West Fraser Timber Co Ltd (WFG) 2016 Q3 法說會逐字稿

Good morning ladies and gentlemen. Welcome to the West Fraser Timber Q3 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 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. Good morning. I think what we will do today is a little different. Larry will -- Larry Hughes will make comments with regards to our performance, and then I will just make a few summary comments at the end. So, with this, I'll turn it over to Larry.

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

For the third quarter, we reported earnings of CAD107 million, or earnings per share of CAD1.35. 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 CAD7 million expense related to equity-based compensation and the loss of CAD2 million related to the translation of US dollar denominated long-term financing, the result, on an after-tax basis, is adjusted earnings of CAD115 million, or adjusted basic earnings per share of CAD1.45 for the quarter. The equity-based compensation expense reflects an increase in the Company's share price over the quarter, and the loss on the US long-term financing resulted from a weakening of the Canadian dollar on a period-ending basis. On a similarly adjusted basis, results of this quarter improved compared to those of the second quarter of 2016 when we achieved adjusted earnings of CAD64 million and adjusted basic earnings per share of CAD0.80.

From an operating earnings and adjusted EBITDA perspective, compared to the previous quarter and the third quarter of 2015, results improved from each of our Lumber, Panels and Pulp and Paper segments. Adjusted EBITDA margin for Lumber improved 19% from 14% in the previous quarter and 4% in the same quarter of 2015. For Panels, adjusted EBITDA margin reached 24%, up from 16% in the previous quarter, and 20% achieved in the third quarter of 2014. For Pulp and Paper, adjusted EBITDA margin improved to 13% from 2% in the second quarter and 11% in the third quarter of 2015.

Our WestPine MDF plant did not run for the entire quarter as we continued to repair the facility following the fire related closure in the first quarter. We recorded CAD7 million against cost of products sold for WestPine in connection with business interruption insurance proceeds. We anticipate restarting WestPine before the end of this year.

Cash generated by operating activities during the quarter after working capital changes was CAD249 million. During the quarter, we repurchased and canceled just under 1.3 million common shares at a cost of CAD56 million. Under the normal course issuer bid, which expired in September of 2016, we purchased approximately 3.9 million common shares at a cost of CAD170 million. We have renewed the normal course issuer bid for another year and have the ability to purchase up to 3.8 million common shares, or approximately 5% of our total outstanding shares.

Capital expenditures for the quarter totaled CAD76 million, bringing our total for the first three quarters of 2016 to CAD182 million. We are projecting total capital spending for the year in the CAD225 million to CAD250 million range. Our balance sheet remains strong, as we ended the quarter with a net debt to total capitalization ratio of 17%.

And Ted, that concludes my report.

Thanks Larry. I will make a few comments regarding our operational performance. I will also briefly comment on lumber and pulp markets, and provide a few comments with respect to the SLA.

We continue to make progress in our lumber business and are seeing the benefits of our extensive capital spending program, including the acquisition of Manning Forest Products which we acquired in October of 2015. We have increased production by approximately 330 million board feet over the first nine months of 2016 compared to the same period in 2015. We are well on our way to achieving the 400 million board feet increase that we projected for the year. We are seeing improvements in manufacturing costs recovery and grade as well.

Our Panels business continues to be a strong performer for the Company. The third quarter was no exception as we generated CAD33 million of EBITDA. We are experiencing better operational results in our Pulp and Paper business as compared to 2015.

Two points of note. Firstly, we are enjoying improving market conditions for our BCTMP business supported by strong industry operating rates and low inventories in global BCTMP markets. Secondly, our Hinton mill continues to show improving results with respect to reliability and production.

I'm quite encouraged by the overall progress we are seeing across the Company with respect to taking full advantage of our capital spending program. In addition, as our capital spending returns to more normalized levels, we are able to focus even more on driving operational performance, and we are seeing the benefits of that as well.

With respect to lumber markets, we have been consistent in our view that, until we see 1.3 million US housing starts, we will experience some volatility in lumber markets. Last week's release of US housing starts and permits reinforces our view that we are in the midst of a steady recovery in housing, which bodes well for medium-term lumber markets.

The soft lumber stand-still agreement expired on October 12. There have been ongoing discussions between the Canadian and US governments on this issue, and we understand that further discussions will occur this week. It wouldn't be prudent for us to speculate on the outcome of these discussions but I will make three comments.

Firstly, during the stand-still period, SPF and southern yellow pine prices are up 20% and 28% respectfully. Secondly, West Fraser has said all along that we would prefer no deal over a bad deal, and we appreciate the efforts of our provincial and federal governments to ensure that any agreement recognizes this approach. Thirdly, West Fraser is well-positioned to mitigate the impact of potential litigation as we have invested heavily in capital to improve the competitiveness of our mills, and as you know, approximately 40% of our lumber production is in the US.

With that, we are ready for questions.

(Operator Instructions). Mark Wilde, BMO.

Good morning Ted. Good morning Larry. Guys, can we just start out by helping us understand the quarter-to-quarter improvement in the Pulp and Paper business? Because it was up about $27 million I think on an EBIT basis -- EBITDA basis. And if I go to the indices and I just look at how much CTMP prices were up, that maybe looks like 20% to 25% of the improvement. So I'm wondering if you can help us kind of parse out the other elements in the improvement, including Hinton.

I think we all set some maintenance downtime in the second quarter, so we need to -- our Caribou mill had maintenance downtime, and we had maintenance downtime at our QRP mill. But again, there's also a lag in pricing, as you know, particular for pulp, given the time between order and the time between shipments. So we have stronger results in pricing for BCTMP.

Our Hinton -- our mills all ran well in the quarter. Hinton ran particularly well compared to past quarters. And as I think I said on the last call, we continue to see margin tightening between, in terms of pricing, between BCTMP and other kraft pulp. So, I think it was a combination of all those elements.

Okay. Ted, is it possible to just get a sense of sort of maintenance in second quarter versus maintenance in third quarter and where that will be in the fourth quarter?

We have no maintenance plans for the fourth quarter.

Okay. And in the second quarter and the third quarter, what was the delta there?

I think, in the second quarter, we had probably -- I'm trying to remember this -- probably a week of maintenance at our Caribou pulp mill, and I think three or four days of maintenance at our Quesnel River pulp mill. But I'm not entirely sure of that, but we can check and one of us can get back to you if we are wrong. But we had no scheduled maintenance in the third quarter.

Just -- it's just helpful in trying to kind of pull apart the pieces. If I turn over to the wood business, this tremendous growth you're getting in LVL, can you talk a little bit about that, Ted, and also maybe give us a sense of how much of that LVL stays in Canada and how much you are selling down in the US?

Well, our LVL business is tied to housing starts, and we've seen improvement there.

In terms of our breakdown between Canada and the US, there is -- it's really -- we are really in both regions in a material way. I don't really want to go much further in detail on that, but it really has to do with improving markets.

Well, you know, I just --

And again, we have one mill. We don't have 10 mills; we have one mill. So -- and our folks up at our LVL plant have doing an excellent job making that mill more competitive as well.

Yes. It's just that you're up about 30% year-on-year. And if I look at the housing start numbers or industry data, nobody else was up in those kind of terms. So I didn't know whether you've done some debottlenecking there or what's going on.

We've added more hours, and given we have one plant, I think we have the ability to be a lot more nimble than maybe somebody with multiple plants.

Okay. And then, over in the plywood business, your pricing was stronger than we expected. And I get that you're mainly selling into the Canadian market, so is it just the Canadian market branded differently than the numbers we see from like random lengths for the US pricing?

I think it's always -- we are basically a Canadian supplier, and so there's really no shift in terms of how the Canadian plywood market works against indexes. It's just that we had a very strong quarter price-wise.

Okay. And can you maybe talk a little bit about the export market to China right now? Because it sounds like it's been pretty good for you all through the year after taking kind of a leg-down I think around the middle of last year.

Yes, I think we've seen volumes being very stable for us. We also have been extremely committed to that market. I mean we are in there in good times and bad times. We've built this as a long-term market for our Company and we continue to be focused on it. So we've seen very, very stable demand this year in terms of our customer base, because I think, for one reason, we've been, as I said, a very consistent supplier.

Okay. And I'm just -- finally on this issue, I'm just -- I wondered if you could speak to the inventory charges, because it seems like the inventory charges have remained relatively consistent even while kind of low-grade lumber prices have been moving up. You might have thought that improved pricing on the lower grades might have translated to lower inventory charges.

Mark, Rodger accuses me of wanting to be an accountant, and I think he would do a better job at it. And I think he would do a better job explaining this than me.

Hi Mark.

Hi Rodger.

Mark, it's basically just a normal lower cost of market test on our utility and economy lumber. And I think you are right. We've seen some improvements in utility prices, but they haven't resulted in much of a change yet on that realizable value test we do. So the write-down in the quarter was about CAD11 million or so. Like I say, most of that is just the regular utility and economy lumber. So we haven't changed methodology and remain pretty consistent.

Okay, thanks. I'll jump back into queue. Thanks.

Thanks Mark.

Paul Quinn, RBC Capital Markets.

Thanks. Good morning Ted and Larry. I just had a couple of easy questions, one just on capital allocation here. You've been buying back shares, the dividend really has moved for any length of time. You've been active in the M&A market. So I guess the question going forward here, and given the sort of market uncertainty around SLA, do you want to keep this under-leveraged balance sheet right now? Are there M&A opportunities, and do you still feel prudent on buying back shares when the time is right?

Those are easy questions. I think three parts to it. I think, fundamentally, we are always looking for growth opportunities, Paul, and that's just a constant with our Company. We haven't seen any in the last I guess 12, 15 months that we've gotten all that excited about. We are going to continue to invest capital in our business. I think, this year, I think we are expecting to spend in the order of about CAD250 million, give or take, and next year will be probably in a similar vein.

Our share buybacks, since we've started this program, we've bought I think over 7 million shares over the last 2.5 years. And as Larry mentioned, we've got a normal course issuer bid. We can buy another 3.8 million shares between now and I guess middle of next September. And I expect we will continue to do that.

Obviously, we will monitor our balance sheet. We are, as you mentioned, slightly -- slightly conservative in terms of our balance sheet. I think we'll continue to remain so unless we saw a very exciting, significant acquisition. And I think, at the end of the day, if no great opportunities are there for us, we are prepared to carry cash for periods of time if that becomes the case as well. So I think really we want to continue with a prudent approach to our balance sheet.

Okay. And just you referenced higher Western SPF and southern yellow pine prices during the standstill. Is that to imply that the increased Canadian shipments into the US haven't had a material effect on pricing, or is that -- the contrary argument would say that prices would be even higher without the increase.

I don't really want to debate the reasons why. I think I was just making a point. And I think it's pretty clear that, in a period of free trade, prices are up significantly in southern yellow pine in particular. So, I'll leave that to others to decide what that means.

I like the point made. Okay. Thanks. Good luck.

Sean Steuart, TD Securities.

Thanks. Good morning guys. A couple of questions. So, if we are thinking about CapEx in 2017 continuing at about CAD250 million, can you give a little bit of detail on the focus for discretionary projects? And I've seen in the local press with regards to the plans at Newberry. Any further detail you can give on that project, and some of the other discretionary spending programs you have in mind?

The Newberry project is not -- it's something that was approved last year, maybe even the year before, and that's a major saw mill upgrade. We put a new planer in there a year ago, and it's in a very good timber drain, so we are modernizing the sawmill.

We are looking at some other potential sawmill grids in the US. And again, our normalized capital, Sean, should be in the order of CAD200 million plus or minus CAD25 million. So, when we talk about CAD250 million, it's not extraordinary spending. But we are continuing to look at projects.

And we haven't finalized our capital plans for next year. We will be doing that over the next month and bring that to our board for approval in December. But I think, when we sort of forecast CAD200 million, that is where we are today, but we are going to continue to look for good projects to continue to improve the Company. So, there's more opportunities, particularly in the US South, for us to modernize our plants.

And Ted, any guidance you can give on incremental volume gains in the South we might expect in 2017 based on the CapEx you're spending now?

I'd put pressure on our operating guys if I did that. But I think we probably would expect to see -- it's probably better to answer that question when we talk about our fourth-quarter results. But I think we are going to continue to see decreases in production, maybe not quite at the same rate as this year, but not too far off either way.

Okay. And a question for Larry or Rodger. Even adjusting for the inventory accounting and how you expense logs in Q2, your lumber unit costs were still better than expected. And I guess the question I have is how much of the July stumpage increase in BC showed up in your Q3 results, and how much should we expect will run into Q4, if you understand what I'm getting at there?

Yes, Sean, in terms of stumpage increases, it was a smallish increase that we've talked about. I would say probably half of that would have showed up in our quarterly results, just given the timing of it and the processing of the logs. So there would perhaps be a small increase in the future. I think the capital projects that we've done in the past in BC were further along in the ramp up curve, and that accounts for a bit of the cost reduction in our sawmill divisions.

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

Hamir Patel, CIBC Capital Markets.

Good morning. Ted, given rising better expectations for sawmills in the South, I'm just wondering if that's changed how you think about greenfields.

Can you ask the question again?

So, just I imagine there's a growing disconnect between what sawmill owners expect (technical difficulty) right now in the South, and I suspect that's going to persist until we get more clarity on the SLAs. I'm just curious if that's maybe changed how you think about potentially doing a greenfield.

Well, the first thing we look at is we look at the timber drain. And that's key for us in terms of understanding if we can be profitable in a timber drain. That's number one.

Number two, we still have significant opportunity to improve our US South operating performance. We have still improvement in terms of bringing our capital online down there, so that's really our focus. We believe we can grow our production, reduce our costs, increase our value really through our organic growth in the US South.

Your comment about vendor expectations is probably true. There have not been that many acquisitions in the last 12 months in the US South, so I think that may be true. At some point in time, greenfield may be of interest to us, but it's not a priority for us today. It's not really something we are really spending any material time looking at.

Fair enough. Larry, just a question for you on pension funding. Is there anything we should be thinking about that for 2017?

This -- we do a valuation, a full valuation, of our pension fund every three years, and this is the third year. So probably around September, we will be establishing our funding base. But you know, our focus with respect to the pension is the deficit that is generated by a very, very low interest environment. And what we are looking at, as a lot of folks are, is, with the future of corporate borrowing rates, a lot of talk in the US right now about an interest rate hike, and so that in and of itself starts to eliminate some of the pension deficit, but it's something that we are looking at. And I think 2017 will be a year that we will be focusing on whether we are comfortable with the size of the deficit in our pension plans. We've got plenty of liquidity, and when we talk about capital allocation, that plays into the mix as well.

Great. Thanks Larry. That's all I had.

(Operator Instructions). Daryl Swetlishoff, Raymond James.

Thanks. Good morning guys. Just a follow-up question on the spread between southern yellow pine and SPF. So, I think, today, it's around CAD116. Can you comment on some of the end-use changes for yellow pine that are driving the spread, and where do you think that spread goes in the event we do get a duty of some kind?

(Laughter) Well, I think we are seeing improvements obviously in US housing construction, so that is helpful.

In terms of what occurs if we go into a duty world, at the end of the day here, if you are paying duties on SPF, that would tell me that you're going to see the spread increase.

Thanks for that, Ted. That's all I had.

Mark Wilde, BMO.

Just a few follow-ups. Ted, where are we at right now, would you say, in terms of the operating performance of Hinton and then kind of just consistency versus what you would like to see that mill at?

Well, if we look back two years ago, I would say we are two-thirds of the way there in terms of production per day on an annual basis. I think we are a little further along if we look at quarter-on-quarter improvement.

In terms of our peak performance of that mill, our great days are significantly higher than our great days were two years ago. So there's a lot of positive momentum going there, Mark.

So, you know, we look at 2017 as being a pretty important year for us. We continue to look for ways to de-bottleneck parts of that mill, which, to me, is a positive step.

But the other thing that's important is when your mill is not running reliability, it really does drive your costs up, maintenance and that sort of thing. And so that's an area that we also expect to come further into line for us as the mill runs better. So, I would say, overall, in terms of overall operating performance, from a financial standpoint, we are not even halfway there yet from my perspective, but we are getting there.

Okay. All right. Secondly, you mentioned in the release that your log costs were down across the southern US. I just wondered if you could quantify that. We noted that the timber by itself prices have been down for I think the last three or four quarters.

You know, we are in 15 different timber drains. So (multiple speakers)

I know it's not easy to model.

So to make a general comment would be probably not all that helpful for us. I think we really can't add much more to what you get in terms of the reported -- the reported -- the numbers from timber, Mark. So, it's fairly flat overall, and we don't see that changing materially in the short-term.

Yes, okay. The last thing I wanted to do is just come back to sort of the trade issue. In the past, you've said kind of a quota is kind of no-go territory. I just wondered whether you could conceive of some kind of a solution which is maybe a hybrid which incorporates elements of a quota and maybe variable duties.

Well, I think, first of all, West Fraser is not the company that's going to decide what's going to happen. It's going to be government -- at least government at least from a Canadian perspective.

We fundamentally believe in free trade, and that maybe has something to do with the comment I made around pricing during the standstill. But we understand that managed trade is what we've had and is what we will end up with. What that looks like, how that looks, at the end of the day, we can't really craft that. We just want to make sure that the competitive mills in the industry are the ones that are running at the end of the day. And we want to be rewarded for the capital we have invested and we want to be rewarded for our operating performance.

Okay. Just one other kind of high-level on the trade. It just seems like the two candidates are both sounding a lot more hawkish on the trade issue than the existing administration down here. And I just, I wondered whether that creates, you think, any incentive on your side of the border to maybe get a deal done with the current administration rather than take whatever is going to come in after January 20.

Let me put it this way. I think the Canadian government has reached out on a number of occasions to the US to try and find a solution. And I think it's been reported what has been what on the table just two weeks ago. And so, from my perspective, Canada has gone a long way, in my opinion. The ball is in the US' court and I guess the US, they will decide whether they want to litigate or negotiate. And at this point in time, the two governments are still talking, so we are going to be supportive.

Okay. Fair enough. Listen. Good luck in the fourth quarter and as we move into 2017.

Okay. I appreciate it. Thanks Mark.

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

First of all, thank you all for attending, and we will talk to you in about three months. Thanks.

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