Interfor Corp

TSX:IFP

Earnings Call Transcript 2023-Q1

[Operator]

Good morning, ladies and gentlemen, and welcome to the Interfor quarterly analyst conference call. At this time all line are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Friday May 5, 2023.

I would now like to turn the conference over to Ian Fillinger. Please go ahead.

[Ian Fillinger, President and Chief Executive Officer]

Thank you, operator, and thank you, everyone, for joining us this morning. With me on the call, I have Rick Pozzebon, Executive Vice President and Chief Financial Officer; and Bart Bender, Senior Vice President of Sales and Marketing. Our agenda today will start off with myself providing a recap as usual of Q1 2023 and our strategic positioning. I'll then pass the call off to Rick, who will cover our Q1 financial results, and then Rick will pass the call off to Bart, who will cover off markets.

But first off, I'd like to call out a couple of key milestones for Interfor that we're very proud of. This quarter, we marked our 10-year anniversary of one of the most important developments in Air Force history when we made our first move to the U.S. South. Before these acquisitions, we are a western-based company. And over the past decade, we have become a major player in the southern lumber industry. Today, we have a solder portfolio of 13 mills across 6 8. In just a decade, Interfor become the third largest lumber producer in the region as part of an evolution that has made us one of the largest lumber producers across the continent. Our vision 10 years ago was about operating in the South and building a business there for the long term.

Now the region accounts for approximately 45% of our total lumber production. Also, tomorrow, May 6 marks the 60th year of our company's founding. From the beginnings as a single sawmill, we have built a company with more than 30 operations located in all the key fiber and lumber producing regions across the continent. Our history is one of vision, focus and discipline. The lumber industry is famously cyclical. -- and reaching our 60th anniversary is a testament to the tenacity and commitment of our people through the years and the ability of the company to weather the tough times as well as identify and seize opportunities.

Now turning to this past quarter, we generated an EBITDA of $26 billion, significantly up when compared to the previous quarter. Our lumber production increased around 18% quarter-over-quarter due to our curtailments easing to match demand, along with our first full quarter of production from our New Brunswick operations. Quarter-over-quarter, we achieved performance metric improvements in conversion costs, net log costs and shipment volumes, and our New Brunswick operations contributed positively to our financial results. We continue to advance our key capital projects in the South, and we also completed our planer upgrade project at Castleger BC.

With respect to the outlook, we remain positive on the medium- to long-term outlook for demand as demographic trends and years of underbuilding will continue to provide strong tailwinds. By focusing on the controllables, the Interfor team has used the recent downturn well to accelerate the integration and the operating techniques in our Eastern Canadian region to ensure we're stronger than we've ever been before. On the supply side, we believe that SPF volume will continue to come out of the BC industry in a meaningful way.

To sum things up before I turn it over to Rick and Bart are guiding principles have always been operational excellence and capital allocation discipline. These principles have ensured that we are well set up to withstand the current markets and are very well positioned to benefit from the stronger markets we see ahead.

With that, I'll turn the call now over to Rick to run through the financials.

[Richard Pozzebon]

Thank you, Ian, and good morning all. Please refer to cautionary language regarding forward-looking information in our Q1 MD&A. Before speaking to the Q1 financial results, I'd first like to provide an update on our growth into Eastern Canada through two acquisitions last year. Overall, we continue to be very pleased with the strategic expansion and regional diversification, which has substantially increased our production of SPF lumber. This positions us well to benefit from the ongoing decline in supply of SPF lumber from British Columbia.

We continue to make solid progress on the integration of these operations and are on track to fully realize the $30 million of identified annual synergies by the end of this year. These acquisitions contributed to Interfor achieving a record level of lumber production in the first quarter with over 1 billion board feet produced. This record is despite taking temporary market-related and project-related downtime in the quarter, equating to over 100 million board feet of production.

Turning to the financial results. The $26 million of adjusted EBITDA generated in Q1 represents a significant quarter-over-quarter improvement. Despite key benchmark prices being lower on average compared to the prior quarter, Q1 earnings benefited from an increase in sales volume combined with substantially lower unit costs as log costs continue to adjust downward across all regions to better align with the current lumber price environment, while conversion costs improved on a unit basis, driven by a substantial reduction in temporary market-related curtailments quarter-over-quarter. These lower costs helped drive a $22 million release of the valuation reserve recorded against log and lumber inventories in the prior quarter.

In terms of cash flows, the typical seasonal build in working capital led to a cash outflow of $85 million from operations. While $64 million was invested in capital projects as we continue to make solid progress on our strategic capital program. From a balance sheet perspective, we ended the first quarter in a comfortable position with net debt to invested capital of 31% and available liquidity of $321 million, providing ample flexibility. We would expect our leverage position to fall meaningfully over the next few quarters as we draw down the seasonally high working capital balance and collect on pending income tax refunds of nearly $100 million, with all else being equal. Looking longer term, it's worth noting again that Interfor's lumber duties on deposit totaled $521 million at quarter end, representing about $10 per share on an after-tax basis.

Regarding capital allocation, looking forward, Interfor's focus on a balanced approach remains unchanged in combination with maintaining conservative leverage on our balance sheet. Ultimately, our capital allocation decisions will be made with the objective of maximizing returns on capital for our shareholders over the long term. We currently anticipate capital expenditures of $210 million for 2023, of which the majority relates to discretionary projects with attractive returns.

To wrap up, our significant quarter-over-quarter earnings improvement was a step in the right direction, one that we are well positioned to build upon going forward. That concludes my remarks. I'll now turn the call over to Bart.

[Barton Bender, Senior Vice President, Sales & Marketing]

Thanks, Rick. I'll provide comments on our market outlook for Q2 2023 and beyond. The fundamentals remain intact and positive for the underlying demand for lumber. North American housing market is underbuilt and needs more supply, especially if you consider the demographic reality that the cohort of first term first-time homebuyers is increasing. The average age of a home is 41 years in the U.S., the oldest it's ever been. This is driving continued repair and remodel activity, but also an elevated number of replacement construction builds.

Home equity remains solid, putting homeowners in a position to invest in their homes, all good things when you think about the demand for lumber. In the near term, high interest rates continue to negatively impact overall affordability, which will continue to suppress the overall housing starts numbers. This demand for houses is not going away, but rather a deferral to when affordability improves, which we all know will.

On the repair and remodel and use sector, with homeowners remaining in place, the incentive is to consider home improvement projects. We've seen this with our Voxtoor comps, which have been strong year-to-date and outlook remains favorable for the balance of the year. While the reality is that lumber demand has adjusted downwards year-to-date 2023, the situation has stabilized and the outlook across our end use sectors is more positive than negative. In particular, I'd like to share a couple of product-specific insights. I-joist demand often seen as a barometer of new home construction is improving. Our network of distributors is reporting increased demand and have increased resupply of inventories.

Our number one position in stud production offered by three of our four producing regions puts us in a unique position on this product line to see changing market patterns and capture the inevitable demand from the new home sector. An example, we've seen notable increase in stud demand, reflecting improved early improvements in single-family construction. Like studs, we're the largest producer of MSR in the world. MSRs you use primarily for trust applications and like I-Joist are often seen as a barometer of new home construction markets, both single and multifamily. The demand for MSR has improved recently, and it is an emerging sign for the broader market.

On the supply side, there have been many curtailments, both temporary and permanent that have brought some balance into the marketplace. -- mill-level inventories at this stage of the year are in a really good position. We've not seen the logistics issues that we did last time at this -- last year at this time. So wood has flowed to the market consistently. In terms of end market inventories, it's always a bit more difficult to read. We understand they are adequate to on the low end, depending on the region and the customer type.

Recently, I attended the Montreal Wood Convention here in Montreal with record attendance over 1,100, I was able to connect with our customers, both from the U.S. and Canada. Our recent expansion into Eastern Canada makes center for a strategic supplier for almost anyone attending the show. The mood was upbeat and encouraging with many comments supporting an improving market, especially on new home construction.

Overall, while the near term has been impacted by inflation and interest rate movements, we feel the fundamentals will once again rise to the forefront and set us up for an overall improving trend going forward.

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

[Ian Fillinger, President and Chief Executive Officer]

Thanks, Bart. Operator, so we're available now for questions.

[Operator]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session [Operator Instructions] Your first question comes from the line of Sean Steuart from TD Securities. Your line is now open.

[Sean Steuart, TD Securities]

Thanks. Good morning, everyone. Couple of questions. First, with respect to the CapEx guidance, which tempered a little bit. I think the wording was partly being conservative with markets having declined as much as they have and part of it is equipment delays. With respect to the latter, is that one piece of equipment or more of a generic constraint on delays? And if you're breaking it between the two, how much of the more conservative CapEx is just being cautious around the balance sheet and how much is equipment.

[Ian Fillinger, President and Chief Executive Officer]

Thanks for the question. So I'll tackle that. The -- it's more of a deferral than -- so just to be clear, we haven't canceled any projects whatsoever. So the there's no dropping the projects that are important for us, and it's more just shifting schedules and more on that than on equipment delay. So it's just shifting it in our project chart a couple of months here or there and moving the parts around it. As you know, we have our own internal CapEx team. We're not tied to turnkey projects. So we have great flexibility with our CapEx team to do these type of things. And this is what we worked hard on for almost 17, 18 years to build.

So more on that, Sean. I'll say that major equipment supplier to the industry was indicating recently that they had a two year backlog of an order file, and they haven't seen any projects canceled. So I think that's an indicator that really shows the confidence of the industry, the market in the medium to long term is favorable. So I took it that way, but we're in good shape. We're just using our flexibility and nimbleness that we've built more than anything.

[Sean Steuart, TD Securities]

Okay. Thanks for that detail, Ian. Then just a follow-up for Bart, on current lumber market conditions. And everything you're saying is consistent with what a lot of your peers are saying with respect to inventories through the channel being normal to maybe slightly below normal. And we're seeing at the margin better news from U.S. homebuilders, housing starts that are coming in maybe a little bit better than expected. So I guess just more context on why we're lacking traction here. And European imports continuing, how much of an issue is that? Have you been surprised there haven't been more closure announcements to this point for higher cost capacity. Any issues on the supply side that you think are constraining prices at this point?

[Barton Bender, Senior Vice President, Sales & Marketing]

Okay. A lot in that question. I guess, first, I'll start off is that from the demand side of the equation, we are seeing some improvement. I mean repair and remodel is always I think multifamily, although volatile, it's still very decent. It's that single-family home construction that's the one that we want to keep our eyes on. And certainly from what we hear from the builders and from our customers, things are improving there. So we are waiting for that and being patient for that to translate into more demand for the mills.

I can tell you on the import side, a lot of what we saw in the first quarter was a bit of a hangover from, I think, what they were planning on and producing towards in the fourth quarter. And so a lot of that would finally made its way to market, I think, in first quarter. And the information that I've received is that we can expect a fairly significant decline in what might come our way in second quarter. That will help. But at the end of the day, I mean, imports are -- they're relevant, but they're not significant in my view in terms of the total supply. So I do believe the inventories in the marketplace are on the lowest end. I think that the situation is very different in the North from a logistics standpoint compared to this time last year.

And so, I would expect that as this demand sees its way through the building cycle, that, that tension should be received fairly quickly at the mills. So I'd say at this stage, patience is the virtue for sure.

[Sean Steuart, TD Securities]

Got it. Okay. Thanks for that Bart. That’s all I have for now. Thanks everyone.

[Richard Pozzebon]

Thanks, Sean.

[Operator]

Thank you. And your next question comes from the line of Paul Quinn from RBC. Please go ahead.

[Paul Quinn, RBC Capital Markets]

Yeah. Thanks. Good morning, guys. Just wondering, we're seeing a big premium on some pine versus SDF, it seems to be narrowing slightly, but it's still around $150. And that's way off the typical through 60-70. What do you make of that? And how do you think that gap closes? Is that a Western SPF coming up? Or is that a Southern client coming down?

[Ian Fillinger, President and Chief Executive Officer]

Hi, Paul. Ian here. I’ll take a stab at tit and Bart, maybe you can jump in if I missed anything. But yes, the gap is definitely unusual. We do see that our view is that what the previous call or question was, that there was obviously European imports have gone up over the last few quarters. We do actually see or have been reading that, that should taper down pretty significantly as one research firm is providing that view. But I also think that the SPF volume that was announced in Q4 and Q1, both temporary and permanent. I mean that volume did not come off the market in our view. The wood still was processed through the back end of the mill and put on trucks and in the permanent curtailments, our view would be that, that volume gap really isn't going to start showing up until Q2, Q3. So there may have been excess volume on the market in Q1 that's not going to be there in Q2, Q3. So I think it's a combination of European imports still having a bit of a hay over on it and then also supply side didn't really taper down in Q1 and probably force that gap. But I don't know Bart Montreal were sort of passing call back and forth, Rick and I are in Vancouver. So Bart, is there anything you'd like to add to that?

[Barton Bender, Senior Vice President, Sales & Marketing]

Yes. There's a couple of things. I think the differential, you have to kind of look at Western SPF and Eastern SPF, there's some differences there. Eastern has held up better than I would say, the Western SPF side. And really, when I look at that and I see the volatility in the market and the kind of focus that's been put on inventories, understanding that [indiscernible] that market is 85% serviced by truck shipment. So it's fairly quick turnarounds, the lead times before you get the wood is a lot quicker well within when you would have to pay for that invoice, whereas from the, let's say, the BC Interior making its way to market, you're talking about a three to five week sort of lead time. And I think in this particular market right now, that's relevant. The other one is on the repair and remodel. I mean the big trader market in the South. And I think that there has been some decent activity in that and new sector that perhaps SPF has quite enjoyed to the same degree. So -- but over time, we'll look at that gap to close, and it's hard to predict which way it will go, but let's hope the SPS moves up towards the [indiscernible]

[Paul Quinn, RBC Capital Markets]

Okay. And then the other thing I'd say that continues me a little bit is we're seeing a little bit of a recovery here in OSB prices, which has got more leverage to new home construction than lumber. You guys signaled that hydro demand is starting to pick up in Q1 and warehouse record those comments. Why are those areas growing so much and lumber is still stagnant here.

[Ian Fillinger, President and Chief Executive Officer]

Go ahead, Bart.

[Barton Bender, Senior Vice President, Sales & Marketing]

Okay. That's a tough one, Paul. I think that I-joist are directly correlated to new home construction. I mean it's used for that end use, whereas dimension lumber is used in so many different things. And so it certainly is a portion of new home construction, but it's used in all the end-use sectors. And so I think in order to get attention on that particular product line, you do need to see some activity across all the sectors. And so I think that on the I-joist side, I can tell you from [indiscernible] and from our vantage point, very responsive to the demand seen from our distributors, inventories have been managed well, and now we're starting to see those kind of come back. And there's a bit of a lead time with the I-joist to get them into market and ready to respond. So maybe they're added a little bit quicker. And I think we'll see that activity start to move its way towards dimension lumber as we go through the quarter.

[Paul Quinn, RBC Capital Markets]

All right. Solid answer, Bart. Thanks guys. Good recovery. Best of luck.

[Richard Pozzebon]

Thanks Paul.

[Operator]

Thank you. And your next question comes from the line of Roshni Luthra from BMO Capital Markets. Your line is now open.

[Roshni Luthra, BMO Capital Markets]

Hi. Good morning. Just a quick question, please. First, you mentioned the tax refunds. I was just wondering if you had any idea of timing on that front?

A - Richard Pozzebon

For sure, Roshni. Ultimately, it depends on the tax authorities, but we're pushing hard to get them back as soon as possible. We currently anticipate about 20% of the balance in Q3 being received and the rest in Q4, but certainly we could see some acceleration of that timing.

[Roshni Luthra, BMO Capital Markets]

Great. And then also, do you have any update on the monetization of the DC tenures -- any way to quantify any updates there?

[Ian Fillinger, President and Chief Executive Officer]

Yes. Ian here. It's a work in process. We've got good, solid interest from a number of parties in the tenure. So it's a work in process as we're getting those. There's term sheets that have been signed and getting those to the next level takes some time. So we don't have a time line on that, and we really can't provide anything solid from a modeling perspective. But we can let you know that this is right up in our top five things in our company that we're putting a full court press on. So we'd like it to go sooner, but they're stakeholders that have to also follow a time line and a process. So we'll just keep working on it and keep reporting on it every quarter.

[Roshni Luthra, BMO Capital Markets]

Great. Fair enough. That’s all I had. Good luck next quarter. Thank you.

[Richard Pozzebon]

Thank you.

[Operator]

Thank you. Your next question comes from the line of Hamir Patel from CIBC Capital Markets. Please go ahead.

[Hamir Patel, CIBC Capital Markets]

Good morning. Just wondering with the weakness we're seeing in pulp markets, is that starting to weigh on maybe some of the chip pricing that you see in Eastern Canada?

[Ian Fillinger, President and Chief Executive Officer]

No, Hamir. We're not seeing that. And in fact, in most of our regions, the prices have been solid and in a few cases, have actually improved on residual pricing through the curtailments that the industry has taken to put a bit of a stress in areas that we operate on. So no -- to answer your question, no. And in some cases, we've seen price appreciation just given our locations and the mills that we're partnered with for customers.

[Hamir Patel, CIBC Capital Markets]

Okay. That's interesting. And then, Ian, with respect to stumpage, I know I think New Brunswick has some large decreases slated to take us back. But what kind of level moderation are you expecting and perhaps New Brunswick, Quebec and Ontario and then also in the BC Interior as you look towards Q2 and into Q3?

[Ian Fillinger, President and Chief Executive Officer]

Yes. I think, Rick, maybe you've got some numbers or data or at least some information you might want to share on that.

[Richard Pozzebon]

Sure. Thanks, Ian. Good morning, Hamir. In terms of the BC Interior, we still expect some moderation of stumpage over the next couple of quarters, let's say, in the $5 to $8 range per quarter on a cubic meter basis. If you look at New Brunswick, you're right, this new stumpage system is coming to effect this quarter, and we do expect some reduction to bring log costs down more in line with fair market value and based on lumber prices. So that could be, let's say, anywhere in the $10 to $15 range on a cubic meter basis in this next quarter versus last quarter.

[Hamir Patel, CIBC Capital Markets]

Great. And in Ontario and Quebec, any sort of moderation there?

[Richard Pozzebon]

No, Ontario should be relatively flat. It's stumpage system is very quick to react to lumber prices and Quebec should be relatively flat as well

[Hamir Patel, CIBC Capital Markets]

Great. That’s all I had. I’ll turn it over. Thanks.

[Richard Pozzebon]

You’re welcome. Thanks Hamir.

[Operator]

Thank you. Mr. Fillinger, there are no further questions at this plan. Please proceed.

[Ian Fillinger, President and Chief Executive Officer]

Okay. Just to wrap up. Thanks, everybody, for your time this morning and the interest in our company, and please feel free to reach out to any one of us if there's any follow-up questions. Thanks. Have a great day.

[Operator]

That does conclude our conference for today. Thank you all for participating. You may now disconnect.