Interfor Corp

TSX:IFP

Earnings Call Transcript 2020-Q2

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Interfor 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 speaker today, Ian Fillinger. Thank you. Please go ahead.

[Ian M. Fillinger, President, CEO & Director]

Thank you, operator, and welcome, everyone, to our Q2 '20 Investor Analyst Call. Firstly, I'd like to say that I hope you and your family are safe, healthy and doing well during this pandemic. With me today, you have Bart Bender, our Senior Vice President of Sales and Marketing; along with Rick Pozzebon, our new Senior Vice President and Chief Financial Officer. Our agenda today will start off with myself providing a recap of our strategic priorities and key themes. I'll then pass the call to Rick, who will cover off financial matters. And then I'll pass the call off to Bart, who will cover off market matters. So turning to our strategic focus. Q2 was quite a ride. We started the quarter with a highly uncertain lumber market and finished the quarter in a completely different spot. However, our overarching priorities have not changed. Core to our company is maintaining our capital allocation discipline and ensuring our balance sheet integrity and that we have strong liquidity. This approach has served us well over the years, allowing us to control our future and take advantage of both internal and external growth opportunities. I'd like to talk a little bit about COVID impacts in some of our forward plans. Production in the quarter was impacted by market-related downtime and adjustments to match our order files. This impacted our quarterly operating rate. However, by mid-quarter, we were back to maximum operating rates and continue to do so today. We are experiencing an increase in COVID-related incidents, particularly in the South platform and to a lesser extent, in our Pacific Northwest region. The health and safety of our employees and contractors is at the top of our priority list, and we will continue to adapt and adjust our safety protocols, in some cases, our operating cadence based on our team's safety. There's no doubt we are experiencing very strong lumber market that appears to reflect real demand. The impacts of COVID-19 early on with curtailments and the permanent supply reductions made in B.C. interior last year appear to have positioned us well during this demand driven market condition. Our improvement efforts were again balanced across the company as we made progress in all regions. In B.C., we approved the construction of an additional dry kiln at our Adams Lake operation. This project complements the completed timber acquisition earlier this year and further positions our B.C. interior region as one of the best in the industry. All of our B.C. mills are well-positioned with secure long-term fiber tenures in modern, highly efficient mills. In the Pacific Northwest, we completed and have started up a major project at one of our stud mills. The start-up KPIs, recovery, cost, productivity, et cetera, are tracking ahead of our pro forma expectations already. In the South, we advanced on our Phase II strategic CapEx plans at our Eatonton, Georgia operation and our Georgetown, South Carolina operation. I want to talk a little bit about our balance sheet and liquidity. Our EBITDA was $43 million despite facing significant early COVID-19 market-related downtime in April and early May. This quarter represents the strongest earnings since Q2 '18. We improved our balance sheet and liquidity by a very proactive operating discipline on working capital, conversion costs and G&A reduction activities. Our net debt to invested capital and available liquidity both improved ending Q2 at 22% and $497 million. We continue to closely manage our working capital and costs, and we see no need to take on any working capital risk in this market. We are still cautious in regards to the overall economy. In closing, we are focusing on maintaining the health and safety and well-being of our employees. We continue to drive cost reductions, and we're matching our production rates to our order files. That concludes my opening remarks. I'm now going to hand the call over to Rick, who will cover off the financial matters.

[Richard Pozzebon, Senior VP & CFO]

Thank you, Ian, and good morning, everyone. Before getting started, I'll refer you to cautionary language regarding forward-looking information on the first page of our Q2 MD&A. The second quarter was positive from an earnings standpoint. Adjusted EBITDA of $43 million was improved from $37 million in Q1. This improvement reflects higher realized lumber prices, partly offset by lower sales volume. Our average realized price was $646 per thousand board feet, up 9% over the preceding quarter, reflecting overall lumber market strength. Lumber sales volumes were 22% lower than the first quarter, resulting from proactive production curtailments taken in the first half of Q2, in response to COVID-19 uncertainty. Midway through the second quarter, production volumes returned to levels typical before the pandemic. Cash taxes have been minimal year-to-date and are expected to remain so over the near term-based on existing tax loss carryforward balances and current legislation. Cash flow generated from operations in the second quarter was $103 million. This includes $66 million from inventory reductions as we focused on balancing inventories through our order file and market conditions. In terms of capital expenditures, $24 million was spent in Q2 with approximately $18 million of that related to our strategic projects on which we are seeing positive results. We've readjusted our CapEx program for 2020 to total approximately $120 million, up $20 million from previous guidance. Our planned CapEx for 2021 remains unchanged at substantially less than $100 million. As Ian mentioned, our balance sheet improved quarter-over-quarter, and we continue to have significant financial flexibility. We ended the quarter with net debt of $239 million, cash on hand of $170 million and our $350 million revolving term line undrawn. In addition, softwood lumber duties on deposit with the U.S. government totaled USD 107 million at quarter end. Substantially, all of which are not recorded on our balance sheet. While we regularly evaluate all options for capital allocation, our priorities in the foreseeable future are to complete our existing strategic capital program, continue to deleverage and be well-positioned to capitalize on value-added growth opportunities. In summary, Q2 financial results were solid, and we're well-positioned with a strong balance sheet to respond proactively to market developments and opportunities for growth. That concludes my remarks. I'll now hand the call over to Bart.

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

Thanks, Rick. I'll talk a little bit about the market. Q2 2020 may go down as the most surreal in history for our lumber markets. There is no pandemic playbook in our business, so anything was possible. My last quarter outlook comments essentially were that we were going to match our production to the demand that we are seeing from our customers. In April, this meant curtailments and inventory reduction. Through May and June, as demand began to come back, we reacted accordingly with restarted operations. The markets have not looked back since. Today, demand continues to be very strong in most every market. In North America, repair and remodel, new home construction remained vibrant with both sectors resuming a growth stance. Time at home, low interest rates and a desire to seek less densified living has driven the demand for lumber. These tailwinds continue into Q3. And currently, we are not seeing any signs of slowing. In our export markets, our approach remains strategic. At roughly 4% of our sales, China remains steady from a volume perspective. Our wide variety of species and sizes affords us flexibility in our approach to this market. In terms of Japan, we have seen a reduction in housing starts and a commensurate reduction in demand for lumber. I've been asked many times how this active market compares to the market we experienced in 2018. From our vantage point, the field is very different. In 2018, supply was artificially constrained for a period due to weather-impacted railcar supply being insufficient to get lumber to market. Additionally on the demand side, new home sales were slowing due to affordability. This market does not have these factors. Interest rates and a renewed desire for single-family homes and a robust repair-and-remodel demand is driving lumber demand. On the supply side, we feel those mills that can produce lumber are doing so feverishly. In the recent past, logistics has not let -- logistics has not played a material role in constraining lumber supply to market and inventory levels throughout the supply chain remain lean by all accounts. However, we should expect some volatility in car supply, as rail ramps back up to capacity. This being said, COVID-19 will continue to drive uncertainty in the months ahead. So as always, we are focusing on the fundamentals, producing quality lumber and servicing our value to customers. I think I'll leave it there, and back to you.

[Ian M. Fillinger, President, CEO & Director]

Okay. Thanks, Rick, and Bart. So operator, we're ready to take analyst calls now.

[Operator]

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

[Sean Steuart, Research Analyst]

Congratulations, Rick, on the appointment. A few questions. I guess for Ian or Bart, it seems that there's constraints in the lumber industry's ability to add supply quickly to address the price environment we're in right now and really strong demand. Can you speak to, I guess, perspective on your system's ability to add incremental supply in the near-term and broader thoughts on industry constraints over the near to midterm.

[Ian M. Fillinger, President, CEO & Director]

Well, I'll take a shot at it. And then maybe Bart can take a shot at it, too, Sean. So thanks. So for our mills and operation, Sean, I mean we're running out all hours that are available. So the -- where it's at or, I guess, where the constraints would come in or the ability to add is pretty limited. The -- I guess, the fallback for where we may not be producing is when we're actually doing capital projects. So for example, in the last quarter we had our Eatonton Mill in Georgia was down for a significant part of the quarter and has recently started up. Our Molalla Mill in the Pacific Northwest also was down for project for a number of weeks. So it's sort of self-induced downtime that we had. Now those mills are back up and running. And so as we're working through the project schedule is where we're maybe losing some hours. But obviously that work is paying off as we bring those mills back up, as an example, Molalla and Eatonton. The labor availability relative to COVID is the other factor. And then there is, particularly in the South, a lot of employees that are either self-quarantined or in some cases, have tested positive. So our team in the South is really adjusting operating schedules to match that. At this point, there hasn't been anything significant that has -- or material that has impacted us from an operating standpoint. So we really are adding or running all hours we can. The availability of labor is a bit of an issue to hire or try to add additional shifts and stuff like that. And it's the government subsidy programs and other factors even though unemployment rates continue to be high. It's still a struggle in some regions to get employees, but we're working on that. But I'll pause there, Sean, and then see if Bart wants to add any color to it from his perspective.

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

Just 2 things. Firstly, at these kind of numbers, everyone's trying to figure out how to make a little bit more, and that's been happening for some time. So I would -- I'd be surprised if there's any mill in North America that isn't doing everything they can. The other point is on the imports into the U.S., mainly from Europe. We are seeing some increases there. They're on track likely for a 20%, 30% increase. However, they're starting off from a fairly immaterial base of production. So when you take that -- all of that into account, I think the side -- supply side response is in full motion. And really, this thing is about inventories in the supply chain and then just the extraordinary demand levels that we're seeing for lumber.

[Sean Steuart, Research Analyst]

That's useful detail. Second question before I get back in the queue, your log sales moderated a little from Q1, and that was, I think, a big driver in Q1. How should we think about log sales, I guess, mostly from the coasts going forward for you guys?

[Ian M. Fillinger, President, CEO & Director]

Well, I'll take that. And then maybe, Rick, if I miss anything, you can jump in. But yes, you're right, Sean. We had a really strong sales program in Q1. It drove our inventory down on the coast. So Q2 wasn't as robust on that end. But it's now building, and we see very positive outlook in this quarter coming up with our log deals from the coast. So it was an inventory drag down in Q1, kind of a rebuild through Q2 and what we believe is a decent setup getting into this quarter.

[Operator]

[Operator Instructions] Your next question comes from Paul Quinn from RBC Capital Markets.

[Paul C. Quinn]

Just on lumber shipments in the quarter. We expected that downtime in Canada, given the lack of a price response for Western SPF. But some of your pine cone prices were actually pretty strong in Q2 and obviously strengthened further in Q3 here in. So I expected to see more volume out of the U.S. South. But I suspect part of that is if it gets Eatonton and probably something else that's down in the quarter, do we expect Q3 to ramp back up to Q1 volumes or possibly Q4 of '19?

[Ian M. Fillinger, President, CEO & Director]

Yes. Paul, there was -- those 2 mills that you talked about were impacted and that did when we did come back. They were down for a number of weeks, they're both running now. We do have some scheduled behind time at Georgetown with its second part of its project, but nothing else material. So our run rate or production rate, I would expect as long as every issue is as good as it is today, will be higher than it was in Q2.

[Paul C. Quinn]

Okay. Let's hope so. And then just maybe on export lumber. I thought I heard you say 4% of sales is exported. But was that just China? Or -- but is it -- I guess, the question is really what this percent export right now? And what was that number like 3 or 4 years ago?

[Ian M. Fillinger, President, CEO & Director]

So it's specific to China. And the number was higher 4 or 5 years ago. Our business in China is, I would say, a bit unique relative to our competitors. We've got such a wide variety of species that we produce and products that we produce. And so the business that we target over there is really somewhat niche-oriented. And we're really afforded the ability to step in and step out. And so a large part of what drives what we do over there is what's happening in North America. There are certain products that the overseas markets are always competitive on, and those shipments continue to be steady. And then there's others, some of the higher-valued products, where when you get a healthy North American market, they're challenged to keep up. They've got other alternatives from other producing regions. And so I think there's sort of a meeting of the minds that they pause on those types of items when North America is busy. So right now, it's 4%. But I guess the purpose of that comment really is to provide some context around the fact that we're not as -- we're not a large SPF producer that's got a significant material business in China or even a dependency on China. We're sort of a consolidated boutique supplier of a number of different products and species that we sell when it makes sense to our overseas markets.

[Paul C. Quinn]

Okay. And then just maybe you could talk about the sustainability of the current demand. What your customers are telling you with respect to the demand going out. How confident do you feel that these prices are on this level of demand that is sustainable?

[Ian M. Fillinger, President, CEO & Director]

Do you want to take that, Bart? Yes, that's the $64 million.

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

Easy one. Easy one.

[Ian M. Fillinger, President, CEO & Director]

Yes. That's right. Well, so what I can do is I can give -- I can give you some context on the conversations that have taken place over the last, call it, 2 to 3 months. When this thing, first -- when the COVID-19 sort of stepped in, in March and early April, the conversations with the customers were all focused on the next 2 weeks. And that's really the only visibility that anybody seem to have confidence in. And anything else beyond that was obviously less certain. That has segued into some pretty good certainty over the 30- to 60-day period. I can get a very good feel for where our customers are 60 days out. But I can tell you the narrative, it's almost every time you make the phone call, the narrative shifts slightly. And now the conversation is that, at least, I hope we get a little bit of a lull in Q4 that puts us in a position to rebuild the inventory in the supply chain so that we're ready for Q1 2021. And so yes, starting to get some of the large -- some of our large distributors talking about how this is going to set up for 2021, which gives me a pretty good feeling for, obviously through Q3, but even to an extent in Q4. So hopefully, that gives you a context in terms of what's going to happen in the next little while. I think we're all playing our cards fairly close on saying anything that would be specific in that regard.

[Paul C. Quinn]

Okay. That's helpful. And just lastly on some of your pine lumber sales to China. You've got, in my mind anyway, a specific advantage given proximity of your mills to ports. Did that pick up? And how material would that be going forward?

[Ian M. Fillinger, President, CEO & Director]

So again, it's somewhat similar to what's happening in the West. So there are certain low grades that the overseas markets are competitive. But when it comes to #2 and better, those products are just lagging -- the prices are lagging overseas. And by a significant amount, not just a small amount. And so really, those markets aren't buying those right now. It's mostly a low-grade play, and those volumes continue as they always have. Now that's a short term phenomenon. We all know that North American markets are far more volatile than what's experienced in the overseas markets. And so we know full well that, in the medium to longer term, the diversification of Southern Hill pine lumber into the export markets is important. There's a number of us that are focused on it, and we feel good about the future. It's just short-term right now, they've got alternatives that allow them to purchase the lumber they need for less than what they can buy North American lumber today.

[Operator]

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

[Mark William Wilde, Senior Analyst]

I wondered -- could I kind of start with Bart. I'm just curious, Bart, if you can talk with us about kind of seasonal cadence in the lumber business? I'm just trying to get a sense of when we would typically expect to see some just seasonal slowing in demand just because of the weather.

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

Yes. Well, so right now, we're kind of -- I suppose, bucking the trend a little bit. August is normally a period of time, especially in the south where we see demand taper off. But that is not the case today. So it's almost like the seasonality piece is shifting around. And I think part of the -- the biggest issue I see out there is really the supply chain. I mean, there was a period of time where we were lowering our inventories. Our competitors obviously were as well. But the distribution channels were also lowering their inventories. And so we've got ourselves in a position where the demand has increased, and there's really just not the buffer of inventory in the marketplace that would absorb some of that volatility in demand. And so that is just being felt rate immediately at the mill level. And so when I look at fourth quarter normally, normally seasonality would say that demand would slow down a bit. And that may and probably likely will be the case. The part that I'm not so sure of is, from an inventory's perspective and to what degree will that period be used as the opportunity to build back up the supply chain, in anticipation of what could be a robust Q1, Q2 of 2021. And that's the piece that could see us with the decent market through the balance of the year.

[Mark William Wilde, Senior Analyst]

Okay. The second question I had, and maybe it's for Ian. Can you just speak to what you're seeing in terms of log costs around all 3 of your regions?

[Ian M. Fillinger, President, CEO & Director]

Yes. For sure, Mark. The U.S. South is stable, let me put it that way. We haven't -- we haven't seen any major swings. I mean there's a little uniqueness here and there. Pacific Northwest, much the same, B.C. Interior with the July 1 stumpage reset, $10 a cubic meter down, positive outweighing. The concern, I guess, that I guess -- what we would like to see is on the B.C. side of it is in this market, just monitoring the bid prices of the open market timber, and seeing how that -- the behavior of the lumber market might drive some of that bidding behavior on the open market. Just as a reminder on the B.C. Interior. The 3 mills that we have there, a pretty secure tenure. So the strategic acquisition we did around Adams Lake last year was to be able to insulate us from those swings that we see in the B.C. Interior when the open log market exceeds what your own delivered tenure can do. So Grand Forks, Castlegar are in very good shape, Adams Lake is in much better shape. And so I would say, generally okay right now. And we don't see anything significant on the horizon changing, other than what I talked about with B.C. and just monitoring the open market bidding.

[Mark William Wilde, Senior Analyst]

Yes. Of the 3 regions you're in and it always seemed to me that in the Pacific Northwest, there is a linkage between kind of the movement up or down in lumber prices and with a lag, kind of a similar move in log prices. You are not seeing anything on the upside right now in terms of your log costs?

[Ian M. Fillinger, President, CEO & Director]

Not significant, Mark. The -- I think what drove -- what drives a lot of the Pacific Northwest is the export log market also. And that -- that's where we'll see major competition for that log. And at this point, logs are staying in the northwest, and they're being consumed by the domestic producers. And the log export market just hasn't driven up the Pacific Northwest logs, like we've seen in different situations.

[Mark William Wilde, Senior Analyst]

Okay. Then the last one for me, are just kind of around demand, the potential demand destruction. I remember several years ago when we had high lumber prices, people started talking about steel studs and things like that. I'd like to get your thoughts on that. And then I did note the other day that the National Association of Home Builders wanted to go see Wilbur Ross and Hauser and some of the other members of the administration on the trade issue. Do you think that if these lumber prices continue to push up or even remain anywhere near where they are right now, that, that creates some political pressure to come up with a settlement?

[Ian M. Fillinger, President, CEO & Director]

Yes. I saw that headline also the other day. I don't know, Mark. I think that if you own a sawmill today, whether it's in the U.S. or Canada, it's a pretty good business. But -- I guess, I don't know how to answer that one on the National Homebuilders and whether they'll make progress on that. But on the substitute products, I'll let Bart take that. But the short answer is we're not seeing a lot of pressure from that. But Bart?

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

Yes. No. It's not a topic that I'm hearing a lot about when it comes to late framing lumber. I mean it's always a topic when it comes to the Western Red Cedar, whether it's decking or siding or any of those things, there's other substitutable products that are active in the marketplace today. Haven't heard a lot about the steel studs. The piece that actually concerns me more is when you get into prices like today, you'll get some people deferring their projects, especially on the multifamily side. I would imagine -- well, actually not imagine, I know that lumber is not the only product that's up in price right now. And so there are a number of inputs to building a multifamily or single-family home that are up from a cost perspective. And so as those developers look at that opportunity, to what degree will they push projects out further and defer demand into next year is a question mark. Now that said, there's all kinds of demand, and the business is good on -- from a sales perspective for the builders. So I suppose it's make hay well this. The sun is shining.

[Mark William Wilde, Senior Analyst]

Okay. Actually, I have one other one for Ian. And that is, Ian, it doesn't seem like the market is really reflecting what's going on in most lumber equities right now. And I'm just curious, I mean, we're going to, in all likelihood, have quite an amazing third quarter. Would you consider taking any portion of, kind of, the third quarter windfall as it were in looking at share repurchase activity?

[Ian M. Fillinger, President, CEO & Director]

Yes. Mark, we -- I mean we talk about that and debate that back and forth. But where we're at right now, and that's always subject to change on different conditions, but where we're at right now, with looking at the uncertainty of the economic or broader economy, unemployment rates and how governments and everyone is going to respond to this, it's kind of playing in a bit safe on that front. However, we are -- we do have opportunities internal that are on -- they're on our list of strategic projects. And so that's being refined, and we're looking at some of those. Obviously M&A comes up and being ready to do something if things lined up. And then the other components of, like I referred to keeping that dry powder available for better insight into how COVID is going to play out through the fall and into next year. So it's definitely one of the levers. But at this point, we just don't see us doing that right now and at the price we're at running right now.

[Mark William Wilde, Senior Analyst]

Okay. Well, listen, I'm a big fan of dry powder. But I also -- I hope that you're willing -- it points to kind of act opportunistically on things like that, like repurchase activity because it often is the lowest price lumber capacity you can buy.

[Ian M. Fillinger, President, CEO & Director]

Yes. For sure. And like I said, we do kick that around on a regular basis. We're always looking at that opportunity.

[Operator]

Your next question comes from Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

Just a couple of follow-ups. And I apologize if I missed it in the release, but did you guys have any of the Canadian wage subsidy embedded in EBITDA this quarter?

[Richard Pozzebon, Senior VP & CFO]

Sean, it's Rick. Yes, we did. We had $4.7 million included in our adjusted EBITDA for the quarter. It's not something we expect to qualify for going forward given our buying client.

[Sean Steuart, Research Analyst]

Understood. And on the 2021 CapEx, you're guiding to still a conservative number. I mean presumably, you've still got a lot you can advance, whether it's finishing up Phase II or early stuff on the third phase in the south. This might be a temporary cash flow windfall. But any context in you can give us on your decision to stay conservative in 2021 on CapEx?

[Ian M. Fillinger, President, CEO & Director]

Well, yes, Sean. The -- like the major CapEx program through Phase I/Phase II and then us looking at Phase III and particularly one of the mills in Georgia, we're getting to the point where a lot of what we had planned to do is starting to get realized and in the mill is getting repositioned to where we want it. So it's not, at this point, would be a lack of cash or funding. It's where is the next opportunity and how do we get that onto the books. So I would put it more that we, in 2021, are looking at obviously completing the next phase at Eatonton. And then looking at another major capital in Georgia and available to do more. But at this point, we've been at it for a number of years now, and we're starting to -- getting the rhythm of now being able to run these things full out. And I would say that's more the driver of the 2021 CapEx than anything else.

[Operator]

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

[Ian M. Fillinger, President, CEO & Director]

Okay. Thanks, operator. Concluding remarks, I'd like to thank everybody for dialing in and participating in the call and your interest in our company. Obviously if you have any questions or follow up, myself, Rick and Bart are available anytime. Thanks, everyone, and stay safe. Thank you, operator.

[Operator]

Welcome, ladies and gentlemen. This concludes today's call. Thank you for participating. You may now disconnect.