West Fraser Timber Co Ltd (WFG) 2017 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Timber First Quarter 2017 Results Conference Call.

During this conference call, West Fraser 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 assessed -- 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.

It is now my pleasure to turn the conference over to Mr. Ted Seraphim, President and CEO. Please go ahead, sir.

Thank you very much, and thanks to everyone joining us today on this call. On our last call in February, when we looked back at our 2016 results, I expressed my optimism of what our future performance, mainly on the basis of the progress that I've seen in 2 key areas: our recruiting, development and retention of great people; and our goal of achieving industry-leading margins driven by operational excellence.

Yesterday, we announced our first quarter results, which, I believe, reflect the continuation of the progress that our company is achieving. I'm not going to go over our results in detail, but I will note that each of our lumber and pulp segments produced improved results quarter-over-quarter, while our panel segment continue to make a strong contribution to our results. We achieved several operating records for the quarter. We continue to invest heavily in our recruiting and internal education and training programs and it is exciting for me to see more and more young women and men recognizing that we are very much a high-tech industry. In fact, West Fraser was recently recognized as one of Canada's top employers for young people.

At our Annual General Meeting in Quesnel last week, I was very impressed and inspired by the levels of engagement and excitement throughout our management group and in all our employees. Our first quarter results also reflect stronger pricing across all 3 of our operating segments, demand for softwood lumber is being driven by improving U.S. new home construction and steady offshore markets. Canadian plywood prices have remained strong as residential construction in several major Canadian cities drives steady demand. And finally, strong demand from China has been the main contributor to the continuing strength of our pulp markets. If you would like to discuss specifics of our quarterly results, please feel free to call Rodger Hutchinson after this call.

And now I would like to make a few comments about the current softwood lumber dispute. Yesterday, the Department of Commerce advised us that West Fraser would be assigned a preliminary CBD rate of 24.12%, which is approximately 4.25 percentage points higher than the all other's rate. The CBD rate assigned to West Fraser is unwarranted and this determination is wholly without merit. The Commerce Department also ruled that critical circumstances did not apply to West Fraser and as such, we will not be subject to retroactive deposits.

We've seen all of this before. The allegations of subsidy made by protectionist U.S. lumber lobby are completely fabricated. They are the same arguments made in previous rounds of litigation, allegations that were rejected and overturned by independent NAFTA panels. As has been the case in the past, West Fraser will vigorously defend itself against this action and expects these unfair duties will ultimately be removed and refunded.

That said, as you know, we have been expecting the imposition of duties for some time. And as we have commented during numerous quarterly calls, we are fully prepared. Firstly, our balance sheet is strong. We ended the first quarter with a net debt to total capitalization of 16% compared to 26% 1 year ago, and that includes borrowings for our Canadian spring breakup log inventories. Secondly, we will benefit from our efforts to diversify our geographic lumber production. Thirdly, we will benefit from our efforts and those of the western Canadian industry to develop offshore markets. Fourthly, we have invested in excess of $1.6 billion over the past 5 years to improve the competitiveness of all our operations. And finally, our employees are the best in the industry in managing the things that are within our control, and I know they are up for this challenge. Just as we have overcome higher export taxes under the previous SLA, I expect our employees will find a way to ensure we maintain and grow our industry-leading margins. This will only further motivate all of us at West Fraser to relentlessly drive performance improvements.

For a number of years, we have been saying that at 1.3 million housing starts, we would experience strong lumber markets. Our view hasn't changed. And as such, the laws of supply and demand will ultimately determine who pays what price for lumber. This dispute may attract a lot of attention and produce lots of headlines and news stories but in no way will it distract us from continually striving to be the world's best forest products company.

And with that, I'll open it up for questions.

(Operator Instructions) And your first question will be from Sean Steuart at TD Securities.

A few questions, Ted. With respect to the preliminary countervailing rate, maybe just walk us through the process towards litigating and, I guess, appealing the rate. I take it the first part is just the administrative review that the Department of Commerce has to undertake over the next several months. Can you walk us through your thinking on how NAFTA and WTO dispute resolution mechanisms will work for you guys this time through?

You're asking me to write a book here. Well, first of all, it's day 1, day 1 of the process. And I think all I can say is what we expect to happen this year. I don't know how things will unfold over the next year or potentially, the next number of years. But I think as I understand it, we will be paying a CBD rate until the end of August, then we will be not paying deposits from the end of August until the end of the year. And then we'll receive our final determination on CBD, which will put -- will be in place for 2018. In terms of litigation and so on, obviously, that's a government-to-government discussion. And I guess the only thing I can say here is I feel tremendous alignment with the province of British Columbia, with the province of Alberta, where our operations are, and we've had tremendous dialogue and cooperation with the federal government. So I know I'm not giving you the answer you want but ultimately, this is going to be solved by the Canadian and the U.S. government, and I think that's all I can really say on that.

Okay. Understood. Next question on pulp markets. We're hearing anecdotal reports of peaking prices and maybe even a little bit of weakness in China right now. Can you give us some context on what you guys are seeing for NBSK and BCTMP in that market?

I think first of all, to be frank, I think pulp markets have been stronger in the first half of the year than, I think, most people would've anticipated in the fall. And I think part of that has to do with the new pulp capacity hasn't come on stream as quickly as people had anticipated, and I think that includes buyers in China. I think people had quite low inventories. And then the other thing that is extremely positive is that paper demand in China continues to be quite strong, quite consistent and we've been quite encouraged by that. So we produce 2 main grades. And I think about a year ago, what we said about BCTMP is we really felt that the supply-demand dynamics were going to improve for BCTMP. One, knowing new BCTMP capacity was coming on. And two, the China board market, which is a big consumer of BCTMP, was very strong. And so we still see extremely strong BCTMP demand. And as you probably saw in our first quarter results, part of our improvement has to do with the lower discount that BCTMP is having vis-à-vis NBSK. So we're quite positive about demand for BCTMP as we look out at the rest of the year. In terms of the broader market, which is the kraft pulp market, which includes NBSK, from our perspective, things are still strong. We keep hearing that things will weaken, but we have not really seen that yet, Sean. And with more capacity coming on, I think we need to plan for it but we just haven't seen it yet. Much to our pleasant surprise, to be honest with you.

Next question will be from Mark Wilde at BMO Capital Markets.

I wondered, the lumber markets have been stronger than I would've expected over the last 4 or 5 months. We've had a pretty significant move up. I wondered, when you look at these markets right now, how do you sort of think about what's driving them? Is it kind of concern over the duties? Is it the strength of the housing market down in the U.S.? Are the rail issues playing in here? How do the pieces fit together for you?

I think you kind of answered the question. But I just want to go back to one of the comments I made in my sort of opening comments. And about 3 or 4 years ago, I know you -- I don't think you've been covering us that long, Mark, but 3 or 4 years ago, we made a comment, we said we expect volatility in lumber markets until we can hit 1.3 million housing starts. And the reason we said that is we just kind of looked out towards production growth. We see limited production growth in North America. We see demand for lumber continue to improve. And I think we're in a position today where the supply-demand dynamics are as strong as they've probably been in the last 5 -- probably last, sorry, 12 years. And so I think that's number one. I think, number two, when there's uncertainty, it creates volatility in markets and so I think we've seen that. Transportation has definitely been a challenge, particularly in January and February, I mean, that affected our shipments. But I think just overall, the macro fundamentals are very positive. So I think that really is what's helped improve market conditions and I think we see that going forward regardless of shipping issues or the, frankly, the softwood lumber dispute.

Yes. I guess another issue kind of related on the lumber side is we're kind of seeing something very unusual now which is the strengthening in these lumber markets but in the southern U.S., log prices continue to fall. Do you have any perspective on that? And what you guys expect over the next 2 or 3 years in terms of southern log cost?

Well, I guess what we expect is a little bit different than the coalition expects. I think what we expect is slow growth in lumber production down there. I mean the last peak was 19 billion feet. Last year, the U.S. produced 17 billion feet. There will be growth there and we will be part of it. But again, I mean, we've had -- we've got an inventory down there, a log inventory down there in terms of standing timber that is extremely mature and so I really expect that this is going to continue on. I think it will be slow growth in lumber production down there. I don't think the response to the SLA will be any different in terms -- materially any different in terms of growth in lumber production in the U.S. South, so I would expect that we're going to see muted log prices for some time to come.

Okay. And then finally, I wonder if we could just turn to that WestPine MDF plan. Sounds like it was an EBITDA drag in the first quarter, and I wondered if you could help us sort of cadence what we should expect from that as we move through this year. And then given the consolidation that we've seen in kind of particleboard and MDF capacity in North America, is there a situation where it might make sense to have somebody else own that mill?

I'm going to answer the second question very quickly. We have an integrated strategy in Canada. And in Quesnel, we've got a plywood plant, 2 pulp, most of which -- one is a joint venture and the MDF plant. We also produce energy in Quesnel. So we have a -- we fully utilize our resource. And as we're competing for timber in the Cariboo, we think having that MDF mill is a huge advantage to our integrated strategy. And frankly, we like the business. And I say this too much, but I only say it because I really mean it, we have an unbelievable group of employees working at WestPine. And so we were always planning to rebuild that mill. It's taking longer than we thought. It did affect our first quarter results. We -- I'm [ not ] going to blame this on Rodger, he's sitting across from me if you want more detail, but we've taken a very conservative approach to accounting for this. We've taken a very conservative approach on this, and we're obviously going to continue to be in negotiations with our insurers. We expect that we will recoup all our costs. So I think we're -- we've been very conservative. We stopped accounting for business interruption late in the fourth quarter and we expect that we will receive that until we start up. It's been delayed for a couple of reasons. One, we put in state-of-the-art fire detection suppression equipment, and we want to make sure that everything is running 100%. We're working closely with our vendors and we're in the startup mode right now. So it's quite a visible issue for us, but from a materiality standpoint, Mark, it's pretty minor.

Next question will be from Hamir Patel at CIBC Capital Markets.

Ted, I was wondering if you had a view on whether Canadian customers will get a full discount for the duties this time or something less. Because I understand during lumber 4, they were getting a full discount at some stages over the process when a refund was looking remote. But you obviously got back 80% last time. So perhaps discounting too much would leave money on the table. Curious, what do you think is going to happen there?

Well, frankly, Hamir, I don't talk about pricing. The market will determine what that will be. And really, I think at this point, that's all I've really got to say. I don't know if Chris McIver, he's in Quesnel, if he wants to add any of those comments. But supply and demand will determine what the price will be and obviously, any funds we put on deposit in the U.S., we expect to get 100% of them back, not 80%, 100%. That may give you an indication what we're thinking.

That's helpful, Ted. And just the second question I had was your release reference to expectations for further escalation in log costs in Canada this year. Wouldn't duties result in lower stumpage costs in BC? Or is that just not enough of an offset to the typical log cost inflation?

Well, we have -- we've been saying this for a long time, we have excess demand. We expect lumber markets to continue to be strong. So I think we should expect that -- some small escalation in lumber -- in log cost because, frankly, of our -- the way our stumpage system works and the fact that we're out in the marketplace everyday bidding up the price of timber.

(Operator Instructions) And your next question will be from Paul Quinn at RBC Capital.

A couple of questions. One on just lumber and taking a look at the run up in western SPF prices at the end of January to probably the end of February, that sort of 25% move. Was -- I guess the idea was that it was around the potential of retroactivity, which we've seen the Department of Commerce rule on now. So you had that western SPF widen out from Southern Yellow Pine but following that, Southern Yellow Pine prices moved up significantly to close that gap and we're still sort of sitting at what we've seen the pricing differential for the past for the [ log ]. Does that surprise you at all? Or do you expect that the current price gap between both on a 2 by 4 basis is going to hold true for the rest of the year?

That's a really tough question. I mean given the fact that we're going to have duties on for -- until the end of -- CBD on from until the end of August then it's coming off, I mean, that's lots of unpredictability, I think, this year, Paul. I mean we don't know how to forecast. Ultimately, I've got to be honest with you, I mean, my experience always is when markets are moving up, customer's setting the price. And when markets are moving down, we're setting the price. And I think demand has been strong enough and customers, I think, probably got caught short and that's probably why things moved up quite a bit on the SPF side. And then when you look at the gap, I think, when you look at not so much May pricing because it's still not May yet, but in terms of April, April, the differential is kind of come back to what you would call historical differential, Paul. Where it goes from here, I know I'm not answering your question, I don't know where it's going. All we know is that we feel pretty bullish about the medium term. But I expect volatility in pricing through this year just given how this softwood lumber dispute is going to go in terms of how the U.S. decides to administer duties.

Okay. Fair enough. To be honest, I don't know where they're going either. So I just thought I'd ask the experts. And maybe just...

Our medium-term sense is that supply and demand is quite favorable to lumber. That's kind of how we look at it. We don't spend a lot of time thinking month-to-month or quarter-to-quarter here at West Fraser, as you know.

Okay. And then in terms of on the pulp and paper side, you've got 6,000 tons of maintenance in Q2, and I think it's 19,000 in Q3. What's -- do you have any idea what the cost impact of those shuts will be on, on your performance in both quarters?

Rodger is telling me I can't say anything. But just to let you know, I mean, we do a shutdown at Cariboo every second year. I think I'm going to get in trouble for that one. We do a shutdown at Cariboo every second year, so that's our share of the 12,000 tons at Cariboo. And in Hinton, we do a major shut every 3 years. And in terms of the cost of those, the cost of that shut down, I can tell you this much, we amortize it over the period, so the actual shutdown costs. The loss production, the margin we would get on that loss production will affect us in the quarter. So we'll lose margin on 6,000 tons in the second quarter, at Cariboo, and 19,000 tons at Hinton in the third quarter. Is that correct, Rodger?

Yes.

Yes. I'm one for one for Rodger's point.

Just a question on plywood prices. We've seen those move up materially in Q2 here. Do you think that price is sustainable going forward? And most of your stuff stays in the Canadian market. How are you looking at that housing market given all the news around maybe an overzealous Toronto and Vancouver market?

Are you trying to get me to predict housing prices in Vancouver and Toronto or the price of plywood?

No, just plywood. Just plywood.

I mean it's just continued to be a strong product for us. And demand is strong. I mean -- I think housing starts to what -- it just came out a few weeks ago for Canada, were extremely strong. So I recognize there's -- they're trying to do things to suppress the market in terms of the housing market, in terms of pricing on houses. But it doesn't really seem to impact demand. I think at the end of the day here, the reason house prices are going up is pretty clear. I mean population is growing in Toronto and Vancouver, and people want to buy houses. So at the end of the day here, I expect plywood and housing to continue to be strong this year.

Okay. And last question I had is it looks like there's a relief rally going on in the marketplace on Canadian lumber names. They're all -- all seem to be up materially. You guys had some great quarterly results, so I can kind of justify yours. But across the other names, I'm a little bewildered because I look at the duties that were assessed and the all other's rate is still 20%, we still haven't got the [ ADD ] and we've got retroactivity on the majority of the Canadian industry. I don't know how you look at that as a positive. Maybe you could comment on that.

I didn't realize I was an analyst, but -- I'm just kidding you. But I mean I just think about West Fraser. And we're still waiting for the [ dumping to ] -- margins to come out. I can tell you this much that we expected to be a respondent for both CB -- well actually, we expect to be respondent for ADD, we didn't expect to be respondent for CBD, that was news. So we've managed our company in a manner expecting to be an ADD respondent for quite some time. So we'll see where we end up relative to our competitors when those duties come out. But I think ultimately -- and I can only speak about West Fraser. I think we're getting rewarded for the hard work our employees are doing. All that capital we spent, easy to talk about. Hard to run a company while you're spending all that capital. We're seeing the rewards for that. And as I said many times, I don't want to get so focused on softwood lumber. I mentioned, I think, last time on the call, it's not in the top 10 things I worry about. It takes a lot of my time but it's not in the top 10 things I worry about. And I still feel that way about it. What I'm excited about is not just the improvements in our performance but the targets that our folks have set for the third quarter, for the fourth quarter, for 2018. We still see a tremendous upside in our company with the capital and our folks. So hopefully, the market is starting to recognize that, and that's West Fraser. I can't speak for others.

Your next question will be from Benoit Laprade at Scotiabank.

Just curious to see if you could reiterate your CapEx guidance for 2017?

Yes. Benoit, it's Rodger. We're still thinking $300 million is the target for 2017. Of course, there's -- sometimes we advance things, sometimes there's delays, but that's still what we expect.

Okay. And just curious, in your MD&A, you were talking about increased lumber production, about 250 million board feet year-over-year. What would be the split between Canada and the U.S.?

Benoit, I'd say roughly 50-50. We're expecting an increase in both jurisdictions. Might be slightly weighted towards the U.S. South, but pretty close.

Next question is a follow-up from Mark Wilde at BMO Capital Markets.

A couple of follow-ups. Is it possible, Ted or Rodger, to get any sense of just how you're thinking about sort of capital spending if we look beyond '17 and '18 and '19? I mean given the strength in the lumber and pulp markets that we're seeing right now, you're performing very well, you've got plenty of capital available to you.

Yes. Well, I think first of all, we've got a number of projects that we're looking at throughout the company. I mean our run rate is probably going to be in the order -- I think, Rodger, the guidance you gave was like $225 million, something like that, $225 million. But we've been so delighted with our capital program. We continue to look for new technology. And with 28 sawmills, we develop something that improves at 1 mill. Before you know it, your 1 small project becomes $50 million to $60 million across the company. We're challenging our mill managers, and that's how we run the company, we challenge our mill managers how they run their mills to come up with more projects. Our balance sheet is strong, and we really believe our best chance that we have control over to develop shareholder value is through -- is frankly, through spending capital within the company as long as it generates good returns. So I wouldn't be surprised if this run rate of $300 million doesn't continue for a couple more years, to be perfectly honest with you.

Ted, is there a lot more catch up to do yet at those southern sawmills? I know you spent a lot since about 2010 at the southern mills, but they were way behind the curve when you bought them.

Well, if you were talking to Hank, if Hank was on the call, he would say that -- he'd be pushing us to continue to look for more projects. And if you talk to our operating VPs, they would be doing the same and I'm in the same spot. So what we've really done up until just recently was our focus is primarily on getting more value out of our lumber, a lot of planar upgrades. We put, I think, 22 continuous kilns in the South. So we just did our first major sawmill upgrade at Newberry. And kudos to our folks at Newberry, they were way ahead of target in terms of achieving production. So I think we'll be doing a bunch of things in our sawmills to improve our recovery, improve performance. Maybe there might be some marginal increases in production. So I think we've got some opportunities down in the south to improve our sawmills. So with 15 sawmills down there, you can -- the capital can add up pretty quick if we've got some good opportunities.

Okay. And the last question for me. You did a lot better at pulp this quarter than we expected. Are the pulp mill issues that have been out there for the last 2 or 3 years with reliability and operating efficiency, are those fixed at this point? Or is there still some work to be done?

Well, I think a couple of things is our BCTMP business, we produced more tons of BCTMP than NBSK. That's always been a tremendous performing business from an operating standpoint, and we've seen discount against kraft pulp shrink for that. So that's number -- that's one point. The second point is, and I don't want to just continue to focus on Hinton because we used to pick on them too much and now, I think we're giving him too much credit, but we've seen tremendous improvement in performance there in terms of production. We still have reliability issues. I mean frankly, if you look at our peak performance there on a weekly or a -- over a 2-week period, I would challenge our folks at Hinton to say there's still 20% improvement there. So probably isn't but in terms of production. But we are so far down -- we're so much further ahead than we were 3 years ago, I'm delighted. And as we improve reliability, we can take maintenance costs out. We think there's still a lot of upside in EBITDA at that business, but I've got to tell you, Mark, I don't spend time worrying about Hinton pulp anymore. I think we don't want to get cocky, but we're definitely on the right track there. We still got room for improvement. So if the folks at Hinton are listening, we've got a ways to go.

(Operator Instructions) And at this time, Mr. Seraphim, it appears we have no other questions. I would like to turn the call back over to you, sir.

Well, thanks very much. And if you've got any further questions, please feel free to give Rodger a call. And with that, we'll thank you for joining the call. Bye now.

Thank you, sir. Ladies and gentlemen, this does, indeed, conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have yourselves a great day.