Interfor Corp

TSX:IFP

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, my name is Simon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor Corporation quarterly analyst conference call. [Operator Instructions] Thank you. Mr. Duncan Davies, you may begin your conference.

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

Thanks, operator, and good morning, everyone, and thank you for joining us. I'm here as usual with Marty Juravsky, our CFO; and Bart Bender, our Senior Vice President of Sales and Marketing, to go over Interfor's third quarter results and to comment on our outlook for the balance of the year.Joining us as well this morning is Ian Fillinger, our Chief Operating Officer, who's been appointed by our Board to take over as Interfor's President and CEO on January 1 next year as I step aside. Ian will provide an update on our capital projects and his priorities for the company later on in the discussion. We're going to keep our remarks brief, and we'll turn the session over to you for questions as soon as we can.To the extent that you've already seen the results of most others in our sector, there won't be any surprises with our results for the third quarter. EBITDA was $16.8 million on sales of $486 million in the third quarter, which compared to EBITDA of $12.6 million on sales of $481 million in the second quarter. Lumber prices in the third quarter were mixed. The Yellow Pine composite, which covers about 1/2 of our production in sales, dropped by $18 a thousand or just under 5% quarter-over-quarter, while the Western SPF Composite went in the other direction, rising by $15 a thousand or about 5%. Overall, our average sales realization dropped by $20 in the third quarter.The negative effects of lower sales returns in the third quarter were more than offset by the impact of higher production and shipment volumes during the quarter, which, in turn, had a positive impact on operating costs. In addition to our normal operating results, our financial results for the quarter included a $31.8 million pretax restructuring provision associated with the permanent closure of our Hammond sawmill and the reconfiguration of our Coastal forestry and woodlands operations. Taken all together, Interfor posted a net loss in the third quarter of $35.6 million after-tax compared with a loss of $11.2 million in the second quarter. Lumber production in the third quarter was 685 million board feet, up from 647 million board feet in the second quarter, an increase of 6%. Production in the Southern region increased to 348 million board feet from 320 million board feet in the second quarter as the Monticello and Meldrim projects ramped up following the completion of the Phase 1 capital projects of those mills.Production in the Western region, which includes our mills in the British Columbia and the Pacific Northwest, increased from 327 million board feet in the second quarter to 336 million board feet as higher operating rates in the Interior more than offset the drop in production in the Northwest.Capacity utilization in the third quarter was 85% compared to 83% in the second quarter, made up of 45% on the B.C. Coast, 90% on the B.C. Interior, 82% in the Pacific Northwest and 92% in the South.During the quarter, we made the decision to reconfigure our B.C. Coastal business, including the permanent closure of the Hammond sawmill and the reorganization of our Coastal forestry and woodlands operations.A few minutes ago, I spoke about restructuring provision taken in the quarter to reflect this change, which includes $14 million in capital asset breakdowns and $17.8 million in severance and other costs relating primarily to the Coastal decision. For many years now, our Coastal business has been negatively impacted by log supply issues and other challenges. In addition to releasing significant amounts of working capital tied up in log and lumber inventories and freeing the Hammond property for sale, we believe the reconfiguration of our Coastal business will enable significantly better financial results from that business unit in the years ahead.Finally, from my standpoint, there isn't much that I can report today on our transaction with Canfor regarding the cutting rights associated with their former Vavenby sawmill. The transaction, I think, as you know, is subject to various consents, including that of the B.C. government.I can tell you that we're making good progress on our discussions with various stakeholders and remain optimistic that we'll receive the required approval and close the transaction prior to year-end.At that point, I'm going to turn it over to Bart, who can give you some comments about what's happening in the lumber market, and then I'm going to turn it over, after Bart, to Ian, who can comment on capital projects and other priorities. So Bart, over to you.

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

Okay. Thanks, Duncan. I'll provide a brief outlook in the lumber market. Minimal construction is gradually increasing, particularly single-family, as purchasers take advantage of lower interest rates and improved affordability. The repair and remodel end-use sector is steady, and we expect favorable home prices and interest rates to continue to help here. In North America, in north of -- in-market inventories, as difficult as they are to accurately read, appear normal for this time of year. Order files across our network of mills are sold. We expect attention to soon turn to next year, but should bring in a level of investment in inventories in preparation for seasonal spring demand. As always, weather will be -- weather between now and the spring of next year will be a factor.Overseas, our business has improved quarter-over-quarter from a volume standpoint. However, inventories remain elevated in most markets and competition from other countries is heightened. On the supply side of the equation, there continues to be some significant shifts, and it's our opinion that the full impact of the 2 billion feet of -- or the over 2 billion feet of curtailments in B.C. have not been fully realized in the markets.Canadian shipments to the U.S. are trending down, and we expect this to continue. In terms of other regions, we see stable supply year-over-year from imports, Southeast, PNW and the Inland Empire. No significant increases or declines.Turning to our Specialty business, cedar, in particular. We are in a transition. With the closure of our Hammond mill, we have been busy transitioning our customers over to B.C. Interior West [around cedar]. Our Interior Western Red Cedar business has grown to be comparable in size to what we previously produced on the Coast.Overall, long-term market fundamentals remain favorable, and we expect lumber demand to continue to grow. I'll stop there, Duncan. Turn it back over to you.

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

Great. Thanks, Bart. Ian, if you could make some comments on the status of our capital projects and your priorities in the company going forward?

[Ian M. Fillinger, Senior VP & COO]

Sure. So our Phase 1 capital projects, just to remind everyone, were Monticello in Arkansas and our Meldrim mill in Georgia; and both of those projects are complete. Spending's done, and we're in ramp-up period and very, very close to declaring those projects complete from a pro forma achievement standpoint.Phase 2 is our Georgetown, South Carolina mill at Eatonton in Georgia, and both of those projects are underway with certain phases happening. Georgetown, completing some projects in the sawmill and [ planer ] and Eatonton with some civil and building work underway at this point in time.And then Phase 3 is really a handful of discretionary projects that are high return, and those are being planned and executed on as we speak also. As far as the priorities, as Duncan alluded to, for us, there's completing -- the first prior to completing the execution of the capital projects and achieving the post-project ramp-ups, priority 1. Two, completing the Canfor, Vavenby purchase is a top priority for us. Maintaining our financial flexibility, managing our working capitals carefully, scrutinizing our spending and improving operational efficiencies everywhere we can, like we do every day, and then monitoring market conditions and adjusting as required. And I think, Duncan, that probably is a good summary of our key priorities.

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

Okay. Great. Thanks, Ian. So in August, it was announced that I was going to be stepping down as Interfor's CEO at the end of this year, and that Ian was going to be taking over on the 1st of January. I've been in this role now for more than 20 years, and, frankly, it's time for a change. Ian's been with Interfor for more than 15 years, and he's done an outstanding job for us. In my opinion, he'll do a great job for the company going forward. I think this is his first time on this call, and I thought it would be good to ask him to provide an update on our capital projects and his priorities.So that really brings our discussion here to an end, operator. And I'm going to turn this session over to our guests for questions. So over to you.

[Operator]

[Operator Instructions] And your first question comes from the line of Ketan Mamtora with BMO Capital Markets.

[Ketan Mamtora, Analyst]

Duncan, congratulations, and all the best for the future.

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

Thanks, Ketan.

[Ketan Mamtora, Analyst]

Maybe to start off, Ian, can you just refresh our memory on what kind of returns you are expecting from these Phase 1 and Phase 2 projects and sort of rough time line?

[Ian M. Fillinger, Senior VP & COO]

Sorry, was it [indiscernible] or returns? Oh, it's for returns. Yes, the returns are -- internally, our targets are to achieve a 20% IRR, less than 5-year payback on the big strategic projects in Phase 1 and Phase 2. Phase 1, the ramp-up is really, Ketan, essentially done. There's a little bit more work to achieve a couple of the KPIs that the Monticello and Meldrim team are focused on. And Georgetown and Eatonton are completing -- Georgetown somewhere in Q1 2020, near the end of that time period, Eatonton, as far as the construction and commissioning goes, is mid-2021.

[Ketan Mamtora, Analyst]

Got it. And then just to be clear, the IRR that you talked about, 20%, that's post-tax or pretax?

[Martin L. Juravsky, Senior VP & CFO]

That's pretax. So it's a cash-on-cash pretax return.

[Ketan Mamtora, Analyst]

Got it. Okay. Perfect. And then just switching gears here. This European pine beetle (sic) [ European spruce bark beetle ] outbreak, are you concerned that lumber imports into the U.S. from Europe could go up meaningfully? I know that, year-to-date, we haven't seen much of an impact yet in the numbers. But as you look ahead, do you guys see this as a potential risk?

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

Well, Ketan, let me comment on that. Maybe Bart can follow up on it. It's something we're monitoring. In the case of Europe's spruce beetle as opposed to a pine beetle, but it's created or driven by the same set of factors as we've seen here in North America with the pine beetle in British Columbia and in other jurisdictions. So it's -- we're starting to see ramped-up harvest levels and production levels in Europe, and we're starting to see product, both logs and lumber, in the different markets of the world. And we had 1 of our senior people over in Europe last week, talking to the people over there trying to get an understanding of just exactly what's happening, what the shelf life looks like, what the harvesting plans are and where we're likely to see that product in the various markets of the world. So it's something we're paying attention to for sure.

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

Yes. And the only thing I would add to that is, within the markets, lots of discussion taking place with our customers. I think it's an uncertainty on the magnitude side of the equation. And I think it's worth pointing out that the constraints that they have over there are, in some respects, the same constraints that we have here when it comes to people and equipment and mills. And so I think that there is an ability to flex on volumes, but it's not intended. So there are some constraints on just how much can be produced out of those logs.

[Ketan Mamtora, Analyst]

All right, that's helpful. And just 1 last for me -- 1 for me. When I think about 2020 CapEx, what's kind of a good kind of ballpark number for now?

[Martin L. Juravsky, Senior VP & CFO]

Yes. Jim, it's Marty. We haven't formalized our budget for next year, our capital budget. But if you look at this year, we'll probably be spending a little less than $200 million, and 2020 will be substantially less than that. Probably in the $140 million, $150 million zone. We'll refine that over the next little bit. But for planning purposes, you can use that as a frame of reference.

[Operator]

Your next question comes from the line of Hamir Patel with CIBC Capital Markets.

[Hamir Patel]

Ian, I just wanted to follow up on the capital projects. Can you give us a sense, given the sort of staging of everything, how much lumber output growth would you be expecting in 2020 and then looking beyond that as well?

[Ian M. Fillinger, Senior VP & COO]

So the Phase 1 projects, Monticello and Meldrim, will add in the neighborhood of 150 million feet to 155 million feet to our South platform. And then the Phase 2, which is Georgetown, Eatonton and Thomaston, will add 275 million board feet. That's over several years, so the impact for 2020 is probably about 100 million feet increment over 2019.

[Hamir Patel]

Great. And Bart, I just wanted to ask do you get a sense as to where inventories are in the channel? And also any indication yet from the big box stores about what sort of volume growth they might be planning for next year?

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

Okay. Well, that's a difficult question. The inventories are always difficult to gauge and, really, aside from the occasional reports that you see, it's all a matter of just discussions one by one with your customers. And I would say that I would characterize inventories today as normal for this time of year, maybe even just a tad below that. And the reason I say that is you can see that in their purchasing behavior when they're buying things, and the question that you can tell that there are some holes in some areas. But overall, I don't think the distributor level has a lot of pressure at this time in terms of their inventory levels. Looking at the big box stores, that is a -- your information is probably as good as mine. Our business with the box stores is not overly significant. We have just a couple of very small programs with them, and those programs are continuing the volumes that we've been selling them, historically, have been very steady. So that's all I can really say about that.

[Operator]

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

[Paul C. Quinn, Analyst]

Maybe start with congratulating you, Duncan, on the retirement. I actually thought you'd never retire, but congratulations. Maybe from your perspective, 20 years in the chair and a lot of leadership on the softwood lumber file. How do you see this all progressing going forward here?

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

Well, I think we've said consistency -- consistently, Paul, that not much is going to happen on the trade front until the legal process starts to work its way through the system. And that's happening now. I don't think there's going to be much more is going to happen until we get some clarity on that side of things going forward. So nothing quickly.The fact that the federal election is now out of the way, I think, is helpful from a Canadian standpoint. I've said on this call before how much regard I've got for Chrystia Freeland and how she's handled things from a Canadian standpoint. I think she's been great. But I think we also need to recognize that we're about to move into another political cycle in the U.S. And if nothing else, the whole softwood files is a political file. So I think we're going to be bucking some headwinds from a U.S. political standpoint if we think we're going to find a resolution to this. So my guidance to everybody that I talk to is this thing historically takes time. The arguments on our behalf are good so we just need to have the patience and the wherewithal to be able to work our way through the system and find those windows of opportunity when economic and political realities and legal realities allow opportunities for solutions to be devised. So I think the end message is don't expect much to happen here in the near term.

[Paul C. Quinn, Analyst]

Okay. So is it safe to say the legal will be wrapped up in 2020 and maybe you get a political decision or compromise negotiation in 2021?

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

No. Well, I don't know whether we'll get a decision in 2021 or not, but the legal process usually takes somewhere between 3 to 5 years to work its way through the system to the point where you're getting some [ultimate] clarity on the case itself. So I think we're still in the early innings. Or if you want to use a football analogy, we're somewhere between probably the first quarter and the second quarter of the whole process, Paul.

[Paul C. Quinn, Analyst]

Okay. And then maybe over to Bart. On markets, Bart, you were commenting that overseas volumes were up, but lots of competition. What has that done for price and what's your outlook going forward?

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

Well, it depends on the market, I suppose, Japan being very different market than China, but I have a feeling you're asking mainly about China. We've been dealing with excessive inventories in that market as well. And so whenever you get that kind of a situation, it tends to put a blanket on your ability to flex on price. So the added variable there is the European volumes that are moving their way in and competing against SPF-type products at various levels, so in the low-grade level and the mid-grade level. And so I think the Chinese did. We don't anticipate a lot of price appreciation. Obviously, the North American market pricing isn't really encouraging us significantly to do anything there. So we think it's going to be a matter of companies deciding to what degree they want to participate at the going market prices in China.

[Paul C. Quinn, Analyst]

Okay. And then just, Duncan, you referenced the Canfor transaction. But we've seen Conifex-Hampton approved by the government. Is yours next in line? Have you submitted your request?

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

We have submitted the request. We are -- I would like to believe we're next in line. I think our situation is quite a bit different for a variety of reasons than the Hampton-Conifex transaction. You have 2 well-positioned, well-financed companies of Canfor and Interfor. And we're just -- we're working our way through this process in a very systematic way. Very good cooperation between ourselves and Canfor. Very good progress dealing with the various stakeholders in the area. And we just wanted to be very careful as we worked our way through that whole piece to make sure that we've got the arrangement set up properly. And now we're moving into the formal part of the discussion with the provincial government, which is happening as we speak.

[Operator]

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

[Sean Steuart, Research Analyst]

Just 1 question for me. Marty, the messaging around the lack of activity on the buyback has been -- you're going through an extended, really deep cash flow trough. You've got a lot of money to deploy towards CapEx, and hopefully, the 10-year acquisition as well. I guess the question I have is, and this is all dependent on share price, I suppose, and valuation, but what sort of visibility would you need on cash flows improving? And what sort of liquidity cushion would you be comfortable with proceeding with buyback activity? What sort of backdrop do you need or confidence do you need in the market recovering to get busy again?

[Martin L. Juravsky, Senior VP & CFO]

Yes. It's a great question, Sean. And I'll give a nonanswer answer to it, how's that? Because there's no 1 variable. We're constantly looking at all of those things that you talked about, some of which are quantitative and some of which are, frankly, quite qualitative in terms of our judgment of how much dry powder do we think is appropriate given what is, frankly, a fairly unpredictable market from time to time and also fairly unpredictable in terms of the opportunities that present themselves in those periods of market volatility. So we're constantly recalibrating those things. We like the flexibility that we have right now. We like the dry powder that we have right now. So we've been inactive under our share buyback program as you've -- as you've pointed out, for the last little bit. But it's really all about part of trying to balance off the various opportunities that are in front of us. And there's no formula that we have per se. We're just constantly looking at all those variables. And right now we just think it's appropriate, given market conditions and the opportunities that are in front of us, both internal and external, to keep that dry powder as we have right now.

[Sean Steuart, Research Analyst]

Well said. Thank you very much that's all I had. Congratulations, Duncan and Ian as well.

[Operator]

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

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

Yes. Thanks, operator. I normally end these calls thanking people for their interest in our company and saying that I'll see you again at the end of the next quarter. But that's not going to be the case for me. This is my last call as Interfor CEO. And I'd like to thank -- personally, I'd like to thank everybody who's attended this call and the other calls that we've had over the last couple of decades. You folks have been very fair with us and very fair with me. I've enjoyed working with you, and I hope you folks feel the same. So thanks, everybody. The group around the table, under Ian's leadership with Marty and Bart, will be here at the end of the next quarter to review Interfor's fourth quarter and 2019 results and to talk about the future of the company.So thanks, everybody. Have a good day. Both Marty and myself, and I guess, Ian, are around later on today if you've got any follow-up questions. But thanks very much. Take care.

[Operator]

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.