West Fraser Timber Co Ltd (WFG) 2018 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Fourth Quarter 2018 Results Conference Call. (Operator Instructions) This call is being recorded on Wednesday, February 13, 2019.

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

Good morning, and thanks for joining us today. I have Ray Ferris, Chris Virostek and Chris McIver with me. We've prepared a PowerPoint presentation which you can follow along, which is being webcasted.

2018 was a year of volatility in lumber markets and a year when weather impacted our operations, transportation capabilities and quarterly financial performance in an unprecedented fashion. Chris Virostek will review our fourth quarter lumber results, as well as providing a high-level summary of our full year results. Prior to that, we thought it might be helpful to provide our view regarding lumber markets and to review our long-held thesis that at 1.3 million U.S. housing starts, we would experience balanced supply and demand fundamentals. With that, I would like to turn to Slide 3.

Housing starts were on pace for the first 6 months of the year to bring us in line with 1.3 million housing starts for the year. While we haven't seen the results for December, we expect that housing starts will come in at approximately 1.26 million for 2018. What is encouraging is that repair and remodeling activity continues to outpace GDP growth, and we expect that pace to continue.

Consequently, as you look out at the next 3 to 4 years, our view really hasn't materially changed from the beginning of 2018, when we projected demand to grow at an annual growth rate of close to 2 billion feet, or approximately 3.3% per year. This is lower than the annual demand growth rate of approximately 4.5% from 2011 through 2017. While demand growth may be somewhat lower going forward, we think that the same can be said regarding our outlook for supply growth over the next few years. And with that, let's move to Slide 4.

For some time, we have been saying that the 2 key factors that will govern North American supply will be the impact of the Mountain Pine Beetle epidemic on B.C. production and that a number of factors will present challenges to growing U.S. South lumber production.

The competition for timber has been fierce in British Columbia, and we forecasted that the day would come when it would be uneconomic for all our mills to run at our historical run rate, given the decline in the annual allowable cut. For that reason, we made the difficult decision last year to permanently eliminate our third shifts at Quesnel and Fraser Lake in 2019. Although we can't predict the timing of the future industry supply reductions, it's been known that the reductions in the annual allowable cut will force further reductions in lumber production in British Columbia. As an aside, that knowledge has driven our strategy to expand in Alberta and the U.S. South.

With respect to the U.S. South, we do believe capacity growth will be slower and potentially lower than anticipated 1 year or 18 months ago, due to the factors that we present at the bottom of the slide. As a result, the potential of somewhat lower demand growth over the next few years will be balanced by materially lower supply growth than we had experienced through the last number of years.

We've been asked by a number of investors to provide our view with regards to the volatility in lumber markets and financial results in 2018. Perhaps Slide 5 will provide some visibility on this.

During the first 4 months of 2018, weather and unprecedented transportation challenges resulted in West Fraser undershipping production by 200 million feet, and we believe the industry as a whole undershipped production by approximately 1 billion feet in that period. From May through August, we overshipped the corresponding volume. On a 60 billion board foot North American market, that means that we undershipped by 5% in the first 4 months on an annualized basis and overshipped by 5% the next 4 months. A 10% net difference in shipments over this period was bound to result in volatility, and this was exacerbated with a slowdown in U.S. housing. As we mentioned during a few of our calls last year, we plan to make this a catalyst for change in how we manage our transportation efforts. We have made great strides, and while we can't rule out some volatility due to weather, we have a much more robust transportation plan today, and it's paying dividends.

With that, I will pass the call to Chris.

Thanks, Ted.

Turning to Page 6. We'd like to spend a couple of minutes talking about the fourth quarter and, in particular, our lumber business. As Ted mentioned, it was a challenging quarter on a number of fronts.

Relative to the prior quarter, lumber production was down 5%, and shipments were off approximately 10%. SPF production was in line with the year-ago quarter but down slightly from Q3, as we took some market-related curtailments over the holiday period. SYP production was lower than Q3, as persistently wet weather in our operating areas in the U.S. South led to challenges in log availability. We were also working on the ramp-up of our new sawmill at Opelika, Alabama, and we're executing on some other planned maintenance downtime during the fourth quarter.

Lumber shipments declined from the prior quarter by almost 200 million board feet. In SPF, our shipments in Q3 were relatively higher, as that quarter included some shipment of backlog from Q1 as we worked through our earlier delays that Ted just described. In respect of SYP, softer market conditions contributed to the shortfall in shipments relative to production. On the whole, our lumber shipments in Q4 were in line with production and similar to the fourth quarter of last year.

SPF benchmark 2x4 pricing was off just over 30% in the quarter, as pricing retreated from higher levels earlier in the year when it was influenced by the supply issues. SYP benchmark 2x4 did not decline as significantly. However, wider dimensions of SYP suffered a significant correction in the fourth quarter. Despite these factors, our lumber segment managed to produce an adjusted EBITDA per 1,000 board feet of $43.

Turning to the reconciliation of Q3 to Q4 earnings for the lumber segment. Of the decline in adjusted EBITDA of $271 million, we estimate that approximately $200 million is due to price and product differentials. The change in the premiums between narrow and wide dimensions, we estimate, had an impact of approximately $31 million, and the remaining $170 million was due to price declines in SPF and the other products. The 10% decline in lumber shipments reduced earnings by a further estimated $35 million, and the impact of higher costs, which was most significantly fiber in Western Canada, represents the balance of $35 million.

Turning to the year, we grew our lumber shipments by nearly 500 million board feet, largely representing the carryover impact of the Gilman acquisition. For the year, 42% of our lumber production was SYP in the U.S. South, up from 38% in the prior year. Pulp production was slightly off to prior year by 2% and remains a focus area for us in 2019. Higher prices across all commodities led to a 33% year-over-year increase in adjusted EBITDA, to just over $1.5 billion. Cash flow from operations was similar to the prior year at $909 million, as cash taxes, pension funding and duties all consumed a higher portion of adjusted EBITDA than in 2017.

To date, we have USD 244 million of duties on deposit with the Department of Commerce. We increased our capital expenditure by 10%, to $370 million, and completed 2 major sawmill rebuilds, 5 continuous kilns and several upgrades in our pulp business, among other projects across our mill network. As stated in our MD&A, we are anticipating capital expenditure in 2019 of between $350 million and $450 million as we continue to action high-return projects across our network of operations.

Net debt to capital was healthy at 17%, and available liquidity remained strong, at $651 million as we closed out the year. Strong in our conviction in the medium-term fundamentals for lumber supply and demand, we executed on our share buyback throughout the year, reducing our share count by 10% and returning $675 million of capital to shareholders while retaining a significant amount of financial flexibility for growth.

The balance that we have applied to our capital allocation strategy has been, in our view, key to creating value. In the past 4 years, we have generated nearly $3 billion in cash flow from operations. We have put roughly 43% of that back into the business to maintain our leading position as the low-cost lumber producer. At the same time, we have put $600 million, or 20% of the cash flow from operations, to work growing the business and expanding our platform in the U.S. South and Alberta as 2 cost-advantaged regions.

Finally, we have returned 38% of the cash flow from operations back to our shareholders in the form of dividends and share repurchases. We have executed that balanced strategy while not compromising liquidity or constraining our financial flexibility to pursue attractive internal investment options or external growth opportunities. Cumulatively, through the end of last week, we have repurchased nearly $1.1 billion in shares. And at the same time, our trading liquidity has improved since we started the repurchase program in 2013.

With that, I'll turn it back to Ted for some summary comments.

Thanks, Chris.

Turning to our summary slide. Despite a myriad of challenges in 2018, West Fraser continues to execute on our long-term strategy to be the leading wood products manufacturer in North America. We were able to build on our leading North American lumber margins in 2018, and we believe that the geographic diversification of our lumber business with the attendant capital opportunities will continue to support margin growth.

What we also want to stress is that operational excellence continues to be our core priority as we run the business. It's clear that we have more work to do, but I know we have the assets and the people to realize our goals.

With that, we'll open the call up for questions.

(Operator Instructions) And your first question is from Hamir Patel from CIBC.

Ted, when you purchased the Gilman mills, I think you pointed to the lumber recoveries at those mills lagging your existing facilities by 20%. Have you started to close that gap there? And if those mills had, I think it was 700 million board feet of capacity when you bought them, what's the potential capacity growth you could see if you close that recovery gap?

Well, I think I'll have Ray Ferris, our President, comment on that.

Hamir, so to Ted's point, we still have that gap to increase. So we're really just getting started on our capital strategy at the Gilman facilities, and that would be something that really, over the next couple of years, that we're going to be able to kind of execute on that plan. So that opportunity is still front and center, and we're looking to capture that.

I think just to add to Ray's comments, I mean, I don't think we want to give a number in terms of capacity growth. But I think where your question is coming from, Hamir, is that our recovery -- lumber recovery is 20% lower than the rest of our U.S. assets. So we can't give a number, but we see material opportunity to grow our footprint there with capital over time.

Fair enough. And, Ted, you guys completed Opelika last year. Do you have any similar projects like that underway that might come online in 2019?

Well, again, I think Ray can probably give you a better detail than I would on that one.

Hamir, we have what I would say is a pretty good runway of similar projects like that, that we plan on rolling out over the next several years. Specifically to 2019, I would say, more specifically, we would be beginning 1 or 2 of those projects, but we may not see the benefits of those until 2020.

That's helpful. And just a final one for me. I'm just wondering if you guys can give your sense as to where you think inventories are in the channel for lumber.

Well, Chris McIver is probably the best one to answer that question as well.

Hamir, yes, I mean, again, it's not clearly evident, but everything we hear and what we're seeing from our customers is it's still pretty lean. They're starting to buy again. They're starting to build. Certainly in SYP, the takeaway has been really good this year so far and is being consumed and put out into the market. So I would say they've probably gone up a little bit from year-end, but are still in really good shape.

Your next question is from Sean Steuart from TD Securities.

A few questions. The $31 million in sequential EBITDA pressure related to price spread differentials, I guess, and I take it most of that was inordinate pressure on the wider dimensions in the South. Can you give us an idea -- is that a normal mix? Was it a normal sales mix for you guys this quarter in terms of dimensions? And absent 2x10 prices in the South catching up, is a mix shift coming in the first half of the year that might expedite that price recovery?

Sean, it's Chris again. Yes, I would say that our mix was pretty normal. But when you do see the 2x4 hold up and the wides not hold up as well, you're going to see that big gap come. Now we are seeing the wides recover some this quarter, and certainly, demand for wides is up. And it seems like 2x4 in the South holds up pretty much throughout most cycles, whereas when we see things slow down, we certainly see wides weaken. So with regards -- I think our mills are always tweaking as to our grade mix, or certainly our width mix.

Yes, without giving numbers, I think a lot of our capital plans in the U.S. South is to give us a bit more flexibility in terms of producing a higher percentage of 2x4 as time goes on here. So that will be a focus for us as well.

Okay. Wondering if you can speak on Western Canadian fiber cost and maybe differentiate what you saw in Q4 between B.C. and Alberta and how you see those costs trending into the first half of 2019.

Sean, it's Ray here. So I'll take a stab at that, Sean. I mean, in British Columbia, the past trend -- despite curtailments, I -- there could be some softening, but quite frankly, our expectations are that we expect that trend to continue for some time until true kind of rationalization happens in British Columbia. In Alberta, a little bit more responsive to market. So log costs did come down, and fiber costs did come down in Alberta and have kind of flattened out. So I would say that's kind of our view of the first part of 2019. It's going to depend on -- quite frankly, on lumber market conditions.

We heard from some of your competitors that bidding for logs in B.C. has become more rational, if not late last year, certainly early this year. Is that consistent with what you've seen?

I think it's a matter of context and perspective. I think it depends on how you look at it. I would say, to qualify -- it may have eased slightly, but still very difficult out there, and there's a lot more work that needs to be done.

Okay. Last question for me. The panel segment, the Canadian plywood pressure was pretty transparent, but the margins still came under quite a bit of pressure. Can you give us an idea of the shift curtailment you had for the LVL segment? How much of that fed into weaker margins? And is that shift still curtailed into early 2019?

I'll take a shot at that. So our LVL strategy -- so I would say they're kind of separate things. So our LVL strategy, it's less a reflection of a reduction in production, more about kind of how we've gone to market. And in 2017, we made a change at the plant to target kind of a different product mix, basically higher strength values, and that came with a view that it probably means lower production but better margins. I'm pleased to say that's kind of where we are at. So I would say LVL is a -- remains a pretty good little business for us. But I think what you've seen in the balance of the panel sector is, frankly, similar cost pressure on logs and a dip in short-term plywood pricing.

Your next question is from Mark Wilde from Bank of Montreal.

I wondered, Chris, if we could just come back to the lumber inventory issue for just a minute. I was -- I've been hearing a lot of the same stuff that you were suggesting. But then I saw this story in Random Lengths last weekend that was suggesting that dealer inventories were up more. Did you see that? And what did you make of it? Because it didn't seem consistent with other sources I've checked with.

Yes. I did see it, Mark. And again, it isn't consistent with what we're hearing. But Random Lengths does a pretty general survey, from my understanding. I don't know how much science is behind it. So what we can tell you, though, is that what we're hearing from our customers every day is that -- and quite frankly, at the beginning or within a couple of weeks ago, when business got a little bit better, you sure saw people wanting to buy in a hurry and get the product shipped to market, which tells me their inventories aren't that big, but -- so I really can't specifically comment on the Random Lengths.

Yes. Okay. I really didn't know how much rigor there was behind that survey, so I was a little cautious myself. Chris Virostek, can you give us any sense of where the big buckets are going to be in terms of CapEx in '19? And just the -- it sort of looks like, to the midpoint, you're going to be up about 8% or 10% just year-on-year in '19.

Yes, I can start, then Ray can probably chime in. I think as we look at the sort of relative comparison of '18 to '19, we do have 2 pulp mill shutdowns coming in '19. And as we started off the call, we see a big pipeline of opportunities there in the U.S. South with respect to modernization, and continuing to work on those projects. So I think when we think about some of the priorities that we have laid down relative to capital, it's modernizing those U.S. mills and bringing them along to where we think that they realistically should be and then continuing to work on our pulp reliability. But the majority of that CapEx would be destined for the U.S. Ray, anything you want to add to that?

No, I think that covers it. I mean, I think we're -- to, I think, one of the previous questions, I would say just this, is that we're pretty excited about the platform and the runway we have in U.S. South. And so it's really kind of deploying as much capital at really some wonderful projects to -- as quickly as we can without disrupting kind of our operating platform. So we're kind of full steam ahead.

All right. And then I wondered, can we talk a little bit about China, both in terms of kind of the pulp business, but also in terms of the lumber business? I noticed year-on-year, your volumes in lumber were pretty flat going into China. I'm just kind of curious in that business, whether this slowing that we are seeing in other businesses in China are having any impact on the lumber business.

Mark, it's Chris again. What I'd say about our China business on the lumber side is we target very steady volume month-to-month. We know some of our competition, particularly smaller producers, tend to chase the market, whether it's in North America or whether it's in Asia. We've got a pretty big commitment there, and so we're pretty stable. We like the volumes that we're doing there. More or less, we hold it steady, and opportunistically, we'll go up and down a little bit. And we're seeing demand continuing strong there on the lumber side. Not overwhelming, and there is competition, but it's very steady for us so. With regards to pulp, we certainly -- going into Chinese New Year, we did see a bit of a weakening in the market. Our -- but saying that, our order file for our pulp group has stayed very strong, and we expect the market to recover there. We'll see what happens as they come out of the Chinese New Year. So...

Okay. All right. And then last one for me, is it possible for you guys to size the mid-January curtailment impacts that you announced?

Well, I think the curtailments we announced, I think, Chris, were 50 million board feet for the quarter, and so that's what we have there. And again, we took our sawmills -- our third shifts down at -- on top of that, we took our third shifts down at the sawmills January 14 at Fraser Lake and Quesnel. And, we'll be taking the third shifts out in the planer probably sometime in the second quarter. So you'll start to see the net impact of that 300 million board feet start to happen over the second and third quarter.

(Operator Instructions) At this time, we have no -- oh, I'm sorry. You do have a follow-up from Mark Wilde at Bank of Montreal.

Just a follow-up. Ted, this might be the last time you have to answer this question. Can you just talk a little bit about sort of the issues at Hinton in the fourth quarter?

I thought I would skate through it. I'm going to do one more call, I think. I know I'm going to do one more call, but...

Hopefully not a Hinton question, though.

No, no. I was going to have Ray answer the operating questions, but I think I'll take this one. Boy, I think we've talked about this just about every quarter for the last couple of years. And we had a good third quarter at Hinton, and we've had a number of quarters that we've been encouraged, then we really struggled in the fourth quarter. And you've heard me say this before, and I'm going to say 2 comments that's starting to feel repetitive. I think the first comment is, we won't tell you that we're feeling good about Hinton until we've got 3 or 4 solid quarters behind us, and we continue to feel that way. Secondly, though, we are putting a ton of effort on reliability, and some days, some weeks, we don't feel like we're seeing the benefits of it. But what I can say is that when the mill runs well, it runs better than it used to. And our folks are putting a ton of effort and focus on putting the right measures into reliability in terms of asset quality and how we're running the mill from an operating standpoint. So it's just like one of those things. You're not seeing the benefits of all the hard work, but we feel we've got a good plan of action, and we've got a big maintenance shutdown coming this quarter. I know we're much better prepared for it than we've been in the past. Obviously, it'll be a fairly lengthy shutdown and will be challenging. But the key, I think, will be to see how we come out of that in the second quarter. And I'm hopeful we'll have a strong -- good shutdown and a strong second quarter. So when Ray reports second quarter results, he'll say, "Ted's gone, and Hinton's running well."

Okay. Listen, just one other one. You talked about sort of the changes in your kind of transportational logistics out there and looks like you shipped production basically this quarter. But are you seeing any transportation issues at all, either from an unavailability or from kind of a cost standpoint here?

Yes, we were running into some transportation issues from time to time, much less so than last year. But we've also put measures in place, Mark, that allows us to adapt to that. We've made some larger commitments to other modes of service. And I think as we said last year, we really got our mills and our sales groups totally engaged with our transportation folks so that we can be much more nimble and have the ability to load trucks, railcars, whatever it takes to move the products. So I think we're -- weather has been better. I've got to say our major rail carriers did a much better job this year than last year, and I know they've put a lot of focus on it. But we've also created the capability to have flexibility in our system. So, so far, so good.

At this time, there are no further questions. You may proceed.

Well, thank you very much for joining us on the call, and stay warm, and we'll talk to you in a few months.

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