Interfor Corp

TSX:IFP

Earnings Call Transcript 2024-Q1

[Operator]

Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor Analyst Conference Call. [Operator Instructions] Thank you, Ian Fillinger, you may begin your conference.

[Ian Fillinger, executive]

Thank you, operator, and thank you, everyone, for joining us this morning. With me on the call, I have Rick Pozzebon, our Executive Vice President and Chief Financial Officer; and Bart Bender, our Senior Vice President of Sales and Marketing.

I'll start off by providing a brief recap of our quarter, provide some comments on the market outlook and several key initiatives before passing the call on to Rick and Bart.

Turning to our Q1 results. Our adjusted EBITDA was a loss of $22 million during another challenging quarter that was impacted by continued weak pricing. To be clear, current pricing is generally below industry breakeven levels, which is simply not sustainable for an extended period of time.

We've been proactive in addressing the controllables during these market conditions. Last quarter, we made the decision to indefinitely curtail our Philomath operation in Oregon. We've also done a good job reducing working capital. And recently, we announced the removal of 175 million feet of production across all North American regions to address the oversupply and weak pricing that exists today.

We have always been fact-based and disciplined and consistently have been an industry leader when it comes to dealing with adjusting capacity or making tough decisions to strengthen our portfolio of operations. We have a more positive outlook as we head into the back half of 2024 and into 2025. However, we intend to continue to manage the business and our balance sheet conservatively. I'll now turn the call over to Rick, and he will walk you through the financials.

[Richard Pozzebon, executive]

Thank you, Ian, and good morning all. Please refer to cautionary language regarding forward-looking information in our Q1 MD&A. At a high level, Interfor's Q1 results were a slight improvement over the preceding quarter. The lumber markets continue to be challenging. Lumber prices remained unsustainably weak relative to average costs across the industry, resulting in cash margins hovering around breakeven levels across North America.

As Ian mentioned, our focus continues to be on the controllables within our business. We're using this down market as an opportunity to strengthen the core of our business and set up for success over the long term. Turning to Q1 earnings. Interfor generated an adjusted EBITDA loss of $22 million on total revenue of $813 million. Compared to the previous quarter, revenue benefited from a 5% increase in lumber shipments and a 2% uplift in the average realized lumber price.

On the cost side, reported production costs on a per unit of lumber basis were 5% lower quarter-over-quarter, benefiting from a $14 million decrease in the provision against inventories. A net loss of $73 million was realized in the quarter, which included $31 million of gains from the ongoing sale of coastal BC forest tenures. In terms of cash flows, there was a $17 million outflow from operating activities in the quarter, as negative operating earnings were partially mitigated by the management of inventories to reduced levels. Capital expenditures were as expected at $26 million in the quarter, while the sale of forest tenures contributed $29 million of cash.

Ultimately, our net debt to invested capital leverage ratio ended the quarter at 34.7%. Looking out over the remainder of 2024, we continue to expect collection of $64 million in tax refunds and further cash proceeds from the sale of coastal BC forest tenures. Regarding capital allocation, we will continue to take a conservative approach as we manage through the sustained market weakness. The primary focus is on reducing financial leverage into our target range below 25% net debt to invested capital.

Capital expenditures will continue to be restrained in line with previous guidance. To wrap up, Interfor's Q1 results reflect significant ongoing market weakness, which we view as unsustainable for the industry as a whole. Fortunately, Interfor is well positioned to successfully navigate through this period as supply rebalances with demand. That concludes my remarks. I'll now turn it over to Bart.

[Barton Bender, executive]

Thanks, Rick. Good morning, everyone. Lumber markets have been difficult to forecast for some time now. The near-term market indicators remain mixed. Longer-term fundamentals remain positive. Our expectation was to see an improvement in lumber demand through the spring building season. However, at this time remains elusive and less likely as time goes on. We are encouraged with the single-family housing starts with new homes continuing to take an increased share of home sales. We expect this to continue as we finish out the year.

Multifamily construction is less certain as affordability takes a greater tool on this segment. When interest rates start to decline, multifamily is positioned to benefit. With that, builder sentiment has been mostly positive, although most recently, it started to decrease. We expect this to stabilize in the coming months. Repair and remodel end-use segments have been mixed -- have seen mixed results recently. The programs we have with Box stores continue to meet expectations at this time of year. However, with U.S. household savings largely exhausted, we are expecting borrowing rates to factor into future spending.

Lumber markets are highly sensitive to demand and supply levels, and we know that there is a fine line here. We've recently announced curtailments and expect to continue to manage our production to meet our customers' demands. We're seeing a similar response across our industry as it becomes more evident that lumber demand is likely to remain at current levels for longer. As we move into the back half of 2024, we expect to better balance between supply and demand. Stop there, Ian, back to you.

[Ian Fillinger, executive]

Okay. Thanks, Bart. Thanks, Rick. Operator, we're ready to take any questions.

[Operator]

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

[Sean Steuart, analyst]

Ian, a question on the downtime plans from May to September, the implication, I guess, is you're taking it across the platform. Wondering if you can give a sense of relative weight region-to-region And I guess what I'm trying to get at is, presumably, the U.S. South is quite compromised at these prices in terms of margins. Any more granularity you can give on the relative weighting of where this downtime is going to be taken?

[Ian Fillinger, executive]

Sean, I don't have the specifics yet because we kind of look at -- when we look at the downtime, we look at the operations that are in performing, I would say, better. So BC is doing okay right now in the Northwest and when we look at Eastern Canada and the South, we looking at it on an individual mill basis, more than a regional basis. So where a mill is in a situation, where it's more positive than a mill that may be in a tougher situation. We're taking the tougher situation in the downtime. And continuing to obviously operate the mills that are in a more positive situation.

So it really is not more regional, it's more mill specific. And so we're being smart about obviously our portfolio of mills and running the ones that we feel are maybe a little advantage over other ones at this point in the market, and so that's how we're managing that. And it really is spread across North America. Each region has different unique situations.

[Sean Steuart, analyst]

Okay. Second question for Rick on leverage. I guess in the hopefully unlikely event that this price trough extends substantially longer. At what point do you start to think about getting ahead of the covenant on debt to cap? And presumably, this isn't a concern in the next few quarters. But you likely don't want that ratio to get to 50% before you worry about it. How do you think about the available liquidity and covenants at this point?

[Richard Pozzebon, executive]

Yes, we -- our leverage ratio is at 34.7% at quarter end, and we've got plenty of headroom up to our leverage covenants. We also have ample liquidity today of around $300 million. So in here and now, we're not concerned. And when we look at, we've got plenty of levers to pull to manage our leverage ratio. First and foremost, it's operational excellence, making sure we're doing the right things at the right time within the business, focusing on maximizing cash flows from operation.

As Ian alluded to, we're targeting our underperforming operations when it comes to downtime and those sorts of things. So that's the first level we're focused on to sustain ourselves through this market weakness. And then as I mentioned in my comments, we've got significant nonoperational cash flows coming ahead, which bolster our liquidity and leverage ratio that would be the tax refunds this year of around $64 million. And when we look out to 2025, we're generating losses this year, which will result in cash refunds next year as well on a tax basis. So there's that to look ahead to as well in 2025.

And then when we think about our BC Coastal tenures, we've got significant progress made already, but looking ahead, there's substantial cash flow as we expect this year and into 2025. You can think about that in the range of $65 million to $70 million in total net cash flows to Interfor to come over the next 12 to 18 months. You can think about half of that happening in the next 9 months of 2024 and then the remainder into 2025.

So when you factor all those things in, we feel we've got plenty of headroom. But certainly, as the market stays down and we progress through this, we're going to be proactive if we need to be. But we're not at that stage yet.

[Operator]

Your next question comes from Matthew McKellar from RBC Capital Markets.

[Matthew McKellar, analyst]

Maybe first, I think you mentioned seeing a supply response in lumber across the industry. Do you think the impact of that response is reflected in the market and current cash pricing today? Or should we expect that impact to be increasingly felt more as the quarter progresses?

[Ian Fillinger, executive]

Yes, Ian here. I'll jump in and Bart, you can do the same. But I would say, Matt, we've been underwhelmed by the response from the industry to really kind of rebalance the situation here. Having said that, we are getting Intel both from announced curtailments and quiet curtailments that are happening, so we're positive that on that, that people are starting to do that.

I would say, Matt, that we're probably not going to feel that capacity coming out for 60 or so days, just given that, as you well know, when you do take a sawmill down, you generally continue to run the planer mill and we continue to move your inventory and that takes weeks to work through. So I think there's a lag there before there will be really any feeling in the supply side in the market. I don't know, Bart, is that fair?

[Barton Bender, executive]

Yes. Totally. And the only thing I would add to that is that the distribution channels over the years have kind of introduced a discipline where they're not reacting to announcements, but rather they're reacting to whether they're able to resupply or what the lead times look like or what the demand side of the equation looks like.

And so they won't react, I don't think, until they actually see it. So less so on the announcement more so on an actual constraint in the marketplace. To Ian's point, that's going to take 60 to 90 days in my opinion.

[Ian Fillinger, executive]

Yes. Matt, maybe just to close on this question. I mean we have seen a sizable decrease in our own inventories through some of the levers that we pulled in quite a bit on the lumber side. So it is our check or our opinion is it's pretty lean out there. And so as this works through, it will be interesting to see how things unfold. But I would use the word sizable decrease for our situation in lumber and log inventories.

[Matthew McKellar, analyst]

I appreciate all the color. And then last 1 for me. I think you noted in February that Hammond Cedar will be 1 weather it impacted log deliveries in B.C. Can you provide an update on how things have trended over the past couple of months and how the log to exit your mills with profits are looking at this point?

[Ian Fillinger, executive]

Yes. I think in B.C, as you know, we've got pretty competitive operations, and we have water storage at a couple of our mills. So I would say that we're comfortable generally in British Columbia. I would say though that in Eastern Canada, there's been challenges in -- particularly in Quebec, when it comes to log inventories with the warm weather and what have you.

So yes, I think it's tight. Our log inventories generally are in Canada are down more than double-digit percentages. If you kind of look from New Brunswick all the way to British Columbia in every region that we operate and kind of use that as an average.

We're, again, double-digit percentages down in Canada. I wouldn't be surprised come summertime, the industry -- some industry mills may be taking downtime for log shortages, especially, if there's an upset condition like a fire season or something like that, that would restrict logging during any kind of summer hours.

[Operator]

Your next question comes from Ben Isaacson from Scotiabank.

[Unknown Analyst]

This is Victor jumping on for Ben. I just wanted to ask about the timing of recent curtailment. Supply seems to be acting rationally. And with lumber prices up somewhat sequentially, and we are at what is usually the peak construction season. So how do you see the demand side of the supply and demand balance develop for the rest of the year and throughout the summer and into winter?

[Barton Bender, executive]

Okay. You've got a lot to unpack in there, Victor. I would have to say that -- the demand side as we're coming into the spring building season. We're expecting -- we were expecting to see an increase in activity. And frankly, that hasn't taken place. And so -- it seems like this year, we're going to miss that part of it.

And when we're looking at that, we think it comes down to 2 factors. A decline on the repair and remodel side of it, especially when you talk about treating, that's an area that we've seen some slowdown. And the other is multifamily and especially in the South, multifamily has decreased. And so -- the demand side of the equation has seen a slowdown. And I would say that the supply side has not, from an industry perspective, has not responded yet. So we're still in a position where we think the markets are oversupplied. And quite frankly, the pricing that's in place is reflecting that.

So overall, we think demand is going to be quite similar year-to-date for the balance of the year.

[Ian Fillinger, executive]

Victor, Ian here. I'll just add to Bart's we see that the spring buying season has essentially failed to take off this year. And so when we look at that, and we look at where the U.S. South pricing is, the U.S. South typically isn't impacted by downtime decisions given the low-cost fiber base there. But prices in the U.S. South are near 50-year lows on an inflation-adjusted basis.

So as we start to see these impacts of permanent and temporary curtailments coming into effect with the lean inventories that we talked about throughout the supply chain, I mean any uptick in demand could provide meaningful tension into pricing. But if they don't recover, obviously, we expect given particularly in the U.S. South at the 50-year lows, continued supply responses.

[Operator]

[Operator Instructions] Your next question comes from Ketan Mamtora from BMO Capital Markets.

[Ketan Mamtora, analyst]

Bart, I mean, I think this weaker-than-expected pickup in R&R demand is echoed by some of the other peers as well. Can you talk about what you guys are seeing in terms of your volumes in R&R on a percentage year-over-year basis. Any color around that?

[Barton Bender, executive]

Yes. I won't get into the detail, particularly, but I will -- the commentary is we have our box store programs that are out there. So we have a pretty good view of the consumption that's taking place there. And I would say it's matched with what we had budgeted so far year-to-date. Generally, Q1 is a bit slower. Q2 starts to pick up, and that's what we're seeing, quite frankly. It's the treating side of the business that I think has really seen the slowdown, and we see that through the programs that we have in place for that as well.

And so really almost need to look at it in 2 ways. So the DIY out-of-the-box store fairly stable, but there does seem to be a slowdown with any of the treated products. Obviously, that's your exterior type projects in the backyard and those types of things. Those have definitely slowed. And I would say, if I was going to give you a percentage on the treated side, you're looking at in the 20% range decline on that side. So fairly significant.

[Ketan Mamtora, analyst]

I see. Okay. No, that's helpful. And then, Rick, on 2024 CapEx is $90 million till the plan? Are there -- do you have any flexibility there?

[Richard Pozzebon, executive]

Ketan, yes, $90 million still is the plan, and we're on track for that. There's certainly a little bit of flexibility there as we take some downtime and maybe that requires less maintenance CapEx. But as it stands right now, we're still on plan for the $90 million.

[Ketan Mamtora, analyst]

Got it. And then just coming back to financial leverage. So you called out a couple of items, the tax proceeds, BC tenures, anything outside of that you can do that could help accelerate bringing down the financial leverage. Revenue advanced materials recently sold their lumber duty rights. Is that something that you guys are considering at all?

[Richard Pozzebon, executive]

For sure. We did see those transactions announced. Without knowing all the terms, though, it's hard for us to comment on the economics. It is nice to see, though, that some value is being ascribed to the duty deposits out in the open market. We certainly believe our USD 560 million in deposits represent significant value to our shareholders. And in dollar terms on a per share basis, our duty deposits represent about CAD 11 on an after-tax basis. So there's significant value there in our minds. .

In terms of the leverage piece, as we look out, I mentioned it's the operational excellence piece, making sure we're getting the most out of our operations out of each individual operations. So we look closely each and every week at each operation to make decisions based on the outlook for those and with the mindset of maximizing operational cash flows and minimizing the impacts on our leverage as we work through the down market.

[Ian Fillinger, executive]

Maybe, Rick, I mean, Ketan, when we look at those transactions that happened, I mean, they're not attractive to us to consider, I guess.

[Richard Pozzebon, executive]

I agree.

[Ketan Mamtora, analyst]

That's helpful color.

[Ian Fillinger, executive]

Yes. Ketan, one thing that when you talked about R&R and what have you, just to come back to that for a second. I mean Southern Yellow Pine supplies a lot of that. And I just kind of want to remind folks that we're not as heavily Southern Yellow Pine as maybe some people think we do with Eastern Canada, about 1/3 of our production is in the SPF. And important is that SPF and Southern Yellow Pine are entirely exchangeable or substitutable.

So we are benefiting on the SPF side of the business when it comes to pricing on -- when you look at the Southern Yellow Pine. So our diverse geography and the move to Eastern Canada to capture some of the SPF that was available through those acquisitions is we're seeing positive pricing when we look at those gaps.

[Operator]

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

[Hamir Patel, analyst]

Bart, I wanted to follow-up on the earlier question about the multifamily weakness. I was just wondering if you had a sense as to perhaps how much more would intensive the multi starts are in the South versus the rest of the U.S.? And as maybe Southern Pine just that much more prevalent in multifamily usage in the South because when you look at the actual starts, they're down more in the south, but not necessarily that much more than the whole U.S.

[Barton Bender, executive]

Yes. I would take a look at the permits side of that equation as well. But I think if you look at the big -- the states that are big consumers and builders of multifamily. So that's your Florida, your Georgia and your Texas, I mean those 3 states, I think the activity has decreased fairly significantly on the multifamily side. And in particular, if you look at the permits, I think you'll see a trend there. And obviously, those markets are right in the backyard of Southern Yellow Pine producers and are largely supplied by Southern Yellow Pine.

So the -- I think the impact of that is a little bit more heightened than south. And that really I'm looking at that as one of the main reasons that we're seeing in the market that we have in the South.

[Hamir Patel, analyst]

Okay. Fair enough. That's helpful. And just last question I had. Ian, as part of the balance sheet management, would you look at potentially divesting any of your sawmills?

[Ian Fillinger, executive]

Well, Hamir, that's a good question. I mean our portfolio of 30-or-so operations now. Obviously, you've got different stages of each ones, and we've got ones that are in the top ones that are in the middle and ones that need some work. So we're always looking at those. Philomath is an example, last quarter you'll recall, we sold Acorn a year or so ago. We shut down our Hammond Cedar mill and then converted that into real estate play.

So at the end of the day, I mean, we're always looking at how do we improve the ones that need it, what's the capital investment, what's the time line? How is the fiber supply and fiber security. So I would say just, Hamir, I mean, generally, I mean that's one of the most important things that we're doing all the time and always trying to improve or find a path to improvement for the shareholder and for the company. So it would be, yes, we're always looking at our portfolio and how to improve it.

[Operator]

And there are no further questions at this time. I will turn the call back over to Ian for closing remarks.

[Ian Fillinger, executive]

Okay. Thank you, operator, and thanks, everybody, for your interest in our company and feel free to reach out to myself, Rick or Bart any time, and this concludes our call. Have a great day.

[Operator]

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