Interfor Corp

TSX:IFP

Earnings Call Transcript 2023-Q2

[Operator]

Good morning, ladies and gentlemen. And welcome to Interfor Quarter Analysts Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct the question-and-answer session. [Operator Instructions] This call is being recorded on Friday, the August 4, 2023.

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

[Ian Fillinger, President, CEO]

Thank you, operator and thank you everyone for joining us this morning. With me today on the call, I have Rick Pozzebon, our Executive Vice President and Chief Financial Officer, along with

Bart Bender, our Senior Vice President of Sales and Marketing.

First off, I'd like to welcome, Nicolle Butcher to our Board of Directors, and we look forward to working with her and her contributions over the years to come.

I'll start off by providing a brief recap of our quarter. And then I'll pass the call over to Rick and Bart.

Turning the last quarter, we experienced production cost decreases, price stabilization and record shipment volumes, which all contributed to an adjusted EBITDA of $41.9 million an improvement over the previous quarter. We also continue to advance in our key multiyear capital projects in the U.S. South, which are focused on delivering significant returns.

With respect to our outlook. Recent housing data has shown modest improvements including in the single-family sector. And it appears that strong underlining demand for housing continues to outweigh the impact of higher interest rates, and homebuilding activity has been resilient so far.

On the supply side, both North American production and European imports are easing, adding tension to the lumber market, while creating a positive supply demand situation.

I'll now turn the call over to Rick who will walk through the financials. Over to you, Rick.

[Rick Pozzebon, EVP, CFO]

Thank you, Ian. And good morning, all. Please refer to cautionary language regarding forward-looking information in our Q2 MD&A.

From an overall perspective, and of course, Q2 results represent significant and ongoing improvement since the fourth quarter of last year. In terms of earnings, adjusted EBITDA improves 61% quarter-over-quarter to $42 million. Revenue has benefited from an 11% increase in lumber sales volume, combined with a 2% increase in the average realized lumber sales price with both driven by strengthened end use demand.

At the same time, cost benefited from continued moderation of log costs to better reflect current lumber prices. And a $27 million reduction in the valuation reserves previously recorded against inventories.

Q2 results were also positive in terms of cash flow on our balance sheet. Cash flow from operations totaled $123 million, including $97 million from inventory reductions. These inventory reductions reflect a conscious management effort to reduce working capital investment on a sustained basis going forward. Especially at the operations we acquired last year and Eastern in Atlantic Canada, which we presented significant opportunity.

For context, our total lumber inventory volume at the end of Q2 represented a 24% reduction year-over-year on a pro forma basis, including all acquired operations. And we also reduced our total Canadian log inventory volume by 24% over the same period, and on the same basis.

The positive cash flow from operations led to our net debt to invested capital leverage ratio dropping to 29.6% at quarter end. With all else being equal, we expect further leverage reduction over the next few quarters with a collection of pending income tax refunds totaling approximately $100 million.

In terms of capital allocation over the remainder of this year. Our two key priorities are to continue reducing balance sheet leverage into our target range, and to continue investing in U.S. sales-focused organic growth and optimization. We continue to anticipate total capital expenditures of about $210 million for 2023, of which the majority relates to discretionary projects in the U.S. South with attractive returns.

As our balance sheet continues to do delever, we will remain open to evaluating other attractive capital allocation opportunities that fit with our strategic plan.

To wrap up, our second quarter results were another step in the right direction. Looking ahead, we will continue to focus on generating the best returns on capital in our industry and are maintaining balance sheet flexibility to navigate market volatility and execute on our strategic plan.

That concludes my remarks. I'll now turn the call over to Bart.

[Bart Bender, SVP, Sale & Marketing]

Thanks, Rick. Provide some comments on our market outlook for remainder of 2023. Although some of the macroeconomic factors relevant to our business remain uncertain, there are several reasons to feel optimistic as we work our way through the balance 2023 and head into 2024.

U.S. single-family starts from May and June are encouraging. Both represent a marked shift from the previous 12 months. The homebuilders in the U.S. are all reporting encouraging results in their quarterly earnings report. And guidance supports a continued trend for the balance of the year.

With many existing homeowners having relatively competitive mortgage terms, the number of existing homes for sale remains low, which supports newly constructed homes taking a larger share of home sales going forward. A benefit for the overall demand for lumber. Builder sentiment remains strong and trending upwards.

Our block store comparables remain favorable and point to a steady repair and remodel market going forward. All of these factors coupled with the other fundamentals such as underpin -- underbuilt housing, demographics, age of homes, home equity et cetera leave us feeling optimistic of improved lumber demand going forward.

In our Q1 2023 quarterly market outlook, we discussed improving I-Joist demand. This trend has continued through Q2 and the outlook remains favorable for Q3 and Q4.

In terms of lumber supply, North American production has tightened in the first half of 2023 curtailments and most recently, wildfires have impacted operating rates. And in turn, shipments in both Canada and the U.S. have declined. We expect this trend to continue as the industry works through the longer impacts of the wildfires in both the Canadian east and west.

And market inventories remain in the lower end of historical norms. And as Rick mentioned, we have driven all -- driven our overall inventories down by 24% year-over-year. We expect that as lumber demand increases lead times to supply will trend upwards. This will put pressure on distributors of lumber to purchase for immediate needs plus additional volumes to grow inventories needed to offset greater lead times to restock.

Overall, we're encouraged with the market direction and look to work our way through Q3 into Q4 and finish the year with momentum.

With that back to you, Ian.

[Ian Fillinger, President, CEO]

Thanks, Bart. Operator, we're at the point to take any questions.

[Operator]

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

[Sean Steuart, TD Securities]

Good morning, everyone. Hi, guys. Bart, I'll start with a question. Just following up on your comments on the market. Your positioning -- your take on channel inventories is still being below normal. And maybe I'm paraphrasing. But just your perspective on markets, lumber markets stalling the last few weeks and weakening I guess a little bit this week.

You're attributing this to summer slowdown, given your perspective that inventories are still lean through the channel. Wondering if you can contrast those two things against each other and help to explain why we've seen things stall a little bit the last few years?

[Bart Bender, SVP, Sale & Marketing]

No problem, Sean. Good questions. Definitely, I think volatility is always one of those things that's going to remain and so we're not going to escape that. But if you sort of step back and you look at Q, and historically Q2 has always been a quarter where supply chain issues seem to be at its lowest.

So I think we're pretty fluid and getting demand to market or supply to market. When you look at the summer, I mean, obviously we dealt with some adversity on weather, pretty much across North America. If you look at the U.S. South, I mean right now we've got people in Phoenix, putting up with 110 degree weather and you're not going to see the pace of building that you would normally when that kind of thing goes on.

And so I do think that that's probably part of it. And again, you know, I can't I got to highlight the supply chain side. Everyone talks about the improvements and that's a real thing. They have improved and so getting resupply is pretty quick, for distributors. And I think that garners a different approach to the market.

[Sean Steuart, TD Securities]

So that's helpful. Question on working capital, you guys, give us good detail on how much log and lumber inventories are down year-over-year? Are you guys at bare minimums at this stage? Is there any room for further reductions at this point?

[Rick Pozzebon, EVP, CFO]

Sean, good morning. It's Rick speaking. Now we're currently in terms of lumber inventories around 18 to 19 days of production. We think on the margin, there's still a little bit to squeeze out there. But we're pretty comfortable where we're at.

[Sean Steuart, TD Securities]

Okay. All right. Just one last one, in this process for potentially selling the tenure on the coast, can you give us a little bit more detail what's involved in this subdividing process and your conversations with the ministry to get approval? How long are you guys thinking to resolve this?

[Ian Fillinger, President, CEO]

Thanks, Sean. I mean, it is a file that we're working on. We've been on the coast for 60 years. So the complexity of dealing with all kinds of different stakeholders, including the government is not always on a timeline or pace that we move at. But all conversations with the government have been supportive in British Columbia. Our vision of how this could unfold is very consistent with the government mandate. And so I would say that we're confident in the partnership that the leadership that the government is showing today. And we just continue to work on that.

The timeline is just quite hard to predict. And I know it's really hard to model. But we have transacted on a couple of tenure sales in the past. And we feel that we've got good counterparties lined up. And we'll just continue to work on it. And it'll be a slow trickle in, we believe over quarter-to-quarter. And we would include when we're successful on sales in our quarterly reports.

[Sean Steuart, TD Securities]

Understood, that's all I have. Thanks very much, guys.

[Ian Fillinger, President, CEO]

Great. Thanks, Sean.

[Operator]

Your next question comes from the line of Paul Quinn, from RBC Capital Markets. Your line is now open.

[Paul Quinn, RBC Capital Markets]

Thanks for much. Good morning, guys. Just trying to determine how much more strength we need to see in the Canadian U.S. housing market to be able to tighten up this lumber market. Is your feeling that prices could move materially higher if we get to our kind of 1.5 million starts next year? How do you guys see the way unfolding going forward?

[Bart Bender, SVP, Sale & Marketing]

Yeah, Paul, it's Bart here. I mean, certainly, we've been encouraged with what we're seeing on the housing starts. We've got the single-family piece that's creeping up from a low of 60% getting up into 65% now the starts. Obviously, that's a boost for lumber demand.

And so we think we're going to see more of that as things move along. When you look at the big builders, and the things that they talk about. It's pretty encouraging, and most, if not all, are talking about improvements going forward. So, it's hard to put a number on it, but I think it's probably more a percentage of single family to multifamily that needs to come up. And, yeah, we just need to continue on with what we're doing.

[Ian Fillinger, President, CEO]

I would just add, on the supply side, Paul. As you well know, I mean, we are seeing a dramatic reduction in imports from Europe, into the U.S., which is super encouraging. Given that it's quite high, and now it's a steep drop off. So that with curtailments and some permanent curtailments. And we still believe there's more to come out.

I think just kind of adds to your comment around, the 1.5. And Bart's comments around the market and in the supply side, contracting in a couple areas is I think at one five that used to be a great number. And just given these dynamics, who knows what market will do. But I think the fundamentals are lining up pretty nicely.

[Paul Quinn, RBC Capital Markets]

Okay, then just wondering, given the current conditions, are we going to see any change in your production profile on the back end of the year from the front half of the year?

[Ian Fillinger, President, CEO]

I would I would say there, given the curtailment that we have taken in the first six months, particularly around balancing the inventory that Rick had talked about, and then the market weakness. We probably, given everything equal today should see a production increase going forward in the last half of this year.

[Paul Quinn, RBC Capital Markets]

All right. That's all I had. Best of luck. Thanks.

[Ian Fillinger, President, CEO]

Thanks, Paul.

[Operator]

Your next question comes from the line of Ketan Mamtora from BMO. Your line is now open.

[Ketan Mamtora, BMO Capital Markets]

Good morning, and thank you. Maybe to start with Bart, can you talk a little bit about, you know, how are the inventories from the European imports, where are they right? I know the actual volumes have started to come down. But is there still a lot sitting around the eastern seaboard?

[Bart Bender, SVP, Sale & Marketing]

Yeah, it's definitely moderating, for sure. I mean, obviously, we saw some fairly significant increases on what was the important tail end of last year and beginning of this year. And that was all about the correction of the supply chain constraints that were happening over in Europe. And so a lot of that would made its way to market.

I will say that, that quite a bit of that what it was aged, so you could tell it was sitting on the docks, whether in Europe or in the U.S. for some time. And so that's one issue that the industry and the markets are working through. I can tell you see the stats as well, the imports that are coming in have dropped dramatically. And our intel tells us that there's potential for further declines. So it's just a matter of time before everything cleans up. But we're certainly hearing a lot less about imports today than we were, call it Q1. So definitely improve.

[Ketan Mamtora, BMO Capital Markets]

Got it. That's helpful. And then give us a quick update on sort of how you guys are thinking about the multiyear CapEx program that you talked about in the past? Is that any sort of -- are you reassessing in terms of kind of how you should approach it given market backdrop, which is quite fluid?

[Ian Fillinger, President, CEO]

Ian, here, thanks for the question. Our adjustments to the CapEx strategic CapEx plan is largely unchanged since our last call. So the key projects in the U.S. South are moving along. And we continue to stay committed to those and feel that, in the long-term, medium term, long-term loans will obviously pay off nicely for us.

So no update or changes expected in the CapEx plan from last quarter.

[Ketan Mamtora, BMO Capital Markets]

Got it. That's helpful. I jump back in the queue. Good luck.

[Ian Fillinger, President, CEO]

Thank you.

[Operator]

[Operator Instructions] Your next question comes from the line of Hamir Patel from CIBC Capital Markets. Your line is now open.

[Hamir Patel, CIBC Capital Markets]

Hi, good morning. Ian, do you expect Interfor will be selected as a mandatory respondent in the trade case for me ongoing review? And do you see any risks there just given the approach that they commerce previously took with the other eastern producer that was previously selected?

[Ian Fillinger, President, CEO]

Yeah, Hamir, we scenario plan for this. Interfor is ready to respond and take on the work that is required if you are selected, so we're in really good shape that way. Obviously, we're continuing running models. So we don't see a big risk coming at us either way, whether we're selected or not. And yeah, I don't really how much more to comment on that.

[Hamir Patel, CIBC Capital Markets]

Okay, great. Do you have a sense of the timing as to when maybe a determination would be made there and when would that potentially take effect?

[Ian Fillinger, President, CEO]

No, I don't actually. This year, so it would be -- I guess it would be next year or the year after. But I don't have the exact timing here.

[Hamir Patel, CIBC Capital Markets]

Okay. Fair enough. And just last question I had was on the fiber cost side. How do you see costs playing out across your different operating regions over the months of the year?

[Ian Fillinger, President, CEO]

Yeah Hamir, obviously, BC and Rick can jump in if you if I missed anything. BC was the some congestion was great for us. As it sort of realign log cost to current market conditions. The BC government moved to a shorter timeline on some of the adjustments we think is positive and something that we've been working with our partners with and government to make happen for many years. So that's great.

But yeah, in our other jurisdictions, they're holding or reassessing downwards. So we're confident that given the market condition today, we're seeing the right trends in low cost across our system.

[Rick Pozzebon, EVP, CFO]

And Hamir, good morning, it's Rick. Exactly what Ian said, the BC Interfor expects stump is to come down and other say $10 to $15 a cubic meter in Q3 versus Q2. Now, we're also going to see some benefit in Quebec from fire salvage timber. So there'll be a reduction in stumpage rate, likely at the end of Q3 into Q4 and beyond about $5 to $10 per cubic meter.

[Hamir Patel, CIBC Capital Markets]

All right, great. Thanks all I had. I'll turn it over.

[Ian Fillinger, President, CEO]

Thank you, Hamir.

[Operator]

There are no further questions at this time. I will now head over to the call to Mr. Fillinger, please continue.

[Ian Fillinger, President, CEO]

Okay, just to wrap up, thanks for your interest in the company. And as usual, feel free to reach out to any one of us at any time. Concludes our call and have a great weekend.

[Operator]

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