Doman Building Materials Group Ltd

TSX:DBM

Earnings Call Transcript 2019-Q4

[Operator]

Good day, and welcome to the CanWel Building Materials Group Ltd. Fourth Quarter and the Full Year 2019 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, Head of Investor Relations]

Good morning, everyone. Thank you for joining us this morning. And joining me this morning are CanWel'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 markets yesterday, 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 March 26. Following management's presentation and commentary, 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 following -- excuse me, 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. Amar?

[Amardeip Singh Doman, Chairman & CEO]

Thanks very much, Ali. Good morning, everyone, and 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 fourth 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 for us. Following an extended period of pricing pressure on building material products, which began in the second half of 2018 and lasted well into 2019, during the fourth quarter, we were pleased to see a certain degree of stability in pricing come back to lumber, OSB and plywood markets. While pricing levels remained nowhere near the peak, the combination of a modest improvement and stability in the pricing environment, our continued focus towards executing our strategic growth objectives, managing costs and optimizing operational efficiencies resulted in encouraging financial results in the fourth quarter of 2019. In the fourth quarter, all of our key financial metrics, including revenues, gross margin, EBITDA and net income performed strongly, while paying our shareholders a quarterly dividend of $0.14 per common share or $0.56 per common share on an annual basis. The unprecedented reversal and decline in the pricing in the lumber, OSB and plywood markets impacted the better part of our full year 2019 results. Despite the severity of the pricing decline, I am pleased with the resilience of CanWel's diversified business model in withstanding these types of external factors and volatilities, which resulted in annual revenues, gross margin, adjusted EBITDA and net earnings of $1.3 billion, $191.9 million, $85.8 million and $17.2 million, respectively, in 2019. Now zooming in on the fourth quarter, the most relevant period. Going back to my earlier comments on the improved pricing environment and our ongoing focus on growth and profitability objectives in the fourth quarter, revenues amounted to $293.4 million. Our gross margin remained strong at 15.1%. Adjusted EBITDA amounted to $18.4 million. Net earnings came in at $3.4 million. And lastly, our quarterly dividend of $0.14 per share was paid. During the quarter, 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 very enthusiastic and confident about the growth prospects ahead, 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. I'm also pleased to report that the commodity pricing environment has meaningfully improved from where we thought the prices had overcorrected. While current prices have significantly improved since late 2018 and a good part of 2019, the [ deal ] remained below where they were at the peak. Having said that, our fourth quarter results would suggest that the pricing environment during the quarter was at a level where we can deliver strong results. This is telling as far as the operating leverage goes into our business model, which demonstrates an ability to withstand marketing pricing volatilities while also being positioned to deliver financial performance and stronger pricing environments. We continue our disciplined approach in managing and growing our core business, while tracking and executing on accretive growth opportunities, further strengthening our financial performance and enhancing shareholder value based on a fundamentally sound and sustainable growth plan. Despite the previously discussed pressures in the first 9 months of 2019, CanWel enjoyed a strong year with all of our key financial metrics meeting and in certain instances, beating our internal expectations. We are tracking well as we continue the path in building a bigger, stronger and more sustainable CanWel for our shareholders for the future. We remain quite excited with the prospects of showing new record highs across our various key financial metrics in the quarters and years to come. Despite the unprecedented volatility in the global equity and debt markets caused by the impact of COVID-19, 2020 is off to a good start. Inevitably, we will be cautiously monitoring the spread and any impact of the virus on our business and making the necessary decisions to protect our staff and the company. We look forward to sharing with you our continued success and performance as we push forward into 2020. With that, I'd like to pass the meeting over to Jay Code, our CFO, to take over and provide a review of the company's fourth quarter full year financial results in greater detail, and then we'll open the call for questions I look forward to taking along with Jay. Jay?

[James S. Code, Chief Financial Officer]

Thank you, Amar, and good morning, everyone. As a reminder, effective the first quarter of 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 and the full year. During today's call, I'll also point out the significant areas affected by the new standard. Sales for the year ended December 31, 2019, were $1.33 billion versus $1.29 billion in 2018, representing an increase of $42.9 million or 3.3%, largely due to the inclusion of revenue from the Lignum acquisition in 2019, acquisitions completed during 2018 and the company's continuing focus on its product mix strategies and target customer base. These positive factors were partially offset by the impact of construction materials pricing, has generally continued on a downward trend until late in the year as well as reduced Forestry segment sales, which experienced reduced demand for timber from local sawmill customers, reflecting curtailments experienced across the industry. The company's sales by product group in the year were made up of 58% construction materials, which is comparable to last year, with the remaining balance resulting from specialty and allied products of 35% and Forestry and other revenues of 7%. Gross margin was $191.9 million in the current year versus $192.9 million in 2018, a decrease of $1 million. Gross margin percentage was 14.4% during the year, a decrease from the 14.9% achieved in 2018. This decrease in margin dollars and margin percentage reflects the negative impacts from lower construction materials pricing levels and pricing trends relative to 2018. This negative impact was partially offset by the inclusion of results from the 2018 and 2019 acquisitions. Expenses for the year ended December 31, 2019, were $147.6 million versus $139.4 million in 2018, an increase of $8.2 million or 5.9% due to the factors to be discussed. As a percentage of sales, 2019 expenses were 11.1% versus 10.8% in 2018. Distribution, selling and administration expenses decreased by $15.1 million or 12.5% to $105.8 million versus $120.9 million in 2018. Excluding the impact of IFRS 16 adoption, distribution, selling and administration expenses increased by $5.1 million or 4.2%, largely due to the additional expenses relating to the inclusion of both Lignum and the 2018 acquisitions' operations. As a percentage of sales, DS&A expenses were [ 7.9% ] in the current year compared to 9.4% in 2018. Depreciation and amortization expenses increased by $23.4 million from $18.4 million to $41.8 million, largely due to the impact of the adoption of IFRS 16, which accounted for $21.6 million of the overall increase. Finance costs for the year ended December 31, 2019, were $21.9 million versus $11.7 million in 2018, an increase of $10.2 million. The adoption of IFRS 16 contributed $4.5 million to the overall increase, while increased average revolver usage relating to this year's working capital requirements and higher overall interest rates resulting from the full year inclusion of our senior unsecured notes accounted for the balance of the increase in finance costs. EBITDA was $85.8 million, and adjusted EBITDA was $86.2 million compared to EBITDA of $71.2 million and adjusted EBITDA of $72 million for 2018, an increase in adjusted EBITDA of $14.2 million or 19.7%. Current year EBITDA and adjusted EBITDA were positively impacted by the adoption of IFRS 16 in the amount of $20.3 million. Excluding the impact of IFRS 16 adoption, adjusted EBITDA for the year ended December 31, 2019, decreased by $6.1 million or 8.5%, largely due to the previously discussed decrease in construction materials pricing levels and trends as well as weather conditions impacting construction activities during the first quarter of 2019, which was partially offset by the inclusion of the results from the Lignum acquisition and the 2018 acquisitions. As a result of the foregoing factors, net earnings for the year ended December 31, 2019, were $17.2 million versus $30 million in 2018, a decrease of $12.8 million or 42.6% due to the foregoing factors impacting the overall financial performance of the company. Turning now to the statement of cash flows. In 2019, operating activities before noncash working capital changes generated $60.7 million compared to $51.4 million in 2018. Changes in noncash working capital items generated $7.2 million in cash this year compared to consuming $55.4 million in 2018. We experienced a significant increase in inventory towards the end of 2018, built up to address a strong order backlog with treated lumber customers and to take advantage of favorable buying conditions at the time. This 2018 activity drove reduced inventory stocking in the first half of 2019 and resulted in the $62.7 million positive year-over-year variance in cash consumed. During the year ended December 31, 2019, financing activities used $56.5 million of cash compared to generating $25.4 million in 2018. Repayments relating to the nonrevolving term loan consumed $11.2 million versus $2.7 million in 2018. Payment of lease liabilities, including interest, consumed $23.1 million of cash compared to $1.7 million in 2018, mainly due to the impact of adopting IFRS 16, which is offset by a corresponding increase in cash from operating activities. Dividends paid to shareholders amounted to $43.5 million, consistent with 2018. The dividends declared and paid on a per share basis were unchanged from 2018. The revolving loan facility increased by $29.6 million in 2019 compared to an increase of $21.5 million in 2018. The company was not in breach of any of its covenants for the year ended December 31, 2019. Investing activities consumed $10.4 million of cash compared to $27.9 million during 2018. Cash purchases of property, plant and equipment were $7.2 million compared to $10.2 million in 2018. Investing activities in 2019 included the Lignum acquisition and the related cash and cash equivalents acquired, whereas last year included the 2018 acquisitions. In October 2019, we completed the sale of a 7,542-hectare parcel of timberlands to a coal mining entity that held an auction to purchase the subject lands. Gross proceeds of $12.2 million were partially -- used to partially pay down our nonrevolving term loan with the balance paid to satisfy outstanding obligations to Rayonier Advanced Materials, a former owner of the lands. The net cash proceeds available to repay these existing obligations resulted in a positive cash impact in investing activities of $10.6 million with a corresponding use of cash in financing activities. The company retained the rights to harvest the remaining timber on the subject lands for a period of 13 years. The company's cash flows from operations and credit facilities are expected to be sufficient to meet operating requirements, capital expenditures and anticipated dividends. The company's lease obligations require monthly installments, and these payments are all current. This concludes our formal commentary, and we'd be now happy to respond to any questions that you may have. Thank you. Operator?

[Operator]

[Operator Instructions] We will now take our first question from Roshni Luthra of CIBC Capital Partners.

[Roshni Luthra, Research Analyst]

I just have a couple of questions through the year ahead for you. How's your M&A pipeline looking for 2020?

[Amardeip Singh Doman, Chairman & CEO]

Yes, Roshni. Looking decent. We do have a few things on the go right now, and we're continuing to focus a little bit more on the U.S. side. And we see the pipeline is decent, and we -- despite obviously, the things that are going around the world, we still -- we're looking long term. So some of these discussions that we have, have been going on for a while, and we'll continue to carry on with our strategy. We're not going to change anything.

[Roshni Luthra, Research Analyst]

Okay. Great. And one just for this year -- last year, how is Honsador doing? Can you quantify, like the year-over-year revenue change for Honsador?

[Amardeip Singh Doman, Chairman & CEO]

We don't break that out for competitive reasons. But I can tell you that percentage sales, we were up. And we had a very, very good year down in Hawaii, and we started off the year very well down there as well this year.

[Operator]

We will now take our next question from Zachary Evershed of National Bank Financial.

[Zachary Evershed, Analyst]

In the context of potential disruptions to trade flows or logistics internationally, are there any country-specific risks that you point out on your supply chain?

[Amardeip Singh Doman, Chairman & CEO]

Yes, it's minor. Coming back to Hawaii, there could be some items that we purchase from China that so far have not had port issues. But that's really the only area where we do any importing, and that's of some type of cabinets and raw blanks for that type of stuff, but it's really a minor part of the business. So by and large, we're not really in any sort of panic. If even China closed, it wouldn't really affect us very much.

[Zachary Evershed, Analyst]

Got it. And then, obviously, no one has a crystal ball here on how things are going to develop. But running through a bear case and a bull case of the interplay between a potential recession and a tailwind from lower rates flowing through the business.

[Amardeip Singh Doman, Chairman & CEO]

Yes. I think we're all reading the same news, and this thing is transpiring as we all sit here, but the fact of the matter is, longer term, this will pass. So we're not doing any except protecting our employees and making sure that in case something happens, that everybody is going to be protected and not spreading this thing if something happens. Many of our sites, we've got plans in place for that. But when we come back to economic factors, it's pretty tough to have visibility going forward, bearish or bullish. What we can tell you is our order files have not fallen off a cliff. Nothing has changed. Spring buyers are buying materials. I think the news is kind of worse than reality of what's going on. Having said that, could there be some type of slowdown later in the year? It's anyone's guess when this cure comes out or when the disease starts dying down, the news gets better. But having said that, so far, from what I can see, and Jay can confirm that, I don't see any slowdown in our business activity at all and order file.

[James S. Code, Chief Financial Officer]

Yes, I agree, Amar. I have not seen anything at this point.

[Zachary Evershed, Analyst]

That's helpful. And then one last one for me. We've seen some pretty sharp pullbacks in lumber futures recently. When we peaked in 2018, your margins took a pretty hard hit in the subsequent quarters. Has anything changed in your hedging strategy or your margin management strategy? Or do you expect we'll see a repeat of that?

[Amardeip Singh Doman, Chairman & CEO]

Yes. I mean that's a good question. So we addressed this yesterday to our Board of Directors at our meeting at length, and the futures market is not correlated to cash whatsoever. So we saw our futures tumble as per your note yesterday, $80, $90 on the Board, along with all the Dow Jones and everything else that was getting pummeled. The cash, even West Fraser took their pricing up. We've seen our cash, lumber piles be on market because the order files are long. So the futures board is not correlating to cash right now. It definitely needs a buyer's market just because of the sentiment, but when you come to supply and demand, there's a complete disconnect on futures and cash today.

[Zachary Evershed, Analyst]

And in your experience, how long is that disconnect going to last?

[Amardeip Singh Doman, Chairman & CEO]

Well, this is an odd disconnect, but the way we're heading into spring and building season is upon us, and the interest rates are low, no one has a crystal ball here, Zach, just because of what's going on. But right now, as of yesterday, even the cash markets are still healthy. And material is trading, and guys are trying to counter into it. But again, on the mill, we're holding firm and taking orders. That gives us confidence that we won't see a collapse. And I don't foresee that, but you never know what can happen here if economic things slow down. I don't foresee that right now. And the market has not moved up to record highs in cash or anything like that, so it's not like its stratospheric, where it's sitting today anyway.

[Operator]

So we then take our next question from Paul Quinn of RBC Capital Markets.

[Paul C. Quinn]

Just a question on the timberland sale, is there any other options out there on your timberland holdings? And what is your net current ownership, given the sale of 7,500 hectares?

[James S. Code, Chief Financial Officer]

And so Paul, it's Jay. That represented about 14% of our total land holdings in the [ Kobe ] region. So it takes us down to about 117,000 acres still remaining. And of course, we're retaining harvest rates, as we said during the call, for 13 years on that auctioned land.

[Paul C. Quinn]

Just so I understand, the retention of the harvest rights, you're paying them effectively as stumpage when you harvest?

[Amardeip Singh Doman, Chairman & CEO]

No. So it's actually a pretty -- I mean, it's a very good deal for CanWel. So we've effectively sold this parcel off to a company, they had an auction on a prior acquisition. They're going to be building a coal mine on it. So we sold it at, we believe, a great value for the company all weighed, and then we get to harvest all the timber, as it would be our own. So there's no stumpage. There's no royalties. There's no nothing going to the buyer. It all comes to CanWel. So we're obviously going to reinforce that or parts of it where the mine doesn't interrupt, as these guys whenever they start to build their mine, but we've got 13 years. And we'll probably have most of that harvested within the first 5 or 6 years and get that cleaned up. And then we'll replant. And of course, those trees will take 50 to 75 years to mature. So we think this is an extremely lucrative transaction for CanWel, and it's a good transaction for the buyers also. It took a while to negotiate it, but it's a good deal.

[Paul C. Quinn]

Great. Potentially the color -- it sounds like you haven't seen any drop in your order files, but orders sort of, in the way I look at it anyway, it's very early innings in this COVID-19 issue. So have you got contingency plans for, if the back half or even Q2 starts to look like a recession, starts to act like a recession, what does that mean for CanWel?

[Amardeip Singh Doman, Chairman & CEO]

Yes, we've got some levers we can pull. Certainly, we're going to be very careful on our inventories, things like that. But you know what, our lumber's at 200 or 400, we still need our good people to be selling the materials, and we don't think this is going to bring housing to a halt. We think rates are lower. But having said that, the levers we could pull really are in the inventory. We do have a very, at least light operation. We can return forklifts. So there's a lot of things on cost that we can pull levers on. The cost of our capital has just dropped significantly. So we like to see that save us cash in this type of environment as well. So that's nice to see on our revolving facility. Those are some of the levers. Can we release a bunch of people? I don't think I would in the short-term crisis. We've got a very talented group. So I don't think you'd see us lever there. But as you know, most of what we do, with the exception of parts of the U.S., all of our trucking, which is our #1 cost, and people, but when you look at trucking, everything's elastic. So we only haul loads if they're full and they're sold. So we don't have a lot of trucking overhead sitting on the books, truck drivers to pay. They've got a full load, out it goes, and we pay from A to B. So our model is set up to be risk-adverse. And so in times like this, if they do evolve into a slowdown, we feel we're the best in the business to be able to manage that. And of course, we manage things daily here. But right now, again, as we look into March and April, so far, so good.

[Paul C. Quinn]

Okay. And then just turning to your balance sheet, how are you guys thinking about that? I mean, obviously, your share price has been hit, just like everything else, in the marketplace. Is that having an effect on acquisition opportunities in terms of potential acquisition prices? And how would you look at those opportunities? Are you -- how long term are you looking versus the short-term issues surrounding balance sheet debt levels?

[Amardeip Singh Doman, Chairman & CEO]

Yes. Paul, this is probably the third or fourth odd period I've lived through, whether it's recessions and all those kind of stuff, or a disease, with SARS. We're -- I'll let Jay address the balance sheet in a moment, but when it comes to M&A activities, we have got a lot of room on our line. We just renewed our credit facility, which Jay will comment on. We've got a lot of room for these tuck-in acquisitions. We're not looking for elephants anyway. We're looking for nice, strategic tuck-ins in regions like we've been building. So we're going to carry on with our acquisition strategy. And with respect to the balance sheet, we're in good shape. We've got our inventories in a very good spot. I admire our team for that. And I'll let Jay speak a little bit further on it.

[James S. Code, Chief Financial Officer]

Sure, Paul. Of course, you probably saw that we amended our revolving loan facility in the fourth quarter, so that from a limit of $300 million up to $360 million. So that's going to be helpful to our availability, especially during our seasonal working capital [ mulch ] periods, which is always a challenge for us. And then, of course, through the [ North Coal ] transaction, we took down our nonrevolving term debt from net proceeds of that transaction. So overall, we've got a very strong balance sheet coming into 2020. And yes, we're confident here.

[Operator]

And we'll take our final question from Anoop Prihar of Stifel GMP.

[Anoop Prihar, MD & Special Situations Analyst]

First question, just a housekeeping issue. Jay, the G&A on a full year basis was down about $15 million. I'm assuming that's an IFRS impact. But is the $106 million that you booked for last year, is that sort of a run rate we can think about for this year as well?

[James S. Code, Chief Financial Officer]

Yes, outside -- Anoop, outside of acquisitions, which are going to impact SG&A, right, pick up in 2019, we added Lignum. In 2018, we had acquisitions that occurred during the year. So in 2019, first full year for those 2018 acquisitions. So as a run rate, you can't quite look at quarter-by-quarter in '19 because of the Lignum acquisition.

[Anoop Prihar, MD & Special Situations Analyst]

Okay. And then on the line of credit, I know you bumped it to $360 million. Is the full $360 million available to you currently?

[James S. Code, Chief Financial Officer]

Yes, of course, it's based on our receivables, our accounts receivable and inventory balances at any given time. So it's the lesser of $360 million and the collateral that we have on hand through receivables and inventory.

[Anoop Prihar, MD & Special Situations Analyst]

So how much of this is...

[James S. Code, Chief Financial Officer]

Yes. You can see at year-end, we're nowhere near coming into that $360 million range base based on positions at year-end. But as we come into this time of year, it's -- of course, that's an increasing. But we don't expect to go near the $360 million this year.

[Anoop Prihar, MD & Special Situations Analyst]

Okay. And then last question -- sorry, go ahead.

[Amardeip Singh Doman, Chairman & CEO]

It's a moving target -- yes, it's just a moving target due to the seasonality, as you know, Anoop. You can set your watch kind of by when we peak and when we decline again. But again, it's for -- it's the big credit card to run the business on working capital. So it does ebb and flow with the assets.

[Anoop Prihar, MD & Special Situations Analyst]

Fair enough. And then, Amar, when you were commenting in the MD&A about the Q4 results, which were actually quite good, so congratulations on that front. You talked about maximizing target customer base. What exactly does that mean?

[Amardeip Singh Doman, Chairman & CEO]

Yes. So looking at whatever region we're in, we're very, very selective of who we're going after -- sorry, who we're going after and with what product lines. So certain areas will be more focused on the allied lines. Certain areas will be focused more on the pressure-treated. And these are strategies that are confidential inside the company. As we get into the U.S., we have different strategies with big-box retailers, Hawaii, with direct-to-builder there, different strategies there. So we continue to refine these strategies to basically line up our inventory, line up our product lines best to suit who our customers are, and who we're targeting. So we're not just out faxing the price list or emailing a price listing, here's what we have for sale today. We're selectively targeting head offices with big programs due to the big inventory and volumes we carry, to be just in time for them. And obviously, that adds a value for our distribution, complemented by the pressure-treated lumber we produce as well. So that's a lot of verbiage to your answer, but it really is about targeting these customers in a strategic way with our product lines.

[Anoop Prihar, MD & Special Situations Analyst]

And this is something that you really started focusing on last year?

[Amardeip Singh Doman, Chairman & CEO]

No, I'd say we're enhancing it. As we continue to grow, we're getting deeper and deeper with a lot of our customers, and we're just refining it all the time. So I don't think you need to read too much into it. We're doing our jobs. It's just we're adhering more to the larger customers as they continue to acquire brands and dealers. And they become more powerful -- they become more powerful to them, and we need each other.

[Operator]

And as there are no further questions, this now concludes the call. Thank you for your participation. You may now disconnect.

[Amardeip Singh Doman, Chairman & CEO]

Thank you, everybody.