long-term market for us, Paul. What the numbers will be next year, I think it would be hard for us to really forecast, but it will continue to be a core market for us.

Great. Thanks, guys. That's more helpful.

Hamir Patel, CIBC World Markets.

Most of my questions have been answered, but just one follow-up I had on the pulp business. Just wondering if you had any thoughts about how contract negotiations in the industry are going for 2016. Are you seeing signs of buyers maybe cutting back on their contract volumes in favor playing more in the spot market?

My memory must be escaping me. I should know this, but I'm pretty sure it's 2017 that we're looking at negotiations. But we'll get back to you in case I'm wrong. But I can tell you this much: it really hasn't been an issue for us in the past. We don't see the buyers being too concerned about it, and we're really not -- not that we're taking our negotiations lightly, but we're extremely focused on our relationships with our employees at every one of our mills, whether they are union or nonunion. And so that's where our focus is. We've had very successful negotiations over the last number of negotiations, and I don't expect that to change going forward. But we'll get back to whether it's 2016, but I'm pretty sure it's 2017.

Okay. No, I guess I was referring more to the actual contract prices in the NBSK market in terms of buyers potentially wanting to play more in the spot market versus --.

Oh, I thought you meant labor negotiations.

No.

Yes, I think that really -- there's so much fluidity to the pulp market. And at the end of the day I think a lot -- we're getting more and more of a world price, so whether you have a contract or not, I don't think it's all that relevant. It's a really what's going on with the world price of pulp. So, I think people want to be kept [better living], and so that's what our expectation is. Really no change from how pulp markets are -- or how we manage our relationships today with our customers. We don't really see that changing.

Fair enough. That's all I had. Thanks.

Thank you. There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Seraphim.

Well, first of all, thanks very much for calling in and hopefully we did our best to answer your questions. And Larry and Rodger and I will be available if there are any follow-up questions later on today. So with that, enjoy your day and thank you very much for calling in.

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