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Potlatchdeltic Corp
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Good morning. My name is Ian, and I will be your conference operator today. At this time, I would like to welcome everyone to the PotlatchDeltic Corporation’s Second Quarter 2018 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session [Operator Instructions] Thank you.
I would now like to turn the call over to Mr. Jerry Richards, Vice President and Chief Financial Officer for opening remarks. Sir, you may proceed.
Thank you, Ian, and good morning. Welcome to the PotlatchDeltic’s investor call and webcast covering our second quarter 2018 earnings. With me in the room are Mike Covey, Chairman and Chief Executive Officer; and Eric Cremers, President and Chief Operating Officer.
This call will contain forward-looking statements. Please review the warning statements in our press release, on the presentation slides and in our filings with the SEC concerning the risks associated with these forward-looking statements. Also, please note that a reconciliation of non-GAAP measures can be found on our website at www.potlatchdeltic.com.
I will now turn the call over to Mike for some comments and then I will cover our second quarter results and third quarter outlook.
Thanks, Jerry. Good morning. This was our first full quarter since we closed the Deltic merger in February and integration has met or exceeded our expectations by nearly every measure. The merger was strongly cash flow accretive given the strength of the lumber market.
We generated 94 million of adjusted EBITDA in the quarter with wood products contributing 52 million. Our lumber market went on a historic run in the second quarter due to a variety of factors which have been well documented.
The Random Lengths framing the lumber composite peaked at a record $582 per 1,000 board feet in June and has started the pullback that we expected. However, we do not expect pricing to collapse.
Industry fundamentals remain strong with capacity utilization rates around 90%, bottlenecks and transportation logistics exists that are easy, and single-family housing starts are in line with expectations.
The repair and remodel segment continues to be robust and fire season has started in British Columbia and the U.S. West. For these reasons, we believe our wood products segment is well-positioned to continue to deliver strong results for the remainder of the year.
Even though lumber prices have been declining for the last seven weeks, our average price for July was about 2% higher than the average lumber of price we realized in the second quarter. We expect our average lumber price for the full third quarter to be just over $500 per 1000 board feet or about 3% lower than the second quarter.
The strong lumber market has also translated into higher Northern sawlog prices since over two thirds of our Idaho sawlog harvest is index to lumber prices. Index log volumes to be delivered through mid-August will reflect the higher lumber prices that existed through the first part of June. Resources third quarter EBITDA will increase significantly relative to the second quarter due to seasonally higher harvest volumes in addition to the strong Northern sawlog prices.
This was our first full-year quarter of operations on the Deltic timberlands, this is reflected in Southern harvest volumes that were 64% higher compared to the first quarter. Our southern resource team is also making good progress identifying management practices that will reduce cost or increase growth rates. Examples include planting genetically seedlings, fertilization and developing site specific treatment plans.
Our real-estate segment had another solid quarter closing on the sale of just over 11,000 rural acres. As discussed on the last earnings call, second quarter rural sales included a $7 million sale of land near the Boundary Waters Canoe area in Northern Minnesota.
This represents about a fifth of the larger multiyear option involving the conservation fund and State and Federal agencies that use conservation funding to secure land approximate to the Boundary Waters Canoe area. Total sales could add up to 40,000 acres over a five year period of all the purchase options are exercised.
Regarding the integration of Deltic, I'm really pleased with the progress that we have made in just a few months. Our annual synergy run rate was $40 million at the end of June. Mill production levels have increased and harvesting has ramped up.
In addition, Deltic is treated as a REIT affective with the merger close in most of the corporate overhead synergies have been realized. In some cases headcount rationalization will not be complete until yearend when accounting, payroll and other systems are all consolidated.
Overall we are off to a great start and we are well on our way to achieve our goal of increasing annual cash available for distribution by at least $50 million by the end of 2019.
By the end of the fourth quarter, we will complete the earnings and profit per associated with converting Deltic to a REIT. Recall that amount is estimated to be approximately $250 million and will be paid 20% in cash and the remainder in stock.
Our dividend payout ratio is expected to be around 50% of cash available for distribution for the year, excluding the cost to achieve synergies. The Board will revisit our dividend late this year, once we have more visibility in the markets, progress on our synergies targets and a special distribution.
Now thinking about share repurchases is also evolving considering the recent weakness in our share price. We plan on reviewing a share repurchase authorization with our Board in the end of August. We are well-positioned to benefit from the improving U.S. housing market and we are excited about PotlatchDeltic's prospects for 2018 which is shaping up to be an extra ordinary year.
I will now turn it back to Jerry to discuss the quarter and then will take questions.
Thanks Mike. I will start with Page 4 of the slides. Adjusted EBITDA was $94.2 million in the second quarter which is $29.5 million or 46% higher than the first quarter. The second quarter includes results from Deltic's operations for the full period, compared to only 39 days in the first quarter. As Mike mentioned in his comments, the combined operations benefited from the historic run in lumber prices in the second quarter.
I will now review each of our operating segments and provide more color on the strong second quarter results. Information for our resource segment is displayed on Slide 5 through 7. The segment's adjusted EBITDA was $43.7 million in the second quarter, which is $6 million higher than the first quarter, we harvested 378,000 tons of sawlogs in the North in the second quarter. This is down seasonally from the 449,000 tons harvested in the first quarter due to spring breakup.
Northern sawlog prices increased 19% on a per ton basis in the second quarter. This increase reflects the effect of higher lumber prices on index sawlog volumes and seasonally lighter logs due to lower moisture content.
Turning to the South, we harvested 1.1 million tons in the quarter, which was up 64% compared to the first quarter. Most of the increase was a result of a full quarter harvest on the Deltic timberlands. In addition, logging conditions were good in the second quarter compared to the extraordinarily wet conditions in Arkansas in the first quarter.
Our southern sawlog prices were 8% higher in the second quarter compared to the first quarter. The volume and price of hardwood sawlogs were both better than we assumed in our forecast. While the price of Southern Pine sawlogs by product type remained flat quarter over quarter there was a higher mix of more valuable large diameter logs from Deltic timberlands.
Log and haul costs were $5.4 million higher in the second quarter compared with first quarter. This was due solely to the net increase in the segment harvest volumes. Forestry crops were higher seasonally in the North.
I will now shift to wood products, which is covered on Slides 8 and 9. The segment's adjusted EBITDA was $51.5 million, which is up $22.5 million or 78% compared to the first quarter. Our average lumber prices increased 11%, from $465 per 1,000 board feet in the first quarter to $517 per 1,000 board feet in the second quarter.
Lumber shipments increased 55 million board feet to 259 million board feet in the second quarter. This was lower than the 275 million board feet that we anticipated shipping in the second quarter. The shortfall was primarily due to truck and rail shipping challenges. We expect to catch up in the second half of the year and still plan to ship just over 1 billion board feet of lumber for the year.
Cost of sales for the lumber mills increased due to higher shipment volumes. Adjusted EBITDA related to our two panel mills increased $1.5 million due to inclusion of Deltic's MDF plant for a full quarter. The MDF plant is benefiting from the replacement of press change and a press belt that Deltic completed in 2017 and ran at 87% utilization in the quarter. Improvement in the MDF plant’s contribution was not included in our $50 million synergies target.
I will now cover our real estate segment on Slides 10 and 11. Real estate's adjusted EBITDA increased $4.3 million in the second quarter. As discussed on our first quarter earnings call, we closed on the sale of approximately 8,000 acres of nonstrategic timberlands to a conservation entity for $900 per acre in April.
Including that transaction, we sold a total of 11,571 acres of rural land in the second quarter. We believe there are solid rural real estate opportunities on former Deltic timberlands and listed the first Deltic rural properties for sale near the end of June. Sale of Deltic rural real estate is not included in our $50 million synergies target.
In the Chenal Valley development business, we sold 13 lots at an average price of $74,000 per lot in the quarter. Lower average price per lot reflected a higher mix of a smaller [Indiscernible] lots this quarter. Lot sales were heavily weighted to the fourth quarter, once development of the next cycle of lots is completed.
Turning to synergies and operational efficiencies on Slide 12. Excellent progress against our targets has occurred since the merger closed in February. As Mike mentioned, we are at a run rate of $40 million at the end of June and remain confident that we will achieve a run rate of at least $50 in 2019.
Shifting to liquidity highlights presented on Slide 13. We ended the quarter with $125.7 million of cash. We also have $379 million available on our revolver. As a reminder, we plan to distribute $50 million of cash to shareholders as a special dividend in the fourth quarter. This is to complete the conversion of Deltic's timber operations to REIT status.
We are also evaluating other uses of cash, including the dividend increase, paying down our 7.5% debt maturing in 2019, re-instituting a share repurchase plan, investing an additional high return project in our mills, acquisitions and accelerating contributions to our pension plan to take advantage of the higher 2017 income tax rates.
Capital expenditures were $13.1 million in the second quarter, we are accelerating some deposits to lock-in delivered equipment related to high return 2019 projects. We expect the capital expenditures will be in the range of $50 million to $60 million for the year.
S&P upgraded our credit rating to BBB minus investment grade earlier this month. Their press release cited strong demand in pricing, timberland coverage, high margins and conservative financial policies as reasons for the upgrade. We are now investment grade rated by both S&P and Moody's.
Before I comment on our outlook, I want to point out that we are no longer providing EBITDA and CAD guidance, now that we have a full quarter behind us as a combined company. As a reminder guidance was provided solely to help with model calibration, while there are a lot of moving pieces with the merger.
The assumptions embedded in our third-quarter outlook are concluded on Slide 14. We expect resource adjusted EBITDA to be up significantly in the third quarter as harvest volumes reached their high-point for the year. We expect wood products adjusted EBITDA in the third quarter to be comparable to slightly higher than the second quarter. This assumes that increased lumber shipments will exceed the effect of slightly lower lumber prices.
We estimate that real estate third quarter adjusted EBITDA will be about half of the amount generated by the segment in the second quarter. We anticipate selling significantly fewer rural acres, due mostly due to lack of large conservation sales in the third quarter. In addition, most of the development, lot sales were planned to occur in the fourth quarter.
The corporate expense run rate is expected to be $11 million per quarter for the remainder of the year. The increase in the corporate run rate reflects an adjustment to the bonus accrual rate due to our strong results.
This year has been tremendous thus far. We expect third quarter 2018 adjusted to be meaningfully higher than second quarter 2018. This is primarily due to a seasonal increase in our Idaho harvest volumes, higher lumber shipments and our expectation that lumber prices will settle at historically strong levels.
That concludes our prepared remarks. Ian I would now like to open the call to Q&A.
Certainly. [Operator Instructions] Our first question is from the line of John Babcock from Bank of America Merrill Lynch.
Hey good afternoon or good morning for you guys. Just want to quickly step in. Could you clarify the guidance me. I think I missed that on kind of wood and resources for 3Q?
So in terms of adjusted log levels, John?
Yes exactly, yes.
Yes, so Q3, we have seasonally higher harvest volumes in Idaho, so we think resources adjusted EBITDA will be meaningfully or significantly higher than second quarter and then for wood products we have a pretty meaningful increase in shipment volumes. So we think that will more than offset a slight decrease in lumber prices so there we think it's either wood products is either comparable or up slightly.
Okay great, thanks for the clarification. And then secondly…go ahead.
And real estate is about half of what it was, just due to the fewer conservation sales in Q3.
Okay, I appreciate that. And then I was wondering if you could kind of talk about the lumber market now, you guys don’t seem to be expecting much of a collapse in lumber pricing from here. Just want to get a sense for kind of where inventory levels stand at both the middle and distributor levels and also what else you are seeing that might help us get a better sense for where the lumber market is going from here?
Well this is Eric, John. Our sense of it is that out on the dealer networks inventories are relatively low levels. What you saw was a really strong lumber price run-up in the second quarter. We think credit limits were pushed for those dealers trying to buy lumber so they probably didn't put a ton in inventory.
You are starting to see the inventory pressure come off a little bit as some of that wood is now coming down from Canada that was trapped up in Canada earlier in the year, so some of that pressure starting to come off, but our view and I have read it in three or different places now is that inventory levels are pretty low out in dealer inventories.
Now when it comes to the mills, I mean I would say things are probably at typical levels, there were transportation issues across the industry. In Q1 and Q2, but a lot of those pressures have now eased. I know we have seen that in our own business, so I would expect inventories of mills to be at relatively typical levels.
Okay, thank you. And then next I was worrying and this doesn’t seem to have a direct impact on you per se, but I was wondering if the trade situation kind of the back and forth with China is having any impact on kind of the confidence that your customers are having, or perhaps even more related even to your business. So any commentary you can provide there would be helpful but realized impact may not be too significant?
I think it’s relatively significant at this point outside of course the tariff situation with Canadian lumber continues, but that is largely not been mentioned in any of the commentary by the administration.
Okay and as far as your customers I mean do they seem pretty confident still at this point?
Yes absolutely.
Yes.
Okay, well I appreciate that. I will jump back into the queue. Thanks.
And our next question is from the line of Collin Mings from Raymond James.
Hey good morning guys. First just following up on John's question, just as you think about the decline in lumber pricing again over the last month and half or so what would you attribute to normal seasonality versus some sort of shift in underlying fundamentals?
Well our guess Collin is that the lumber prices ran up in the spring and roughly a third to half of that was due to transportation issues down in Canada. So those issues are now more or less behind us and some of that wood is still flowing across the border but some of the that price trend is going to get given back here.
I think what you are really seeing at this part is just psychology in play. Once those prices started to rollover, if you are a dealer you had any kind of inventory you stayed away from the market and so you thought lumber prices were have bottomed and lumber prices are still falling.
We think there maybe a little bit more to go here before prices do hit a bottom, but at some point in time it comes back to fundamental supply and demand, with dealer stocks like and with homebuilding continuing to be pretty robust all be it most recently announced numbers are weak, still the trend is in the right direction.
Demand for lumber remains robust and so we think pricing will find a floor here and get back again. So I don’t know if that answers your question, but that is how we characterize the price run-up and then decline.
Maybe moving just to fire situation, have any of the fires in Idaho impacted to your ownership yet, it looks like most of the activity is little bit further south, but just an update there an even if not directly impacted has there been any indirect impact on operations in Idaho?
No. So the fire risk in North Idaho today is currently rated as moderate by the District Fire Wardens and with the rating scale of low, moderate, high and extreme, we are still the moderate. We have had a couple of small fires in our Idaho ownership less than one acre in size, but they quickly been extinguish and no merchantable inventory was burned-up.
So far and so good, most of those fires as you mentioned they are in central and southern Idaho so far, we have been spared, and we think we have probably got about two more weeks to go before the fire wardens tell us that they will pick up the rating on the fire possibilities to high from moderate, we still got a couple of more weeks to go. So far and so good.
And the answer to your second part of your question is, no we really haven't seen any secondary effects from the fires that are hitting the Western half of U.S. and D.C so far.
Okay alright. And then just one last one and I will turn it over. Just and again the prepared remarks you went through a lot of the capital allocation discussions you have or plan to have with the Board, quarterly share repurchases maybe on the margin becoming more attractive given the pullback in the stock, dividend a lot of flexibility there. But just as you think about the timberland acquisition and I know we have discussed this on some prior calls, but maybe just an update there, Mike from your perspective. I'm thinking about growing the timberland's footprint, it looks like on the cash flow statement maybe just a nominal amount of timber purchase activity during the quarter, but just maybe update us on that front given the growing cash balance.
While we have certainly like to grow the footprint of the Company and areas that are geographically adjacent to where we already have a footprint in the Central U.S., South and Northwest here in Idaho. As you know that is challenging to do with the very few properties currently on the market in Alabama, Mississippi and Arkansas.
It’s also hard to find returns that are attractive in those Southern markets at the current kind of price level of [2 billion] (Ph). Northern Idaho has been the more attractive place for us to find small acquisitions that we bought about 25,000 acres last year as kind of bolt-on, but there has been a shortage of timber properties on the market, but it’s still something try to do and think that we can have some advantage with these bolt-on acquisitions.
Okay. I will turn it over. Thank you for the color guys.
And our next question is from the line of Gail Glazerman from ROE Equity Research.
Hi. Just going back to the lumber outlook and assumptions, is it the assumption is that pricing is going to stabilize and probably rebound by the end of the quarter or are there some timings lags where you have locked in higher pricing that we should think about and can you maybe give a little more detail on how that flows into your Northern log pricing in quarter as well, just a little bit more color and what are you expecting there?
Yes Gail so this is Eric. We always sell our lumber anywhere from two to four weeks out into the future, so when prices peaked in June we didn’t feel the immediate effect of that because until mid to late July let’s say so we are always selling forward our lumber so there is a lag effect from when lower prices that you see actually affect our business.
So we have prices gradually coming down over the course of the year, we will finish the year frankly at prices that were higher than where we started the year in Q1. So there will just be a slow, gradual softening of demand as we move through a slow, gradual decline in prices, we move through the back of the year, but still prices that are relatively high, resulting in very high margins for our wood products business. So I guess does that answer your question on that part?
Yes I mean I was just trying get my head, I mean the Random Lengths composites are something like $90 which is obviously a far cry from what you are doing, are there kind of great differences that you are performing significantly better than that?
Well we were very much in line with Random Lengths Q1 to Q2, Random Lengths was up I think 12% and we were up 12% to 13%, so we have been in line with Random Lengths, now there are differences between our business and our product mix versus Random Lengths, so in any given quarter you will see deviations between the two, but for the most part we are going to track Random Lengths.
Now as it relates to Northern sawlog prices. Yes, 70% of our sawlog production in Idaho is indexed to the price of western lumber, so you really got to drill in the Western lumber prices to find out what is going on with northern sawlog prices. But what I can tell you in this most recent quarter our Northern sawlog prices were up 19%, the Random Lengths index was up 13%.
So there is a difference between the two about 6% and that was really entirely due to the density issue of wood as you get into the summer months wood dries out, so its lighter, but we sell it on a dimensional basis through an MBS, so the price per ton looks like it's going up when it may actually be flat.
So one additional piece of color also in terms of the lumber price effect on our outlook as we mentioned on the call we are not longer providing explicit EBITDA guidance, but with lumber prices running to a higher level in Q2 than we anticipated.
That correction we talked about last quarter's call is coming from a higher peak if you will or higher level, which means that when you look at our internal forecasts that we have for the rest of the year, lumber price averages are about 10% higher than what was built into the outlook that we had like I said for the last quarter's earnings call.
So that represents when you just pencil that through that represents probably 25 million or 30 million additional EBITDA for wood products just for that segment.
Okay and last quarter you talked about small bits and pieces that were starting to add up to maybe five million to seven million of incremental synergies, during your script you have mentioned specifically a couple of things that weren’t in your initial synergies MDF and HBU are those being additive to that five million to seven million that you stated last quarter, are they part of it and is there any sort of update on kind of what upside to the 50 million you may see just given how you have performed so far?
Yes, so Gail we said five to seven million last quarter I would tell you that our number is probably eight million to 10 million these are annual run rate synergies, we are not there with the eight to 10 yet, we are probably about half way there with these operational synergies; so they are starting to flow through the P&L and they touch virtually every area of the business.
I just saw one of the other day that we are going to save I don’t know $200,000 a year on franchise taxes, because we now have fewer subsidiaries filing. So, individually they are small, but collectively they add-up to a lot and we are making great progress on capturing those synergies.
Okay, and then just one last one. Any sort of update, any new investments in your wood basket in the South that we should be looking for?
In terms of competitors and mills and what not?
Yes.
No, I think that there is at least 12 new mills that have been announced that are not yet operational and collectively they amount to something like 4 million board feet a year driving 15 to 20 million tons of increased log demand in the South, but I think all of those are well publicized.
I think the most kind of exciting market that we have in our wood basket is in Alabama, we have seen the several new mills either built our announced their including GP Talladega, which will start this fall as well as the [Indiscernible] which hasn’t been cited yet, but all those are in the central Alabama wood basket which is pretty advantageous for us and we are starting to see signs of an improving market for pine logs there.
Yes and just to Mike's point so in that central Alabama area where you have two rivers taking to Talladega. We just saw a $3 a ton price jump here very recently in Southern Yellow Pine sawlogs as people see the increased demand coming.
Very helpful. Thanks so much.
And our next question is from line of Ketan Mamtora from BMO Capital Markets.
Thanks for taking my question. My first question how is that relative attractiveness of further growth in Southern timberlands versus saw mill investments or saw mill M&A change in your view at all, I know you have mentioned in the past that you think Southern sawlog pricing in your wood basket so it will take some time to recover, you are also a net buyers of logs in the South. How is that changed how you think about those two pieces of your business in the long term?
No, really Ketan. We continue to focus on expanding and improving the mills that we own and we have got attractive capital investments, particularly in the three Southern pine mills and the new MBF plant. We will focus on that rather than any standalone M&A activities. We will continue to focus on timberland opportunities as a timber REIT, but we grow the wood products business kind of internally and organically rather than expanding.
Got it and do kind of further investments in saw mills whether it's M&A mostly focused on M&A complicate your REIT status in any way or do you have enough headroom on that count?
We re fine to focus on our capital investments in our existing mills and which is almost practically unlimited in terms of what is practical and how much we want to put into those. A standalone wood products acquisition of just to go by standalone mills, certainly we would have to flush that against our REIT test and evaluate. We have plenty of headroom as we sit today.
Got it, that’s helpful. And then just a couple of clarification question. Jerry as you move from Q2 to Q3, how does the density issue play out in northern Idaho log prices, it seemed like it was about 6% to 8% in Q2 versus Q1?
Yes so, Ketan this is Eric. The impact is about another 3% lighter, so all things equally, you will see about a 3% price rise from the density issue in Q3 versus Q2.
Well another 2% increase, okay got it. And then…
The logs continue to dry out in Q3 when you get into August and September, and July can be pretty hot in Idaho.
I see that’s helpful. And then typically when you move from Q3 to Q4 how does that play historically?
It goes the other direction, you start to get snowfall, it gets cold outside, the logs get denser, its’ probably a 4% to 5% the other way.
Got it. And then you mentioned earlier in response to one of the questions at your Northern Idaho timberlands sawlog prices linked to Western lumber pricing, is it that western composite or is it a specific rate within that, is that something you would be able to tell us?
No it’s broken down by species, so it’s really quite complicated I mean, our view is you can start with an estimate of what is going to happen in Northern sawlogs by looking at Random Lengths. If you want to get a little bit more accurate you can compare it to the WWPA lumber index, which is a Western index and then if you really want to get accurate you really drill into what is going on with Hem-Fir and Doug-Fir.
Because I’m noticing that the Inland Hem-Fir pricing has held up significantly better than either Southern Yellow Pine or even Western SPS so I was just curious whether on your contracts are more skewed towards Hem-Fir than kind of the broad index.
Yes. You also have to take into consideration Cedar is part of the mix too.
Yes, okay. Okay, perfect. That’s very helpful, I will turn it over.
And our next question is from the line of Chip Dillon from Vertical Research.
Hi yes and good morning, good afternoon. If you could first talk a little bit about the land basis, it looks like maybe on the real estate sales, it was a little lower than what we might have thought in the second quarter and how do you see that on the land sales that you expect in the third and fourth quarter?
This is Jerry Richards. So you are correct in terms of the trend of land basis you saw. In the second quarter we have the 8,000 acre sale, conservation sale in Minnesota, and Minnesota has the lowest land basis of any of our land sales, so that is why Q2 was lower; when we guided or in my comments I mentioned 30% would be the land basis, in Q3 and then it probably spaced somewhere near that zip code in Q4.
Okay that’s helpful. And you also gave some very good - I think Eric mentioned the just doing the math on the lumber prices versus your assumptions, but 25 to 30 million additive to wood products, but also could that also have a little topping up in resources given the indexing you have in Idaho and would you add another 5 million for that?
I think that’s fair Chip I mean somewhere in the five million to 10 million range would be the corollary effect based on the index sawlogs.
Okay. And then last question just for what is the take. It seems like with the stock having come in from January with everything else tied to housing of course and building and your comments about the Southern timberland situation. Would you see buying back stock incrementally more positive or I guess preferable especially versus buying timberland in the south at this point given what you are seeing in terms of the returns offered on deals?
Sure Chip. I think it's fair to say that buying our own stock back at these price level which are at a significant discount in most analyst estimates of NAV is more attractive than buying our fully price Southern timberland that call it $2000 an acre that has embedded in that prices and assumption that overtime, Southern Pine sawlog prices are going to have to increase to make that justified. So I think at these levels we would be more satisfied buying our stock from timberland and we are going to discuss that with our Board in the next quarter.
I guess one more quick one if I could just jump in. I know Deltic's former chairman is consulting with the Chinese based company Sunbio in Arkansas. I don't know if you have any thoughts that are maybe because you are on the ground there regarding the permitting process of the faith, I understand that they have not gotten the cleaner permit and what does that involve just keep in mind that on one hand we haven't seen a virgin mills permitted in 30 years On the other hand, maybe there hasn’t been that many tried.
Well we have had conversations with the delegation in Arkansas including the Governor about how helpful it would be to have another paper mill in the state from standpoint of a market for pulp wood to allow continued investments in forestry in the state and employment, I think the administration in Arkansas is extremely supportive of the Sun Paper project. I can’t imagine that they are going to hold up a permit process, but these things take time. So we continue to be a hopeful and optimistic with the Sun Paper plant gets built.
Okay. Thank you.
And our next question is from line of Mark Weintraub from Buckingham Research.
Thank you. I appreciate all the color and I just wanted to follow-up you indicated, given the strength in lumber pricing that should add 25 to 30 versus your prior guidance on outlook in wood products and maybe another 510 on the resources, but are there any other variables of significant be it from cost or anything else that we think you would want to highlight given that you didn’t actually give - that you would want to highlight at this point.
No I think we have covered a more…
The biggest wild card is really can we ship the - we will have a significant increase in shipments from Q2 to Q3 as we catch up and some of that that is a matter of making sure that we execute on that and we are well on track to do that.
Yes. The transportation issues have - were the real boogie man in Q2, rail and trucking were challenging virtually everywhere and what I would tell you is lot of that pressure is now come off as we move into late July and August.
Okay. so it's fair to say that if we take your prior guidance and add order of magnitudes 30 million to 35 million recognizing things can always play out a bit differently that's a reasonable starting place from your perspective?
The short answer Mark is yes.
Okay, and then I'm really curious as to what the relative profitability at the saw mill is in the West versus the South. And what implications if any that might have in how pricing dynamics play out if we continue to have pressure. I imagine in the South the sawmill is making a ton of money still whereas in the West given much higher log costs, maybe they are not making that much money there, I’m just curious as how you are seeing it?
Yes Mark, I think it's fair to say that Southern mills at $40 a ton logs are making lots and lots of money right now, compared to Western Mills that are paying who knows $80, $90 a ton for logs. So yes, I think Southern mills are a lot more profitable than Western mills. Now that being said Western mills are still making pretty good margins at these high prices.
Okay fair enough. And are you seeing any I guess we are getting the new capacity coming on in the South, which overtime might tend to equalize these things out, are there any other dynamics that work which are working to arbitrage what looks to be an unusually large differential on profitability from one region to the next?
Well what you are seeing is that Southern Yellow Pine is gradually taking market share from other species across U.S. in lumber, yes, you are starting to see Southern Yellow Pine find its way into California, we have seen it Denver, we are starting to see it up in Canada and the Lake States. It’s now being exported to China. So you are seeing some dynamics, just natural supply and demand at play here taking advantage of really cheap Southern Yellow Pine logs.
Okay. And then just one small one. I think you have mentioned in terms of potential uses of capital, pension contribution in reference, taking advantage of 2017 income tax rate, I was just a little confused by that, maybe you could clarify?
You bet Mark. So, not yet too far in the weed, we have until September 15th to make a voluntary contribution to the pension plan, and the IRS rules allow us to actually deduct that on the 2017 tax return which should be at the higher Corporate Federal rates.
Okay great. Thank you.
And our next question is from the line of Steve Chercover from D. A. Davidson.
Thanks good morning everyone. So first off going back to the subject of lumber contracts, given your view that lumber stabilizing and the futures are way down, I’m sure it’s not really of interest right now, but is there a level where you would start to lock in more volume?
Yes Steve. What I would tell you is the principal party that we do our lumber hedging with has told to us they have got enough risk on the table for the year, so they don't want to offer any more contracts. So we are not looking to hedge any lumber production for the back half the year.
Okay got it. And then switching gears. I understand that Q4 is when we will see the bulk of the log sales in the Chenal Valley, are you targeting the small kind of local builders or are there any national builders that are on the radar?
That community, Chenal Valley has traditionally been local builders. Little Rock is kind of the tertiary markets for the larger national homebuilders. so it’s always been more local.
Got it. And then finally, with respect to the repo, I expect the Board will authorize it later in July but in August, but are you capable of actually acting on that prior to the E&P purge?
Yes.
Okay, because I assume you would want to get that share price up there to I guess lack of better words diminish the dilution, is that correct?
Yes, I mean when we look at share repurchases Steve, I mean will it be based on what we think the relative use of the cash and potential return here. So I'm not sure that we see a direct tie with the [E&P] (Ph).
Okay. Thank you.
And our next question is from the line of Paul Quinn from RBC Capital Markets.
Yes, thanks so much. Good morning guys. Just a question on Timberland transactions. I know you guys are still integrating Deltic that probably is still active in the marketplaces even on marketplaces inactive and I'm just wondering why from your perspective why do you think that there are so few transactions or so few properties for sale at there right now?
Paul, I could only guess I really don’t know the answer to it. If I would speculated if the - mills and others that hold a lot of property that may come on the market due to the fund life of their investments as they see an opportunity or if they see a maybe timber prices, Southern Yellow Pine timber prices are going to improve in the next 18 to 36 months maybe that's a window that causes them to wait and pull property from the markets thinking that they will get more money. I really don’t know the answer. It’s all I could think of.
I scratch my head too. Just maybe on the lumber side when you guys are thinking about CapEx budgets of various mills given the variability of the profitability based off region and cost and value. How big is that as a consideration between investments something in say Northern saw mill versus the Southern saw mill?
So Paul whenever we go to our make a capital message investment in our mills, we don’t look at spot pricing, we use lumber pricing averaging multiple years five, six, seven, eight years on average. So we are never looking at spot pricing to rationalize our CapEx. And we are always looking for returns that are probably I would say at a minimum in the 10% range, but often will go up into the 20% to 30% range.
We are going to install a new auto grader at our older sawmill that we just picked up in the Deltic merger as we know those $3 million, $4 million project and it's going to have the 30% IRR attached to it, I would imagine. Using average lumber prices going back seven years or so. So I don’t know that we really think of capital investments in our Northern mills versus our Southern mills any differently. We use kind of the same approach and methodology for each.
Okay. It wouldn’t be safe to say that you have got more opportunities for capital investment as the Southern mills specially to Deltic mills just because you have reinvested in your Northern assets over the last say five plus years?
Absolutely, that's correct. There is an abundance of resource, we are a little bit more constrained on resource in some of our operating areas in the North whereas we don't have that issue in South.
Okay. Have you guys down like a limit to the amount of capital machine or that you can put in your mill before it really affects the operation. i.e. you might want to stagger some projects of once former Deltic's mills just because it's doing all this work really hinders the product and flow.
What I would say Paul is that we have definitely seen a real tightening in equipment vendor community for installations into our saw mills, improved capacity or productivity or cost. So some of the projects we are looking at now won’t go until 2019 and we just put a deposit on one that won't get installed until 2020.
We are putting a new stacker at our St. Mary's mill, so the market has tightened considerably and lead times have lengthened considerably and that's happened over very short period of time. That being said, we are constantly trying to uncover new opportunities and get after this as quickly as we can.
Well you raised an important point, maybe given the profitability of lumber right now even though prices come off, everybody is making money and some of those making lots of it, therefore everybody I would suspect is incentivized to add capital, is that going to be the constraint going forward, just on the equipment side and the installation?
Yes. I think for the next two or three years, I mean the U.S. south is got the world’s highest saw milling margins right now, there is no reason why capital shouldn’t continue to flow into that wood basket and the issue is those lead times now pushing two to three years, while where is economy going to be in two to three years, fed is raising rates and who know, but it’s becoming more and more of a gamble, put it that way.
I think Paul with the companies like [Comax] (Ph) and others that are building turnkey brand-new sawmills, they are focused on those opportunities more than they are one-off projects for the great leader in a standalone mills, just hard to get their extension understandably.
Yes, very good point. That’s all I had. Thanks guys, good luck.
And ladies and gentlemen I am afraid we are out of time for questions. I will now turn it back to the presenters for any closing remarks.
Alright thank you Ian and certainly thank you everybody for your interest and focus on PotlatchDeltic; we would be available for questions almost as soon as this call ends here.
Ladies and gentlemen this does conclude PotlatchDeltic’s second quarter earnings call. We thank you greatly for your participation and you may now disconnect.