Interfor Corp

TSX:IFP

Earnings Call Transcript 2019-Q1

[Operator]

Good morning. My name is Miriam and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor Corporation First Quarter Analyst Call. [Operator Instructions] I would now like to turn the call over to Duncan Davies, President and CEO. You may begin your conference.

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

Thanks very much, operator. Good morning, everyone, and thanks for joining us. I'm here with our CFO, Marty Juravsky; and our Senior Vice President of Sales and Marketing, Bart Bender, to go over Interfor first quarter results and to look at our outlook for the next few months. I'm going to keep my remarks brief and then we will turn this session over to you for questions as soon as we can.To the extent that you've already seen the results of most of the others in our sector, there won't be any surprises about our results for the first quarter, which is best for you to describe as disappointing. The price recovery that was generally expected in the first quarter simply couldn't come to pass. After some encouraging signs from the first 6 to 7 weeks of the year, prices reversed course and gave up a significant portion of the gains recorded in the first half of the quarter. Much of the [ blandness ] can be attributed to adverse weather that impacted takeaway levels in key markets throughout North America. But that wasn't the only factor. Higher mortgage rates and economic uncertainty also impacted demands especially in the new home segment. [ View of ] a quarter-over-quarter basis, prices for the main commodities were up somewhere between $10 and $40 per thousand board feet in the first quarter from the levels recorded in the fourth quarter. After taking into account of order pile lags in the lake, our sales average for the first quarter was $613 per thousand board feet before duty charges, up $14 from the fourth quarter.During the first quarter, we also dealt with the impacts of high log cost in B.C. Interior that have come about as a result of timber shortage and a disconnect between the lumber prices and the mechanism used to determine stumpage rates in the region. In fairness, stumpage rates in the Interior were lower in the first quarter than they were in the fourth quarter, but they were high compared to historic rates in across B.C. and other regions.Taking together these factors contributed to a net loss of $15.3 million in the first quarter of 2019. This compares to a loss of $13.5 million in the fourth quarter and to earnings of $32.7 million in the first quarter of 2018. Our results for the first quarter this year includes some [ loss ] associated with the redundancy of certain assets affected by the capital projects in the South and to prior period expenses, but those highly proved relatively minor.EBITDA in the first quarter was $16.3 million compared to $8.9 million in the fourth quarter and to $83.5 million in the first quarter last year. Firstly, all of the gain in EBITDA in the first quarter compared with immediate preceding quarter can be attributed to the increase in sales values described earlier, with the positive and negative effects of items such as increased production, lower shipments, lower log costs and lower SG&A expenses canceling each other out. Production in the first quarter was 646 million board feet, up 40 million board feet relative to the fourth quarter following the return to the normal operating schedules post the holiday season. Capacity utilization was 83% overall versus 78% in the fourth quarter, made up of 47% on the B.C. Coast, 84% in the Interior, 85% in the Northwest and 90% in the South. Shipments amounted to 621 million board feet, down 26 million board feet quarter-over-quarter. Cash from operations during the quarter was $17.1 million. Working capital increased by $75 million, reflecting a combination of higher log and lumber inventories and work payables.Capital spending in the quarter was $43.8 million, more than 70% of which was directed to our ongoing projects in the U.S. South. The remainder was directed towards maintenance and woodlands activities.During the quarter, we repurchased and canceled 515,000 shares of cost at $7.8 million, bringing the total to date to 2.8 million shares and cost of $44.7 million. Adding all of this together left Interfor with net debt of $173 million at quarter end, equivalent of 15.6% of invested capital and with available liquidity of $425 million. On March 4, our normal course issuer bid was renewed, permitting the purchase of almost 6.7 million shares over the course of the next 12 months. Activity under the NCIB on a go-forward basis will be ranked against other investment alternatives and balanced against our leverage targets, similar to the way the 2018 program was managed.While the first quarter was nothing to write home about from a bottom line standpoint, I can tell you that I'm extremely pleased with the progress being made on our strategic capital initiatives in the South. The Monticello and Meldrim projects were great and are on track for completion this month. We expect Monticello to be running its first log next week, and the new kiln at Meldrim should be running by the end of the month. Our most recent estimates show these projects coming in within 10% of their capital purchase of USD 62.5 million, with the overage associated with steel and labor costs. We've also experienced some vendor delays, most notably at Meldrim, which has also contributed to the overrun. The good news is that each of these projects is delivering results on the already completed phases in excess of pro forma, which provides comfort that the cost overages will be offset by greater-than-anticipated results from the project's ramp-up. The Phase 2 projects at Thomaston and Eatonton and Georgetown remain on track for completion in stages over the next 2 years. To date, almost USD 22 million has been capitalized on these projects, and we remain on track from both the timing and the budget standpoint. At this point, I'm going to ask Bart Bender, our Senior Vice President of Sales and Marketing, to provide some comments on the current state of the lumber market and his outlook for the coming quarters. Bart?

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

Thanks, Duncan. I'll provide a brief outlook of the lumber market. Anticipation of a spring building season, combined with low inventories profit, increases in pricing mid-quarter, weather and the continued pause of new home construction tempered this anticipation late quarter, and that continues quarter 2 to date. The repair and remodel sector continues to demonstrate quarter-over-quarter increase in growth rates at approximately 40% of the U.S. lumber consumption. Growth in this sector is meaningful. That said, we are still not seeing full demand from the marketplace as some areas of the country remain under adverse weather conditions. We expect this to clear up in May, which should give us a better picture of the true demand. In the meantime, as announced, Interfor has responded with curtailments in the B.C. Interior. In terms of our export business, Japan remains consistent and steady. Some pressure on J Grade prices, however [ GAN band ], Hemlock squares and Doug-Fir squares are balanced. This should continue through Q2. For Interfor, China has slowed somewhat this past quarter. This is a reflection of uncertainty in tariffs for U.S. lumber and high-end market inventories for Western Canadian SPF and Doug-Fir dimension products. We expect those to clear through Q2 and market activity to normalize accordingly. Our specialty business, consisting of cedar and reserved pine boards, remain steady. Long-term market fundamentals are favorable. We expect lumber demand to continue to grow. As expected, price volatility will continue as we navigate these short-term market shifts.I'll stop there, Duncan, and pass it back over to you.

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

Great, Bart, thanks. Late last week, as Bart mentioned, we announced plans for a series of rotating curtailments at our B.C. Interior operations. These curtailments will move about 20 million board feet of production from our portfolio over the next 20 days or so. They're being taken in response to the combination of weaker-than-anticipated demand, weaker lumber prices and high log costs in B.C. Interior. Our intention is to continue to monitor the state of the market going forward when we adjust our production rates as required. Operator, at this point, I think it would be more productive for our guests if we turn the session over to them and took questions.

[Operator]

[Operator Instructions] Your first question comes from Sean Steuart with TD Securities.

[Sean Steuart, Research Analyst]

A few questions. You mentioned the modest inflation to the Phase 1 budget. And Duncan, I think you suggested that Phase 2, which is obviously a lot bigger, was on track. And I'm hoping you can reconcile that. I mean when you initiated the Phase 2, you started talking about it. I would guess that number would be subject to some inflation as well. Can you help us reconcile those 2 things?

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

Yes. We learned a bunch of things during the Phase 1 projects, Sean, both from an impact of steel price increases or decreases and how that could affect the cost structure of a project. We've been able to build some mechanisms into our arrangements to cover that, which is helpful. So that will affect the Phase 2 projects as opposed to the Phase 1 projects. We also learned a lot about labor cost and labor productivity. In the South, we've been able to build some increased costs into the Phase 2 projects to account for the experiences we had in Phase 1 cost.

[Sean Steuart, Research Analyst]

Got it. Question on the credit facility modernization. Can you let us know if there's any change to the borrowing cost there? And I guess just more broadly speaking, the rationale for increasing the borrowing base. I would've guessed you would have been comfortable with liquidity position already. Just any context you can provide there.

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

Sure. Marty is the author of this. I will let him comment.

[Martin L. Juravsky, Senior VP & CFO]

Hey, Sean. So just in terms of the last question first, we've got lots of liquidity. We got $425 million of liquidity in total. $350 million is in the bank facility. So there's no great element attached to that $20 million variance other than there was more flexibility available. So we decided to make a nice, clean, round number in terms of the total availability. In terms of the costs, it's actually -- there's a whole variety of elements attached to it that are enhancements to what we had in place. One, it's way simpler; two, some of the nonfinancial covenants are way more streamlined. And yes, there was an impact in terms of more preferential costs for us. So it works very well from a variety perspective, including having the term shifted out to 2024 in terms of its maturity. So it just gives us an awful lot of flexibility as we pursue our various initiatives.

[Sean Steuart, Research Analyst]

Got it. And then, Marty, maybe just a housekeeping question, if anything, but the $1.2 million of expenses in Q1 that you referred to as refinements of prior estimates, what exactly is that? And is that a one-off? Or should we think of that as recurring?

[Martin L. Juravsky, Senior VP & CFO]

No. It truly is a one-off. There are a couple of -- there's 2 specific items, neither of which by themselves are huge, but they were refinements of items that happened a couple of years ago. And as we looked at them, they had nothing to do with the current quarter. Yes, they had nothing to do with the current quarter. One was associated with when duties came into place and some timing issues associated with the original introduction of duties. And then another piece associated with some costs that have been incurred related to log procurement activities over the last couple of years that had nothing to do with the current quarter. And neither of those issues that we've accrued for have -- are ongoing factors.

[Operator]

Your next question comes from Hamir Patel with CIBC Capital Markets.

[Hamir Patel]

Duncan, can you give us your outlook for fiber costs in B.C. over the balance of this year? And then also when would you expect some moderation in the South after the sort of weather-related increase in Q1?

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

We expect stumpage rates from the B.C. Interior to go up quite significantly on the 1st of July as a result of the annual update that's taken in to determine stumpage calculations. To the extent they offset some of the reductions that have occurred over the last couple of months, there's -- the quarterly updates have been brought into effect. But to the extent that log costs in the B.C. Interior are now higher than they are and most of the competing regions in North America, it's going to be a difficult pill to swallow in that region. And we think we'll force additional curtailments to occur, some temporarily and some likely permanently in the Interior region as a result. In the South, we've seen -- we saw some modest cost inflation in the Southern region, largely because of weather conditions. People talk an awful lot about adverse weather and how it's affected takeaway levels to job sites, but it also has an effect on operating rates, particularly in the logging side of things, where you get to pretty -- maybe pretty quick in the South. And if you get significant rainfall, it can impact logging productivity and logging rates and tends to result in somewhat higher cost. As we move through into the spring and into the summer, you'd expect that to moderate. And that would be our expectation and so far, we've seen that coming into effect in there.

[Hamir Patel]

That's helpful. And for -- your specific region where your mills are in B.C., what's that July 1 adjustment? What does that sort of translate to on a sort of total wood cost? And can you just remind us what is your percent quota wood in B.C.?

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

Well our percent of quota volume varies by different regions, the Adams Lake region versus the operations in the Kootenays. We have a higher degree of self-sufficiency in the Kootenays than we would at Adams Lake, for example. And the number will be -- I don't know, $10 to $15 a cubic meter is our expectation.

[Hamir Patel]

Okay. Great. That's helpful. And just a final one from me for Bart. Can you give us your sense as to where inventories are in North America, both at the mill level and the channel?

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

Sure, Hamir. My -- I think that the inventories at the mill level would be largely a function of some of the inconsistent railcar supply that we saw as a -- due to the weather factors. But I can tell you that the last 2 to 3 weeks, the flow there has normalized, and so I would imagine a lot of that -- a lot of the mill inventory is making its way to market or has made its way to market. The end market inventories are the more, I suppose, relevant factor that we're dealing with today. Last quarter, I would've told you that they were at the low end of the average, and I would say they're in the bottom 1/3 of the average today. The fact is that the inventories that have built at the distribution level have been unable to get to the job sites. So there's higher than normal, but they're earmarked for jobs or have been presold already. So as the weather cleans up, we think that those inventories will start to flow to the job site, which will make the inventory picture a little bit clearer and perhaps more advantageous for ourselves.

[Operator]

[Operator Instructions] Your next question comes from Mark Wilde with Bank of Montréal.

[Mark William Wilde, Senior Analyst]

Bart, I just want to swing back around to that inventory issue because I was just hearing from another big West Coast producer the other day who was saying that their read is that inventories in places like Southern California are actually quite high. Are there regional differences here that you might like to call out?

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

Well, no, that's fair. I think if you look at areas like California, it's kind of hard to look at the weather. I think you probably have to need to look at more of the building activities in that particular area. But if you go around, let's call it, North America, the U.S., Canada, there are areas that are still getting snow in this -- within the last week. And so obviously, those areas I don't think are operating at full capacity in terms of the building activities. So you'll see pockets. And I think that as we move into Q2, there are a number of markets that have really picked up in activity. So places like Texas seem to be getting back to business, operating on all 8 cylinders. So I think as this thing starts -- as the markets start to normalize, you'll see certain pockets free up on the inventory side sooner than others.

[Mark William Wilde, Senior Analyst]

Okay. And Duncan, I'm just curious. The first quarter was a tough one. It looks like just based on kind of where lumber prices move, the second is going to be more of the same. What's it going to take, do you think, to create a better second half for the lumber industry?

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

Well, the good news about the current market is we usually love company. And we've got lots of that.

[Mark William Wilde, Senior Analyst]

You do. No doubt.

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

We've seen over the course of the last couple of weeks some curtailment announcements. And one of the things I've learned in this business over the years is when demand is weak, you're not going to sell anymore, you drop prices. And what you really need to do is production rates need to adjust relative to the takeaway levels. And we're -- I think we're seeing some -- we're seeing signs of that happening, currently. And I think what you're going to see as we progress through the second quarter and takeaway levels pick up, we're going to find out how much of this -- these doldrums we're in is really weather-related and how much of it is underlying economic issues. And I don't know what the percentage makeup is, but my sense is we're going to see a combination of increased takeaway levels, we'll see some production adjustments, we'll see a rebalancing of the equation, and then we'll find out what we're really dealing with here in terms of what the overall market situation looks like for North America. But the thing that gets the key piece of this puzzle has always been, I mean, the market is the market. It's how you react to it, and we've always tended to be more proactive than less proactive in dealing with that if we see a weak takeaway situation. And my guess is we're going to get to that other than just people begin to wake up to those realities or the cost structures force them to deal with.

[Mark William Wilde, Senior Analyst]

Okay. Can you address that Pacific Northwest operations that you got? I talked to a big producer like 3 or 4 weeks ago, and he was cash negative already, and prices went down further from that. So my sense is that a heck of a lot of capacity in the Pacific Northwest must be cash negative. We've actually seen a couple of permanent closure announcements done in Oregon in the last few weeks. So just assessment of your Pacific Northwest business right now.

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

Well, Mark, the Pacific Northwest -- and people certainly has certain views of the Northwest. We actually do pretty well there, and that business has done pretty good for us. Certainly, better than the B.C. Interiors have been doing for us. Because the equation between log cost and sales values is quite a bit better in that region than it is in, for example, in B.C. Interior. And so you can't say everybody's in the same circumstance. We've invested pretty actively in a number of our mills in that area. We've got the benefit of pretty well-capitalized operations, stud mills. And we've got the benefit of a pretty neat product line and good sales values out of our specialty board facility in Southern Oregon. So I'm not unhappy at all with that business, and right now, it's not the squeaky wheel in our organization. The log cost situation in the B.C. Interior, that is a much bigger concern for us than the situation that's in Pacific Northwest.

[Mark William Wilde, Senior Analyst]

Okay. Well, just one other issue, coming back to kind of B.C. and the B.C. Interior. We heard an argument that most B.C. Interior mills accumulated really quite healthy log decks this winter, and that nobody is likely to take any decisive action until they've worked through those decks. Do you agree with that?

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

Well, I don't know that. I only see what our inventory situation is. We've announced downtime in the B.C. Interior, and I think Canfor has announced downtime in the B.C. Interior. Conifex has announced downtime in the B.C. Interior. And I think there's other unannounced downtime that's happening as well. Part of that strategy is the costs are high in that area, and there's no sense taking a high-cost log even if it's in inventory and trying to push a product in the marketplace if the market is telling you that doesn't fit their need at this point in time. And so for those folks that are well-financed, and Interfor is certainly is one of those, we've got the luxury of being able to make decision of whether we will operate or not based on the economics of the business at the time. We're also fully aware of the fact that we've had some pretty extreme fire seasons the last couple of years in the B.C. Interior, and we haven't missed the fact that some of which is going on in the B.C. Interior in July. So we're adjusting our overall operating plans both in the mill level and the woodlands level given the circumstances that we're dealing with. My presumption is others that can afford to do it are doing the same thing.

[Mark William Wilde, Senior Analyst]

Okay. Actually, I have one more question, if you could, just on the trade issue. I wonder with the weak markets, whether you're seeing any more incremental sense of urgency around this issue and also whether you think the sort of much-talked-about U.S.-China resolution might toggle some attention back to kind of U.S. and Canadian trade issues?

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

We're not -- I'm not seeing anything, Mark. So I'm not aware of anything. And if there was something going on, I would probably know about it. So I've not seen anything, and I think it's just going to play out over time. Our expectation has always been that these things take time, and there's not a lot to be gained by trying to rush.

[Mark William Wilde, Senior Analyst]

Yes. Okay. And I bet it was some U.S. guys who seem to be really insistent yet on a quota-based solution here. Is some kind of a quota-based system, do you think that's a starter or just a complete nonstarter on the Canadian side of the border?

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

It's a nonstarter.

[Operator]

There are no further questions at this time. I will now turn the call back over to the presenters.

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

Okay. Thanks very much, operator. And thanks, everybody. We very much appreciate your interest in the company. Marty and I and Bart are available if you want to follow up. Don't hesitate to call us directly. In the meantime, it's -- we're going to deal with the markets as they -- we have in front of us. As I said, we appreciate your interest. Look forward to talking to you over the course of the quarter and very much look forward to talking to you at the end of the second quarter when we announce our results. Thanks. Take care, and have a good day.

[Operator]

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