Interfor Corp

TSX:IFP

Earnings Call Transcript 2018-Q1

[Operator]

Good morning. My name is Kelly, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Interfor first quarter analyst conference call. [Operator Instructions]I would now like to turn the conference over to Duncan Davies, President and CEO. Please go ahead, sir.

[Duncan K. Davies, President, CEO & Non]

Thanks very much, Kelly. Good morning, everyone. Thanks for joining us. We are here to discuss Interfor's first quarter results and to provide some comments on the outlook for the next few quarters. Joining me, as usual, are Martin Juravsky, our Chief Financial Officer; and Bart Bender, our Senior Vice President of Sales and Marketing. I'm going to keep my remarks brief, and I'll turn the meeting over to you for your questions as soon as I can. In the first quarter of 2018, Interfor recorded net earnings of $33 million and sales of $528 million. EBITDA, adjusted to exclude the effects of long-term incentive compensation and other onetime items, was $81.1 million. This compares with net earnings of $19.7 million and EBITDA of $60.3 million in the same quarter last year and with net earnings of $36.2 million and EBITDA $89.5 million in the fourth quarter of 2017. Our results from the first quarter were positively impacted by higher lumber prices, which before duties were CAD 38 per thousand or 6% higher than the prior quarter. The gains from higher lumber prices, however, offset by lower shipments, which came in at 95% of production in the first quarter compared to 102% in the fourth quarter. Higher duty rates, which totaled $12.9 million in the first quarter versus $1.9 million net in the fourth quarter and higher unit cost, which were up 6% quarter-over-quarter, partly due to higher log cost, but also due to adverse weather conditions and capital projects related to downtime in the South. Lumber production in the first quarter was $666 million board feet, up 2% versus the fourth quarter. Production in the South was $302 million board feet compared with $296 million board feet in the fourth quarter, as additional shifting at our Thomaston and Georgetown plants more than offset lower production at a couple of other facilities. Production in the Northwest totaled 146 million board feet, up 6% -- sorry, up 6 million board feet quarter-over-quarter. Interior came in at 181 million board feet, down 1 million board feet, while the coast was flat at 37 million board feet in the first quarter. From a capacity utilization standpoint, the coast came in at 46%, the Interior at 97%, the Northwest at 91% and the South at 86%. Like most other producers, our shipments in the first quarter were negatively impacted by logistics challenges, most notably in the South and in the interior, where adverse weather conditions exacerbated shortages of railcars and trucks. Shipments in the Interfor product were 635 million board feet in Q1 versus 666 million board feet in Q4. As I mentioned earlier, product prices were strong against the board in Q1. The Southern Pine Composite was up $37, the SPF Composite was up $33 and dry Hem-Fir studs were up $63 quarter-over-quarter. Import duties on Canadian shipments to the U.S., at a combined rate of 20.23%, applied for the full quarter this year and were fully expensed. The first quarter was another strong quarter from the standpoint of cash flow with cash from operations before changes in working capital coming in at $75.5 million. After working capital changes were taking into account, the total amount of cash generated in the quarter was $18.5 million. Capital spending totaled $18.1 million on a combination of discretionary, maintenance and woodlands projects, the most notable being the -- an automatic grading system at our mill in Perry, Georgia. Net debt end of the quarter at $127.1 million or the equivalent of 12.4% of invested capital. We closed the quarter with $445 million of available liquidity. We made good progress in the first quarter on our strategic capital plan, which is designed to capture the opportunities within our existing operations and to pursue opportunities for further growth. The previously announced projects at Meldrim and Monticello are on track for completion in the first quarter next year. These projects will materially improve the economics of those mills and will add approximately 150 million board feet of production for our portfolio. We are also well advanced in our planning for the next round of our upgrade strategy and expect to be in a position to announce our plans at some point during the second quarter. The same holds for the greenfield opportunity we are looking at in the central region of the U.S. South. These projects are central elements of our business strategy and replicate the process of improvement in investment that we employed previously in the Pacific Northwest and the interior regions, and we are excited to be at this point of moving forward. In terms of the near-term outlook, I can tell you that the second quarter has started off very nicely. Demand for all products is strong and prices continue to increase. The Southern Yellow Pine comps that was reported yesterday at $511 per thousand versus $453 in the first quarter and the SPF comps that was at $530 compared to $472 in the first quarter. Also as weather conditions improve, some of the logistical challenges we faced are beginning to fall back in the line, which should permit a catch-up on shipments, at least in part, in the second quarter. On the other side, log supply issues in the interior continued to be a challenge and we are concerned about the potential for flooding in some parts of that region that would impact log availability and/or the potential to ship product. At that point, Kelly, I think I'm going to stop and I'd like to open the session to questions for our guests. Thank you.

[Operator]

[Operator Instructions] Our first question comes from the line of Sean Steuart.

[Sean Steuart, Research Analyst]

Couple of questions on the longer-term capital plan. I guess, we can expect to hear something definitive on the greenfield projects in the coming months. Just more generally, there has been some industry speculation that due to contractor and equipment availability constraints, the timeline for building these assets, the long list of greenfield projects we have in the South now, some speculation that timeline can be pushed out. Are you guys still comfortable that end of 2019 is feasible for your project?

[Duncan K. Davies, President, CEO & Non]

Yes, we are. I think your premise is correct, Sean. I think there is enough projects in the pipeline, whether they are greenfield or upgrade projects or what have you, that vendor availability and contractor availability is a major consideration. We're fortunate enough to be working with some folks that we're very comfortable with. And we've talked a lot about timelines and the like, and we're quite comfortable that we can meet our timelines, both for the mill upgrades that we have on the drawing board, but also the greenfield plant that we're giving consideration to.

[Sean Steuart, Research Analyst]

And on the greenfield project specifically, I think I asked this before. Maybe just remind me that the capacity multiple that you guys reference is quite a bit higher than some of your competitors are talking about, and I think it was explained as a fully baked number, including working capital and start-up costs. Is there additional contingencies built into that number though that...

[Duncan K. Davies, President, CEO & Non]

Well, Sean, one of the reasons why it's taking us the time to complete our plans on this is we're looking to find the sweet spot between size of the project, the amount of capital cost and the timing of the project itself. And we want to make sure that we are able to build a facility to not only that will achieve the operating parameters that we think are important, but also will be built to the standard that we're used to in our capital projects. And I think you've been to some of our facilities, and probably have a pretty good idea what I'm talking about there in terms of standard and operability and reliability. And so we've been back to the drawing board. We've been back and forth with our primary supplier on that particular project. And I don't want to say too much yet because we haven't finalized the plans exactly yet. But we are looking at a whole -- we've been looking at a variety of options to find the sweet spot. So there is a strong likelihood that if we go ahead with that plant, it will be bigger than what we've been talking about, but fit well with the timber basket in the area that we're looking at and able to deliver the right level of economies of scale and productivity and cost on a go-forward basis.

[Operator]

Your next question comes from the line of Mark Wilde.

[Mark William Wilde, Senior Analyst]

Duncan, first, just kind of a detailed question. Can you just give us a little update on kind of what you're seeing in terms of log cost kind of across all of your different fiber baskets?

[Duncan K. Davies, President, CEO & Non]

Yes, sure. The biggest increases that we've experienced, Mark, have been in the B.C. Interior, and it's a combination of log availability, impacts from reductions in allowable cut, impacts from fire season last year. So we've seen some fairly significant inflation in the B.C. Interior region in the last while, exacerbated, of course, by weather conditions as it always is at this time of the year. We think that the rate of increase in that area will moderate somewhat as we move forward. In the South, there's been some modest increases, but nothing to get excited about. The Northwest, we saw some increases going back aways, but that's moderated somewhat. And on the coast, it's typical weather-related conditions on the coast that impact cost during the first quarter. So all in all, I think we can always expect, with lumber prices where they are, you're going to see some inflation in log cost. But you've got to tie it back to the time of the year, weather conditions and the things of that nature.

[Mark William Wilde, Senior Analyst]

Yes, okay. That's helpful. I wondered next kind of turning to kind of balance sheet and capital deployment, if markets remain strong, would you be willing to stood on a net cash position and perhaps wait till slower markets offer some better opportunities?

[Duncan K. Davies, President, CEO & Non]

Well, we're sitting on a significant amount of cash currently, right. The whole question of capital deployment and figuring out the most advantageous time is something that we spend a lot of time thinking our way through. Our conclusion over the last while is that we've moved out of a phase where we grew the platform quite significantly between 2013 and 2015, but then we delivered to the point where we're in a pretty attractive position from a balance sheet standpoint. That gives us the ability to move forward with the internal capital projects that we've got on the drawing board and the greenfield opportunity that we are looking at where we think the metrics are better than some other alternatives. And so it's the typical cycle where sometimes it's better to buy stuff and other times it's better to fix stuff or build stuff, and that's we're looking at to -- it's all part and parcel of what we think generates the best return on capital employed over the course of the cycle.

[Mark William Wilde, Senior Analyst]

Yes, okay. Would you care to comment on just what you're seeing, particularly down in the Southern U.S., on sort of M&A valuations right now?

[Duncan K. Davies, President, CEO & Non]

I don't want to get too specific. But I think expectations are certainly higher than they have been. And with lumber prices where they are, I think we all need to remember, this is a cyclical business. And there's times when opportunities for acquisitions are overpriced relative to their long-term value. And we just think it makes more sense to focus internally at this point in time. It doesn't mean that if there was something particularly attractive that was available to us that we wouldn't pursue it, because we've got the financial capacity to do that. But I just think that the potential returns from a long-term standpoint are better on the programs that we've got right now and the upgrading of our existing platform and looking for opportunities for well-positioned greenfield development.

[Mark William Wilde, Senior Analyst]

Yes. All right. Well, I actually agree with that. And last one from me right now is, just can you give us some sense of sort of the opportunities that you've seen for both yield and efficiency gains as you upgrade these southern sawmills? I guess, I'm thinking about just your ability to take labor out, but also just to get a better yield. I know a lot of southern sawmills have been fairly undercapitalized historically.

[Duncan K. Davies, President, CEO & Non]

Yes, well I think that's a fair comment. I mean, there is obviously some that are well positioned, but in a lot of cases, that's not the case. So from a technology standpoint, whether it's primary breakdown systems or autograding systems, you can improve the yield, both from a volume standpoint and from a grade standpoint, quite significantly and we think contribute to very attractive paybacks. In addition, with the kind of technology that exists now that you've seen, for example, at Adams Lake, Mark, is the levels of the feed speeds, the levels of productivity in primary breakdown systems are dramatically better than what we've seen in some of the older facilities in the Southeast, which translates, we think, into opportunities. So as we've grown our platform there, we've looked specifically for opportunities in attractive timber baskets that have got a workforce that we can work with, but also where we think we can apply technology to upgrade those systems and come up the back end with a reasonable amount of capital employed in a facility, but with modern technology and metrics, generating a significant improvement in the financial performance and operating performance metrics of a facility.

[Operator]

Your next question comes from the line of Hamir Patel.

[Hamir Patel]

Duncan, I want to follow up on Sean's question about the capacity. And just given some of the equipment issues that you mentioned and labor constraints, how much actual production growth do you think we can see in North America this year and into 2019?

[Duncan K. Davies, President, CEO & Non]

Well, I leave that to you guys. You tally up all that stuff. I cannot. I tend to focus a bit more on our own situation. What I can tell you, Hamir, is we're seeing demand grow by something in the million -- or 1.5 billion to 2 billion foot a year range. And we are seeing supply restrictions in some other areas that make the net effect even more than that. And so I personally am of the view, and I think most of my colleagues are of the view, that the industry is going to have a difficult time meeting growth and demand without reinvestment and will even be challenged to meet the growth and demand with investment. And I think we're seeing some of those effects now where we seem to have passed the point where the industry in North America is capable of supplying the demand that exists. And we're seeing product prices move to record levels, partly as a result of that. Now that's not the only factor, but it's certainly a big factor in that equation, and I fully expect is as economic activity in the U.S. continues to ramp up, we're going to see increases in growth in demand for our product not only in housing but also in other industrial [ end ] uses and in other areas that I think is going to be a challenge for the industry to be able to supply. So I'm as excited about the future of our business today as I've ever been. At the same time, I am fully cognizant that that's a cyclical business and there could be unforeseen circumstances that arise that impact overall demand. And that's one of the reasons why we're so focused on making sure that the assets that we own and operate are really well positioned in the industry from a cost and competitiveness standpoint.

[Hamir Patel]

Sure enough. And Duncan, we're seeing more talk of, I'd say, innovation in the building products industry to help deal with some of the labor issues, whether it be ready-frame products or longer-term sort of factory built homes. What do you think that means for the larger producers such as yourselves and maybe the amount of lumber that actually gets used for a level of -- given the level of housing starts?

[Duncan K. Davies, President, CEO & Non]

Well, I think it's a trend that's inevitable. And for anybody that's been involved in the industry in Japan, they're used to seeing this. It's exactly the same thing in terms of lack of available labor has resulted in a much more mechanized construction system in Japan with the precutting systems. And so we fully expect that that's going to take place in North America, and we are working with a number of firms that are involved in that area. And I think it's just another area of opportunity for us.

[Operator]

[Operator Instructions] Our next question comes from the line of Paul Quinn.

[Paul C. Quinn, Analyst]

Just wanted to ask you a question on greenfield sawmill locations and maybe you could just prioritize on these 3 factors where -- what would make the ideal location and the factors that, that I look at are timber -- low-cost timber, one being, 2 being labor and 3 being just sort of residual offtake. And I'm just curious as to how you prioritize those and where you're going to locate a new mill.

[Duncan K. Davies, President, CEO & Non]

Well, you've hit the nail on the head. Those are the 3 factors. And as far as we're concerned, you need to have all of them.

[J. Barton Bender, Senior Vice President of Sales & Marketing]

And logistics and a market.

[Duncan K. Davies, President, CEO & Non]

You Thanks, Bart. You just reminded me. The other thing is, you need the logistics and the ability to serve the market, right. So those are the factors and as far as we're concerned, you have to have all of them to have a successful project. And we think that we've got a situation that provides all of those for us.

[Paul C. Quinn, Analyst]

Okay. And then just, we've had robust conditions on a saw milling side for a while now. Everybody is making a lot of money. You guys have got a pretty broad geographic footprint. So you're seeing your neighboring saw millers across North America. Is everybody reinvesting in their assets? Or is there a number of -- is there certain areas that haven't seen a lot of investment? I'm just wondering if I fast-forward 5 or 10 years and eventually we see a downturn, whether we're -- whether it's going to be a flat cost curve across the industry or if it's got quite a slope to it?

[Duncan K. Davies, President, CEO & Non]

Our sense is it's a slope. I think the larger, better-capitalized operators are all investing in their business. I think there is a number of others that do that maybe less so than we do. So our expectation is the cost curve is going to tilt. A lot of it depends, too, on the cost of raw material and the byproduct offtake piece, which is, it's -- we all say, it's 1/2 to 2/3 of our cost structure. And so whether -- it's not just conversion, what we call conversion cost that determine what your relative competitive position is. It's the combination of your conversion cost and your fiber cost. And so there's going to be continue to be, as it always has been, significant differences in different regions in terms of what fiber costs look like. All I know from our standpoint is, if we believe if we're going to be successful long-term in generating the kind of returns on capital employed that are consistent with the value to our shareholders, we're going to need to take advantage of the opportunities to invest in our business that we think will put us in that position. And that's been our business strategy ever since I came to Interfor. And I suspect it will be out strategy long after I have gone. But we've got this opportunity right now in U.S. South that we captured through some -- some pretty good acquisitions that we made in the 2013 to 2015 period. We've got -- we're 5 years into that now. We've got a pretty good feel for that business. We made really good progress putting in place our systems and processes for operations. And now we're moving forward with the discretionary investment that we think is going to really put that business in a great spot going forward. So I'll let others worry about themselves. We're going to worry about capturing opportunities in our system and delivering returns for our shareholders.

[Paul C. Quinn, Analyst]

Okay. Last question I had. One of your CEO peers announced his retirement for 2019. Just wondering if you're still having fun there?

[Duncan K. Davies, President, CEO & Non]

Yes, I'm having the time of my life. Yes, I'm not going anywhere.

[Operator]

Your next question comes from the line of Mark Wilde.

[Mark William Wilde, Senior Analyst]

Just I have a couple of follow-ups. I'm wondering if you could just talk about how you see kind of supply in the B.C. Interior over the next few years. I don't know whether kind of salvage from some of the fires is going to buy some of the marginal mills some more time before they need to close down. But just how you see kind of capacity in the interior evolving over the next few years?

[Duncan K. Davies, President, CEO & Non]

Yes. I think the fire thing was maybe overrated a little bit. I think it's had a short-term impact on available supply. I would be surprised if all of a sudden there is a big bubble of volume that flows through the system just because of salvage efforts on the fire. I fully subscribe to the point of view that there is -- the industry hasn't seen the full effects of the pine needle infest -- yet, there is still, we think, another 1 billion or 1.5 billion feet of production that's going to fall by the wayside [ indiscernible ] over the next number of years. So I think that industry is timber constrained. I think that, along with growth in demand, is going to create tension in the overall demand-supply position in North America that's going to create opportunities for well-positioned operations that are capable of investing in their facilities to grow their production in regions outside of B.C. Interior.

[Mark William Wilde, Senior Analyst]

Yes, okay. Well, second follow-on just on -- in addition to that capital that you're spending internally and what you've done in M&A that I just -- I wondered how you think about sort of your overall portfolio over the next few years? You're in a lot of different markets geographically. You're in some niche markets. Any likelihood that we see kind of a repositioning within the portfolio?

[Duncan K. Davies, President, CEO & Non]

Nothing planned right now. I think what we're going to see with our discretionary capital program, Mark, you're going to see the percentage where our production represented by the South increase. But we're generating pretty good returns in each of the other regions too and I've got some things that I'd like to be able to do beyond the existing platform from a growth standpoint. But we haven't seen the opportunities yet available to us at prices that we think makes sense from a long-term standpoint. But like as I said earlier, it's a cyclical business. And one of the things we want to do is make sure that we maintain our financial capacity, even during a period of fairly aggressive capital spending. We want to be able to maintain the financial capacity that gives us the ability to jump on opportunities when they come along in the manner that makes sense for us.

[Mark William Wilde, Senior Analyst]

Yes. Well, I think, we all know the bigger players that kind of lack the discipline and forgetting about cyclicality that they've been burned by over time. And last question from me. You're taking a little different approach in terms of expensing anti-dumping duties versus some of your peers. Would you care to comment about what you're doing?

[Duncan K. Davies, President, CEO & Non]

We are fully expensing. I do know because Marty tells me all the time what others are doing. Others can make their own decisions. Our conclusion is we're better off to fully expense at the time, I wish, of what we're doing. So we have basically an off-balance sheet asset that's developing. And I just can't put a probability on it. I fully believe that our case is strong and that we should get all the money back. And if we do, it will be a windfall game for us. And I think that's a better way to handle it than going about it in a different way.

[Martin L. Juravsky, Senior VP & CFO]

And Mark, it's Marty. Just to put a little precision on that, on one element. We're -- all of the companies are encountering pretty much the same fact set, but there are different perspectives in terms of the accounting treatment that different people have taken. So we've taken a fairly conservative approach. Others have also taken a fairly conservative approach and what we pay is what we expense.

[Operator]

[Operator Instructions] And there are no further questions at this time. I will now turn the call over to Mr. Davies for closing remarks.

[Duncan K. Davies, President, CEO & Non]

Yes, thanks, Kelly. Thanks, everybody. We really appreciate the interest you have in our company. I'm around the rest of the day. I think Marty is around most of the day if you've got follow-up questions and everybody knows how to get a hold of us. So please don't hesitate to call. And if we do, great, and if not, we will talk to you at the end of the next quarter. Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.