Interfor Corp

TSX:IFP

Earnings Call Transcript 2021-Q2

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Interfor quarterly analyst call. [Operator Instructions] I will now turn the call over to Mr. Ian Fillinger. You may begin.

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

Thank you, operator. Welcome to our Q2 '21 Investor Analyst call. I hope you and your family are safe and doing well during this pandemic. I would also like to acknowledge the heroic efforts of our Interfor staff and contractors that are fighting the wildfires in British Columbia. I'd also like to welcome all of our new employees who may be listening in from the 4 mills that we purchased last quarter. With me today, you have Bart Bender, our Senior Vice President of Sales and Marketing; along with Rick Pozzebon, our Senior Vice President and Chief Financial Officer.Our agenda today will start off with myself providing a recap of our financial results, our strategic focus and our improvement efforts. I'll then pass the call to Rick, who will cover off financial matters and then I'll pass the call off to Bart, who will cover off the markets.Turning to our financial results. Our Q2 adjusted EBITDA was again an all-time record, coming in at $611 million. By executing on our strategic plan, we are generating both top decile lumber margins and returns on capital. I encourage you to look through our investor deck on our website and take note of these metrics.Turning to our strategic focus. We continue to focus on achieving greater results of capital through our unrelenting focus on operational excellence and capital deployment. We continued on our CapEx improvement plans in every region and deployed $41 million last quarter. We are now developing our next round of key strategic projects, which are focused mostly in the South platform. We continue to work hard on our capital allocation discipline to ensure the best returns for our shareholders.And we are seeing strong performances from our recent acquisitions. I'm also pleased to report that we intend to restart the DeQuincy mill in Louisiana. Our team has full confidence in the log supply, the regional customer demand and the availability of the at-ready workforce. I also want to thank both the state and local governments for their support and incentives.Our improvement efforts were again balanced across the company as we made progress in all regions. Our operating team achieved record production during the quarter and balanced that with very strong shipments. Our conversion costs and overhead costs both continue to trend positively to our ongoing cost control and increased production levels. Our capital spending program continued to advance forward as we continue to modernize all of our operations.Of note and what doesn't always show up in production numbers is the grade mix outturns that we're achieving. Our value extraction from logs in the South has significantly improved. Finally, we continue to apply our very disciplined approach to our working capital by ensuring that we don't build excess volume in the supply chain and that we're as lean and mean as possible.Lastly, we continue to have significant financial flexibility to consider a number of further capital deployment options that Rick will cover. In closing, we are focused 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. And I'll now hand the call over to Rick.

[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 in our Q2 MD&A. As Ian mentioned, this was a very strong quarter for our company. Our fourth successive quarter of new records for both sales and EBITDA. While the market environment has been favorable, we are also seeing the benefits we expected from capital allocation decisions our team has made over the past year. Interfor continues to generate top-tier margins from its lumber operations and is now consistently meeting the industry and returns on capital employed. I'd encourage you to take a look at our latest investor presentation on our website for more info on this.Our recent acquisitions have been immediately accretive. And we realized the margin enhancements for our multiyear strategic capital program and the strong operational focus across our business. The result is that Interfor is now very well positioned to deliver attractive margins and returns over the course of the lumber cycle. We're also well positioned with the financial capacity to pursue further accretive growth and continue optimizing our current portfolio.Looking at Q2 specifically, Interfor generated record adjusted EBITDA of $611 million, representing a margin of 56% on sales of $1.1 billion. We produced 716 million board feet in the quarter and shipped virtually all of it, at a record EBITDA margin of $856 per thousand board feet. Our EBITDA margin on lumber continue to rank very well against other publicly listed lumber producers. This reflects the high quality of our sawmill portfolio and the continued focus on product mix, improvements and cost control.In terms of cash flow, we generated a record $7.46 per share from operations in the quarter, finishing in a net cash position with ample available liquidity of $1.2 billion. These record results were based on the strong foundation our management team has built over the past several years and driven by the exceptional lumber markets. We also received $40 million of cash or $0.63 per share from the sale of the former Hammond sawmill site following quarter-end. The exceptional cash flows year-to-date have bolstered our balance sheet and allowed us to rapidly advance in our strategic plans to dramatically transform with scale, profitability and returns potential of our business.We've added about 900 million board feet of high-quality lumber production capacity through 2 acquisitions this year. Collectively, the 5 mills we've acquired generate above-average EBITDA margins, provide significant economies of scale and increase the concentration of our asset base in the attractive U.S. South and Northwest regions. The Summerville South Carolina sawmill contributed significantly to our second quarter results. And the sawmills we acquired from Georgia-Pacific on July 9th has been immediately accretive to earnings and cash flow.We've also returned a significant amount of cash to shareholders, which has helped position our business to generate even higher returns on capital from our growth. We purchased $49 million of Interfor shares in the second quarter, bringing total purchases under our NCIB to $94 million at an average price of just under $25 per share or about 1x book value at June 30th. One times book value has been a very attractive price level for our shares historically. We also rewarded our shareholders with a special cash dividend of $2 per share, totaling $131 million in recognition of the extraordinary cash flow generated in the second quarter.What's truly exciting is that we still have substantial financial capacity to grow further and create shareholder value. As part of this, we've announced an expanded strategic capital plan focused on our U.S. South platform, with an additional USD230 million to be invested over the next 3.5 years to increase production by 250 million board feet per year while also enhancing our margins.Interfor's total capital expenditures are now expected to be approximately $175 million this year and likely in the range of $200 million to $250 million next year as the company executes on its expanded strategic capital plans. We've also announced plans to restart a recently acquired 200 million board foot to DeQuincy, Louisiana sawmill in the first half of 2022. In addition to this organic growth, we see potential for more sawmill acquisitions at sensible risk-adjusted returns and we'll continue to opportunistically repurchase Interfor shares.To wrap up, our second quarter earnings and free cash flow were exceptional, reflecting recent market conditions as well as the deliberate steps we've taken to position Interfor to deliver strong financial performance and shareholder value. We've also dramatically transformed the scale and free cash flow generating potential of our business through acquisitions.Looking forward, our focus will continue to be on building shareholder value through disciplined execution of our strategic plan, while generating industry-leading returns on capital.That concludes my remarks. I'll now hand the call over to Bart.

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

Thanks, Rick. Good morning, everyone. Macroeconomic factors remained positive for the future of lumber demand. Housing starts are strong. Interest rates remain low, demographic support increasing first-time buyers and housing stock average age will increase repair and remodel. In terms of repair and remodel, and use sector outlook remains positive while our short-term DIY buying patterns have shifted. Every quarter, we always make the statement that we expect lumber prices to be volatile and this quarter is obviously no exception.From a supply standpoint, we enjoyed having the Summerville mill in our portfolio, which put us in a position to grow with our customers. In addition, we look forward to realizing the opportunities that exist with the acquisition of the GP sawmills. The product mix at the Philomath and sawmill complements our existing sawmills in the region will now produce dimensioned studs and timbers both in Doug-Fir and Hem-Fir in that region.The 2 other operating -- and Fayette Alabama and Bay Springs, Mississippi add relevance and reached to our customers in the South Central region. And lastly DeQuincy. I can tell you, we received many calls from our customers asking us when we will start this mill. The product mix and location expand our market reach to the Southwest region and again puts Interfor in a position to grow with our customers. We are looking forward to seeing this mill operating and servicing our customer base. Back to the market. Through Q2, very high prices drove some short-term shifts that played into an eventual market price adjustment. Subtle shifts in supply lines, export being repatriated into North America and pursuit of those higher prices.U.S. softwood lumber imports increased year-over-year. And of course, North American box store inventories increased -- increased their inventories in anticipation of high demand of spring. In terms of demand, affordability prompted some to delay postpone or even cancel projects, most prevalent in the DIY segment. Job site demand constrained by other building materials, EWP, windows, appliances, you need it. They're all dealing with the same supply chain issues that we are. Lastly and likely most significantly, consumer desire to vacation connect with family and entertain comp taking on more projects at home. I think we can all get our head around that.On top of this, at such high prices, distribution risk increased substantially. You can't underestimate this side of the equation. No one wanted to be caught with such high cost inventories, purchasing became very cautious given the risks. Reduced demand in DIY increased availability result -- which resulted in increased availability to other distribution channels, reducing replenishment weights, given the increase in supply within North America and somewhat reduced demand, price tension declined in the lumber markets. This said, looking forward, we do remain optimistic. New home construction remains strong. Constraints in other building materials are expected to subside. Non-res and industrial markets remain resilient. Repair and remodel is starting to pick up. Inventories are normalizing. Lumber pricing is more affordable and weekly consumption is improving. The export markets are active, taking advantage of the more competitive North American lumber prices. We feel the fundamentals continue to support robust lumber markets going forward.With that, I'll turn it back to you, Ian.

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

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

[Operator]

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

[Sean Steuart, Research Analyst]

A couple of questions. The higher CapEx guidance, we've seen some competitors tempered their midterm CapEx plans due to delays and backlogs for equipment. Are you -- how are you guys able to avoid that? And is any portion of the increased spend tied to equipment cost inflation?

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

I'll take that, Sean. The -- getting out front of -- and as much notice as possible obviously is going to help the supply chain issues on parts, equipment, steel and those things. So we have factored that into our time line. And as far as cost and cost escalation goes, we have -- we do do that. We run different index, sort of hedging sort of scenarios and models, things like on steel and other equipment. So we do have a pretty sophisticated program when it comes to covering off those risks. And also, what we have learned is the contingency needs to be up a couple of percent just to cover off any other risks. So all of those are factored into our IRR calculations prior to approvals on those projects.

[Sean Steuart, Research Analyst]

And IRRs on this incremental CapEx you're still consistent with the types of returns you would have talked about before from your perspective?

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

Absolutely.

[Sean Steuart, Research Analyst]

Okay. And then, my second question was, I read your comments on M&A. And I guess the question is, how long do you expect the integration of the GP assets to take? It sounds like things are proceeding well out of the gate. And when do you think you'd next be ready to move on an opportunity? And any context on scale of opportunity that might be out there?

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

Integration-wise, Sean, we're very proud of where those mills, both mills, Summerville and all of the GP mills. We take that so seriously and plan to the length degree. And with partnership from the site leaders from GP that is now with us, it's going extremely well. In fact, there was one report where I think it took 2 hours to sign up the employees. And by lunchtime, production was happening. And we were shipping lumber into 4 lumber by that afternoon and that continues to go very well. So I would say our integration right now as far as impact to any metric coming out of those mills is behind us. So we're smoking and blowing on those ones right now. So we feel very good on that. And then, as far as readiness for future opportunities, we're ready to do. We can -- we feel very strongly about the team that we have and the neat integration capability that we have that if the right opportunities was in front of us and it was available and it met our thresholds, we go after it and make it happen.

[Operator]

Your next question comes from the line of Mark Wilde with Bank of Montreal.

[Mark William Wilde, Senior Analyst]

I'll start out, whether it's possible apart for you to give us a sense of kind of demand trends in the various channels, whether it's creators, the big boxes, the pro dealers, to homebuilders?

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

Sure. From our vantage point, the demand side on the new home construction is solid. We've got the housing starts to support that and we're seeing that through those distribution channels. On the repair and remodel side of the business, we'd see the pro contractor. That business continues to be quite strong. It's the DIY sector that appears weak. And I think that there was some fairly decent inventories built up in anticipation of a fairly strong spring on that segment and that didn't necessarily materialize. So I would call that 1 weak. And then, looking at export. Actually, I think exports worth mentioning that now the prices have moderated in North America, a lot of the markets that haven't been getting their supply of North American lumber have stepped in to take advantage of that. So yes. So essentially, to sum it all up, I would say that repair and remodel is fairly stable. That all work its way through. Industrial, non-res is very stable. And then, of course, there's obviously upside leverage to the housing segment.

[Mark William Wilde, Senior Analyst]

Okay. And is it also possible Bart to get some sense of where you're seeing in its inventory in your own system kind of across the 3 regions and also kind of what your sense is of inventory kind of through the channel?

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

Okay. Well, in terms of our own inventories, we maintained an order file. And so we don't sit on inventories for very long. In fact, mostly the inventories that we have are simply working their way through the logistics process on their way to market. I would say that the box store side of the business, that's where you saw the biggest inventory build. And we've seen that with our own programs, but we've also started to see consumption picked back up. So I think that they're getting close to being done with that process of rightsizing those inventories. And I think what happens when you -- that side of the channel gets full, the availability that flows into all the other distribution channels increases. And as soon as that right-sizes, it goes back to where it was. So I would suggest to you that the majority of distribution is still working through their high-priced inventories. They're working those down. And so far, they haven't replenished to the degree to which they may be moving that inventory. And so I sort of see a crossroads coming here fairly soon, where all markets will have to replenish at some point.

[Mark William Wilde, Senior Analyst]

Yes. And I guess on that, just with the fire situation, not only in BC but down into Oregon and Northern California. Any problems just getting logs for your mills?

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

Mark, Ian here. I'll fill that one. Well, absolutely. In British Columbia, there's no logging activity happening in the province, as you know is under a state of emergency with the wildfire situation. So yes. I mean, typically, log inventories in the British Columbia region are pretty low in September and then build through the fall and winter for, as you know, spring breakout. So log deck today are traditionally pretty low. And then, you throw the wildfire on top of it and there's not a lot of room and that's why you've seen us in some of our peers taking downtime.That situation is pretty fluid. It's not getting any better here. And so we've got to monitor that on a week-to-week basis. But before extending this much longer into August, it does start to impact I think further potential curtailments in BC. For our company in Oregon, Washington we're monitoring the situation. We don't have much risk in our areas thankfully. And just obviously challenging for other companies that have operations in those areas. But at this point, it's business as usual for Pacific Northwest log supply program.

[Mark William Wilde, Senior Analyst]

Okay. And then, Ian, I'm just curious with the -- with your announcement about curtailing production up in BC. Can you just help us understand what the key metrics are that you're watching as you make a decision to curtail, whether it's kind of log supply, just price versus cash cost, inventory levels. What are the pieces of your equation? And what's the relative weight of each of them?

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

Yes, for sure. I mean in this situation, our mills obviously you're very profitable in most regions. And I'd like to remind everyone that our mills are located in Central BC or Northern BC there in sell their BC with alternative species to SPF. And in fact, SPF is a very small part of our interior business. But in this situation, Mark, it was simply can we get logs in, the speed and pace of production and the risk to trying to push it on the log side and it just didn't -- the math didn't work.It was -- we're going to be running out of logs here than later. And everybody up here is focusing on the wildfires and all resources. All of our Interfor logging staff is fighting fires alongside of the firefighters that the province has deployed. So it just became as simple as that. But I mean, any time we're making decisions on curtailments, we don't take them lightly and the impact of whole bunch of stakeholders, most importantly, employees and customers. So we look at the profitability, try to see through the ups and downs and have disciplined decisions for the profitability of those things and we've hit a number of those metrics that we look at already.

[Mark William Wilde, Senior Analyst]

Okay. And the last one for me. Rick, just within the context of the CapEx numbers you threw out, can you give us some sense of both how the Summerville mill and then the 4 GP mills fit within those CapEx numbers that you gave us?

[Richard Pozzebon, Senior VP & CFO]

Yes. For sure, Mark. In terms of the Summerville mill, it's about USD30 million for that project. That will be complete by the end of 2022. And then, in terms of the GP mills, there's a little bit of spend included in that later on in 2024.

[Mark William Wilde, Senior Analyst]

Okay. And is that GP spend since it's a few years out, would you say that there is kind of a reasonable likelihood that is let's say, you've had these mills for 6 to 12 months that we may see some capital for those mills kind of pulled forward?

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

Mark, it could, but I don't think it's going to be major strategic capital. There may be some projects identified that are less than $10 million, for example, that have super high paybacks that we may deploy. But at this point, the strategic capital is part of those numbers that Rick said.But you're right. As we get to work with the teams there and understand the mills, and there's a small project here or there that we can capitalize and pay off in less than 12 months, we'll do it. But as far as Board-approved strategic capital, those are the numbers that Rick is quoting.

[Operator]

[Operator Instructions] Your next question comes from the line of Roshni Luthra with CIBC Capital Markets.

[Roshni Luthra, Research Analyst]

I just have a couple of questions. So for the Quintero, how much production do you expect next year once have ramped up in January?

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

Well, I'll flip it over to Rick for a second on this. But it's not -- we haven't said it will ramp up in January, it's the first half of 2022. So that mill produces annually about 200 million board feet. And so it will be somewhere 100 million hopefully, somewhere around there for that year as we bring it online. But we fully expect to get it up to the 200. And that may advance. And so we're hoping it will, but a very conservative number would be the number that I just gave.

[Roshni Luthra, Research Analyst]

Okay. And then, for stumpage, what are you expecting it to go up in October? And how much do you think it will decline in January?

[Richard Pozzebon, Senior VP & CFO]

This is Rick speaking. For Q3, we're looking at probably $100 per 1,000 board feet of stumpage increase, and then Q4, maybe 1/3 of that on top of what we see in Q3. And then, we're looking forward to normalize down to where it was in Q2 this year, starting in Q1 and 2022.

[Operator]

Your last question comes from the line of Paul Quinn with RBC Capital Markets.

[Paul C. Quinn]

Just following up on the stumpage question. Lumber printed western SBF at 490 last night. Just wondering if you're still cash positive in the BC mills given the stumpage increase?

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

Well, Paul, right now, we're down in some of our mills, as you know. But I don't know if we really want to share that. I can tell you that Adams Lake, Grand Forks and Cassada are as you know very top decile operations with very little exposure to SPF. So our pricing, we look at SPF, but those mixes with Cedar, Hemlock, Fir, et cetera. That wouldn't be a really good benchmark. Let's put it that way. We're realizing higher numbers.

[Paul C. Quinn]

Okay. Fair. You've had to GP mills for almost a month now. What's the takeaway? And what's required to bring back DeQuincy?

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

Well, the takeaway on the mills that are running. So the 3 flow mills Bay Spring and Fayette as Rick pointed out and Bart contributing on day 1, great teams. When you do a deal with a company like GP, you get good infrastructure, you get the ability not have to pay for certain site upgrades because they're at a very high standard. So it's been a plug-and-play to be honest. For DeQuincy, our team has been at the site prior to us owning and then every day since working with the local management team there. We've done a full assessment of the equipment, done an asset health check. We've got the plans in for the maintenance materials and supplies that we need to bring in to the site. We've done the due diligence with our logging contractors in the area, their ability to deliver, done customer outreaches, particularly in the Texas area. And we've been working with local state and local government on employees, secured incentives and have been actively working for that at ready employment base there. So that's everything we've been doing over the last month, which is a pretty awesome effort by everybody involved at the site and in our southern platform.

[Paul C. Quinn]

Okay. And then, just on equipment. I mean there's a lot of -- there's a number of greenfields that are being done and lots of people are upgrading, given the console that they've had. Are you guys experiencing any difficulty on access to equipment? And are you splitting it between the 2 main sawmill providers? Or is it -- are you more exposed on one than the other?

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

No. We have -- we don't pioneer any new equipment. So we're not going to do any leading edge stuff. So just -- that's one thing that we've always adopted. But no, we have preferred vendors for preferred equipment, and we don't vary from that. And it's a mix across the equipment supply industry. The time lines, as we've outlined in our project gate chart are solid, and they've taken into account the delivery time lines, commitments from the vendors, et cetera. And as a previous question was asked, we do scenario out through different tools on forecasting on impacts to cost on steel cost, oil costs, transportation costs, and we have a pretty robust plan to forecast that outing or budgeting process. So Paul, short answer is our Gan chart that you'll see in our investor deck has been vetted 3 weeks to Sunday. And at this point, we don't see any risk to those time lines.

[Paul C. Quinn]

Okay. That's great. And just on the M&A side. I mean you're obviously ready for growth, as you pointed out. What's the appetite is there in terms of new owners looking to sell now? Are they -- I mean, we've seen a big reversal in lumber prices going up and then coming down? Are they now want to get out? Or are you seeing any change at all in the number of offerings out there?

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

There seems to always be, Paul, something in that space. We think we always know and we're in on those through, obviously, processes. And in a lot of cases, through the personal relationships that we've leveraged over the last number of years. So we see opportunities out there still. I'm not sure if everybody's re-corrected their expectations given where they were a few months ago, but we're thinking and talking about that every day.

[Paul C. Quinn]

Okay. And then just lastly on softwood lumber deposits. You've got not that much exposure there, but have the amount of money there. Any moving on that file at all? Or what do you expect to happen going forward?

[Richard Pozzebon, Senior VP & CFO]

Paul, it's Rick. Yes, you're right, we've got USD158 million on deposits today. So pretty substantial amount. If you look at it on an after-tax basis, it's about $2 per share, so pretty significant. There's been no significant movement on the file over the course of the last quarter.

[Operator]

We have time for one next question from Mark Wilde with Bank of Montreal.

[Mark William Wilde, Senior Analyst]

Yes, just 2 quick follow-ups. I wondered, Rick, whether you can provide us with just some general guidelines for kind of financial strategy for managing your leverage, not an issue right at the moment. But just as we look out over the next 3 or 4 years and you're looking at M&A and taking your CapEx, what should we think about in terms of balance sheet management?

[Richard Pozzebon, Senior VP & CFO]

Sure, Mark. If you look historically, we probably averaged about 20% net debt to invested capital over the last 10 years or so. We've got a target range in mind here going forward of probably 15% to 30% net debt to invested capital, and we'd be comfortable going up to about 35% net debt to invested capital.And that's obviously well below our covenant at 50%. So we're leaving ourselves. It's quite a bit of buffer and being very conservative. We think that provides us lots of flexibility to take advantage of M&A opportunities and other growth opportunities when they do present themselves. So we'll look to maintain a fairly conservative leverage going forward.

[Mark William Wilde, Senior Analyst]

Okay. And then, secondly, Rick, is it possible to get some sense of kind of where your July lumber realizations were versus the second quarter average?

[Richard Pozzebon, Senior VP & CFO]

I don't have that number in front of me, Mark. We're actually still including the one, Mark.

[Mark William Wilde, Senior Analyst]

Okay. All right. And if we could get that at some point, I think it would be helpful to us. Just to try to think about sort of the sequential bridge into the third quarter.

[Richard Pozzebon, Senior VP & CFO]

For sure.

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

Operator, that's the end of the questions as I understand?

[Operator]

And it's correct sir.

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

Okay. I just have a couple of concluding remarks. Our strategy has been consistent over time and across regions. We focus on assets with future potential by applying our efforts on operational excellence, the establishment of best practice even followed by capital investments. Our strategic investments are resulting in well capitalized, low-cost sawmill portfolio. We're delivering top-tier margin performance across all market conditions and our strategic CapEx and other capital deployment actions are having a notable impact on our return on capital. I'd like to thank you for dialing in and participating in our update call this morning and your interest in our company. If you have any further questions, please reach out to myself, Rick or Bart. Thanks and have a great day.

[Operator]

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