Interfor Corp

TSX:IFP

Earnings Call Transcript 2018-Q2

[Operator]

Good morning. My name is Kim, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor second quarter earnings conference call. [Operator Instructions]Duncan Davies, you may begin your conference.

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

Thanks very much, Kim. Good morning, everyone. Thanks for joining us. We're here today to discuss Interfor's second quarter results, our outlook for the balance of the year and most especially, the announcement we made yesterday regarding the second phase of our strategic capital plan for our mills in the U.S. South.Joining me, as usual, are Martin Juravsky, our CFO; and Bart Bender, our Senior Vice President of Sales and Marketing. Also joining us this morning is Ian Fillinger, our COO, who also has responsibility for our capital projects activity.We're going to keep our remarks brief, and we'll turn the meeting over to you for questions as soon as we can.Obviously, we're very pleased with our results in the quarter. Net earnings were $63.8 million, and sales were $620 million. EBITDA before share-based compensation was $123.8 million, 38% higher than the previous quarterly record set in the fourth quarter last year.On an LTM basis, net income was just under $150 million of sales at $2.2 billion. EBITDA before share-based compensation was just under $355 million.Our results in the second quarter were positively impacted by higher lumber sales realizations, which before duties were $65 per thousand board feet higher than the prior quarter, reflecting the strength of lumber prices, which set numerous records before peaking at the end of May; and the decline of the value of the Canadian dollar, which was off 2% quarter-over-quarter.Production and sales volumes were also stronger in the second quarter. Production was up 22 million board feet or 3% versus the prior quarter in spite of weather-related curtailments at our Grand Forks mill in the B.C. Interior. And sales of Interfor-produced lumber was up 54 million board feet or 8% versus the first quarter.During the quarter, we shipped 100% of production compared to 95% in the first quarter of the year.Production costs were essentially flat quarter-to-quarter as lower mill-level costs in the South were offset by higher log costs in Canada and by the weakening of the C dollar.On a regional basis, lumber production was 325 million board feet in the South, up 23 million board feet versus the first quarter; 148 million board feet in the Northwest, up 2 million board feet. In the Interior, production was 175 million board feet, down 6 million board feet versus the first quarter due primarily to the curtailments at Grand Forks. And on the coast, production was 40 million board feet, up 3 million board feet relative to the first quarter.From a capacity utilization standpoint, the South, Northwest and Interior each operated at 93% during the second quarter compared with 86%, 91% and 97%, respectively, in the first quarter. The coast operated at 50% in the second quarter compared to 46% in the first quarter. Overall capacity utilization was 89% versus 86% in the first quarter of the year.As mentioned earlier, product prices were very strong across the board in Q2. The Random Lengths' Composite Index, which measures pricing on a wide basket of products, was up 11.5% quarter-over-quarter. More specifically, the Western SPF index was up almost 13%, while the Yellow Pine composite was up 16%. Cedar decking, on the other hand, and pine boards, were flat quarter-over-quarter.Looking at pricing in a bit more detail. We see more volatility this year than has been the case in the last couple of years, which is a reflection of the relatively [ fake ] balance between overall demand and available supply, combined with some logistics constraints that limited buyers' ability to access supply in the early part of the year.Prices moved up steadily in the first 10 weeks of the year, peaking in the 1st week of March; then after retreating for 4 weeks, took off again in the 1st week of April; and rose steadily until the last week of May, with SPF 2x4 hitting a peak of $655 per thousand board foot mill and Yellow Pine 2x4 Eastside at $621 per thousand board feet, when they began to move back to more normal levels, following in the case of SPF, by $65 by quarter end.Import duties on Canadian shipments to the U.S. in the second quarter were expensed at the full "all others" rate of 20.23% and amounted to $14.8 million compared with $12.9 million in the first quarter.The second quarter was another very strong quarter from the standpoint of cash flow with cash flow from operations before changes in working capital of $123.2 million or $1.76 per share.On an LTM basis, cash from operations before changes in working capital has totaled $340 million or $4.85 per share. Capital spending in the second quarter totaled $23 million.Net debt was reduced by a total of $93 million in the quarter, coming in at $34.4 million or 3.4% of invested capital at the end of the quarter.The company closed the second quarter with more than $500 million of available liquidity, which puts us at a very advantageous position to pursue a variety of value-creating opportunities.In that regard, for some time now, we've been working on a strategic capital plan designed to capture the opportunities within our existing mill platform, particularly in the U.S. South, and to pursue further growth.The previously announced capital projects at Meldrim, Georgia and Monticello, Arkansas are on track to completion on the first quarter next year. Both projects will materially improve the economics of those mills and will add approximately 150 million board feet of additional production to our portfolio.And yesterday, we announced the second phase of the plan, which will see USD 240 million invested in our plants at Thomaston and Eatonton, Georgia and Georgetown, South Carolina over the course of the next 3 years. These projects will increase production capacity by 275 million board feet as well as substantially improve the cost structure, product mix and grade outturns of these mills.The significance of these projects can't be overestimated. Considerable time and effort has been expended over the last 6 to 8 months to bring the projects to this stage, and I'd like to thank all of the people both inside our company and outside who put in the time and effort to bring these projects to where they are today.The design and construction of capital projects is one of Interfor's core strengths. We have a track record of delivering projects on time and on budget and achieving returns above pro forma. I'm completely confident that we're going to do so again with these projects, and I'm going to be excited to watch them come to fruition.I can also tell you that we have a number of smaller machine center upgrades, either planned or on the drawing board, at mills throughout our system in Canada, the Pacific Northwest and in the U.S. Southeast over and above the plans aligned today, which will be undertaken at the same time and will also deliver very attractive returns.We also continue to look at opportunities to move forward with a greenfield facility in the South. And while we continue to advance our assessment of alternative locations in the quarter, our primary focus was to put the finishing touches on our internal plans, which has resulted in pushing off the decision on the greenfield strategy to later this year.In anticipation of the ramp-up of capital spending over the next few years, including the possibility of a greenfield project, we took steps during the second quarter to modify our debt financing arrangements to extend the repayment terms on a portion of our U.S. dollar fixed rate notes to begin in 2027 versus the current commencement date of 2021. This refinancing is scheduled to close in 10 days or so.Turning now quickly to an outlook for the market. It's apparent to everybody that product price has continued to normalize for the first 5 weeks of the third quarter. Although the Composite is off almost $120, 1,000 from its peak, and some of the main commodities are off more than $170, I think it's important to keep things in perspective.In all the discussions we've had with our largest customers, takeaway levels continue to be good, and inventory levels are reasonable for this time of the year. Probably most important, prices are even higher than they were last year, which was not a bad year. Quite frankly, I think pricing is much healthier today from a long-term go-to-market standpoint than it was 2 months ago.So there will be -- continue to be volatility in product pricing. We believe the market will continue to grow. The pricing will continue to reflect demand and supply balances, which we believe are tight, and well-performing, well-run companies with quality assets will continue to deliver above-average returns.On that cheery note, I'm -- operator, I'm going to turn the meeting over to our guests and take their questions. Thank you.

[Operator]

[Operator Instructions] Your first question comes from Hamir Patel from CIBC Capital Markets.

[Hamir Patel]

Duncan, on the greenfield front, it looked like maybe the language had shifted a bit. I'm just curious, are you looking at still one opportunity or potentially multiple opportunities?

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

Well, we are looking at a variety of different sites. And if the economics and the opportunity present themselves, we have the capacity and the interest in doing more than one. But I prefer to look at it from a sequential standpoint, Hamir. If we can get one, we'll do it. And if we can find another one after that, we'll do that, too.

[Hamir Patel]

Fair enough. And then maybe just a question for Marty. With all the projects underway, excluding any potential greenfields, what level of CapEx should we be budgeting for 2018 and 2019?

[Martin L. Juravsky, Senior VP & CFO]

Well, for 2018, you're talking about something in the zone of $150 million for this year up until now. The other is probably going to be a little bit shy of that and is more or less a function of timing of capital spending. Some of the spending that might have otherwise happened in the fourth quarter is probably going to filter into the early part of next year. It's just more of a timing issue. In terms of 2019, I mean, the biggest chunk of it, Hamir, is related to the strategic capital projects [indiscernible] strategic capital projects that Duncan articulated. Those are going to be spent over a multiyear period. But I think, directionally, if you're thinking something in the order of magnitude of around $200 million for next year, that'll give you a frame of reference.

[Hamir Patel]

Great, Marty, that's helpful. And just turning to the markets, Bart, can you comment on what you're seeing in China on the demand side for both SPF and Southern Yellow? And all the trade rhetoric with China heating up, what percent of the Southern Yellow Pine exports like go to China? And where is the rest going?

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

Okay. Good question. I -- my take on China is they've been a bit slow to react to what's happened in North America, and you can expect that. They have lots of options. We are managing to sell the volumes that we're willing to allocate into that marketplace. So Q2, actually, was an improvement over Q1 in terms of volume. But year-to-year, we are allocating less to that market than we have. And that's just due simply to the fact that there is a gap between the prices that you see in China versus the prices that you see elsewhere, including other export markets. For Southern Yellow Pine, we continue to be actively improving our position in China on that product. We see that as a real growth opportunity for us. We're continuing to focus specifically on that market. But I think it's important also to acknowledge the other Asian markets. We've had tremendous success in other areas other than Japan and China -- the other Asian countries and introducing Southern Yellow Pine and growing our sales there. So we've actually done very well year-to-date with the volumes that we sold in those markets.

[Hamir Patel]

Great. That's helpful. And just curious, with SPF prices coming off, what do you think is the level at which maybe the European producers pull back?

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

Oh, I can't speculate on the European market. I've -- my understanding is that they continue to see robust demands over there as well, and so the markets will have a way of sorting that out. But obviously, the peel-back in North America is going to put a -- is going to close that gap with what we're doing overseas, and so we should start to see more SPF, more Doug Fir and quite frankly, more Southern Yellow Pine, making its way over to China in the next quarter or 2.

[Operator]

Your next question comes from the line of Paul Quinn.

[Paul C. Quinn, Analyst]

Duncan, you're spending $240 million on Phase 2. Maybe you could go through some details of what you're upgrading in each of the mills that you identified?

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

Yes. I'm not going to get into the specific dollar amount at each of the mills, Paul, but I can tell you, we're looking at very significant modernizations of both the Thomaston and Eatonton mills and somewhat more modest program at Georgetown. But we think, in each case, it's going to move those mills from a performance standpoint, from a volume standpoint and from a product mix standpoint, very nicely going forward. So we're pretty excited about these. We've put a lot of time and effort into them over the course of the last 6 months to 8 months, looked at a whole variety of different options. And quite comfortable what we've got planned for these operations is very consistent with what we've done in the B.C. Interior, when we rebuilt those facilities. And it's going to deliver the same kinds of gains for us that the investments at Adams Lake, Grand Forks and Castlegar have done for us.

[Paul C. Quinn, Analyst]

So -- it sounds like the Thomaston and Eatonton, that's a whole rebuild, not just front-end, back-end planer kind of thing?

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

It's a significant rebuild [indiscernible].

[Martin L. Juravsky, Senior VP & CFO]

Paul, just to augment it. One thing to put also a frame of reference around in terms of these projects, these projects are much more than just capacity. When we actually think about the impacts of these projects -- Duncan talked about 275 million board feet of impact, but the reality is, a fairly significant part of the returns are associated with grade outturns, product mix, improved recovery, lower conversion cost. So these projects are fairly comprehensive in terms of what they're going to do from an economic standpoint.

[Paul C. Quinn, Analyst]

No, I understand that. Just the 150 million board feet and the 275 million board feet in Phase II, how should we model that out? Is that -- will you capture that after 12 months? After 18 months? Or how would you model that out?

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

We'll spread it pretty equally over the 3-year period of time. The Monticello and Meldrim projects will be completed in the first quarter. We built a ramp-up period into our pro forma, so we would expect to see both of those facilities operating pretty much at capacity by the third quarter of 2019. And then as we take on the other projects, they'll be phased in over the course of 2019, '20 and '21 periods of time. And so they'll ramp up over that. We'll see the full -- we won't see the full increase in volume until the back end of 2021, which we think fits in pretty nicely with the expectations that the market is going to continue to grow in the course of the next few years.

[Paul C. Quinn, Analyst]

Okay. And then just -- you've got a lot of capital projects on the go here. What's the -- what are your conversations like with the equipment suppliers? And how constrained are they in bringing additional capacity to the marketplace?

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

From my standpoint, I think they're very constrained. But we've -- we've been talking with them through this whole piece. We've bought slots some time ago, knowing that these projects were on the drawing board. And so I think we're in pretty good stead in terms of being able to undertake these projects in a sequenced way and bring them onboard using quality equipment, quality support and contractors through this piece. Ian, is there anything you want to add to that?

[Ian M. Fillinger, Senior VP & COO]

No. I think you covered it well.

[Operator]

[Operator Instructions] Your next question comes from Kasia Kopytek from TD Securities.

[Kasia Trzaski Kopytek, Associate]

It's Kasia. Back to CapEx, about $240 million, how much will you spend this year and next year?

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

Well, we won't spend any of it this year. The -- it's a 2019 through 2021 project scope. The -- we're spending currently on the Meldrim and Monticello projects, which, I think, is a combined total of $62 million or something and -- USD, which will be spread over the latter part of this year, but a big significant portion of that will be spent in the first quarter of next year. The projects that were -- we've announced here today, we'll be moving through the planning phase of those projects. So what we've been doing up to now is the conceptual design and engineering and economics on the plants. But when -- we now need to move into the detailed planning phase of each of those projects, which takes a fair amount of time. And we wouldn't expect to see any commencement of construction until the middle part of next year at the first of the plants. And then the -- most -- low ramp-up over the course of the next year, 1.5 years from a construction standpoint with the last one completing in 2021.

[Martin L. Juravsky, Senior VP & CFO]

And so just, just for planning purposes or for remodeling purposes, what I said earlier on the call was think about next year being around $200 million plus or minus with it not being split evenly between the front and back half of the year. So it'll be less than that in the front half and more than half in the back half of the year.

[Kasia Trzaski Kopytek, Associate]

Okay, got it. So assuming construction commences kind of midyear next year, like as you mentioned, maybe 1/4 of that $240 million next year? Is that a safe assumption?

[Martin L. Juravsky, Senior VP & CFO]

Well, you have to look at it in -- and get to other things that we're doing as well. So there's a whole bunch of components Duncan articulated on other spending. So if you -- don't focus just on the USD 240 million. If you're looking for the aggregate number for next year, some of that $240 million is coming in next year, but there's other things as well, including maintenance spending, including some smaller discretionary projects. But in terms of the $240 million, some of that will be next year, but less than half of it will be next year.

[Kasia Trzaski Kopytek, Associate]

Got it. Okay. Yes, that's really good detail. And that less than 5-year payback that you guys mentioned that was underlined by conservative lumber price assumption, what is exactly the Southern Yellow Pine price assumption that you guys were using in that estimate?

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

Well, we don't disclose that. But let's just say it's well less than where it is today.

[Kasia Trzaski Kopytek, Associate]

Okay, got it. And it's the Eastside price, right, that you guys are...

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

Pardon me?

[Kasia Trzaski Kopytek, Associate]

It's the Eastside price that you guys are talking about or Westside?

[Martin L. Juravsky, Senior VP & CFO]

Yes. We tend to use -- if you're using a frame of reference, what we've put in our public disclosure is the Southern Yellow Pine composite. But regardless of what -- whether using Eastside, Westside, central, whether you're using composites or specific products, to Duncan's point, any of those references, what we're using in modeling out is less than current stock.

[Operator]

Your next question comes from Mark Wilde from Bank of Montréal.

[Mark William Wilde, Senior Analyst]

Duncan, just to kind of start off on some of these capital projects, is it possible to give us a sense of how much just capital costs have moved up over the last couple of years? Like if you were doing these projects 3 years ago and you'd bid them out, would it have been $240 million? Or would it have been something less?

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

Well, it's something less, and it's a fairly significant inflation. We see prices have obviously increased significantly over this last period of time. And just from a pure demand-supply standpoint, there's more folks looking at doing projects, which has translated into higher cost of projects. Currently, that was the case 6 months ago, a year ago and most certainly, 3 years ago.

[Mark William Wilde, Senior Analyst]

And also, turning to just the greenfield, can you give us some sense of sort of what kind of the critical conditions are around a potential greenfield for you?

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

Yes. Sure, Mark. And we've said this continually, and it's got to be an appropriate fiber basket. You got to have a pool of people, both from a labor force standpoint and from a management standpoint, that you can access -- skilled trades that you can access. So in our view, it needs to be reasonably close to a decent-sized center where you can access the supply of labor. You need appropriate byproduct offtake arrangements with credit-worthy customers, and you need the logistics piece to be able to move the product. And, I think, as production ramps up in the Southeast and declines in similar areas in North America, it's our view that product is going to move farther than it has historically from the Southeastern region. So whether it's additional access to rail or highway systems or ports. Bart talked about our strategy to move Yellow Pine offshore, which is a big part of our strategy. So trying to find a combination of all those factors and economics that make sense, given the inflationary environment we're in from a capital [ goal ] standpoint are all the key factors. And we've got lots of things on our plate from the standpoint of our internal projects, which is our priority, obviously. But if we can find a situation that fits those criteria, we're comfortable taking on -- whether from a financing capacity or from a management capacity, we're prepared to go down that path because it's consistent with our long-term plan to grow the value of the company.

[Mark William Wilde, Senior Analyst]

Okay. And are -- just taking a step back, I mean, we've seen, I would say, since probably the July or August last year, a really marked acceleration in the number of Southern lumber projects, whether it's debottlenecks or kind of a growing list of greenfield. Does this concern you?

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

No. We expected it. I think it's going to take longer for production to ramp up than most people think. I think lead times on equipment and contractors and others are going to be more difficult than, I think, a lot of people assume. I think you've got an environment where the market is continuing to grow, whether it's 1.5 billion or 2 billion feet per year. And the ramp-up in capacity, I think, is necessary to enable North America to meet it's own demand requirements. So we're totally comfortable with it, Mark, and right now, don't see the number of additions of capacity or greenfields or whatever it is to match what we think is going to be the growth in demand for the product over the course of the next 3 years or 4 years or 5 years. So we're completely comfortable with it.

[Mark William Wilde, Senior Analyst]

Okay. And then some of the -- both the TMOs that I've talked with and the REITs are talking about sort of -- in some areas where they're seeing kind of sawmill capacity being added or maybe [ close to ] ports for the [ Southern ] export mills, they are pointing to some tensioning in the log markets. Are you guys seeing this at all?

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

Well, we haven't seen it yet. We've done very detailed analysis of the various timber baskets throughout the Southern region, and the areas that we are looking at have significant inventories of standing timber, and they've got growth/drain ratios that are really quite favorable. And so my expectation is one of the primary beneficiaries of the added capacity in the South will be the landowners but more by way of increased volume as opposed to inflationary pricing arrangements. That said, we've taken a -- just like we've taken a conservative approach on lumber prices, we're not naive either about potential impacts on log costs. So as we look at the various alternatives available to us, we're constantly looking at what we think lumber prices might be and constantly looking at what we think log costs might be and constantly looking at what we think byproduct revenue might be. And adding it all up, and unless we're completely comfortable that we've got a circumstance that's going to suit our needs, we're just not going to proceed.

[Mark William Wilde, Senior Analyst]

Yes, so you've got a lot of moving variables in those equations. The last question I have is really just on kind of current markets. And I just -- I wondered as the transportation bottlenecks kind of ease on the rails out in Western Canada, whether sort of backlog orders hitting the distributors right now or hitting the retailers, whether that is actually bumping their inventory levels and hence, kind of contributing to some of the turmoil we see in the market right now, if you follow me. Because I assume that a lot of these guys have had orders sitting out there, and that orders have been sort of lagged in terms of rolling into them, and all of a sudden, the whole thing is going the other direction now, and orders are coming in at accelerated pace.

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

Well, what -- all you're seeing right now is a reverse of what we saw in the first quarter and the first part of the second quarter. The logistics constraints, combined with a tight demand/supply balance, create a situation where buyers are bidding up product and trying to access it; you're just seeing the reverse. And I think the best way to look at it is to look at it across the board and say, "You had the run-up. Now you got the rundown. What does the average look like compared to last year or any other reference point you want to look at?" And all in all, it's a pretty good market. The market continues to grow. Pricing is better today even after the -- I call it the normalization or the correction that's happening. It's a pretty good situation. And we're not at all uncomfortable with what's happening. We think it'll shake out over a period of time. And I think it'll just continue to be quite a positive situation. I think there's a -- there seems to be a view out there that prices are going to 0. Well, I'm not an advocate or a supporter of that thesis. I just don't think that makes any sense. And so we'll move through volatile times, but overall, I think that the circumstance for the industry right now in terms of long-term fundamentals for a well-positioned producer are pretty darn good.

[Mark William Wilde, Senior Analyst]

I think that's pretty calm, pretty rational. We haven't ever seen 0 before. We have a lot people who can worry about that.

[Operator]

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

[Hamir Patel]

Just had a couple of follow-ups for Ian. Following the flooding, Grand Forks, I think you had referenced some ongoing transportation issues at that site. I'm just wondering if that's still the case. And when do you expect that to be resolved?

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

Actually, it's Bart here, I'll take that. Yes, the [ sand foil ] line was affected by the floods coming into Grand Forks. That line's owned by OmniTRAX. And they have announced that they're going to repair it. And I'd say, we've probably got about 5 week or 6 weeks before that line is fully prepared and back operational. In the meantime, we have other means of accessing both the BN and the CP to keep that product flowing. So we haven't seen any issues on inventory builds and whatnot currently going through the reloads that we've set up.

[Hamir Patel]

Great, Bart. And then, I just had a question about labor, so maybe for Duncan or Ian. Just what are you seeing in terms of availability of workers in the various regions? And maybe what sort of wage inflations do you think we may need to kind of factor in, in particularly the U.S. South?

[Ian M. Fillinger, Senior VP & COO]

Yes. Sure. So I guess, on a positive side, we've had a couple of our operations in the South that were not running on a 2-shift basis in over the last 6-or-so months, we've been able to get those up to 2 shifts with the labor pool. We're working real hard with our recruiting department and number of different initiatives, which I think are really [ neat ] there, starting to bring a new pool into our operations. And then when you look at the capital investments going into the South, I mean, it really does create a different story, both from a management recruiting standpoint and from a frontline employee, a trade employee. I think these investments that we've announced are going to change the story of job security and professional positions that come available. So I think we're in very good shape and positioned well, and our brand in the South over the last number of years has continued to improve. So having said that, it's tight, and we're always looking at ways that we can access talent pool through wage adjustments or other means.

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

You asked a question about inflation in wage rates, and I think in an unemployment situation like we've got in the U.S., labor is tight. And I think we're going to see additional inflation in wage rates. But part of the capital strategy we've got is to position ourselves with higher productivity, greater levels of efficiency and greater ability to pay higher wages to people over time just because of your relative competitive position. So it's all part and parcel of our strategy based on what we see coming forward in the industry.

[Operator]

There are no further questions in the queue. I now turn the call back over to the presenters.

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

Great. Thanks, Kim. Thanks, everybody. We very much appreciate you attending the call today. Appreciate your interest in our company. Myself, Marty, Ian and Bart are available if you have follow-up questions. And if not, we look forward to talking to you again at the end of the next quarter. Thank you.

[Operator]

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