West Fraser Timber Co Ltd (WFG) 2019 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the West Fraser Q4 2019 Results Conference Call. (Operator Instructions)

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 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, as is supplemented by the company's quarterly MD&As. Accordingly, listeners should exercise caution in relying upon forward-looking statements.

This call is being recorded on Wednesday, February 12, 2020. And I would now like to turn the conference over to Ray Ferris, President and Chief Executive Officer. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us today. With me is our Chief Financial Officer, Chris Virostek; as well as Chris McIver, our Vice President of Sales and Marketing; and there are a number of our other senior management team. I will make a few opening comments, and then Chris Virostek will review our fourth quarter results.

2019 was a transition year for West Fraser on several fronts. Firstly, we adjusted our B.C. capacity to more closely align with the available timber supply, which included permanent capacity elimination of over 600 million board feet of lumber production, including the closure of our Chasm sawmill.

Additionally, late in the third quarter, we implemented variable operating schedules at several of our B.C. operations to further adjust to the economic available log supply. Although most of British Columbia operations have since returned to normal schedules in early 2020, we will continue to be disciplined to reduce our costs and to manage to the available log supply. As log supply and demand normalizes in British Columbia, we expect to see B.C. return to being a profitable region. It is important to recognize that B.C. is home to some of the most highly-skilled workforce and achieves the safest, most productive, utilizing some of the best technology available in any forest manufacturing region in the world.

Secondly, outside of British Columbia, our Alberta operations in 2019 were impacted by a severe early fire season, which was closely followed by wet weather throughout the summer and fall. When coupled with contractor shortages in Northern Alberta, this led to unprecedented low log inventories, which impacted our productivity and led to several curtailments. Additional logging and hauling contractors have been added in 2020 in Alberta to ensure inventories return to normal levels, and we expect to return -- have normalized operations in 2020. And in fact, we already have.

Our panels group, despite curtailments in British Columbia in the fourth quarter, continued strong operational performance for the group. With respect to pulp, our BCTMP operations continued to operate very well in the quarter. Our NBSK operations slowed somewhat in Q4 over an improved third quarter, and our pulp group remains focused on reliability and cost reduction initiatives. And although we have much work to do, we expect to see gradual improvement in performance going forward.

It is important to note that we have 27 U.S. South and Alberta sawmills and when combined, now represent over 70% of our West Fraser lumber production.

And then finally, in the U.S. South, we continued our aggressive modernization and growth plan with several key capital project completions occurring in the last half of 2019. Early progress on the start-up curves for these projects has not been easy, but it has been encouraging. Our U.S. group is excited to have a significant disruption period behind them, and they are focused on achieving their expectations. I'll discuss later 2 of the major initiatives currently underway in U.S. South after Chris reviews our fourth quarter financials. Chris?

Thanks, Ray. During the fourth quarter, the macroeconomic data indicators for lumber demand improved favorably. Housing starts and permit numbers strengthened in the fourth quarter. The annualized pace of housing starts reported in December was the highest level since 2006. While repair and remodeling growth may be slowing, absolute spending is still on the increase. Lumber benchmark prices increased modestly in the fourth quarter, a trend we are continuing to see early in 2020. World annual pulp shipments have been in line with the previous 2 years.

The coronavirus outbreak in China appears to be slowing paper production in recent weeks. Excess hardwood supply also currently exists in South America. And these factors appear staged to keep a lid on pulp pricing through the first half of 2020. North American lumber production declined in the year by 5% and is down approximately 3 billion board feet as a result of permanent and temporary curtailments announced in the year. British Columbia lumber production decreased by 21% in the year, and curtailments announced in the interior British Columbia have permanently reduced lumber supply by an estimated 2 billion board feet per year or the equivalent of approximately 200,000 housing starts.

Mill curtailments and closures take a period of time to be reflected in reduced supply as mill working capital is reduced. We believe during the quarter, our inventory was rationalized to align with current production run rates at our lumber mills. Although there was an increase in lumber imports in the fourth quarter, for the year, offshore imports remain at reasonably consistent levels. U.S. South production was up just 2% or 325 million board feet through November. There has been significant capital spent in the region in recent years, but growth and output has been slow to materialize.

In early 2018, weather caused delays in shipments, which disrupted the supply chain, and caused SPF shipments to be well below production. As demand and supply became unbalanced, prices started to increase. As this backlog of inventory was shipped into the market in the second half of 2018, concurrent with a softening in new home construction, prices began to decline, which led to both permanent and temporary curtailments announced in British Columbia.

Shipments exceeded production in 2019 as working capital from curtailments and closures was liquidated. It appears this working capital liquidation was still in the process of being completed during the third quarter, the latest information we have available.

Lumber pricing showed modest increases in the fourth quarter of 2019, a trend that has continued into 2020.

Turning to our financial results. The lumber segment performed better in the quarter as EBITDA improved by $30 million to $69 million on improved lumber pricing and lower fiber costs. Annual results were in line with the previous quarter as lower sales returns were offset by improved conversion costs. Pulp and paper results declined $4 million to a loss of $1 million as higher shipments and improved conversion costs were offset by weaker prices in the quarter. Comparing to the third quarter of 2019, price positively contributed to our results with our Canadian lumber business experiencing improved SPF benchmark pricing in the quarter. SYP and pulp prices were relatively unchanged quarter-over-quarter, while plywood prices had a small decline. Fiber costs improved overall as we work through higher-cost fiber procured earlier in 2019 and late in 2018. Variable operating schedules were implemented in a number of our mills in an effort to consume only cost-effective fiber. Volume was a negative contributor in the quarter as we finish shipping the backlog of inventory associated with our permanent curtailments in the previous quarter.

Turning specifically to lumber. Price positively contributed to our results as the SPF 2x4 benchmark price increased. Fiber costs were also a benefit in variable operating schedules that were implemented in a number of mills. Lumber production declined from the third quarter as variable operating schedules were deployed in a number of these mills and SYP production was flat. Lumber shipments were lower in the quarter due to lower production and due to less inventory being drawn down as compared to the third quarter. Pulp and paper shipments improved with better BCTMP production.

Cash flow from operations declined $76 million to $40 million for the quarter, which was impacted by the seasonal log inventory accumulation in our Canadian operations.

Adjusted EBITDA improved in the quarter by $25 million to $80 million as a result of lower costs and improved pricing. CapEx declined by $46 million sequentially as we wrapped up projects earlier in the year. Net debt increased slightly, and liquidity remains strong. Debt levels remain very manageable. An ample financial flexibility of approximately $500 million remains available with no near-term maturities. With that, I'd like to turn it back over to Ray for an outlook on 2020 and an update on some key projects.

Thanks, Chris. Just a couple of general comments on the outlook for 2020. As we look forward, we do anticipate our Canadian SPF lumber production and costs to improve over 2019, primarily as a result of recapturing production loss due to temporary curtailments and the return to normal operations in Alberta as well as an expected general overall productivity improvements resulting from just less disruption.

These comments are the same for our panels business as they are closely aligned with our Canadian lumber operating strategy. With respect to pulp, NBSK production is expected to increase on improved reliability and benefit from somewhat smaller planned shutdown impacts. We expect continued strong operational results in our BCTMP business, albeit what we expect will be tough markets. With respect to log costs in British Columbia, we do expect a continued decrease in 2020, as we have seen in late 2019, as our operational footprint is better aligned to the available fiber supply.

U.S. South and Alberta log costs are expected to generally be within a range relatively flat year-over-year. In the U.S. South, our Southern Yellow Pine production is expected to increase by roughly 10% as we continue to execute on our modernization and growth plans. Despite headwinds in the U.S. South, we remain confident and motivated about the opportunity still ahead of us.

So with that, typically, with 47 operations, I'm reluctant to often talk about individual projects. But it is important to describe our U.S. South strategy. Our sawmill in Opelika, Alabama is a great example of the opportunity that we see in the South. We've been ramping up the sawmill facility in 2019, and we'll complete the final planer mill phase in the first half of 2020.

With respect to technology, we are making a multi-generational upgrade essentially from a 19A technology to the currently best available. As expected, we are seeing a significant uplift in all of our key metrics, safety, productivity and in cost reduction, with significant further upside as we reach our operating expectations. Perhaps most importantly is our people strategy. Improving the work environment while creating fewer but higher value jobs is key in reducing turnover and key in our ability to recruit and retain the people needed to be able to execute on this technology. Turnover has reduced substantially, which we believe is key to achieving our expectations.

We have also begun construction of our new manufacturing complex in Dudley, Georgia. The area benefits from a good fiber supply and is strategically located close to key lumber-consuming markets in the U.S. South. The current Dudley mill will continue to operate through this period with no impact on day-to-day operations. We will be working through the construction of the mill through 2020 and anticipate a start-up in early 2021. Similar to Opelika, we expect -- as with other projects, we expect growth in production, cost reduction and further execution of our overall people strategy.

Our focus is on achieving our operational expectations. Reducing costs while improving value are the areas that we control, and we see significant opportunity to improve in both. We are encouraged by the projects we've been able to bring to completion in the U.S. South and look forward to continuing to operationalize them in 2020. We remain committed to deploying our capital prudently to support our low-cost operating platform. While there are many factors that can temporarily influence markets that may be outside of our control, market fundamentals appear favorable, and the environmental benefits of building with wood have never been more clear and more accepted. Both of these conditions bode well for the continued growth in lumber consumption.

Further to that, the recent news on duties was encouraging. Notwithstanding an unforeseen change, we expect to see a meaningful reduction in cash deposit rates later in 2020. Finally, it is our employees at West Fraser that have taken on the burden of transition in the past year and in doing so, have improved our overall ability to tackle whatever challenge comes next. The dedication and perseverance of our people across the company is what I am most thankful for and I'm proud of.

Thank you. And with that, operator, I'll turn it back to you for questions.

(Operator Instructions) Your first question is from Paul Quinn from RBC Capital Markets.

Just a question on you singled out imports of lumber in North America being flat over the year and -- but up in Q4. We're seeing other companies report a lot more activity from especially the Europeans. As that trading in China gets plugged and they're looking for a home for this lumber, do you expect that in 2020? And is that going to be a material increase?

Paul, it's Chris McIver. I'll give your question a shot. We -- it's -- I find this quite interesting. We've -- we haven't really bumped into a lot of European lumber. We hear about it all the time, but it really hasn't affected our business in North America and U.S., in particular. If you look at the stats, there are roughly maybe a little bit more than 1/3 of the peak in the early 2000s. So it's a factor, but I don't think we've seen it in any way coming in the way that some people are talking about it yet. Now will that change? It could. It certainly could. We do see a bit more of a factor, we think, in China, particularly on logs, and we see a bit more lumber going into Japan as well from Europe.

Okay. And then, I guess, moving over to the CapEx side. You mentioned that Dudley is a good chunk of your CapEx budget in 2020. Can you give us sort of an approximate cost? What greenfield costs now? And has that moved materially over the last number of years?

Paul, it's Ray here. So I'm just going to answer that 2 ways. I'm not going to kind of give the -- what the cost of Dudley is, but I don't think it's changed a lot in the last, let's say, 18 months. But I would say there was a material change, I would say, for a couple of 3 years here on capital costs. But I'd say they've kind of flattened out somewhat in the last 12 or 18 months, a little bit. So...

Okay. And then with the drop in the Southern Yellow Pine prices of late, what's the level of overall M&A activity down there? Is there -- mill owners, are they looking to get out? Or are they happy to hold on? What -- can you compare the activity versus, say, 6 months or a year ago?

Good question. I would say for at least from my perspective, I'd say it's the same. I'd say there's always something that's available. It doesn't mean that that's something that's West Fraser. But I would say it's probably slower than it was a couple of years ago. But it's been pretty consistent over the last, say, 12 months, something like that. It's quieter, but I think my guess is people have high expectations much the same as we do.

Okay. And then just lastly on the pulp side. You mentioned shutdowns will be a positive with respect to 2019. What is -- what do you think the delta will be in money?

I can't give you what that delta would be, Paul. I think our -- we just have smaller scope shutdowns. And I don't think it's a material change. I just think it will be a little bit better than it was last year. So...

The next question is from Mark Wilde from BMO Capital Markets.

Ray, just kind of starting out or maybe for Chris. You flagged the lower fiber costs in the fourth quarter, $24 million on lumber. I'm curious, how much of that is just lower costs in British Columbia? How much of that is just kind of a shift in your regional mix toward Alberta and the U.S. South?

A piece of it would be that shift, but that's probably not the biggest piece of it. The biggest piece is really the management of the fiber supply to only bring in what is -- what economically makes sense for us to operate on. That would be the biggest portion of that improvement.

All right. And then another one on fiber, I guess, just more broadly. It's striking to me that we do have less fiber available in Western Canada, but it hasn't really had much of an effect on pulp and paper capacity in Western Canada. Should we anticipate some more ripple from this over the next couple of years, do you think?

I think it's public knowledge that there's been information out there in the public domain. And when you reduce the amount of residuals that are being produced in British Columbia, there's certainly a strain on residual throughout British Columbia. I can't forecast what that will mean. But when I look at our operations, we've been planning how to make sure that we have the fiber to run our mills for a long time.

But without a doubt, Mark, there's going to be stress in British Columbia, and we'll have to see how that plays out.

Okay. And then, Chris, can you help us? With the change in duties, I mean, it looks like if these duties are for prior periods are being kind of reduced, will that mean that you'll get a refund of sort of the difference between what you've been paying and the newly assessed rate?

I think our assessment of the situation is that it's highly unlikely that we get any cash refunded in the near term in the absence of some sort of settlement of the process. The change in the rates themselves as a result of the administrative review does not trigger a refund of what you paid in excess of what those rates that they determined.

That's a little screwy, but okay. And then can you guys also give me a little sense of kind of what you're seeing in the pulp market right now just vis-à-vis kind of activity in China? You mentioned lower activity. I've also heard maybe some backups at the ports. There were some reports this last weekend that maybe people -- in China reneging on some earlier pulp purchase agreements. So just any color that you can give us there would be helpful.

Mark, it's Chris. Yes, we're -- it's early days. First of all, we're coming out of Chinese New Year, which always is a bit of a slow period for us. But what we're hearing from our customers is generally they're busy. The paper guys, a little bit less so. Tissue and towel producers are very busy. We do know that they're struggling a little bit with workers. We have some concern around logistics with shipments getting delayed and then vessels getting out of sync. But we haven't seen that yet, and we've also had no problems with -- on the financial side at this time, but it is early days.

Okay. And then just kind of toggling over to this project at Dudley. It just kind of raised the question for me of where you're at overall with productivity improvements that you talked about being able to get out of Gilman back when you made that acquisition. So maybe just an update on that. I think you talked about potentially fiber productivity improvements of all the way up into kind of 20% and 30%.

Yes, Mark, it's Ray here. So first, I want to say that we expect to get our duties returned to us at some point.

So -- okay. And the second part. So -- because I agree with your comment. The second part, someone asked me where we were in our capital program a quarter or 2. And I think I said the bottom of the fifth or something like that. So -- and I still would say we may have moved from the bottom of the fifth to the top of the sixth or something. So we still have -- what I would say is that we -- our U.S. platform is going to be far less disrupted than it was for the last, say, 12 or 18 months almost. And so the impact of the capital won't have -- just won't keep us off our game. And I would say, with respect to the Gilman assets, we still have a quite a bit of opportunity that we see ahead of us. We like our current position very much. We're going to be thoughtful and prudent on how we move forward with that, but -- and so it's not something that we're trying to close the books on in the next 1.5 years. We see this as a bit of a path for the next few years. So -- but there's quite a bit of runway left that we see.

Okay. And then in Opelika, has that start-up been a longer curve than you expected?

I have not -- I've probably had 2 start-ups in my career that were shorter than I expected and the other 98% the other way. So a good question. I would say our start-up at Opelika has parallelled many of our other start-ups. Would I have liked it to be faster and better? Absolutely, but we're quite pleased with where we're currently at and where we're trending to.

Okay. And the reason that I asked the question is that I have heard that there are some other new projects that have had really significant, longer start-up curves than were expected. And just what I'm hearing about is just issues with the contractors and things.

So Mark, I'll just comment quickly. Look, we're not immune to those things either. I think we've got broad experience, both North and South, on these things or the good and bad. And I would just say that it's a big challenge, and it's always a little bit harder than what you expect. But with shortage of labor, shortage of contractors, sometimes shortage of skills, it just adds that challenge to execute in those regions. And so it is a little bit more difficult. And I don't think the challenge is waning with the current economy in the U.S., but good economy has pluses and minuses. We'll take the pluses.

The next question is from Sean Steuart from TD Securities.

A couple of questions. Chris McIver, I'll start with you. Your perspective, I guess, on the lack of momentum we're seeing for prices and lumber prices in the U.S. South to this point, how much of that is just ongoing capacity ramp, both greenfield and brownfield? It sounds like you aren't seeing European imports affecting things too much. Is it the wet weather? Or any context you can give us on the lack of momentum in that region?

Sean, it's quite interesting what we're seeing right now in the South. I -- there's no question. We got a bit of a seasonal effect. The weather hasn't been great. It hasn't been nearly as bad as it was a year ago. I think we're also seeing customers keeping their inventories pretty tight. Our treating customers, which is a big segment for us, certainly, have been holding back a little bit more than usual. They're starting to buy a bit more. But there does appear to be ample supply. Our order book is really good in the South right now. Our inventories are in exceptional shape. But we -- price has been a bit of a struggle. So it appears that there's certainly ample supply around right now, which is different than in Canada.

And Ray, a question on the pulp production schedule this year. It sounds like you're expecting overall better productivity out of the Kraft mills. Can you give us some detail though on the -- how the downtime schedule stacks up this year just to help us dial in the quarterly variation a little bit?

So Sean, so we split it up. So I think last year, we kind of went back-to-back with our pulp. We're going to split that, do one shot in the first half and the second shot later in the third quarter. So there'll be a bit of a gap. And we've done that for that reason, so that we can be better organized and spread it out, make sure that we're -- we have the full attention of our contractors and vendors in order to tackle both shutdowns. So that's -- I think that's the detail I can give you.

(Operator Instructions) The next question is from Hamir Patel from CIBC Capital Markets.

Ray, I wanted to get -- in your outlook, you referenced R&R indicators decelerating and reduced -- signs of reduced industrial demand. So any color you can give there on what you're seeing in terms of your own volumes with the big box stores for R&R? And how are you measuring the demand trends in industrial?

Well, Hamir -- and I'm going to let Mr. Chris McIver tackle that one.

Hamir, so both industrial and R&R are pretty hard for us to measure accurately, but we do think that R&R is slowing down. That doesn't mean it's still not increasing year-over-year. It's just that the increase is less than it has been. So that's still a huge segment for us, call it, 35% to 40% of our market. We see that being consistent, but not a huge growth this year. That's kind of what we're seeing. With regards to the box stores, our South business with the box stores was up year-over-year, and it started out pretty strong this year. And in Canada, our program tends to be a lot heavier to plywood. But we're seeing Canada a little slower, generally, and I think most people would say that, whereas the U.S. has been okay.

So in the industrial side, we kind of flex that production because a lot of it's low grade. So we flex up between the U.S. and China depending on where we think the better return is.

The next question is a follow-up from Mark Wilde from BMO Capital Markets.

Yes. You called out the reduction in B.C. fiber costs in 2020. I just wondered if it's possible to help us quantify that at all.

The year is still in front of us, Mark. What I would say is that in British Columbia, we tend to secure our fiber pretty significantly in advance. Well, you have to remember, when we started making and the industry were making pretty significant changes in British Columbia to change our behavior really early last year. So I would say we expect some cost reduction in B.C., but we -- significant cost reduction probably doesn't happen until really 2021, but I -- our expectations is a continuing trend of slightly reduced fiber costs.

And Ray, would you expect, with kind of fiber costs coming down and the duties coming down, much capacity that might be idled right now winds up coming back?

Well, I can't speak for others, Mark. I can only speak to -- regardless of markets and regardless of duties, I see we can only operate on what the available timber supply is. That will continue to decline. So albeit you may see less temporary reductions like we experienced last year, where we took a week or went to a 4-day week, or you may see less of the temporary, the ultimate piece is I don't see really anything that was announced permanent coming back, at least from a West Fraser perspective. And quite frankly, over the next 2 or 3 years, I'd expect to see the industry and to some extent, West Fraser have some reduction based solely on the timber supply available, almost irregardless of market.

Okay. All right. That's helpful. Last one for me is just lumber volume going into China, I'm just curious about the influence of 2 factors. One is the kind of the competition from that spruce beetle in Central Europe. But the other is just, will your volume tend to come down over time just because you have less beetle kill -- low-grade beetle-killed lumber to sell? Can you kind of help us with both of those factors?

Yes. I would say on the first part, what I think we're seeing a little bit of is that you're seeing substitution log-for-log on the timber side. So it's the European spruce maybe substituting New Zealand pine or something. I think you're seeing some of that. And maybe it will take a little bit of the lumber demand, but I don't really see that. With regards to -- yes, as our -- well, as we get into more and more green timber and our low grade is reduced, unless we increase the amount of timber that we are putting into China, our volumes will go down some. And I think there's opportunity to do both. But certainly, I would think that you would see less -- certainly less low grade.

The big question is, are we able to develop and find markets in China for our upper grades? And that's still to be found out. So...

I think just to add to that, I mean, our expectations are -- is that we'll make less low grade going forward over the next few years.

There are no further questions at this time. You may proceed.

Well, with that, I'd -- no further questions, I'd like to thank everyone for joining us, and I look forward to talking to you next quarter. Thank you.

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