Doman Building Materials Group Ltd

TSX:DBM

Earnings Call Transcript 2022-Q3

[Operator]

Good day, and welcome to the Doman Building Materials Group Ltd. Third Quarter 2022 Financial Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ali Mahdavi. Please go ahead.

[Ali Mahdavi, executive]

Thank you, operator. Good afternoon, everyone, and thank you for joining us for our third quarter 2022 financial results conference call. Joining me this afternoon are the company's Chairman and Chief Executive Officer, Amar Doman; and Chief Financial Officer, James Code.

If you have not seen the news release, which was issued after the close of market yesterday, it is available on our website 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 November 19. Following the presentation of the third quarter results, 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 Doman 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 Doman, executive]

Thanks, Ali, and good day, everybody, and thanks for joining us on today's call. On the back of the second quarter, which was impacted by macroeconomic headwinds and pricing volatility, stemming primarily from rising interest rates, inflationary pressures and concerns around the risks of a recession, the third quarter started off as expected. Our expectations were that we would see some pricing normalization in a tighter range than the second quarter as a result of the market adjusting to the evolving supply/demand dynamics in light of consumer behavior and reaction to inflationary cost pressures and overall consumer sentiment, which I would qualify as cautious.

Given the continued pressure and volatility on pricing in the third quarter, we continue to closely manage our inventories to protect and improve gross margin to the extent possible with positive results when compared to the second quarter. During the third quarter, we saw signs of pricing stabilization at levels which remain healthy for our business, which combined with steady consumer demand provides us with cautious optimism going into the fourth quarter with what seems to be less price volatility, leading to normalized margin levels and continued reasonable market demand in our key markets on both sides of the border.

Despite the continued pricing trend and concerns caused by the global macroeconomic environment, I'm pleased with and very proud of our financial performance during what I continue to consider a challenging quarter where we were extremely responsive to industry-wide price volatility while ensuring that our first-class level of service remained on point. As a result of our collective efforts, our revenues amounted to $744 million; gross margin improved compared to our previous quarter, however, continued to be challenged per my earlier commentary on inventories and pricing dynamics at 12.3% or just under $92 million; adjusted EBITDA amounted to $40 million; and our net earnings came in just over $11.6 million. And lastly, of course, we paid a quarterly dividend totaling $0.14 per share, our 50th consecutive dividend.

While we are on the subject of financial performance, I'm also very pleased with our steadfast and relentless focus on balance sheet management and optimization. To this point, during the last 12 months, while working through some of the aforementioned challenging market dynamics, we were able to reduce our debt by $103 million, thanks to the strength of our free cash flows.

Looking ahead, we remain excited and cautiously optimistic as we believe that the pricing environment and market demand has reached an equilibrium at healthy levels, while we continue to manage our costs and always look for growth opportunities. However, we are cognizant of the external pressures, which may come into play not only for our industry, but any others that touch similar end customers.

A little bit of color on how the fourth quarter has started off. So far, we are feeling optimistic based on a tighter pricing environment, inventories and importantly, the demand profile we are seeing, as mentioned, on both sides of the border. End markets and users who may have been on the sidelines remain cautious but active. As always, we remain confident in our ability to work through volatile markets diligently while serving our customers' needs with the highest level of service.

We remain excited about our growth profile and the overall prospects of the business. And with that, I'd like to ask Jay Code, our CFO, to take over and provide a review of the company's third quarter 2022 financial results in greater detail, and then we look forward to opening the call for your questions. Thanks very much. Jay?

[James Code, executive]

Thank you, Amar. Good day, everyone. Sales for the quarter ended September 30, 2022, were $744.1 million compared to $625.3 million in 2021, representing an increase of $118.8 million or 19%. The increase in revenues was largely due to the impact of construction materials pricing, which remained relatively consistent through the third quarter of '22 compared with sharp pricing declines we experienced during the prior year's third quarter.

The company's sales by product group in the quarter were made up of 72% construction materials compared to 66% last year, with the remaining balance resulting from specialty and allied products of 24% and other product sales of 4%. Gross margin dollars increased to $91.5 million in the quarter compared to $80.7 million in '21, an increase of $10.8 million.

Gross margin percentage was 12.3% in the quarter, a slight decrease from the 12.9% achieved last year. Expenses for the quarter were $68.4 million compared to $63.5 million in 2021, an increase of $4.9 million or 7.7%. As a percentage of sales, expenses were 9.2% in the current quarter compared to 10.2% last year.

Distribution, selling and administration expense increased by $5.3 million or 11.5% to $51.5 million in 2022 from $46.2 million last year, mainly due to recent inflationary pressures contributing to higher operating expenses during the quarter as well as increased sales resulting in higher personnel costs. As a percentage of sales, these expenses were 6.9% in the quarter compared to 7.4% in 2021.

Depreciation and amortization expenses decreased by $464,000 or 2.7% from $17.3 million to $16.9 million this quarter. Finance costs for the third quarter were $9.8 million compared to $8.7 million in 2021, an increase of $1.2 million or 13.5%, largely due to higher interest rates on the company's variable rate loan facilities, which was partially offset by lower average loans and borrowings balances.

EBITDA for the third quarter was $40 million compared to $33.2 million in '21, an increase of $6.8 million or 20.6%. EBITDA for the comparative third quarter of '21 was impacted by nonrecurring directly attributable acquisition-related costs of $1.3 million. Adjusted EBITDA before these nonrecurring costs for the comparative quarter was $34.5 million. This quarter's increase in adjusted EBITDA of $5.5 million or 16.1% was mainly due to increased sales and gross margin dollars, which were favorably impacted by the previously discussed changes in construction materials pricing. As a result of these factors, net earnings for the third quarter were $11.6 million compared to $7.7 million in the same quarter of '21, an increase in earnings of about $4 million.

Turning now to the statement of cash flows. The significant comparative factors affecting operating activities for the first 9 months of 2022 were largely related to lower earnings as a result of the previously discussed construction materials pricing declines and strong working capital management. Operating activities before noncash working capital changes generated $126.2 million in cash compared to $144.2 million during the same period in '21.

During the 9-month period ended September 30, '22, changes in noncash working capital generated $27.8 million in cash compared to consuming $128.4 million in the same period in 2021. This significant improvement was largely due to management's recent efforts to reduce inventory volumes in anticipation of potential slowing of market activity, along with the construction materials pricing declines during the current year and its impact on the company's average unit cost of inventory as at September 30, 2022.

The overall change in working capital in the current 9-month period was comprised of an increase in trade and other receivables of $34.3 million, a decrease in inventory of $51.2 million, a decrease in prepaid expenses of $2.1 million and a net increase in trade and other payables of $8.8 million. The revolving loan facility decreased by $99 million this year compared to increasing by $144.3 million in 2021. The significant year-over-year decrease in net advances from the revolving loan facility is partly a result of the previously discussed decrease in cash consumed by working capital changes.

Additionally, the prior year comparative period included partial financing for our 2021 business acquisitions. Shares issued net of share issuance costs generated $1.3 million of cash compared to $82 million in 2021, with the prior year comparative period, including proceeds from our public share offering in May of 2021. The company also returned $36.4 million to shareholders through dividends paid during the 9-month period compared to $32.2 million in 2021.

The company updated its dividend policy during the fourth quarter of 2021, resulting in a dividend increase beginning with the dividend paid on January 14, 2022. We also note that the company was not in breach of any of its lending covenants during the 9-month period ended September 30, 2022. Investing activities consumed $3 million of cash compared to $501.8 million in 2021, representing this year's purchases of property, plant and equipment, net of proceeds from disposition, whereas the prior year comparative period included consideration paid for our 2021 acquisitions.

This concludes our formal commentary, and we'd now be happy to open the call to any questions that you may have. Thank you. Operator?

[Operator]

[Operator Instructions] Our first question comes from Hamir Patel with CIBC Capital Markets.

[Hamir Patel, analyst]

Amar, can you tell us how much of your sort of annual sales come from Lowe's Canada? And what impact you would expect, if any, from the sale of their Canadian business?

[Amardeip Doman, executive]

Yes. We won't disclose our customer volumes publicly, but certainly, they're an important piece of our business. We see this as a lateral move and someone that will take Lowe's Canada, probably rebrand it and be more focused as Lowe's divested Mexico; Orchard Supply in California; and finally, Canada. So Lowe's just kind of going back to U.S.-centric. And of course, they're being a large customer of ours in the United States.

[Hamir Patel, analyst]

Okay. Fair enough. And just a question for Jay. I noticed you have the $60 million unsecured notes maturing in October 2023. How are you thinking about refinancing that? Or would you potentially just cover that with the revolver?

[James Code, executive]

Yes. Thanks, Hamir. Yes, we would definitely have the excess availability on our revolver to cover that. So at this point, we're going to take the approach that will monitor that. And if we choose to let that go right out to October '23, we'll do that, and we'll use the revolver to pay that off.

[Operator]

The next question comes from Zachary Evershed with National Bank Financial.

[Zachary Evershed, analyst]

Congrats on the quarter. How lose is the supply chain generally at this point? Anything hard to source or that you're expecting to be hard to source?

[Amardeip Doman, executive]

No, not really. Supply chain, with the exception of rail, has caught up. Trucks are kind of back in order, if you will. And the only items that are hard to find are some of the upper grades for some of our pressure-treated lumber programs, but we're not hitting any panic button. There's just -- there's still a lot of activity out there.

So despite what you kind of read in the papers, construction is very busy all over the place. And still trying to finish off some projects, I think, that were started in the last 18, 24 months. So it's just active. You can see by our sales number on lower commodity pricing, how much volume we did. So it's still very busy out there. It's active, but supply chain appears to be back in order.

[Zachary Evershed, analyst]

Good color. And then you're feeling optimistic heading into Q4. Thus far, would you say it's been conforming to usual seasonal patterns?

[Amardeip Doman, executive]

Yes. In fact, a little bit stronger than normal. But yes, we're feeling okay here as we're -- we've begun November now. And yes, as long as the volatility in pricing remains sort of out of the picture, and those big up and downs are hopefully well behind us. Things look pretty steady here in the fourth quarter.

[Zachary Evershed, analyst]

That's a great segue actually. In your outlook in the MD&A, you seem to have struck a bit more cautious of a tone. What's your view on commodity pricing going forward? Is it still anyone's guess at dartboard? Or do you think we're honing in on a floor here?

[Amardeip Doman, executive]

Yes. I believe we are honing in on a bit of a floor. I think that's a good term to use. Again, no crystal ball here at the office, but certainly, we think that we're kind of going back into more normal patterns just because the availability is there. I think we all know that 7% mortgages in the U.S. aren't a great thing. So there'll be some slowdown at some point. But certainly, that's why we've been very cautious with our inventories.

We've got our balance sheet in the best shape it's ever been. So we're prepared for whatever comes at us and returning our inventories a bit quicker. Our operations teams are doing a heck of a job there. So we're in good shape. Just no matter what comes at us in the next couple of years.

[Zachary Evershed, analyst]

Excellent. And then just one last one. Could we get an update on how you're balancing M&A opportunities with commodity pricing coming off? How do you view your leverage ratio versus debt in dollar terms when you're evaluating opportunities?

[Amardeip Doman, executive]

Yes. No change there, Zach. We certainly value the acquisitions, the same, whether the market is strong or weak, evidenced by whether it was Hixson, Cal Cascade, Honsador, Fontana would treat. We certainly don't get out of our strike zone. So to us, it doesn't really matter what's going on in the macroeconomic world. We're obviously not going to over-lever. We pay attention to our balance sheet.

But certainly, we do see a lot of opportunities there. We need, I think, some of the valuation metrics to sober up a little bit coming off the COVID bump our industry experienced. But certainly, the M&A is on the front. But currently, nothing that would be on the front lines, if you will, currently. We're just busy working hard and making good cash.

[Operator]

Our next question comes from Paul Quinn with RBC Capital Markets.

[Paul Quinn, analyst]

And maybe just some color on the treated market. It's an area that I don't get a lot of exposure to except for you guys. So maybe you could just help us understand how that market has done over the last year and your expectations for 2023 in treated?

[Amardeip Doman, executive]

Yes, we thought this year would be a little bit slower than it was. And especially in the U.S., it certainly has been strong to up on volumes in the U.S., 2022 over '21. Canada, a little bit slower in the East just because there's an inventory overhang that all of us treaters are working through. But Paul, very, very pleased with the volumes.

And after kind of a new home surge, the decks and fences, which we play heavy in certainly start to appear once a homeowner has built or finished a new home, then they finish the backyard. So we see some good runway ahead of us out of the treated sector.

[Paul Quinn, analyst]

Okay. And maybe -- I mean, I'm not sure how much engineered wood products you handle, but what are you seeing in that market? It seems to be running flat out.

[Amardeip Doman, executive]

Yes. Engineered wood has been super strong. Again, that one was tied directly to new housing construction. We finally have come off allocation. So that is saying that the wheels are slowing down a little bit, but it's been a great category for us. Of course, we were with Louisiana-Pacific. They sold their engineered wood division recently to Pacific Woodtech based in Washington State, just down the street here. And we're very pleased with the new owners and our new 5-year agreement with them. And it looks very positive for us to continue to grow in the engineered wood category.

[Operator]

Our next question comes from Steve Hansen with Raymond James.

[Steven Hansen, analyst]

Just curious how we should think about the margin profile here against the backdrop of a slightly slower market but also less volatility with some of the commodity lumber. Should we expect something to be a little bit more consistent going forward? Or how do you think about it?

[Amardeip Doman, executive]

Yes. It's -- we kind of given up guessing on this. So what we've elected to do as a company is run with less inventory, faster turns. I mean, hey, that's what you want to do anyway. But certainly, that's been a bigger focus for us, especially on the price-sensitive materials. I think we're kind of the once bitten, twice shy thing after those huge ups and downs that we saw during the pandemic.

So we're looking at lumber forecast, maybe $450, $500 kind of -- it's kind of what we think it's going to be. But again, we don't know, Steve, but right in that range. And our gross margins will continue to recover, still doing decent, but I think we can come up a little bit more as well as we go into a nice just hopefully steady band of lumber pricing and OSB and plywood.

[Steven Hansen, analyst]

Okay. That's helpful. And I apologize if I missed it in your opening remarks, I was struggling to get on. But just curious about your CapEx profile over the next little while. You've got some time now with your U.S. operations having beefed up? Are you through a lot of the capital projects you had planned post acquisition? And where do you stand there?

[Amardeip Doman, executive]

Yes, we are, and we're actually underspent this year. We implemented technology at Hixson. We put it in the DMSi system. It's now live at all 19 locations. We -- actually Jay and I were there yesterday down in Texas in a couple of our mill sites and checking in on that technology and everything is running well there, right on budget.

So the CapEx spends are, again, a little bit underspent this year. Some of that, we need to replace some trucks, some in Hawaii and some in California. The issue there has been supply chain trying to get trucks, but that should start to appear in the first quarter of next year. But on the CapEx side, everything is in good shape.

[Operator]

The next question comes from Ian Gillies with Stifel.

[Ian Gillies, analyst]

One of the things that looked encouraging in the quarter, the U.S. revenue came in a bit ahead of where we were thinking. I'm just wondering if -- would you qualify that as being due to continued R&R market that remains to be healthy? Or is it the long tail on new home builds and you guys just continuing to plug away and as these homes get finished up?

[Amardeip Doman, executive]

Yes, I'd say it's a bit of both. We were surprised at how the volumes held sort of summer and fall even until now. Kind of in the Midwest and Texas, those markets were pretty heavy and now -- and even the West California hasn't missed a beat. Hawaii has been strong. So yes, we're pleasantly surprised. But again, we did our job on inventories and leaning up the balance sheet just in case things do slow down. But again, right into the fourth quarter here, we just haven't seen that slowdown happen yet.

[Ian Gillies, analyst]

Yes. So Amar, that's a good lead into my next question. The inventory has been much better or much tighter in recent quarters. And are you kind of targeting that 50 to 55 days of inventory moving forward?

[Amardeip Doman, executive]

Pretty much, yes. And we think we can improve that a little bit more as time goes on as well, but that's coming to zone and target that we're very happy with.

[Ian Gillies, analyst]

Yes. Okay. And then last one for me, following on some previous questions was you've obviously done a pretty good job managing the working capital here for the past few quarters. Have you -- are you hearing anything? Or are there any signs of distress yet in the private market for some of your peers there that may create an opportunity? Or is it still too early to say?

[Amardeip Doman, executive]

Still too early to say. It's interesting because if we read a lot of media, you want to switch your wrists, what's going on, but the activity is strong. We're busy. And that means our competitors are busy and our acquisition targets are busy. Everybody is still rolling along here pretty well. And that makes a bit of a disconnect for us on valuation of what we like to acquire businesses on and run our models internally and how we can glue those companies into our models.

So certainly, right now, we're all letting the circus go by a little bit. And then hopefully some value transactions will come to us in the next 24 months.

[Ian Gillies, analyst]

Yes, that's fair enough. And sorry, one last follow-on there. Would it be fair to say that private equity has largely left the market right now as is competition just given what's transpired with interest rates?

[Amardeip Doman, executive]

Hard to answer that, with honesty, Ian, but I would say that evidence we were a little surprised that private equity took out Lowe's Canada yesterday. Stepping into the space when it looks like things are going to slow down due to the cold water that the federal governments are putting on with interest rates. So interesting to see that. But no, we're not really seeing a lot of private equity competition on the acquisition targets that Jay and I are looking at in our office.

[Operator]

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

[Ali Mahdavi, executive]

Thank you, operator. On behalf of the Doman team, I'd like to thank you for joining us for today's call, and we look forward to speaking with you again on the back of our Q4 and year-end results. That concludes today's call. I'll ask the operator to close things up. Have a great weekend.

[Operator]

This concludes today's call. Thank you for your participation, and you may now disconnect.