Doman Building Materials Group Ltd

TSX:DBM

Earnings Call Transcript 2019-Q2

[Operator]

Good day and welcome to the CanWel Building Materials Group Ltd. Second Quarter 2019 Financial Results Conference Call. Today's conference is being recorded.At this time, I'd like to turn the conference over to Mr. Ali Mahdavi. Please go ahead, sir.

[Ali Mahdavi, Head of Investor Relations]

Thank you. Good morning, everyone, and thanks for joining us for CanWel's Second Quarter 2019 Financial Results Conference Call. Joining me this morning are CanWel's Chairman and Chief Executive Officer, Amar Doman; and Chief Financial Officer, James Code.If you have not [indiscernible] the news release, which was issued yesterday after the close of market, it is available on the company's website at canwel.com as well as on SEDAR, along with our MD&A and financial statements. I would also like to remind you that a replay of this call will be accessible until midnight on August 16. Following the presentation, we will conduct a Q&A session for analysts only. Instructions will be provided at that time for you to join the queue for questions.Before we begin, we are required to provide the following statements regarding forward-looking information, which is made on behalf of CanWel Building Materials Group Ltd. and all of its representatives on this call. Remarks and answers to your questions today may contain forward-looking information about future events or the company's future performance. This information is subject to risks and uncertainties that may cause actual events or results to differ materially. Any information regarding forward-looking statements is made as of the date of this call, and the company does not undertake to update any forward-looking statements. Please read the forward-looking statements and risk factors in the MD&A, as these outline the material factors which could cause or would cause actual results to differ. The company will not provide guidance regarding future earnings during today's call, and management does not anticipate providing guidance in future quarterly or interim communications with investors.I'll now turn the call over to Amar.

[Amardeip Singh Doman, Chairman & CEO]

Thanks, Ali. And good morning, everybody. Thank you for joining us on today's call.Let me begin by highlighting some of our key financial metrics, followed by some color on our operations during the second quarter and what we are seeing so far which gives us continued confidence across our business segments. Then I will hand the call over to Jay Code, who can drill further into the numbers.On the back of a first quarter which was impacted by the usual seasonal nature of our business, coupled with the continued weak pricing environment for lumber, OSB and plywood markets, we saw a meaningful improvement and momentum buildup in the second quarter. While the pricing environment continues to present its pressures on the industry at large, we continue to mitigate this impact through our strategic focus on the diversification of our business model while maintaining discipline in our acquisitions and overall growth strategy. The start of the second quarter was similar to where we ended the first quarter, with a quiet construction industry across Canada and some of our key markets in the U.S. being impacted by unfavorable winter weather conditions which reduced overall product volumes. However, as we pushed through the quarter, we started to see anticipated seasonal momentum in our key markets build up, resulting in yet another quarter of robust EBITDA generation despite the continued volatility impact of the year-over-year pricing decline.Despite the headwinds we were faced with in the last number of quarters, we were successful in showing growth and highlighting our ability to protect gross margin through managing our costs and focus on pricing. As a result, in the second quarter, revenues modestly increased to $386 million. Despite the pricing pressures, gross margin remained robust at 14.1%. Adjusted EBITDA remained almost flat at $27.5 million. And we continued to pay a quarterly dividend of $0.14 per share.Our core Distribution business continued to perform in line with our expectations. We also remain pleased with the overall performance of our Forestry business segment. We remain confident about volumes and the key activity level in our key markets as we continue our work in our peak seasonal period in Q3 and look forward to further demonstrating the strength and leverage available in our business model as we continue to take advantage of all sensible organic opportunities as well as strategic scenarios where we can accelerate growth and profitability.During the quarter, we completed the acquisition of Lignum Forest Products, which is a specialty professional lumber trading operation based in Vancouver. The acquisition has already enabled us to enhance our U.S. sales while entering new markets with new products such as MSR and specialty cedar products. Lignum Forest Products is a good contribution to our top line results in the second quarter and is expected to be accretive in 2019.The commodity and pricing environment continues to show volatility even at the lower end of historical levels. We remain confident in our ability to work through this environment as we have during other periods of volatility and weak pricing. We are well positioned to benefit from a return to more normalized pricing levels. Based on our current view of the business and the pricing environment, we feel confident about the back half of the year, especially given that the year-over-year comparison in pricing will start to look meaningfully better in the first -- meaningfully better, pardon me, than the first half of 2019. We continue our disciplined approach in managing and growing our core business while tracking and executing on [indiscernible] opportunities, further strengthening our financial performance and enhancing shareholder value based on a fundamentally sound and sustainable growth plan. 2019 started off with its challenges. However, we have been successfully working our way through the challenges and have once again demonstrated the strength of our business model.We remain excited about the prospects for the rest of the year. Our building materials Distribution and Forestry business segments continue showing strength and promise, and we look forward to sharing our successes with the market in the months to come.With that, I would like Jay Code, our CFO, to take over and provide a review of the company's second quarter and financial results in greater detail, who will then open the call for questions from analysts.Jay?

[James S. Code, Chief Financial Officer]

Thank you, Amar. And good morning, everyone.As a reminder, effective January 1, 2019, the company adopted the new lease accounting standard known as IFRS 16. The impact of IFRS 16 is described extensively in our financial statement disclosures as well as our management discussion and analysis for the quarter. During today's call, I'll also point out significant areas affected by the new standard.Sales for the 3-month period ended June 30, 2019, were $385.7 million versus $382.1 million in the comparative period in 2018, representing an increase of $3.6 million or 0.9% during the -- due to the following factors. Sales for the Distribution segment increased by $2.8 million or 0.7%, largely due to the inclusion of the results from the Lignum acquisition in 2019 and the 2018 acquisitions of Western wood preservers and Oregon Cascade Building Materials and the company's continuing focus on its product mix strategies and target customer base. These year-over-year improvements in the quarter were partially offset by the impact of construction materials pricing, which generally continued on a downward trend until late in the quarter.Sales for the Forestry segment increased by $928,000 or 7.5%. The increase in sales relative to the same quarter in -- of 2018 was largely driven by increased product demand, particularly for agricultural posts.The company's overall sales by product group in the quarter were made up of 62% construction materials compared to 63% during the same quarter last year, with the remaining balance of sales resulting from specialty and allied products of 31% and forestry and other sales comprising 7%.Gross margin dollars decreased to $54.4 million in the 3-month period versus $57.9 million in the comparative quarter 2018, a decrease of $3.5 million. Gross margin percentage was 14.1% in the quarter, a decrease from the 15.1% achieved in the same quarter of 2018. This decrease in margin is mainly attributable to the previously discussed downward trend in construction material pricing, which was partially offset by the inclusion of the results from the Lignum acquisition in 2019 and the 2018 acquisitions.Expenses for the 3-month period ended June 30, 2019, were $37.6 million compared to $34.9 million in comparative quarter in 2018, an increase of $2.7 million or 7.7% due to the factors that follow. As a percentage of sales, expenses were 9.7% in the quarter compared to 9.1% during the comparative quarter in 2018.Distribution, selling and administration expenses decreased by $3.4 million or 11.2% to $27 million in the second quarter of 2019 from $30.4 million in the same period of 2018. Excluding the impact of IFRS 16 adoption, distribution, selling and admin expenses increased by $1.7 million or 5.6% largely due to the additional expenses relating to the Lignum acquisition in 2019 and the 2018 acquisitions' operations. As a percentage of sales, these expenses were 7% in the quarter compared to 8% in the same quarter in 2018.Depreciation and amortization expenses increased by $6.1 million from $4.5 million to $10.6 million. Depreciation and amortization expenses for the Distribution segment increased by $5.4 million largely due to the impact of the adoption of IFRS 16. Depreciation and amortization expense for the Forestry segment increased by $695,000.Finance costs for the second quarter of 2019 were $6 million compared to $3 million in the same period of 2018, an increase of $3 million. Finance costs for the Distribution segment were $2.8 million higher than the same quarter in 2018 partly due to the impact of the adoption of IFRS 16 and partly due to higher average borrowings in order to finance the company's working capital requirements. Finance costs for the Forestry segment were mainly largely in line with the second quarter of 2018.EBITDA was $27.3 million and adjusted EBITDA was $27.5 million, consistent with the comparative quarter of 2018. Current quarter EBITDA and adjusted EBITDA were impacted by the adoption of IFRS 16. Excluding the impact of IFRS 16, adjusted EBITDA decreased by $5.2 million or 18.8% largely due to the aforementioned downward trend in construction materials pricing throughout the quarter, which was partially offset by the inclusion of results from the Lignum acquisition in 2019 and the 2018 acquisitions.As a result of the foregoing factors, net earnings for the quarter ended June 30, 2019, were $7.8 million compared to $14.7 million for the same period in 2018, a decrease of $6.9 million due to the previously discussed factors impacting the overall financial performance of the company.Turning now to the statement of cash flows. In the first 6 months of 2019, operating activities generated $31.2 million of cash, before noncash working capital changes, compared to $33.1 million in the same period of 2018. This decrease in cash generated is primarily the result of the year-over-year decrease in net earnings; and partially offset by the impact of the adoption of IFRS 16, which resulted in an increase in cash generated from operating activities of $10.8 million, with a corresponding decrease in cash provided by financing activities.Dividends paid to shareholders amounted to $10.9 million in the quarter and $21.8 million year-to-date, consistent with the same periods in 2018. The dividends declared and paid on a per share basis were unchanged at $0.14 per share per quarter.The revolving loan facility decreased -- or sorry, increased by $124.3 million compared to $132.4 million in the same period in 2018. And the company was not in breach of any of its lending covenants during the period ended June 30, 2019. Investing activities consumed $17.9 million of cash compared to $9.9 million in the same 6-month period in 2018. Overall cash purchases of property, plant and equipment were $3.7 million, consistent with 2018. And note that investing activities in 2019 included the Lignum acquisition and the related cash and cash equivalents acquired.The company's cash flow from operations, the aforementioned temporary increase in the revolving loan facility and its other credit facilities are expected to be sufficient to meet operating requirements, capital expenditures and anticipated dividend. The company's lease obligations require monthly installments, and these payments are all current.This concludes our formal commentary, and we'd now be happy to respond to any questions that you may have. Thank you very much.And operator?

[Operator]

[Operator Instructions] We will take the first question from the line of Paul Quinn from RBC Capital Markets.

[Paul C. Quinn, Analyst]

2019 started off very slow in housing obviously because of the weather and a couple other factors. Are you expecting a back half pickup? And where are you seeing strength in the marketplace on a regional basis?

[Amardeip Singh Doman, Chairman & CEO]

Yes. So we're definitely seeing strength pickup in all of our business segments. This kind of started in late May and into June, and July was a good month. So we are seeing activity pick up right across Canada, Paul. I would say the regions that are the busiest would be -- Quebec is very strong right now. Ontario has slowed a little bit. BC slowed a little bit. Prairies are picking up now, and Atlantic is flat. When we go down the West Coast to the U.S., Northern and Southern California become extremely busy for us. And our margins have come back after sort of the [indiscernible] in the last 12 months. So it's nice to see some stability in pricing. So that's been good for us. And Hawaii has been very busy. So with the exception of BC and Ontario having some housing weakness here and there, everything else seems to be coming up pretty good. And the weather is much better, so we expect to have a very good third quarter and fourth quarter for finishing out the year.

[Paul C. Quinn, Analyst]

Great. And then just taking a look and just wondering how you're feeling about your balance sheet strength in -- with respect to potential M&A opportunities and what the marketplace is looking like there. Is there lots of stuff to buy? And is it at attractive prices?

[Amardeip Singh Doman, Chairman & CEO]

Yes. So when we finished the year, if you recall, we had a lot of inventory. We elected to purchase ahead for our treated lumber programs, which was a smart move. So we did come into the year pretty heavy. And then we had the softer spring, so we were trying to stock. Inventories moved out. Our availability has opened up nicely. So if we have some tuck-in acquisitions, Paul, we could certainly use the credit line. And with lumber pricing being off still 30% from last year, that's created its own room compared to last year when you look at our balance sheet. So we're okay for those opportunities. Where are those opportunities? We still have ongoing discussions with several acquisition opportunities currently. And we'll provide you updates as they happen or not, but currently right now we're just working hard on running the business.

[Operator]

We'll take the next question from Steve Hansen from Raymond James.

[Steven P. Hansen, Senior Vice President]

Just a quick one for me. Are you able to give us just a sense for how much Lignum contributed in the quarter to the top line? I'm just trying to understand on sort of an organic basis how the business kind of performed on a top line basis, like, given the backdrop.

[Amardeip Singh Doman, Chairman & CEO]

Yes. Steve, we don't break out the divisions, just for competitive reasons, so I can't give that to you, but it was a full April, May, June in our results. Of course, lumber pricing being off from last year, Lignum will have a softer top line, like sort of the whole fraternity in the industry right now just due to pricing, but we're pleased with how kind of June, July shaped up here for Lignum. And they're very busy. So sorry. I can't answer that directly, but it's about the best I can give you. It's [ all-in ] good now.

[Steven P. Hansen, Senior Vice President]

Okay. No, I understand. That's fine. And then just -- if I'm just circling back on Lignum and just more the strategy side of it. I think you described the ability of introducing new products down into the U.S., the specialty cedar, MSR. And do you know -- are we in early inning from that, Amar, with where that strategy fit relative to where the opportunity lies?

[Amardeip Singh Doman, Chairman & CEO]

Yes. We've been spending a lot of time with our new family at Lignum, and we believe there is good growth opportunities on a strategic basis. There are certain markets where they were a little constrained on what they could do, so we're certainly looking at these opportunities seriously. And we think there's opportunities into California and in some other markets where Lignum can add value with their product line and they already have deep relationships. And of course, Lignum not being [ sown alone ] now opens up some other opportunities on the supply side through CanWel, which is part of our strategy, where they're kind of wide open and getting good looks from the mills at certain product lines and opportunities. So we're excited about what Lignum could do. And it's only been 3 months. So we like what we see.

[Steven P. Hansen, Senior Vice President]

Okay. Great. And then just lastly, your comments on California are encouraging. Can you just elaborate a little bit on what you're seeing that's driving the activity levels and the margin improvement? Is it just the general activity backdrop? Or is there a fundamental shift in the competitive environment or all of the above?

[Amardeip Singh Doman, Chairman & CEO]

Yes. All of the above. It was a very late start in California. The spring just didn't seem to want to get dry for a long time. They had record snowfall in the Nevada area, record rainfall in Northern California, Southern California. So it was really a lot of pent-up demand. We got started -- I would say it started to generate good business for us kind of in May, June, and July, August looks great. The order files are good. There's still a lot of box stores in the U.S., so we're seeing that takeaway almost exceeding last year's. That's a good indicator of what's happening. There's a lot of cash and carry and construction, and the same down in Hawaii as well. There's a lot of pent-up demand going on and jobs are happening. So do we think housing starts are going to run away up? No. We think they're going to just stay right where they are, kind of in a band. And at that level, kind of where we're sitting, we can do very well.

[Steven P. Hansen, Senior Vice President]

Okay. Great. And just lastly, if I may, just on the BC, Ontario areas that are seeing a bit of slowdown. How do you manage that part of your business for the slowdown? Is it just reducing the working capital into those segments? Or how do we think about managing that risk?

[Amardeip Singh Doman, Chairman & CEO]

Yes. We don't -- it's nothing alarming. It's just slowing a bit. So it still takes at the same guide, take an order, whether the lumber pricing is high or low, whether it's 10 units or 9 units. But we're just seeing those single families come off in those 2 provinces. They've got a hell of a run, so it's correcting a little bit. I think the foreign tax has really thrown cold water on the residential markets and the condo markets. So it's certainly correcting up a little bit. I think, Steve, as you know, we both live in BC, so we see that -- what's going on in kind of Vancouver as well, but it's nothing that -- the rest of the country being spread across really helps because other areas of strength seem to help. So we're not really reducing our working capital into those distribution centers or anything else, but towards the fall, when we prepare for 2020 and we do our budgeting and outlooks, we'll certainly look at inventory levels and what's anticipated for sales and then tie that back into our working capital requirements.

[Operator]

[Operator Instructions] We'll take the next question from Zachary Evershed from National Bank Financial.

[Zachary Evershed, Analyst]

In the Distribution business, do you think you've gained market share organically in Canada or the U.S.?

[Amardeip Singh Doman, Chairman & CEO]

In the Distribution side, hard to say. I would say that we're getting our fair share in Canada. We do review our customer accounts year-over-year, month-over-month to kind of gauge that a little bit. I wouldn't say that we're eroding a lot of market share, but we're just happy the season is underway. And it's very busy right now, so that's good for us. So I don't -- probably early to tell. Maybe in the next quarter I can let you know a little bit more once we have a little more runway behind us.

[James S. Code, Chief Financial Officer]

Yes. And Zachary, I'll just add that one encouraging sign we see is that our -- we're actually picking up volumes, although you don't see that come through on the top line because of the depressed commodity pricing. But beneath that we're seeing some nice increases in volumes year-over-year. So that could indicate we're picking up market share.

[Zachary Evershed, Analyst]

So you are getting volumes. It's being masked by the pricing. Is there a big product mix factor that plays a part there as well?

[Amardeip Singh Doman, Chairman & CEO]

There is. And that product mix changes on a daily basis, but as Jay indicated, I think in our Q2 our volumes were up year-over-year. But again, it is being masked by the low commodity pricing on lumber panels and oriented strand boards.

[Zachary Evershed, Analyst]

Yes, okay. And can you give us a little bit of color on the expected ramp-up of Oregon Cascade?

[Amardeip Singh Doman, Chairman & CEO]

Yes. Oregon Cascade, we're pleased to report, is now underway treating. We have our permitting in place. And we've been treating borate lumber, which is for the residential new home construction market. And we just started to treat with copper-based chemicals this week, which is great, so -- in operation. And we should have some good business here in the third quarter and fourth, and we'll be well prepared now for the 2020 season. So we're pleased to report that, Zach.

[Zachary Evershed, Analyst]

And last one for me. How do you interpret the supply-demand balance in lumber in light of the mill curtailments in BC?

[Amardeip Singh Doman, Chairman & CEO]

Good question. I think we're all scratching our heads a little bit, looking at last year's pricing, when the wheels started to come off right about now a year ago and didn't stop. But when we look at large curtailments, Canfor, West Fraser. Total has had some as well. I don't think that's been priced in yet. And we're halfway through the year, so how much torque can come? But West Fraser, I believe their curtailments start in the third quarter, somewhere near September. Those aren't even felt yet, so in my view, we might see more of an upside to lumber than a downside. Quite frankly, we've got kind of pessimism in the market on the buy side. Everyone thinks we're being -- keep going back down. And usually when everybody is on one side of the boat, it goes the other way, so I'd be a little more worried. And I would not want to be short lumber today.

[Zachary Evershed, Analyst]

And you don't think that the temporary curtailments keep a bit of a lid on pricing set in upper ceiling?

[Amardeip Singh Doman, Chairman & CEO]

Hard to say, Zach. Just we're trying to get a gauge on the inventory that's out in the pipelines, and we don't think it's stuffed. So that's what tells me that, when there is quite a pull on lumber, it could drive prices up. We're seeing day-to-day volatility on futures and things like that. So it's indicating to me that it's tight out there already without these curtailments fully baked in.

[Operator]

[Operator Instructions] We'll take the next question from Colin Healey from Haywood Securities.

[Colin Healey, Research Analyst of Mining]

Just a question about the kind of housing starts and segment stuff. We're seeing an influx of low-rise and mid-rise wood construction, multi-unit residential in the West Coast. Is this segment gaining any importance relative to the single detached in terms of an indicator for your business volumes? Or do you see the same kind of trend in any other markets?

[Amardeip Singh Doman, Chairman & CEO]

Well, we are seeing a little bit more in BC, although starts on the multi side have pushed up a little bit. BC, some of that just skews to, like, concrete in the downtown, in metro areas of the greater Vancouver area. But I wouldn't say it's meaningful yet, but I think the trend is something we can all be excited about long term. We're seeing cross-laminated timber starting to appear more; or [ these specs ], kind of the green effect of that; using less concrete. So I think the trend is our friend. I think it's still early days, Colin, but I think it's something that's very positive for forest products in the long term.

[Operator]

We'll take the next question from Abhilash Shashidharan from GMP Securities.

[Abhilash Shashidharan, Associate]

I was wondering if you could provide some color on how Honsador performed during the quarter.

[Amardeip Singh Doman, Chairman & CEO]

Yes. So Honsador is performing well. As you know, Hawaii is a very steady market, but it's busy. The outer islands, being the exception of Oahu, are extremely busy for us, especially Maui doing big numbers. But -- Maui is a small place, but we're doing big numbers. Our market share is very strong in Hawaii. Oahu has been a little bit softer due to certain projects that have been delayed, but there's a lot in the pipeline for the second half of the year. So Honsador for us is performing well. We've brought in a bunch of [ mill-direct ] strategies there that we've talked about over the years, and that's increasing our margins as we promised. So things are running well. We've made some personnel changes in kind of our first 1.5 years; and getting them a little bit more, I'm going to say, production focused with our trust plants or treating plants, et cetera, down in the island. So Honsador is performing as we would have expected, and our job is to continue to work on sourcing better to build the margin and behind where we have a great customer base.

[Abhilash Shashidharan, Associate]

Okay. That's helpful. And also, on the revolver, if you could provide some color on how much room remains to further draw down on the line of credit.

[James S. Code, Chief Financial Officer]

Sure, sure. On the revolver, of course, we announced that we've put a temporary increase. That revolver is normally a $300 million facility. We temporarily increased that on April 3 to $350 million. That temporary increase comes off on -- effective Monday, this coming Monday. The loan balance subsequent to quarter end is now down in the $270 million range, so comfortably under that reduced loan limit. Availability-wise, as is the usual outlook at this time of year, it is increasing at this point as our working capital requirements are being relieved through this busy season. So no concerns on availability at this point.

[Operator]

It appears there are no further questions. At this time, I'll turn it back to Ali Mahdavi for any additional or closing remarks.

[Ali Mahdavi, Head of Investor Relations]

Thank you, operator. On behalf of the CanWel team, I would like to once again thank you all for joining us this morning. We look forward to speaking with you again during our third quarter 2019 results conference call. Have a great day.This concludes today's call.

[Operator]

Thank you. Ladies and gentlemen, this concludes today's call. Thank you for your participation. You may now...