Interfor Corp

TSX:IFP

Earnings Call Transcript 2022-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to Interfor's Quarterly Analyst Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]

I would now like to hand the conference over to your first speaker today, Mr. Ian Fillinger. Thank you. Please go ahead.

[Ian Fillinger, executive]

Thank you, RJ. Welcome to our Q1 2022 analyst call. With me today, you have Rick Pozzebon, our Senior Vice President and Chief Financial Officer; and Bart Bender, our Senior Vice President of Sales and Marketing.

Our agenda today will start off with myself providing a recap of our financial results, our strategic focus and our improvement efforts. I'll then pass the call to Rick, who will cover our financial matters. And then Rick will pass the call to Bart, who will cover off the markets.

Turning to our financial results. Our Q1 adjusted EBITDA was $570 million, approximately 4x higher than Q4. All lumber benchmark prices increased significantly throughout most of the quarter before peaking in mid-March. We are executing on our strategic plan, and we're generating industry-leading lumber margins and returns on capital. I encourage you to look through our investor deck on our website at these metrics.

Our improvement efforts were again balanced across the company as we made progress in all regions. Production volumes were again an all-time high quarterly record, which included the of our Eastern Canadian region and the ramp-up of our DeQuincy, Louisiana mill and strong operational portfolios across most of our other operations.

Our total unit production costs increased slightly due to higher log costs in the U.S. and conversion costs in all regions, driven by largely by the ongoing inflationary pressures. We continued on our CapEx improvement plans in every region spending $51 million in the quarter, down slightly from the previous quarter, but on track and on target for the $275 million for the full year, of which approximately $200 million will be on discretionary high-payback projects.

Turning to our financial capacity. We continue to have significant financial capacity to consider several further capital deployments, which Rick will cover off shortly. I'd also like to provide an update on the early integration of our Eastern Canadian platform. You'll recall the acquisition of the Eacom was completed on February 22. And since then, we've been onboarding and have had several welcome events with our new teammates to Interfor.

Our key focus areas in the near term are to enhance the historical performance, operation performance, identify further opportunities for easy improvements and synergy realization, planning for back office, corporate and system integrations and assessing potential long-term strategic investments.

Since the acquisition of our Eastern team, we performed well. And in many areas, we've had productivity at best-ever performances, in fact, at 5 of 7 mills in the last 8 weeks. While still early and more work to do, we have already realized almost half of our $25 million synergy targets within the first 8 weeks, and we expect more operational synergies to be tracked and tackled over the next coming months.

Turning to our strategic focus. We continue to push forward on achieving greater returns on capital through our unrelenting focus on operational excellence and capital deployment. As such, I want to outline a few key initiatives. Our DeQuincy mill in Louisiana continues to progress well, and we now have moved to a 2-shift operation several months ahead of schedule.

In Georgia, our largest capital project at our Eatonton mill continues on track and will be fully completed in the next month. We expect a new standard set for our U.S. held operations in terms of volume, conversion costs and earnings. In B.C., we are nearing completion on the sale of our Acorn mill to the San Group. And in Eastern Canada, we recently announced our purchase of 16% of GreenFirst shares from RAM.

In summary, our capital returns are again exceptional for Q1, generating a year-to-date 87% return on capital. We continue to work hard on our capital allocation discipline to ensure the best return for our shareholders, and we continue to see strong performances from our internal projects and recent acquisitions.

That concludes my opening remarks, and I'll now pass the call over to Rick.

[Richard Pozzebon, executive]

Thank you, Ian, and good morning. First off, I'll refer you to cautionary language regarding forward-looking information in our Q1 MD&A.

The first quarter saw Interfor continue its rapid transformation into one of the largest and most profitable lumber producers in the world. We added nearly 1 billion board feet of annual lumber capacity upon closing the Eacom acquisition and further diversified into a new region with attractive fiber fundamentals.

Closing on Eacom capped an 11-month span in which we grew our total lumber capacity by over 60%. This rapid growth drove our lumber production and shipments in Q1 to record levels. The exciting part is that the most positive impacts of our growth are just now starting to be reflected in our results. Growth through acquisition has been just one facet of our disciplined and balanced approach to capital allocation in the quarter.

We continue to make great progress in our multiyear strategic capital program, we saw significant value in buying back our own shares and we completed our 10% normal course issuer bid program shortly after quarter end. And we further rationalized our with the sale of the Acorn Specialty Mill. Collectively, these actions have positioned our balance sheet conservative leverage and further optimize our portfolio to continue generating best-in-class returns on capital.

In terms of the first quarter financial results, Interfor generated adjusted EBITDA of $570 million. Included in this figure is $68 million of nonrecurring purchase accounting expense driven by having to record the acquired inventories at fair value. Adjusting for this, EBITDA would have been a quarterly record of $638 million. We expect a further $17 million of similar fair value adjustments to impact our second quarter results as we sell through the remaining acquired inventory.

First quarter earnings benefited from the strong operating performance and elevated lumber prices, while we continue to face inflationary pressures on the cost side and the challenging logistics environment. In terms of cash flow, we generated $379 million from operations. Of this, $98 million was invested in working capital with seasonal inventory builds and increased receivable was driven by lumber prices.

Working capital reductions are anticipated in the second quarter. We also invested $51 million in capital projects and returned $194 million to shareholders through share buybacks at an attractive average price. We ended the quarter with our balance sheet in a conservative leverage position and ample liquidity and to continue advancing on our strategic plans.

These plans include spending about $275 million on capital improvements for the full year 2022, which is similar to prior guidance. We continue to see significant opportunity enhance our returns through capital reinvestments. At the same time, we will continue looking for attractive opportunities to deploy capital on lumber focused growth and to return additional capital to shareholders.

To wrap up, Q1 was a transformational record-setting quarter for Interfor, and we are well positioned financially and operationally to continue our momentum in growing value for our shareholders.

That concludes my remarks. I'll now turn the call over to Bart.

[Barton Bender, executive]

Thank you, Rick. Good morning, everyone. I'll provide a few comments on our lumber markets. First off, we are very pleased to welcome the Eastern Canadian operations to the Interfor team. With that comes virtually 1 billion feet of pure SPF production, both dimension and studs. In addition, we now have a regional office in Montreal servicing our customers.

Further, we increased our product offerings to include I-joists and remanufactured lumber. We're excited about this diversification of the strategic customer base and the group of professionals we now get to work alongside in Eastern Canada.

Now to the markets. The fundamentals remain consistent quarter-over-quarter, however, not without some areas of uncertainty. Specifically, tailwinds remain strong when it comes to household balance sheets, demographics, rising home equity, age of housing stock, all encouraging when considering the demand for lumber in North America.

In terms of uncertainty, inflation, interest rates and ultimately, affordability come into question. New home construction seems to have such a degree of pent-up demand that growth in this area still feels very strong. Comparing our model, which is perhaps a bit more sensitive, is showing a level of volatility as we work through Q1 into Q2.

Lastly, the Russia-Ukraine war will bring shifts to supply lines globally. We expect buoys left in Europe and Asia from cessation of Russian softwood lumber imports to drop some European imports to North America and also add to exports from North America to some parts of Asia.

Specifically speaking about repair or remodel, a new sector. We started Q1 off very strong, both from an inventory and consumption perspective. In the latter part of the quarter, we're starting to see consumption temper, but so far in Q2 consumption has started to increase.

It's important to point out that the inventory position of the box stores this year is very different from the circumstance 1 year ago. From our perspective, the inventories are well managed.

The new home construction end-use sector continues to show encouraging demand, starts at close to 1.8 million. It's encouraging but far outpacing the completions, which are running at 1.3 million. We see this situation positively as we expect supply chain issues to subside in all products, which should increase the rate of completions, which translates to more demand for lumber in this sector.

Supply chain is a word we've been using considerably more these days and remains an interesting dynamic in our business. We are expecting constraints to continue in all modes right through Q2, into Q3 and quite possibly Q4. At Interfor, our operations are well diversified not only geographically, but also in terms of transportation modes and carriers.

Overall, our markets for Q2 remain resilient, and we're encouraged in what we see for the balance of the year.

With that, Ian, I'll turn it back over to you.

[Ian Fillinger, executive]

Okay. Thanks, Bart. Operator, we're ready to take questions from the analysts now.

[Operator]

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

[Sean Steuart, analyst]

A couple of questions. I want to start with the GreenFirst investment. And can you give us some of the context behind the motivation there? Is it cybersecurity potential for the sawmills, synergies, maybe all of the above. But any context on the motivation and appetite for consolidation on that front? And further to that is more M&A potentially temper your appetite for further returns of capital to shareholders.

[Richard Pozzebon, executive]

Yes, for sure, Sean. I would kind of just refer to the press release that we put out. It was an investment opportunity that we saw, and that's really about it. There was a seller and we were a buyer, and it's done last Monday and not much more to comment on that, Sean. We're concentrating on what we're doing at Interfor when it comes to sales and marketing and operations and capital investment. But we just saw that as a good opportunity to make that investment, and we saw GreenFirst as an attractive opportunity for the company to pick up those shares. Rick?

[Sean Steuart, analyst]

Understood.

[Richard Pozzebon, executive]

No, I think that covers it, Ian.

[Sean Steuart, analyst]

Okay. A question for Ian or Bart. Any sense that transportation headwinds are starting to ease? And more to the point, I'm looking for some guidance on the inventory that you've built up over the last couple of quarters, that 100 million board feet increase to your finished goods inventory. How long do you expect it will take to work through that surplus at the mill level?

[Barton Bender, executive]

Okay. Sean, it's Bart here. I'll tackle that question. First off, I think our inventory build in excess of the shortfall in production versus shipments was $61 million. I think the 100 million that you're referring to is perhaps some of the Eastern operation's normal course volume. So we'll have to get used to carrying a bit more inventory than we usually do from that perspective.

I would say, pre-COVID days, we would have been in that 18 days production, that would be our normal range. And I'd say post the Eacom acquisition, that's probably bumped up to more like 20 days that we would normally carry in inventory. And today, we're at roughly 23 days. So we actually feel pretty good about where we're at with inventories. And we'll consider -- we'll continue to work hard and keeping those well managed as we go forward.

When it comes to transportation capacity, I think it's been one of those volatile sort of files for everyone, quite frankly. And I think some months are good and some months aren't, it depends on what mode and what region. So we still think we're dealing with quite a bit of congestion and disruption from that standpoint. And we expect that to continue through the balance of Q2. And we have been given some ideas that we'll see improvements in Q3 and further improvements in Q4.

So I think this situation with -- on the logistics side isn't going to fix itself overnight. I don't believe it's going to fix itself within Q2, it will take a bit longer. But when it comes to Interfor, we feel very comfortable with where we're at from an inventory perspective, and we'll continue to manage those accordingly.

[Operator]

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

[Hamir Patel, analyst]

Bart, I was wondering if you could give us a sense as to what you're seeing in some of the other end markets like R&R and industrial?

[Barton Bender, executive]

Well, repair and remodel, I think I commented a little bit about that on our opening comments. Repair and remodel started off the quarter very strong, quite frankly. It was a decent momentum. And it wasn't until partway through that we saw some pause. But really, when I talked about the inventory position this year versus, say, last year. And I was in a position to really manage that shift in demand, and I would have to say that the shift wasn't that dramatic. And since then, we've seen things pick back up.

So repair and remodel as we go into Q2 seems fairly stable, I think, is the best way I'd put that. And I think importantly, the inventories that have been allocated to that end-use segment are well managed. And I think that's the difference this year versus what we saw last year.

From an industrial standpoint, our customers are very active. We have -- that's kind of an end-use sector that's quite stable and has been stable. So we're not seeing anything that would give us any different opinion on that. So overall, both of those items are in a good spot.

[Hamir Patel, analyst]

Okay. Great. That's helpful. And I want to get your sense as to Ontario and Quebec, obviously, a new region for you. How do you see log costs there evolving over the next year or 2?

[Ian Fillinger, executive]

Yes. Hamir, I mean, we are very positive on the log cost dynamics in Ontario, Quebec. And especially when you compare to British Columbia, there's definitely an advantage that the Eastern Canadian region has. And so we feel very good about it in here. And we've got good log cost and low log cost in South. Obviously, some creep up there depending upon where the mill might be located, but we're very pleased with that. And the bolt-on for our Eastern Canadian mill region, we have a very favorable outlook on the log cost.

[Operator]

[Operator Instructions] Your next question comes from the line of Paul Quinn with RBC Capital Markets.

[Paul Quinn, analyst]

If you could outline Eacom's Q1 contributions. What are they generating EBITDA in Q1?

[Ian Fillinger, executive]

Well, we completed it on February 22, so not a lot of track history there. But Rick, maybe you can kind of give a context around that.

[Richard Pozzebon, executive]

Yes, for sure. So we disclosed they produced around 100 million board feet and sold through just slightly less the max, and we commented on the purchase accounting adjustment. So if you back out that purchase accounting adjustment, it would be north of $70 million of EBITDA for the 6 weeks of ownership.

[Paul Quinn, analyst]

Pretty impressive. Maybe you could just remind me, what are the residuals of Eacom going to?

[Richard Pozzebon, executive]

Yes, various takers in the region, well-capitalized facilities, Paul. We've got no real concerns around the residual offtake from the operation.

[Paul Quinn, analyst]

Okay. So do you think residuals is a concern back to you for other countries, though?

[Ian Fillinger, executive]

No, we don't think so, Paul. I mean, the takeaway, as Rick alluded to, is strong. We have arrangements and agreements and contracts in place that are multiyear and strong customers that are taking away the residual. So no, we're feeling good about it.

[Paul Quinn, analyst]

Okay. And then just on the cost side. You've got a couple of mills up in Q2. Do you expect your cost to move up materially as a result?

[Ian Fillinger, executive]

With the start-up, like, DeQuincy, going into 2 shifts and Eatonton?

[Paul Quinn, analyst]

Yes. No, plus more contribution from the Eacom, right?

[Ian Fillinger, executive]

Yes. No, we think our cost will be reduced on a unit basis with that added production coming in and being -- while helping the individual mills, but also spread out across the company, we should see cost reductions going forward.

[Operator]

And there are no further questions over the phone line at this time. I would now like to turn the call back to Ian.

[Ian Fillinger, executive]

Okay. Great. Thank you, operator. Just concluding remarks in closing, we are focused on maintaining the health and safety and well-being of our employees, we continue to drive cost reduction across the company and we're matching our production rates to our order files, and we're continuing with a balanced approach to our capital allocation.

We'd like to thank everybody for dialing in and participating in our update call this morning and your interest in our company. If you have any further questions, feel free to reach out to myself, Rick or Bart at any time. Thank you, operator.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you all for participating. You may now disconnect.