Interfor Corp

TSX:IFP

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. My name is Ina, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor analyst conference call. [Operator Instructions]

Thank you. Mr. Fillinger, you may begin your conference.

[Ian Fillinger, executive]

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

I'll start off by providing a brief recap of the quarter before passing the call off to Rick and Bart.

Turning to our Q2 results. Our adjusted EBITDA was negative $17 million during yet another challenging quarter that was impacted by continued weak pricing. Log costs and conversion costs were down in most regions and shipments were ahead of production. Our team continued to drive cash from working capital with reductions made in receivables and also in both log and lumber inventories. We did see additional industry supply reductions made and believe about 5% to 7% of industry capacity has been removed since the beginning of this year, and we expect more volume to come out.

We are updating our production forecast, and we will be curtailing several of our low-margin mills for the remainder of the year. Our updated guidance represents approximately 15% of our production volume or around 280 million to 350 million feet. It's not lost on us, the difficulties and challenges these decisions have on our employees, families, suppliers, communities. We have been and we'll continue to be an industry leader when it comes to dealing with adjusting capacity or making tough decisions to strengthen our portfolio of operations. We have a more positive outlook as we head into 2025. However, we are planning for continued weakness until more industry supply is removed.

I'll now turn the call over to Rick, and he'll walk you through the financials.

[Richard Pozzebon, executive]

Thank you, Ian, and good morning all. Please refer to cautionary language regarding forward-looking information in our Q2 MD&A. At a high level, Interfor's Q2 results from operations were fairly similar to the prior quarter and continue to reflect the ongoing weak lumber market.

With respect to earnings, Interfor generated an adjusted EBITDA loss of $17 million on total revenue of $771 million. Revenue declined by 5% quarter-over-quarter, driven by a 4% decrease in lumber shipment volume, combined with a 1% drop in the average realized lumber price. On the cost side, reported production costs per unit of lumber sold were 2% lower quarter-over-quarter. This reflects benefits from our ongoing focus on productivity and cost efficiencies. Ultimately, a net loss of $76 million was realized in the quarter.

Regarding Interfor's financial position, it remains stable quarter-over-quarter, and in Q2 with a net debt to invested capital leverage ratio of 35% and available liquidity of $331 million. The company's financial position was supported by $48 million of operating cash flows in the quarter driven by the release of $72 million of working capital. This working capital improvement is attributable in part to our active management of log and lumber inventories. Also supporting the financial position was $21 million of cash generated from asset sales, including assets of the former sawmill in Philomath, Oregon.

Looking out over the remainder of 2024, we continue to expect collection of tax refunds totaling approximately $59 million and further cash proceeds from the sale of Coastal B.C. forest tenures. We anticipate completing the sale of all remaining coastal tenures by the end of 2025 for estimated total net proceeds in the ballpark of $70 million, with approximately 50% in the second half of this year and the remainder in 2025. Regarding capital allocation, we will continue to take a conservative approach as we manage through the sustained market weakness. Our primary focus remains on reducing financial leverage into our target range below 25% net debt to invested capital. As part of this conservative approach, total planned capital expenditures for 2024 have been reduced to $70 million from our previous guidance of $90 million.

To wrap up, Interfor's Q2 results reflect the persistently weak lumber market, which we continue to view as unsustainable for the industry as a whole. We continue to be focused on positioning Interfor and its operations to successfully navigate through this period as supply rebalances with demand.

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

[Barton Bender, executive]

Okay. Thanks, Rick. Lumber markets remain difficult to forecast as demand and supply remain out of sync. The much anticipated spring building season was a nonevent, frankly, coupled with no interest rate change by the Federal Reserve has made -- has left many on the distribution side and consequently, the manufacturer side, reassessing the go-forward strategy. All will agree the fundamentals remain positive. However, economic confidence and affordability concerns are at the forefront. From a manufacturer standpoint, lumber demand has slowed. This is partly a genuine drop in consumption and partly distribution driving down their own inventories. The true level of consumption isn't exactly clear currently, but in our assessment it is better than it is appearing today.

Single-family housing remains a positive story. However, repair and remodel and multifamily remain under pressure. A clear signal from the Federal Reserve that interest rates will start to ease, which go a long ways in setting the market towards recovery. Interestingly, mortgage rates are already starting to decline. We're hearing rates in the mid-6% range. Perhaps this is the mortgage market anticipating lower rates. Regardless, it's much closer to a level that would encourage more move up and new home purchases.

With supply chain issues far behind us, the available capacity of both rail and truck are more than enough to put distribution in a position to drive their inventories as low as possible. It is our view that the market inventories are in the lower end of the historical spectrum. On the same basis, we've been able to maintain our own inventories at historicals, which when coupled with high discipline on maintaining short order files will ensure quick tension when supply/demand balance comes into the market.

Softwood Lumber duties on Canadian producers are set to increase from 8% to close to 14%, quite frankly, in days here, that's going to obviously increase the level of uncertainty in lumber production from Canada, which represents 23% of the U.S. market share. We think the market response will be higher prices, most likely achieved through more curtailments in Canada.

Further on the supply side, there have been sizable curtailments so far. Most of them announced, however, a meaningful portion unannounced. The impact of the curtailments takes time to settle in the market. We don't believe they are fully realized at this point. We fully expect there to be continued curtailment in our industry, most significant in the regions with the lowest margins, which today has been most significant in the South. Lumber prices will continue to be range bound until such time as lumber availability becomes difficult. We continue to believe that SPF prices will appreciate relative to Southern Yellow Pine over time, primarily due to the lack of substitution in some applications and also constrained fiber. At the end of the day, Interfor will continue to adjust production to meet the demand.

Back to you, Ian.

[Ian Fillinger, executive]

Okay. Thanks, Bart. Operator, we're good to turn the call over for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Kasia Kopytek from TD Cowen.

[Kasia Trzaski Kopytek, analyst]

It's Kasia on the line. Question about the temporary curtailments -- incremental temporary curtailments that you guys announced yesterday, 280 million to 350 million board feet, that's over August and December. And I'm just curious -- does that include any overlap from the curtailment that you announced back on April 30, which were from May to September. So I guess, the overlap over the August and September period is what I'm asking.

[Richard Pozzebon, executive]

Kasia, it's Rick here. Thanks for the question. Certainly, there's a little bit of overlap there, but I guide you to think about that as being forward-looking guidance. So from August forward through the end of the year, that is our stated temporary curtailments of 280 million to 350 million board feet and sort of ignore the prior guidance and just look at our actual production year-to-date through June and factor in this new guidance we've provided.

[Kasia Trzaski Kopytek, analyst]

Got it. Okay. So basically, that's all incremental kind of your go-forward guidance from the stage.

[Richard Pozzebon, executive]

Correct.

[Kasia Trzaski Kopytek, analyst]

Right. Okay. And would you have taken anything in Q3 from that April 30 announcement -- sorry, in Q2 rather?

[Richard Pozzebon, executive]

There's some included in our Q2 results that we reported, correct.

[Kasia Trzaski Kopytek, analyst]

Okay. But I assume most of that was in Q3, right?

[Richard Pozzebon, executive]

Correct.

[Kasia Trzaski Kopytek, analyst]

Okay. And Bart touched on this in his prepared remarks, but can you maybe speak to the U.S. [ South ] and how Southern Yellow Pine is more exposed to renovation end markets? Is that something that's more at the margin? Is that something that you guys do see being played out in market dynamics? Just thoughts on that in general?

[Barton Bender, executive]

Sure. Thanks, Kasia, it's Bart here. So the U.S. South, on the repair and remodel side, heavy on the treating side, obviously, that fiber lends itself very well to the treating applications. And so we've seen kind of a mid-single-digit decline in activity on that side. The other piece that I think is pronounced for the south is a couple of things. One is on the multifamily side, the area that's hit the hardest and has the most significant declines are the markets in the south. So take your Florida, your George, your Texas, they've seen pretty significant declines in that area. And of course, that would have a direct impact on the south.

The other thing I think we can't forget about is the fact that we're right in the middle of the summer. And this is kind of that time of year when things are slow. And so we've got weather to think about, I mean obviously, we've had some storms, we've had some wet weather, the heat is high. I think all of that impacts, I think the consumption of lumber. So we're kind of at the toughest part of the year. We'll look to the balance of the year to improve. And I think, as I said in my comments, I think some clear signals from the Feds -- the Federal Reserve on interest rates, I think will set us well in that regard.

[Operator]

And your next question comes from the line of Matthew McKellar from RBC Capital Markets.

[Matthew McKellar, analyst]

First, I'd just like to ask, I think Bart mentioned Canadian supply came out of the market with duties moving higher, how would you potentially think about the lead time or timing here? Does capacity come out pretty quickly after rates move higher? Any thoughts around that issue would be helpful.

[Barton Bender, executive]

Yes, it's a tough question to answer, really. I mean when people make curtailment decisions, often there's [indiscernible] still and process and shipments on orders that have been taken. So it is a bit of a longer-term process. It's going to be interesting to see how the duty increase kind of settles into the marketplace. I mean, our position is that we think prices are going to go up. We think they're going to go up, not just for Canadian lumber, but also for U.S. production as well. I think it's a relative degree. And the fact is, is that the Canadian market, the prices that we have today are not sustainable before the duty increase. And so our position is that this will drive a fair amount of uncertainty on the Canadian side. And really, with absence of any meaningful shift in Japan -- or demand, sorry, we're going to see a supply side response just has to take place. And it will take time to filter it to the market. There's no question.

[Ian Fillinger, executive]

Matt, Ian here, I would just add to Bart's comments too. The highest -- as you know and the highest cost region in Canada is B.C. So this added cost, if it's not recovered on a sales price, will probably impact some mills in British Columbia. I would forecast when you look across the country, that's kind of the area that's most difficult, particularly in the central and northern area and coastal regions in B.C., the other jurisdictions tend to be pretty decent.

[Matthew McKellar, analyst]

Great. So much for a bit of additional color too on maybe what came out of the CapEx budget. It sounds like maybe there was a project or 2 that maybe didn't pencil out with current lumber price assumptions. Do those projects come back at some point? Or do you expect those to remain off the table for the near future?

[Ian Fillinger, executive]

Yes, Matt, Ian here. Well, as you know, you've been down in the south, we launched on a pretty aggressive CapEx program. I think it was back in 2018 largely completed the biggest ones, Eatonton and Thomaston, is near completion. The other ones that are, I would say, larger are paused at the moment and being reassessed, just given the conditions. The CapEx guidance that Rick talked about also -- the one thing to keep in mind is as you run your mills less hours, and we've done that fairly significantly in almost all regions, you should be spending less on maintenance capital. You're running your chains and your mobile equipment and other parts of your mill with less operating hours.

So part of what our operating team is doing is looking at that and making the right adjustments when it comes to the maintenance side of the business also. So largely our strategic projects, the big dial movers are done or near done, and then on the maintenance guidance on the CapEx, it really is a reflection of some pullback, but also an adjustment given different operating rates across our mills, which naturally would bring down the spend.

[Matthew McKellar, analyst]

Okay. That makes sense. And if I could just sneak in one more. Do you expect any kind of notable impact to log costs in Q3 in the U.S. Southeast, in particular, following tropical storm Debbie?

[Ian Fillinger, executive]

No. I think it's a little bit too soon, but no, not -- we're not hearing of anything or seeing any kind of price movement on up or down after that. I mean we're -- we have some mills that were in the path, they've done inferred very well. There's been a bit of downtime because of it, but don't anticipate much more cost movement there.

[Operator]

And your next question comes from the line of Ben Isaacson from Scotia Bank.

[Ben Isaacson, analyst]

Just 2 questions on the demand side. Can you talk a lot about waiting for industry rate -- or waiting for rates to come down. And it seems like that's the holy grail that we're all waiting for. But can you provide some context in terms of the magnitude and what we should expect? I mean, is 5.5% 30-year mortgage rate, is that what's going to cut it? I mean, is it -- do we have to go much lower? So what exactly are we waiting for when it comes to rate cuts?

[Ian Fillinger, executive]

I'll take a little shot at it. Ben, it's Ian, and see if Rick has a view to add on to it. But we've been discussing that this week also, what is the magic number? Is it -- it used to be 8% a number of years ago, then it was 6%. The psyche, we just -- we don't know. I don't think there's a path that we can look back on and kind of follow. So I think we're in sort of uncharted territories when it comes to trying to predict that. It's a discussion we have internally, and I wish we could share better insight. But unfortunately, we can't point to a path of where that trigger might happen.

I don't know Rick, if there is...

[Ben Isaacson, analyst]

Can I frame it a different way then -- or just maybe if I can just ask a different way, isn't no rate cuts also good if there's a perception that there's not going to be any improvements and people have to make a decision to buy their home? I mean, isn't this hold out only because of the expectation of rate cuts?

[Ian Fillinger, executive]

Yes. I mean that's -- I think that's very interesting comment. I don't have an insight on that, but anything that's not going up is good and stability is good as what we always kind of fall back on. So I don't have the expertise to really comment on that.

And Rick, not sure if you've got anything to add, but...

[Richard Pozzebon, executive]

I just think -- Ben, it's Rick here. I think it's encouraging where rates are trending, how far they need to go to stimulate more demand is anyone's guess. But certainly, as we get lower, that's better. In terms of the consumer psyche, I think you're right. If rates are more stable that should drive more confidence in consumer psyche. So I think it's a fair assumption.

[Ben Isaacson, analyst]

Okay. And my second question is on -- I think Bart mentioned that industry inventory is kind of on the lower end of historical ranges. Does that mean that destocking is complete and now your customers are really hand-to-mouth and given the capacity cuts that seem to be accelerating, is it not just a matter of time, even before rate cuts, that we start to see some restocking as the customers believe that prices won't get much better than where they are right now.

[Barton Bender, executive]

Yes, absolutely. It's an interesting situation. It's almost we think as we sit here and look at some point, this is going to come to roost, I think in the marketplace. We're finding our customers really focused on days sales in inventory. And so they're aligning their inventories directly with the demand that they're seeing from the marketplace. And they're doing it at a time when there's ample supply and where logistics is completely available. Capacity is there. We're not -- we're having very little difficulty coming up with any logistics capacity. So the environment to drive inventories is ideal.

And so there's a number of uncertainties that are going to come up as the industry pulls off or puts in curtailments as we deal with some more potential disruptions in logistics, things of weather. Those types of things will come into play. And when that happens, the lead times to reorder are going to be -- are going to increase and they're going to increase quick just because there's just not the buffer that I think that the industry would have had historically. So yes, no, I do believe the table is being set, and we just need to see a shift that will push this thing in a positive direction. So we think it's coming.

[Ian Fillinger, executive]

Ian here, Ben, just to add a bit to Bart, too. I mean just -- and you said this, I mean, there's been significant destocking through the channel over the last 12 to 18 months, which has actually weighed on lumber prices. We've seen a sizable decrease in our own inventories and also data from the other public lumber peers. So it appears everybody has drawn down. So the setup we feel is positive and probably one of the best setups that we could have at this particular point in time when demand does start to pick up.

[Operator]

[Operator Instructions] And your next question comes from the line of Roshni Athaide from BMO Capital Markets.

[Roshni Athaide, analyst]

Maybe I just want to start off with, you mentioned the curtailments from August to December. Is there any way you can give us some more color as to the percent distribution of those curtailments between Canada and the U.S. South?

[Ian Fillinger, executive]

Yes. Well, it's across both. I don't have the percentage right in front of me right now, but it's South and Canada and also the Pacific Northwest. When we talk about we often skip over our Washington and Oregon stud mills in that area. So it is spread across the company.

[Richard Pozzebon, executive]

I've got the numbers here. Roshni, it's Rick. It's roughly 2/3 in the U.S. and 1/3 in Canada. And we will adjust that if we see price conditions changing between the various species and regions.

[Roshni Athaide, analyst]

Okay. Appreciate it. And just talk on your financial leverage beyond the income tax refunds, the DC monetization. And I think Ian, you mentioned there was reduction of CapEx. Is there any other things you're considering in order to reduce it?

[Richard Pozzebon, executive]

Obviously, we'll continue to monitor our capital spend and really just focus on the operating decisions that are in front of us here. We're obviously taking some downtime to manage cash flow, and we'll continue to make operational decisions that maximize cash flow. Obviously, some of the recent lumber price improvements that we've seen will help going forward here.

[Roshni Athaide, analyst]

And just a last one for me. Maybe Bart, you can answer this. But are you able to touch on demand trends through Q2, what you saw and what you've seen since Q2 into July and the early days of August?

[Barton Bender, executive]

Okay. Well, I think I mentioned on the repair and remodel side, we kind of look at that in 2 buckets. One is the treating side and I suppose the other side is just the nontreating side. And I would say the nontreating side for us is off in that sort of 4% to 6% range depending on the customer and the comp. And on the treating side, I would say it's more 5% to 7%. It's been hit a little bit harder. However, I will say that things are -- things have been relatively stable. It's not like there's been a sudden move in one or over another. I would say that's been the trend for most of the year. And of course, the story on the new home construction side, 33% of the consumption of lumber. The bright story has been the single family. They're obviously getting a greater percentage of the new -- of the home sales these days. And so that's being reflected, I think, in the housing starts that you're seeing on that side.

It's the multifamily that seems to be taking the greater declines. And what we see from -- my feeling is on the multifamily side, it's more sensitive to the interest rate side of things, both from the developer standpoint and also from the type of home buyer on that side as well. And so a lot of times, we can see these projects deferred. And so our feeling is that a lot of this decline is still projects that are out there. It's just more or less a timing issue on when they're going to actually start to build them. So I think that's pent-up demand that will come our way in the future. But right now, it's a significant one.

And then when you go into nonres and industrial side, I think, fairly steady. I mean industrial is more a reflection of the general economy, packaging and pallets and those types of things, and I mean that business has been slightly off, but I can say it's improving lately. And so I would term both of those [ and new ] sectors is fairly stable.

[Ian Fillinger, executive]

Yes. And just to add -- on the demand side, the R&R takeaway is there's obviously been headwinds in the last quarter, us and others have pointed to that and carried into the -- from Q1 into Q2. But in the medium term, more optimistic is homeowners are locked in, in the low mortgage rates and overall housing stock continues to age and other components. So I would say the R&R factor in the last quarter and the previous quarter hasn't been great, but the setup in the medium term, obviously looks much better.

[Operator]

That concludes our question and answer session. I will now hand the call back to Mr. Ian Fillinger for any closing remarks.

[Ian Fillinger, executive]

Just thanks, everybody, for your interest in our company, and feel free to reach out to Rick, Bart or myself any time and this concludes our call. Thank you. Bye-bye.

[Operator]

That concludes our conference today. Thank you for participating. You may all disconnect.