West Fraser Timber Co Ltd (WFG) 2018 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Q3 2018 Results Conference Call. (Operator Instructions) This call is being recorded on Tuesday, October 23, 2018.

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 the 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 conference over to Mr. Ted Seraphim, Chief Executive Officer. Please go ahead.

Thank you, and good morning, everybody. We're going to do this a little different today. I've got Ray Ferris, our President and Chief Operating Officer; Chris Virostek, our Chief Financial Officer; and Chris McIver, our Vice President in Sales and Transportation there in Vancouver. And I'm up here in Cornell with our Vice President of Woodlands, Larry Gardner. So I think Chris Virostek will start off the call and give us some comments on the results, and then I will make a few comments at the end.

So with that, Chris, I'll pass it to you.

Thanks, Ted. Good morning, everyone, and thanks for joining us today. I'll make some opening remarks on the financial, and then Ted will provide an update on the current market conditions and outlook.

The last 12 months have been marked by significant volatility in lumber markets influenced by severe weather events, duties and irregular transportation availability. In the third quarter, we experienced a significant reversal of SPF lumber prices from the first half of the year.

In our lumber segment, our adjusted EBITDA of 28% of sales or approximately $194 per thousand board feet was off the second quarter pace due to the reversal in SPF prices but remains solidly ahead of the third quarter of last year. Shipments were slightly off the second quarter pace as we continue to work through the accumulated finished inventory from the first quarter.

In our panel segment, shipments were also off the Q2 pace as we largely cleared that backlog in the second quarter. Plywood pricing, which was influenced by supply constraints in the first half of the year and during the third quarter of last year, were treated as well.

Our pulp segment posted improved results as compared to the prior quarter and the third quarter of 2017. Improved pricing, coupled with higher production rates and shipments, all served to increase the adjusted EBITDA over the prior quarter, and more significantly, over the prior year.

Cash flow from operations for the year-to-date period was $897 million. We reinvested $284 million back into the business this year in capital investment, including rebuild at High Prairie, Alberta and Opelika, Alabama. We increased the dividend in the third quarter for the second time this year and the third time since 2017.

Subsequent to the end of the quarter, we entered into an agreement to purchase $335 million of annuity contracts with pension assets, pension plan assets, to further derisk our defined benefit pension plan liabilities. In addition to the $145 million that we settled in the first quarter, we have now settled this year $480 million of pension liabilities through annuity purchases with plan assets.

Since the end of the second quarter through October 19, we have repurchased 4.3 million shares for $357 million at an average price of $82.65.

Since we commenced repurchasing shares in 2013, we've purchased a total of 15.1 million shares for $994 million. We have consistently deployed our capital over the period through a balance of organic growth, through capital expenditure, accretive M&A transactions and returns to shareholders, at the same time maintaining a liquidity profile and capital structure that provides flexibility to continue to grow and invest in the company.

With that, I'll turn it over to Ted for some more comments.

Just one moment.

Oh, I'm sorry. I had it on mute. There you go. Anyways, thanks, Chris. First of all, I thought I would touch on a few topics. From an operational standpoint, we continue to see progress in our pulp & paper division. We achieved the highest quarterly production on record.

Nevertheless, we saw a significant upside at our Hinton division. Production improved at Hinton by more than 10% during the quarter from the first half of the year, but we still have more progress to make before we achieve our production and reliability expectations.

Our lumber segment production was impacted by weather and fires, which caused some minor downtime over the quarter at a few of our mills. Most notably in the quarter, we started up our new sawmill in Opelika, Alabama. The project was completed on time and on budget in approximately 12 months.

The new mill increases the site capacity by approximately 100 million board feet, and we expect to see improvements in grade and in recovery as well. The mill benefits from a strong workforce, a robust timber supply and good outlets for residuals. We see the success of this project as a blueprint for future project opportunities in the U.S. South.

Our transportation, sales and operating groups have worked very hard to develop alternative strategies to ensure we are able to ship our production throughout the year. We continue to have a very strong and positive working relationship with our rail providers. But our expectation is that a more diversified transportation strategy will provide dividends this winter.

Moving to markets. I will focus my comments on our lumber business. We have all been surprised by the volatility in lumber markets this year. The inventory buildup in Western Canada of 800 million to 1 billion board feet in the first quarter was unwound in the second and third quarter. It's clear that this has had an impact on the markets to the upside in the first part of the year and to the downside in the last few months.

While the impact of the shipping issues is primarily behind us, lumber demand has been recently impacted by the hurricanes and wet weather which dampened housing starts and construction in some of our key markets.

At West Fraser, we focus on the medium- to longer-term fundamentals, and our view remains consistent with what we have been sharing for some time. Demand in 2018 continues to grow at almost 4% or 2 billion board feet annually, and our expectation is that demand should continue at a similar pace going forward.

There's no question that housing remains a key market for lumber, but we think it's important to recognize 2 other key factors that drive demand. Firstly, the repair and remodel segment accounts for over 40% of lumber demand. Secondly and lesser known is that lumber has gained share in multifamily and nonresidential construction.

Coming out of the 2006 SLA agreement, Canadian and U.S. producers created the Softwood Lumber Board, which is essentially designed to grow lumber demand in North America. Working with architects, builders and others, we have been working collectively to increase our market share of building materials. Today, you see many more buildings constructed with wood, and we expect that market share growth to continue given the success at 6-story construction as well as growing interest in other forms of construction such as cross-laminated timber.

In addition, lumber production in North America is growing at a slower pace than demand. U.S. lumber production is increasing, and we expect to see production in the U.S. South growing at 1 billion feet or so per year for the next 3 to 4 years.

That being said, Canadian lumber production is down this year from 2017, and we expect that decline to continue, driven by the ongoing impacts of the mountain pine beetle and other environmental pressures.

Given the volatility in lumber markets this year, sometimes it's helpful to step back and put things in context of our overall strategy at West Fraser. Over the past 5 years, we have focused our efforts to improve the competitiveness of our manufacturing assets and grow our lumber capacity in Alberta and the U.S. South. We have also returned a fair amount of cash to our shareholders.

Since 2013, we have generated almost $3.7 billion cash from our operations. We invested 50% of that in capital expenditures, 20% in acquiring mills and 30% in share buybacks and dividends. We believe this balanced strategy puts the company in a strong position to take on the challenges as well as the opportunities that we'll face in the future.

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

(Operator Instructions) Your first question is from Hamir Patel from CIBC Capital Markets.

Ted, given some of the log shortages at some of your sites and where lumber prices are, are you thinking of taking any curtailments or slowdowns in Q4?

Well, first of all, the market is moving pretty quickly and we don't really react to any short-term market fluctuations. And so as we look at it, there's always a number of factors. It includes our view on markets and also impacts on our integrated model and cost structure. So I think at some point, we're going to see British Columbia get smaller. But at this point, we are -- we're running all our mills, and that's how we look at it today.

Fair enough. And Ted, you mentioned Opelika would likely serve as the blueprint for future projects in the South. Do you have anything planned that may come up in 2019?

Well, why don't I let Ray Ferris comment on that? I mean, we don't generally comment on any projects until we're actually starting construction. But I think Ray can maybe talk a little bit about how we're looking at our U.S. South capital plan from a broader base. And I think as I said earlier, we're using Opelika as a bit of a model.

So thanks, Ted. Hamir, I think the short answer would be yes. We continue to kind of have a pipeline in U.S. South of projects similar to Opelika and smaller projects, quite frankly. And I think it's kind of very similar to what we've done the last couple of years. But short answer will be yes, and we'd expect to kind of continue on that path through 2019.

And maybe just one final one for me on the log cost side. Given the move in lumber prices, how do we think about log cost sequentially in Q4? I figured B.C. is still moving up, but Alberta's probably coming down, so where does that net out?

Larry, do you want to comment on that?

Yes. Log cost through the next quarter and foreseeable future is going to continue to be very competitive. I don't see them tailing off very much. They will be -- 50% of our wood is quoted in B.C. and that will come down with lumber price somewhat, but purchased wood will continue to be very competitive.

And what about Alberta?

Alberta costs react with the falling lumber values, and they subsequently also go up with lumber values. So we're -- we'll see a market-driven reduction in the duties paid in Alberta.

Your next question is from Sean Steuart from TD Securities.

So one follow-up on Hamir's question. You suggest you're not taking any market downtime in Western Canada at your sawmills, but did you lose any production on the back of the Enbridge rupture? And if so, can you articulate how much?

Yes. We -- well, it wasn't -- we had some impact on our 2 pulp mills in Cornell for a few days and a little bit of impact on one of our plywood plants. I think that was pretty much it. It wasn't really significant at this point. And we also had a scheduled downtime for our Quesnel River pulp mill where we're putting in a new refiner, which is a pretty significant project. And the mill's down for about -- it's coming out of its shutdown. It was down for 7 to 10 days but that all got replenished back down, so it was a bit fortunate for us.

Okay, understood. On your lumber price realizations this quarter, you were down on average, backing out logs, about $60 per thousand board feet quarter-over-quarter. And I know in volatile markets, you get these timing lags and sometimes it could be pronounced. It's still a bit better than we expected. And I'm just wondering if you can give us some context on if there'll be, I suppose, a negative [WIPs] on Q4 in terms of your price realizations? Some of the weakness that we saw really towards the tail end of Q3, will that show more in Q4, I suppose, is the question.

Yes. I mean, it's a bit difficult for me to answer. Maybe Chris McIver could add some substance to that. I mean, I guess, the one thing is the order files were fairly short going into the fourth quarter, so there wouldn't be a significant -- there shouldn't be too significant of an impact. But maybe, Chris, you can provide maybe a bit more detailed guidance for him?

Yes. Thanks, Ted. Yes, Sean, I think Ted kind of nailed it. Our order files are pretty short right now, so we are -- we're pretty much right on top of what the market is right now. And it's pretty much anyone's guess as where the prices are going over the next couple of months, quite frankly. So we'll -- obviously, our realizations will be affected by wherever the market goes over the next while. But you won't see a huge lag at this time.

Okay, understood. And I guess just more broadly on lumber demand. You guys articulated an expectation of ongoing steady growth from the U.S., and we've certainly seen slowdown in the home construction, which I appreciate is not the biggest bucket for demand. But can you comment on order activity across the renovation market, commercial and industrial? Are you seeing any weakness in those end markets right now?

Chris, do you want to comment?

Sure, sure. So Sean, I would say that we've seen weakness in Canada specifically pretty much across the country but more in the East part of the country than the West. In the U.S., we've gone into a seasonal slowdown. This is sort of a slower time typically till you get to December. I think the Southeast has been really affected by weather over the last couple of months, and I think we'll see that start to come out. And the rest of the country is pretty good, and R&R remains pretty robust, at least from our view. And our customers say they're busy but not crazy busy, so we're just average.

Your next question is from Paul Quinn from RBC Capital Markets.

Just a couple of questions. One, if I look at your production versus shipments year-to-date, you're kind of bang on in the U.S. South, but sort of you've over -- well, not overproduced, but production is over shipments by about 38 million board feet. What did you come into the year with? Is that -- should we expect all that to come out in Q4? Or half that? I mean, did you have low lumber inventories coming into 2018?

No, they were -- I think they're fairly normalized, maybe a tad to the high side because we were working our way into the winter period. But we're going to -- as I think we've put in our MD&A, I mean, we've probably got about 40 million excess that we need to ship over the fourth quarter, which is pretty modest for a company our size. That would probably be about it, Paul.

Okay. Then to set the markets, when you started noticing the weakness in the North American market off the peak pricing in the end of May, have you guys started to ship more volume to -- and this is on the lumber side to Asia as a result?

Well, I think we've been very consistent in Asia. Our approach has been consistent through strong markets and weak markets. So I think it's been relatively consistent. Chris, do you have any further thoughts on the overseas markets?

Paul, Ted's right. We -- what you'll find, Paul, is that majors tend to stay in Asia all the time, and so our volumes haven't really changed much. I can't speak for anybody else. Certainly, there's a lot more small players trying to get into the market right now because of the weakness in North America. But we are seeing Japan slow down just a little bit right now. But again, we think that'll pick up. They've struggled a bit with the price fluctuations, which is unusual in Japan. But we've seen more ups and downs in price there than we usually do, so -- but demand is good offshore.

Okay. And while I got you, Chris, what has been the impact of the Chinese duties on log and lumber coming out of the U.S.?

Well, I would say -- I can't speak to the logs much, but I would say on the lumber side, first of all, the SYP business in China is relatively small. It's definitely bigger on the log side. Our understanding is it has really slowed. We are not a big player in SYP over there at this time. So there's still some coming, but it has slowed, I would say.

Has that given you bigger opportunity in Canada to ship more? Or is it really not that much volume, so it doesn't really matter at the end of the day?

It's kind of a different end use as well. It's used for treating mainly over there. And so SPF, not so much. So no, it really hasn't opened up a lot there.

Okay, and then last question. In referencing Sean's better realizations than we had forecast, he also had better cost than we had forecast. Is that attributable to the capital projects that you spent over the last couple of years? Are you starting to see a material pickup in productivity at the sawmills?

Ray, would you like to comment on that?

It's a great question. And so Paul, I think that's -- I think that's kind of the answer to the question. I mean, I can kind of answer that 2 ways. I think we're not actually that happy with our costs, but certainly, they've improved over the quarter. But I think -- honestly, I think we would say that that's kind of a normal spot where we should be and maybe we're too a high cost in the second quarter might be my reaction there.

(Operator Instructions) Your next question is from Mark Wilde from BMO Capital Markets.

Ted, I hope you're buying lunch up in Hinton today.

I'm actually in Cornell, and we've got all our senior operating managers here this week. And I'm going to teach them how to run a sawmill.

Okay. All right. Well, somebody learned how to run a pulp mill this quarter, that's good. I'm just -- I think you've answered this already, but it sounds like you plan to have that 40 million board feet of inventory out by the end of the year-end, is that correct?

Yes. I mean, I think when we commented at the end of the first quarter, we were hopeful to have it shipped by the end of the third quarter. We've put tremendous effort and more trucking programs. We work very closely with our rail providers. The market probably didn't really help us towards the end of the quarter, but I think we're in a much stronger position than obviously were 6 months ago. And the one thing -- and I think that shipping created some market volatility as well. And our goal is to continue to make sure that we ship our inventory through this winter. I think that's something that we're really going to hold ourselves accountable to.

Yes. It sounded, Ted, like you're going to diversify your transit a little bit. I know you don't want to get too specific, but can you give us some -- just some general ideas of what that involves?

Well, I'll start, and if Chris or Ray want to jump in, they can. But fundamentally, most of our sites we prefer to ship rail. I mean, that's what we've been doing our whole history. And so you have to make commitments to trucking companies. You have to have your mills set up to ship both rail and truck and we have done that. It's been a tremendous amount of effort, really strong coordination between our operating, sales and transportation groups. And so we have a keen focus there. In all honesty, you've got to support these trucking companies not just when we need them but when they need us. And we've got a number of mill sites where it's really -- we're agnostic in terms of costs between truck and rail. So we've really put a major focus on it, and I think it will pay off dividends for us. And I think, frankly, as I said at the end of the first quarter, if we don't learn from this crisis, shame on us, and we should be taking advantage of our size. And I'm hopeful that all that hard work our folks have done, we'll see the results of that through the winter.

Okay. And would you say you have a pretty high degree of confidence that you can kind of -- you won't go through what we went through this last winter in the coming year?

We're planning for the same winter that we had last year, so that tells me we're going to end up with better results if the winter is the same as it was last year, which was a pretty tough winter. Chris, do you want to add anything to that? Or should I -- or am I sticking my neck out there for you?

No, Ted, I think you've explained it pretty well. The one thing I might add though, Mark, is we are rail reliant and that's not going to change. We're doing these other things, but we still remain rail reliant as a company. And so those relationships continue to be very important.

Okay. And then Ted, I wondered if you or Chris could talk a little bit about capital allocation. I mean, you gave us a pretty good sense of sort of what you've been doing over the last several years in terms of CapEx versus M&A versus return of capital to shareholders. But I wondered if you could just give us any additional guidance on your approach to repurchases, and I'm particularly curious about, given the volatility in the stock, whether there's anything you can do to kind of take advantage of that when you're trying to time your share repurchases?

That's a very good question. I think I will start and then, I think, I will ask Chris Virostek to give you his perspective as well. We've been working on this for 5 years, and I'll get to the share repurchases in a minute. But -- and our whole focus at West Fraser, even including the acquisitions, wasn't really about the size of the company. It was about how strong the company is. And so our first priority is always going to be to invest capital and make our mills stronger and better. And ultimately, we look at pretty short paybacks on average. I think we set 3 to 4 years on average is what we look like for our paybacks. And Ray and his team have done a tremendous job in that over the last 5 or 6 years. And then our next goal is acquisitions. And our third goal is really returning cash to our shareholders. We've done that through dividends. I mean, we're -- our dividend today is $0.20 a quarter, and that's a significant increase over where it was just a few years ago. And then obviously, share buybacks, as I said, we've been doing it for some time. We have, I believe, Chris, the ability to buy 10% of our float. I think it's just over 5 -- around 5.5 million shares. And I expect that we'll achieve that over the year. And I think the lower the prices, the more shares we buy every day. So I think from that perspective, we are somewhat opportunistic, but we're not trying to be opportunistic here. We're really trying to return capital to our shareholders in an efficient and effective way. And we look at it over time. We don't really think we can time market share too much. But ultimately, we really like that balanced strategy. And at the end of the day, if we don't have a use for that cash, we should be returning it to our shareholders. And given the strength of our balance sheet, we think that's what we should be doing at this point. Chris, do you have any further comments?

No, I think that's a great summary, Ted. I think -- and the last point that you mentioned is the one that kind of governs things at the end of the day. We think that our financial flexibility with the amount of liquidity that we have and the low debt levels, kind of regardless where we are in the cycle, doesn't really preclude us in any way from capitalizing on opportunities that would be in front of us to grow the company, whether that's through the investments that we make in our mills, in projects in the U.S. South or M&A opportunities that may present themselves. So we don't believe that what we've done in any way limits us from continuing to execute on the strategy.

Okay. Last question I had is just any kind of additional thoughts on kind of the state of the U.S. and Canadian housing markets, whether your kind of view on the trajectory there has changed? And finally, whether all of this easing that we've seen in the U.S. starts, do you think this is causing any of the players from the industry to kind of pull back on capital plans at all, Ted? I'm sure you're all talking with the equipment suppliers all the time.

Yes, yes, yes. And I'll have Ray talk a little bit about the capital side in a minute. I think this is really the big question is, are we facing something structural or is it just current market? And when you look at the big, big picture -- and listen, in our company, we don't pretend to be forecasters, I'll start with that. And secondly, there's a lot that's going around in the globe from an economic trade standpoint, politically, et cetera, et cetera. And again, we have to have some view on it, but it doesn't really change the way we run our business. I mean, our job here at West Fraser is to have the best margins in the industry. And again, that's how we look at things. But when you look at housing, we are trying really hard to take a step back because when you look at the fundamentals behind housing, I mean, we're not worrying about -- we're not at 2.2 million housing starts, and we're concerned about a falling market. We don't have a lot of speculation in homebuilding. Inventories are in good shape. Interest rates, while they're increasing, are still relatively low. But I think a lot of things kind of converge over the last few months with weather, with rise in interest rates, with people's concerns around the stock market, whether they should be real or not. So I think there's a lot of broad macro issues that are impacting people's view on housing, but ultimately, we're still below 1.3 million housing starts, and that's not enough to replace the housing stock. So we really believe we're more in a kind of short-term pause situation than a long-term structural change because the population in North America continues to expand and the housing inventory continues to get older by the year. So we continue to see demand there, and we continue to see demand in repair and remodel. And so we still look at the macroeconomics 101 of demand growing at a couple billion board feet a year, and supply is going to be hard-pressed in the future to grow much more than 1 billion board feet a year. So we're still quite bullish, and we'll continue to evaluate that as we look at the next couple of years. When it comes to our view on capital, ultimately, we want to have the best margins in the industry. And when we talked about Opelika, that really is a new sawmill on an existing site where we've got a workforce, we've got a timber supply. We're looking to get better recovery, so we're going to -- on a percentage basis, we'll have less residuals going in the marketplace. Those things all makes sense and production increase is really just a bonus and that's -- production increase is somewhat tied to our view on market price. But really, the projects that we're doing are really aligned on improving our margins. And production is a bit of a bonus. I don't know, Ray, you might want to talk a little bit about the pipeline for projects and maybe the cost of capital, how we've seen it over the last, say, 12 months or so?

Certainly, Ted. Mark, it's hard for me to comment on what others are seeing, but I can certainly comment on what we see. I mean, first, I mean, I think we're -- we don't see ourselves slowing down on our capital execution plan. And our vendors, suppliers, contractors seem to be pretty much fully committed. We've -- I think we've been somewhat ahead of this in making sure that our vendors and suppliers are kind of well matched to our plans. So I think it'll be kind of full steam ahead on that. Saying that, I mean, I think doing more if others slow down, that might be an opportunity. But it's very difficult in today's vendor and contractor constraints to significantly grow capital today. We see that everywhere. On capital escalation, certainly, there isn't -- there really isn't an area, be it labor, skills, steel, in electric motors, it doesn't matter what aspect you're touching. It -- I mean, I'm not going to give a percentage, but it's been a significant escalation in capital cost in the last 12 months. And as we look at our capital line in the next 12, 24, 36 months, we're certainly building some of that view in as to what impact that may have on future capital.

Your next question is from Benoit from Scotiabank.

I was just curious, Ted or one of you guys. Would you dare to guess how much of the B.C. lumber industry today would be losing money at today's lumber prices?

I think we'll leave that up to you to determine. I mean, we don't really comment on our costs or others. But ultimately, we know that British Columbia is the highest -- is one of the higher-class producing regions in North America, and that gives us a fair amount of comfort given that we now have almost 70% of our production outside of British Columbia. But in terms of specifics, I don't think we'd go into that.

We have a follow-up question from Sean Steuart.

Just one quick follow-up on pulp markets, guys. NBSK markets in North America are strong, I think, for apparent reasons. But it feels like things are a little more fragile in China. And I'm just wondering if you can give us an update on your order files for both softwood kraft and BCTMP in China right now.

Chris, do you want to comment on that?

Sure, sure. Sean, yes, I would -- it does seem China has slowed a little bit. Certainly, our order files both BCTMP and our NBSK are good and pretty long. We wouldn't be surprised to see a bit of a slowdown over the next few months. But fundamentally, it's still pretty strong in China. And the strengthening in the U.S. is certainly helping.

Any sense of what the inventories on the pulp side look like at the buyer level in China?

I think they're up a little bit. But -- actually, our guys are over there right now, but it's not overly concerning.

Thank you. There are no further questions at this time. Please proceed.

Well, again, everybody, thank you for joining us, and we look forward to speaking to you when our fourth quarter results come out. Take care.

Ladies and gentlemen, this concludes your conference call today. We thank you for participating and ask that you please disconnect your lines.