West Fraser Timber Co Ltd (WFG) 2019 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Timber Co. Ltd. First Quarter 2019 Results Conference Call. (Operator Instructions) This call is being recorded on Friday, April 26, 2019.

Forward-looking statements 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 depend 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 plan, 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, sir.

Thank you. Good morning, and thank you all for joining us today. Joining me is our President, Ray Ferris; our CFO, Chris Virostek; and other members of our senior management group. I will make a few opening comments, and then Chris will review our first quarter results.

It was a challenging operating quarter on a number of fronts: weather issues in the U.S. South and the implementation of curtailments in our B.C. lumber division, whether they be temporary in nature or permanent as was the case for the removal of our third shifts at Fraser Lake and Quesnel, and these impacted our lumber results. We also had another difficult quarter at our Hinton pulp mill.

But what gives us the greatest concern are the myriad of policy changes that the B.C. government is planning to implement that could potentially impact the B.C. forestry industry. Our company has invested in excess of $600 million in British Columbia over the last several years to modernize our business and to be able to fully extract the value from a declining timber resource due to the impact of the Mountain Pine Beetle. We've been planning for this eventuality for more than 15 years.

What we have difficulty planning for are government policy decisions that impact industry competitiveness and competition. We believe that policy proposals, such as the Caribou Plan and Bill 22 legislation, could potentially impact the ability of the B.C. industry to compete in a very competitive global environment. This also has a potential to materially change our view regarding further capital investment in this province.

For the last 15 years, West Fraser has also invested significantly in Alberta and the U.S. South. Those jurisdictions not only have a cost-effective timber base, they also support industry competition and competitiveness. West Fraser recognizes that we compete on a global market, and the latest policy initiatives from the B.C. government further reinforce the importance of our diversified strategy.

15 years ago, we had a capacity of just over 600 million feet outside of British Columbia. Today, our lumber capacity outside of B.C. is just shy of 5 billion feet.

With that, I will pass the call onto Chris.

Thank you, Ted. And thanks, everyone, for joining us this morning. I'd like to start by touching on the demand picture.

While housing starts are running below the levels we saw in early 2018, positive signals from declining mortgage rates and recently increased activity in the sale of new homes bodes well for a recovery in the growth of housing starts and consequently lumber demand later in 2019. At the same time, repair and renovation expenditures, which now represent the largest component of lumber demand, continue to grow at an attractive rate.

Modest low single-digit growth and demand from new home construction and repair and renovation spending has the potential to increase lumber demand by 1 billion to 2 billion board feet per year, which is a trend we have seen for the past several years.

One of the factors that we believe may be influencing the housing market in the recent months has been a significant amount of rainfall that has plagued key U.S. South lumber-producing and building markets. As shown on the slide in our operating regions, rainfall was up to 1.5x above average in the last 2 years. These conditions have influenced both job site activity, customer demand and logging activities. While it is unlikely that the resulting delayed construction will be caught up in the short term due to a tight labor market, it does create the potential for a longer backlog of demand when conditions eventually improve.

At the same time, we believe that there are significant constraints to growth in lumber supply. While capacity is being added in the U.S. South due to attractive fiber dynamics, other significant lumber-producing regions: British Columbia, the Pacific Northwest, Eastern Canada, are experiencing a wave of temporary and permanent curtailments of capacity, limiting the growth in lumber shipments year-over-year to just 0.5%.

Turning to the financial results for the quarter. We experienced a very difficult quarter in pulp, which was mostly offset by a rebound in our lumber and panels businesses. Sales declined by $33 million, and operating earnings declined by $5 million on a consolidated basis. Slightly higher finance expenses and foreign exchange movements, captured in the other expense line, reduced earnings before tax by $34 million in the aggregate.

Looking specifically at lumber. Pricing rebounded early in the quarter, which contributed approximately $27 million of additional earnings versus the fourth quarter. Lower SPF shipment volumes, partially offset by a recovery in SYP shipment volumes, led to a reduction in earnings of $5 million in the quarter. The combination of higher B.C. log costs, difficult manufacturing conditions from cold weather in Canada and lost production from wet weather in the U.S. South, in addition to capital project-related downtime, all served to increase our manufacturing costs by $6 million in the quarter.

In pulp, pricing moved in the opposite direction from lumber, although some of this was carried over from the fourth quarter in order files. A delayed vessel-sailing of BCTMP pulp at year-end spilled over into Q1, which resulted in a favorable volume impact as compared to the fourth quarter. NBSK shipments were largely in line with the prior quarter.

Costs were a significant negative as scheduled and unscheduled production interruptions at Hinton and maintenance costs from the shutdown resulted in higher absolute manufacturing costs. Our efforts to stabilize production rates at Hinton are continuing.

On a consolidated basis, the impacts in the segments were largely offsetting, resulting in a $10 million reduction in adjusted EBITDA in the quarter, with costs stemming mostly from the pulp segment being the most significant factor.

As commented earlier, lumber shipments were down 125 million board feet from the prior quarter, while pulp shipments were up a similar amount in percentage terms, resulting in a small volume impact overall. And the inventory build of 177 million, principally for log inventory in Canada, was the largest working capital factor influencing cash flow from operations. A large portion of this log inventory will be drawn down in the second quarter during spring break-up, which will add to liquidity going forward.

We maintained our commitment to investing in our facilities to preserve our low-cost position as capital expenditure increased in line with our full year targets.

Our net debt to capital increased as it normally does during this seasonal period of working capital build and remains well within our leveraged parameters. Given the attractive valuation during the first quarter, we maintained our balanced capital allocation strategy and repurchased an additional $50 million of our shares.

Despite 2 difficult quarters at the seasonal peak of working capital build, we maintained a significant degree of financial flexibility with $208 million of available liquidity from cash and bank lines. Subsequent to quarter end, we secured an additional $100 million of credit facilities for further flexibility. We have no near-term debt maturities and remain well on sight of our financial commitments.

Reflecting on the first quarter, weather and a slow start to 2019 building activity has kept lumber pricing and demand under pressure in 2019. We remain committed to improving our performance at our Hinton pulp mill and have taken steps with respect to the scheduling of shutdowns.

The B.C. government has announced a number of policy initiatives that could have a significant effect on the forestry industry in B.C. in the coming years. We believe we are well prepared to face these challenges.

As we look forward to the balance of 2019 and beyond, we remain committed to our approach and have built on our financial flexibility to execute our strategy.

With that, we'd like to open it up for questions.

(Operator Instructions) Your first question is from Sean Steuart from TD Securities.

Two questions. I'll start with the pulp downtime. In Q2, you're taking Quesnel down for maintenance. How many tonnes will that downtime be? I'm just trying to benchmark, I guess, the potential unit cost impacts relative to what we saw in the first quarter.

Sean, it's Ray here. So Sean, we're scheduled for 12 days. And so that would be about 6,000 tonnes.

Okay. Smaller scale. A question for Chris or Ted or Ray. Just want to walk through your thinking on the buyback. Share price is well below the levels where you are a lot more aggressive on the buyback last year. The pace year-to-date has slowed quite a bit. Trying to understand the rationale there. Is that just because of liquidity constraints in light of the Q1 log inventory build and accelerating CapEx? Does it reflect your view on mid-tier market challenges? Maybe give us some thinking on -- some context on your thinking around the buyback right now.

Sure. Thanks, Sean. I think -- as we think about the history of share buybacks, the company has been active since 2013 in doing buybacks and over the last couple of years has certainly taken up more. When we think about this, we don't think of it necessarily with a 1 month or 2 months of hindsight. We'll be looking at this 3, 4 years down the road and judging it. I think as we've looked at our balanced strategy, we believe that we've got the flexibility to invest capital and to continue to buy back shares. I think certainly, when we look at where the last 6 months have been, it's been a surprise for folks. But we're committed to continuing to take it up. There are limits of what we can do on an annual basis and on a daily basis, and we're just trying to prudently operate within those parameters and within our view to liquidity.

Okay. And just want to confirm, you talked about overall lumber volumes being down at least 200 million board feet this year. Does that -- in Q2, are you taking any downtime beyond the permanent shift reductions at the 2 sawmills? Or do you envision taking any downtime at these price levels?

Sean, it's Ray here again. So Sean, what I would say is that -- kind of 2 things. One, we look at our operating strategy kind of every day. And so if -- so that's what I would say. So today, I can't forecast what we'll do kind of going forward.

On the other hand, with respect to the downtime that we have taken and the downtime that is actually kind of happening right now. So the 300 million board feet of permanent curtailments at Quesnel and Fraser Lake, some of that occurred in the first quarter, but a lot of it will actually take place here in the second quarter. So in some cases, a lot of that impact is still yet to be seen in the marketplace.

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

Is it possible, Ted, to give us just some prospective time line on determining the impact, the fallout from these various B.C. policy proposals?

Well, I might take a start at it and then Ray may want to comment as well. I think, first, in terms of the Caribou Plan, which I think you heard that announced 3 or 4 weeks ago, I think government is taking a bit of a pause there. They've asked a fellow by the name of Blair Lekstrom, who was an MLA or a member of government with the previous, previous government, to get involved and to make recommendations to government. We are guardedly optimistic that we will see this plan be altered. But if it goes the way that we think it's -- or the way it was initially announced, it could have a severe impact on production in British Columbia. And I can't give you the timing of that. But it would obviously -- as soon as they implement it, it would start to have implications for the way we all run our businesses in British Columbia.

In terms of the proposed Bill 22 legislation, the first thing the government says, as I understand it, the industry has to get smaller and that rationalization needs to happen. If this bill is implemented as proposed, I think that the ability to rationalize will be that much more difficult because government will have to approve every single commercial transaction. And there are a lot of uncertainties about what it would take to get a transaction approved. But I think bottom line, it affects the ability for the industry. You get smaller in a competitive and cost-effective manner. Again, timing remains to be seen. But I think it puts the whole B.C. industry on pause right now.

And does that put your CapEx in B.C. in a kind of a pause, Ted?

Well, let me just give you some perspective here. Just one example. So we invested almost $150 million in Chetwynd in Northern British Columbia on upgrading the mill and also building a large energy plant. That is one of the areas that really wasn't impacted in any major way by Mountain Pine Beetle. So really, what is -- could potentially impact the future of that mill is government policy.

And so if we are uncertain about government policy, for sure, we're really going to have to take a much -- have a much higher payback for capital or potentially defer capital until we better understand the playing field that we're on. But right now, the playing field looks very uncertain.

I don't know, Ray, if you want to add anything to that.

No. I think you covered it, Ted.

Okay. So we're quite concerned about it. I think, Mark, I think that the entire industry is concerned about it. And we've come together as an industry to talk about that through our -- through the Council of Forest Industries. And I think you'll expect to see a response from our industry as -- and we're hoping to work collaboratively with government. But let's be clear here. They're making decisions without consulting with industry at this point. So we're hoping that we can get them to understand the impacts this will have on industries, communities and employees. But we are very concerned.

And Ted, is there anything where you've just -- you've kind of -- you've put projects on hold right now until this is resolved?

Well, we've invested a fair amount of money in British Columbia. Our footprint is fairly modern. There are some other projects we're looking at. But really, today, a lot of our capital in terms of large projects is in the U.S. today in any event. So there really are no major projects that are in front of us today, but there are projects that we've been thinking about over the next couple of years. But I think for now, anything major is definitely on hold.

Okay. The other question I had is could you just kind of walk us around B.C., Alberta and then the Southern U.S. in terms of what you're seeing for kind of log costs.

I can take a shot at that, Mark. It's Ray here. So -- well, of course, it's no secret that we continue to see, quite frankly, despite curtailments and pullback in the industry -- I mean, log costs from British Columbia, at best, are kind of flattened out but frankly are probably still raising.

The Alberta system is, as you're aware, I mean, we did see log prices go up last year with the strong market. And of course, with a lower market, they come down reasonably quickly. So I would say Alberta is pretty steady.

In U.S. South, there certainly have been some regional impacts. The sustained weather events throughout the U.S. South -- our belief, it certainly have an impact. It's not huge but in the range of kind of a couple of bucks a tonne. Depending on the region that you're in, it certainly had an impact. So our belief is that as weather conditions improve and logging conditions improve -- and we've seen similar cycles in the past, but expect to kind of -- to retreat a little bit. But who knows?

Your next question is from Hamir Patel from CIBC Capital Markets.

Ted, you mentioned the potential Caribou changes could have a significant impact depending on well, I guess, the extent of it. But in the worst case, what do you think that impact on industry production could be?

Well, I will take a shot at it, but it's still to be defined. The first one that they're really looking at is in Chetwynd area, but there's Caribou all down the mountain ranges and throughout a good part of British Columbia. So it does remain to be seen what the impact is. And I think our concern around this, Hamir, is really that we weren't consulted with. Our communities weren't consulted with. And we've been dealing with this issue, for example, in Alberta for probably 7 or 8 years. And there's -- I can't tell you how much time we spent on this issue with government, trying to -- the Alberta government, trying to find a solution that works for Caribou, that works for communities, that works for the industry, that gives us confidence to invest.

So in all honesty, it's a bit hard to determine what the worst case is. But the big issue here is when industry and communities aren't consulted, it just really erodes our confidence. And so again, as I said earlier, we're hopeful that government will take a pause and realize that the proposal that they were thinking of implementing is just not workable for communities, industry.

And I'm not going to get into the science of a Caribou recovery, but we don't believe it really has a material -- a materially different impact than if we found a solution that was more in line with what's happening in the rest of Canada. But we don't know what's going to happen. We think -- we understand that the recommendations from this fellow, Blair Lekstrom, have to get to government, I think, within the next 30 days or so, 30 to 60 days. I don't know the exact date. And then we'll see where we go from there.

Fair enough. So that's helpful, Ted. And maybe on the Hinton mill, can you just maybe share more about what went wrong with the unplanned downtime and how are you feeling about the pace of the improvement going forward as you switch the maintenance cycle?

Hamir, Ray here. So I'd kind of answer that a couple of ways. So we certainly had an unusual event early in the year around Hinton, really on the outside of the mill, that essentially took power of the mill and had a very significant impact to us right out of the gate, and that, frankly, really wasn't tied to operational performance. Saying that, as they come out of that, we went right into our shutdown, had some difficulties coming out of the shutdown and kind of that's -- there's the quarter.

So with respect to the change in maintenance cycle. I think a number of years ago, the industry started to move away from -- to these longer periods between and see -- and the larger maintenance shutdowns every 3 years. Our experience, and I believe others are kind of looking at that, that hasn't -- we haven't been rewarded the way we'd expect. And that we're seeing that going to more frequent but smaller shutdowns is, we believe, is the way to kind of improve reliability. So it's part and parcel of attacking our -- of really, both Caribou and Hinton. But they're really the same issue -- not the same issue, but with respect to reliability, we think that will help both operations. So...

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

Just maybe I'll start with CapEx. I think the budget for '19 is somewhere -- flows between $350 million and $450 million. Do we have major projects that you can maybe speak to, where you're going to be spending that money?

Paul, it's Ray here. Good question. I always hate saying that, but good question. We do have major projects. And I would say the major projects are primarily in the U.S. South, in the Southeast region. But I don't think we've kind of come out and said exactly how we're going to distribute that yet. But we do have major projects, primarily in the U.S. Southeast at our Southern Yellow Pine [growth].

Okay. And then maybe moving to Caribou because we're talking a lot about it. What has been the lessons that you've learned between yourselves and the things that you've tried to do in Alberta that you would like to try to implement in B.C. if you had some consultation with government?

Well, I will take a shot at it. And well, first of all, initially, the Alberta government was probably going to take, I wouldn't say quite the same stance as British Columbia, but they consulted with us quite a bit. And then community leaders got very engaged, understanding the potential impact on jobs. And I think the Alberta government decided to pause and recognize that this is also a negotiation between the province and the federal government. And so the province decided to enter into, I think, a more deliberate negotiation with the government -- the federal government and look at areas in the province where it would actually make a bigger difference in terms of Caribou.

And so they looked at a number of undisturbed regions in the northeast part of Alberta, and that's where they really put their focus on. That doesn't mean that where we operate, that we were going to come away unscathed. We expect there will be an impact, but we expect it to be much more benign than initially contemplated. So I think they really tried to look at all the factors, not just -- and look at other solutions to Caribou recovery. And if you want more information on that, we can get one of our woods folks to really give you a lot more detail, if you like, Paul. But fundamentally, I really think it was really collaboration and cooperation, looking for broader solutions and -- rather than one simplistic solution that had significant repercussions.

And so that's where we are in B.C. today, and we're hopeful that B.C. will take a look across the Rockies and see what Alberta -- and by the way, what Québec has done and what Ontario has done, what Manitoba has done, which is a really balanced approach. And it's not just about restricting access to land base. It's about looking at a variety of solutions: penning of -- maternal penning and a variety of other things that, frankly, others know way more about it than I do.

Okay. Fair enough. So maybe let's turn over...

Yes. Sorry to be -- this is not one of these black and white things, I think, Paul, is the main [issue].

No, no. It's -- [absolutely], the areas are gray here. So maybe turning to something easier with Bill 22 here. When you guys did a swap with Canfor a few years ago with the tenures, that didn't require and you didn't consult the government until after you did that. Is that correct?

I think the short version of that would be that's correct, yes.

Is the worry around Bill 22 is that you worry that the government reallocates some of that tenure? Or is it more just the extra body at the table to try to negotiate a deal?

Paul, so I think it's both of those. I think you have to kind of go by what their stated intentions are, and I think they've been relatively clear on they want a seat at the table and they want others involved. So it's really about that. So it really comes down to too many people at the table all wanting a piece of the same pie. And I think that would be the concern. If you were trying to maintain a strong B.C. industry, it's how do you do that. And what's -- and to me -- I think our concern would be, "Is the government view of what a strong B.C. industry is the same as what ours would be?"

But may -- I might just add to that. So let's talk about that transaction we did in 2013. We made a decision to shut our Houston mill down. That was an independent decision. We could have -- we did a trade with Canfor, but we could have moved that 250,000 cubic meters very inefficiently to some of our other mills in British Columbia.

Obviously, everybody knows that annual allowable cut was shrinking in the Quesnel region as well. Canfor made their decision, and then we got together with them and said, "Does it really make a lot of sense for us to be moving wood around like this? Why don't we do it in a more cost-effective way?" But that is done for us in Quesnel. It's helped us compete. And let's remember, B.C. has got the highest wood costs, I think, in North America. So if we're trying to compete in a global market, we have to find efficient ways to rationalize. That was a very efficient way. And I think, obviously, it allowed -- at least I just want to speak for West Fraser, it allowed us to improve the competitiveness of our remaining mills. And that's what we're looking for. And we're afraid that this will affect our ability to rationalize in a way that makes our business better.

All right. And then just on log costs. I think, Ray, you mentioned B.C. flat to rising. What's the impact of the July 1 stumpage change? I thought that was a material move up in rates.

It is a material move up in rates. So -- and so still, we kind of see exactly how that flows out region by region. But it will be material, and it's certainly something that we're focused on. Different than in past years, quite frankly, for us, the curtailments and improved logging conditions. Our inventories are in pretty good shape in the entire British Columbia. So -- but we're looking at that and is a material impact we'll kind of look going forward in the third quarter.

Okay. And then maybe just to end my questions with a bright spot. Plywood was -- or panels was better, and I suspect it's better plywood pricing that outpaced our expectation. What are you seeing in that market?

Paul, it's Chris. Yes. I mean plywood's really held up really, really well. We do have some concerns around the Canadian market. Definitely, housing has slowed. We are moving into the bigger R&R period for us, and plywood is a very big part of that. So we're seeing it holding up reasonably well. I wouldn't say it's quite as good as it was last year, but I think we're going to be in pretty good shape for the balance of the year.

(Operator Instructions) We have a follow-up question from Mark Wilde from Bank of Montreal.

Yes. Ted, I wondered if you or maybe Chris or Ray wanted to talk a little bit about what you're seeing in terms of valuations for potentially more sawmilling capacity down in the Southern U.S. Is the direction we've seen over the last 9 months, does that put any downward pressure on valuation?

Yes. Mark, it's Ray here. There's -- I would say, there's -- I don't think -- there's always something going on every day, but I would say it's not that busy today. And I would say, at least -- I can't give you a lot of color there. I would say, at least in the short term, I don't think there's been a big change in valuations. But I guess we'll see what the next transaction looks like when it comes out. But I'm not sure if Ted has a...

Well, the only thing I would add to that is when we look at our capital allocation strategy, as Chris talked about before, there's really 3 things we can do: we can look at acquisitions, we can invest in our existing business, and we can return money to shareholders. And I think today, I think the latter 2 are much more attractive to us, and particularly reinvesting capital in our business.

We've done a number of acquisitions over the last number of years, and we really want to modernize that footprint. So I think for us, we're going to continue to look at acquisitions. But ultimately, at West Fraser, our goal here is not to be big. It's to be great. And we've got a lot of work that we want to do to get our U.S. mills running at the level our Canadian mills are running at. And so that really is our primary focus. That doesn't mean we won't look at acquisitions, Mark. But it's not our first priority today, in all honesty.

Well, is it fair to say, Ted, that the kind of priority in terms of the existing assets is probably pretty heavy toward kind of upgrading the Gilman assets?

Yes. Mark, it's Ray here again. Without a doubt, our -- we see significant runway in front of us in the U.S. South. And so it's the bulk of where our capital strategy is deployed. It's the bulk of where our execution strategy is. And further just to Ted's point, it's -- in the next period of time, it's really about managing up what we have. And quite frankly, we're looking forward to that.

Yes. So essentially, the same thing that you did in the wake of the IP [predictions]?

Yes. I think the last thing, Mark, is that there really isn't that many large opportunities in the U.S. today. As you know, it's really a mill here, maybe 2 mills there. So unless it really moves the ball for West Fraser, I don't really see that to be all that exciting, at least in the short term. That doesn't mean we don't want to grow, but we just don't see those types of large-scale opportunities today.

Yes. Okay. Ted, is it possible for somebody there to talk a little bit about what you're doing in offshore markets? Because I've been noticing that the Canadian volume into China has been going down, trending down over the last 4, 5 years. I'm just kind of curious about how you're approaching China but also approaching the other export markets for lumber.

Yes. Mark, maybe -- it's Chris here. I'll take a stab at that. Firstly, there's been a major decrease in the amount of low-grade that we're producing in our B.C. mills. That was a very heavy product for China as their construction ramped up. So -- which is a good thing for us. So we reduced that. We've had a very good market in North America for the last number of years. We've taken a bit more advantage of that. But I would say geographic diversity for us is really important from the sales side.

Japan has slowed some. But again, it seems to be picking back up, and we got a significant footprint there. There's a lot of competition into China from all over the world, and that will continue. But we're well positioned to get there, and we're trying to grow the higher-end uses of lumber in China. That's taking time. We think there's great opportunity in Southern Yellow Pine there. We're just scratching the beginning there. And we're actually starting to get some traction throughout the world, whether it's in Pakistan, a little bit in India, some of the Middle East for our products. So we feel that we have an opportunity to grow that little offshore business some but have it balanced with Canadian and U.S. demand. So...

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

Well, thank you all for joining us and enjoy the rest of your day. Thanks very much.

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