Interfor Corp

TSX:IFP

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, ladies and gentlemen, and welcome to Interfor quarterly analyst call. [Operator Instructions] This call is being recorded on Friday, November 4, 2022.

I'd now like to turn the conference over to Ian Fillinger.

[Ian Fillinger, executive]

Thank you, operator, and good morning, everyone. Welcome to our quarterly analyst call. With me today, we have Richard Pozzebon, our Executive Vice President and Chief Financial Officer; and Bart Bender, our Senior Vice President of Sales and Marketing. 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 Rick will pass the call to Bart, who will cover off the markets.

Turning to our financial results. Our Q2 adjusted EBITDA was $129 million. We're continuing to execute on our strategic plan, and we're generating industry-leading lumber margins and returns on capital. I encourage you to look through the investor deck on our website. Our improvement efforts were again balanced across our North American platform. Our production was slightly below the record level of the previous quarter. Our lumber inventory was reduced during the quarter and remains within our target range. Our financial flexibility is strong. Our DeQuincy Louisiana mill has reached its full shift capacity. Our Eatonton, Georgia sawmill rebuild is complete and is in the final stages of ramp-up.

Our new planer mill project at Castlegar British Columbia mill will be completed in Q4, and we expect a value uplift in great outturns. This mill poles from the very high-quality fiber in this region of British Columbia. In total, our CapEx was balanced as we deployed $86 million across 4 regions. At the beginning of October, we announced the agreement to acquire Schuler's 2 mills in New Brunswick. These 2 quality assets, along with Woodlands management business will add value, scale and further geographical diversification to our portfolio. Despite persistent inflationary pressures, our SG&A expense continues to decrease quarter-over-quarter as economies of scale are being realized from our strategy.

I'd also like to provide an update on how our integration is progressing with our Canadian Eastern platform. Our key focus areas in the near term are to enhance the historical operating performance to identify further opportunities for operational improvement and synergy realization and to assess potential long-term strategic investments. In summary, our balance sheet is in great shape, and our 48% year-to-date return on capital, again, is very strong.

That concludes my opening remarks, and I'll now hand the call over to Rick.

[Richard Pozzebon, executive]

Thank you, Ian, and good morning, everyone. First off, I'll refer you to cautionary language regarding forward-looking information in our Q3 MD&A. Interfor's third quarter results were relatively strong given the normalization of lumber prices as market uncertainty dampened demand. We generated adjusted EBITDA of $129 million and extended our track record of generating the best returns on capital of all publicly listed lumber producers.

These positive results demonstrate the significant benefits of Interfor's transformation over the past several years with significant scale and regional diversification achieved through acquisitions, continuous investment in portfolio optimization and a focus on operational excellence. Our capital allocation in the quarter continued to be balanced and driven by our focus on maximizing shareholder value over the long term. We recognize significant value in Interfor's share price and launched a $100 million substantial issuer bid, successfully buying back 6.1% of outstanding shares at a historically attractive valuation of 0.72x book value per share.

We continue to optimize our sawmills through discretionary capital investments at attractive risk-adjusted returns. We seized an opportunity to strengthen our company through the acquisition of 2 sawmill operations in New Brunswick with an annual capacity of 350 million board feet. These are top quartile operations with attractive fiber costs and fiber security and are expected to boost and enforce profitability and returns through all parts of our business cycle. The renewal of our normal course issuer bid to buy back up to 10% of Interfor free float provides us flexibility to return capital to shareholders and increase leverage to earnings for remaining shareholders.

We intend to operate this buyback program under parameters, ensuring we purchase shares at an attractive valuation while remaining within our conservative target leverage range. Expanding on financial results, third quarter earnings benefited from our larger scale and regional diversification. Interfor shipped a near-record 1.1 billion board feet in the quarter with positive EBITDA contributions from each of our operating regions. And earnings also benefited from $26 million of recovery recorded for softwood lumber duties previously expensed as the Department of Commerce finalized duty rates for the 2020 period at a reduced level.

We continue to see transitory cost inflation across several aspects of our business and remain focused on operating decisions to maximize returns and profitability. From a balance sheet perspective, our financial flexibility remains strong with ample available liquidity on existing facilities of over $600 million with substantially more financial capacity available within our financial covenants, if needed. Pro forma, the closing of the Schuler's Forest Products acquisition expected in the current quarter, net debt to invested capital at September 30th would have been approximately 23% and remain within our conservative target range of 5% to 25%. It's also worth noting that Interfor softwood lumber duties on deposit totaled USD 419 million at quarter end, representing $8 per share on an after-tax basis. To wrap up, I'll highlight that our business continues to be well positioned operationally and financially to succeed through ongoing market volatility. Our priority will continue to be disciplined capital allocation to maximize returns on capital and shareholder returns over the long term.

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

[Barton Bender, executive]

Thank you, Rick. Good morning, everyone. I'll provide an outlook on lumber markets through quarter 4, 2022 and into quarter 1, 2023. The medium to long-term fundamentals remain favorable to overall lumber demand. Demographics support an increased level of participation in the first homebuyers market. Aging housing stocks encourage increased repair and remodel work, household balance sheets are solid, led by equity in their owns and new home construction has led to underlying demand for some time, increasing the pent-up demand for homes in the U.S. In the short term, there are some macroeconomic challenges that are reducing the demand for lumber in North America. Inflation and economic uncertainty will drive conservatism in spending.

Interest rate increases are impacting affordability a new home construction and simultaneously encouraging those with more affordable mortgages to stay in their existing homes. Homebuilders are addressing this to a certain extent, through incentives and features, so more is to be seen on that side. The [indiscernible] model is impacted, however, to a lesser degree. Those avoiding the move-up housing market will undoubtedly consider more repaired model work. Equity and homes will support this; however, to the extent that is required, affordability could still be a factor. We've been proactive in addressing the reduction in lumber demand with a reduction in production. The curtailments that we've announced for the balance of 2022 will allow us to align to our customers' needs.

Switching to the supply side of the equation, it's times like these lines of how important diversity is in our business, making sure we have the right products in the right areas to meet the demands of our distribution partners. Interfor has always had diversification as a part of our corporate strategy, and that continues today. I'd like to highlight that since 2019 through acquisitions, we've added to that diversification, only supplier with production in 4 major producing regions in North America.

Our SPF capacities increased from 8% to 25% of our production. We've added the Eastern region and once our most recent acquisition closes, increased our capacity to $1.275 billion board feet, added dimension and timber production to our P&W regions, which prior to this was 100%, also acquired 3 dimension mills in the Southwest region, increasing our ability to service our customers further west in the South. Interfor has never been positioned better to serve our customers across North America today, which is affording us to see the boardroom table with any distributor in North America. Overall, we're well positioned to address the short-term uncertainty in the market with diversity, and we look to markets to improve as we work our way through the balance of 2022 and through 2023.

With that, I'll turn it back over to you again.

[Richard Pozzebon, executive]

Okay. Thanks, Bart. Operator, we're ready to take our analyst calls now.

[Operator]

[Operator Instructions] We'll take our first question from Sean Steuart with TD Securities.

[Sean Steuart, analyst]

A couple of questions. I want to talk about the NCIB renewal. And Rick, you mentioned that adjusted for Schuler, your net debt to cap is up to 23%, which is towards the upper end of your stated target range. And I'm wondering if Ian or Rick could comment on where buybacks fit into the capital allocation pecking order as leverage has climbed, then free cash flow prospects are moderating here. How do you think about the willingness to proceed with that NCIB over the next year?

[Richard Pozzebon, executive]

Buybacks certainly have been a priority for us when there's a disconnect between the share price and what we think is the underlying value of the shares. We'll continue to operate our NCIB program under our few parameters. One is certainly a pricing parameter to make sure we're not overpaying for our shares and the second parameter would be around leverage. So, we don't intend to buy shares outside of our target range in terms of leverage. So we'll be following those just like we have throughout the last couple of years. Our priority in terms of capital allocation continues to be our internal investment in our sawmills, our discretionary capital program that we have well underway. And certainly, growth is an objective of ours, and we'll continue to look for M&A opportunities and consider those as they come about.

[Sean Steuart, analyst]

Just to clarify, Rick, so the 25% net debt to cap, is that a ceiling above which you would not consider buybacks or is there some legal room around that depending on how I think you're shaping up quarter-to-quarter?

[Richard Pozzebon, executive]

Yes. I would say it's a guideline for us. Is it hard to stop, nil, but it's something we would want the target staying within that range.

[Sean Steuart, analyst]

Okay. Second question for Ian, I wonder if you can speak to fiber costs across your various regions and I suppose, specifically in the U.S. South, where we've seen some inflation and I'm hoping you can categorize that as is this capacity build on lumber in the U.S. South driving increased demand for fiber or is it freight surcharges and contractor cost inflation that's driving it and your outlook with respect to that region specifically as we move ahead into next year?

[Ian Fillinger, executive]

Yes, for sure, Sean. Thanks. Well, the South region, first off is one of our top-performing regions and continues to be right there. The specific to your question on log costs, there have been some minor inflations that we've experienced, but I would say it's less than 5%, and in some cases, it is generally flat. If I had to characterize the whole region from Louisiana to South Carolina, I would say they remain flat, and there's pockets of where it's been higher and there's pockets where it's been actually lower in some cases, but generally flat across the region. But just some small pockets of dynamics depending upon where the sawmill is located. Okay.

[Operator]

[Operator Instructions] Next we'll go to Mark Wilde with Bank of Montreal.

[Mark Wilde, analyst]

I want to just start off by saying, I have a lot of regard for what you guys have done over the last 2.5 years in terms of kind of capital allocation and the balance that you have shown, you kind of definitely walk to talk on that. As we look ahead, though, I'm curious, we're clearly heading into what looks like much more challenging markets. We've definitely seen tougher markets than we're dealing with at the moment If you just look back over the last 4, 5 years. I'm just curious about your preparations, 4 more challenging markets.

[Ian Fillinger, executive]

Yes, for sure, Mark. I mean, as long as you've been covering this industry and we've worked and then we've seen these ups and downs. So our playbook is pretty refined on that. It does the first leverage making sure that your inventories are matching your order files and your profitability and when some of that starts to disconnect, we feel obligated to make decisions like we did announcing the curtailments in Q4. So that would be the first leverage that we look at, making sure we're not running for the sake of running and that we're looking at the whole value outlook from a shareholder perspective. And then you can get a little bit more specific down to plant level, numbers and be prepared for your staff or whatever to do those. We don't see that coming out at this time.

We obviously, like others and yourself, I think it could be a little bit of a rough 2023. But the difference, I think when we look at Interfor, the strength of our company today compared to 10 years ago is just dramatically different. Some of that risk that we have in all playbooks is we've updated and obviously feel that we're a much stronger company if we have some headwinds here in the next 12 to 18 months. I would say that, in the market there's all kinds of different levers that we can pull beyond that. But the most is just making sure you're not building your inventory and taking write-downs and trying to force a product into a market that doesn't align. And so we'll monitor that pretty closely as we're right now for the next several months.

[Mark Wilde, analyst]

Second question I have, I know this is a sensitive one for you. But is there a way for you to give us some sense of sort of profitability by region across your portfolio right now?

[Ian Fillinger, executive]

No, Mark, we can't really do that. I mean, what we have shared is just the trend by region over a long period of time. I think it's 10 years or so. And what we find is that it's balanced. There's puts and takes at different times. And so we're really pleased with the geographical diversification because we do see that, especially a number for us, which is kind of what we do, being able to have those different regions, which have different log dynamics at different points in times in the cycle and different product dynamics. When we think about the SPF volume that Bart talked about, that's a big change for us. And we think that's a very positive contributor to Interfor as far as their strength goes as we go forward. But regionally, 1 year one region may be stronger than the other, but over a period of time, it's pretty balanced across North America in our portfolio anyway.

[Mark Wilde, analyst]

Last one for me, Ian. I wondered if we just step back, I think it was about 9 years ago that you bought the Rayonier mills down in the South. That was your first move into the U.S. Can you give us some sense of what you've been able to do, both capacity-wise and profitability-wise at the Rayonier mills since that acquisition?

[Ian Fillinger, executive]

Yes, that was a great acquisition for us. You got right, Mark, it was 2013. Those 3 operations start with Swainsboro, Baxley. We haven't had to put a lot of capital into those plants. They were well run, and they have a great product line. So those 2 plants contribute very well today. On the Eatonton plant, which was the third of those Rayonier. It's a top quartile, top decile plant right now that we just finished the upgrade and it's going North of 200 million board feet from, it was around $89 million when we bought it, but even a little bit less. But the purchase price for Interfor it goes up, it was so attractive, and we're extremely pleased with those, and we're very pleased to see Eatonton in a highly optimized technical mill, best-in-class engineering and equipment. And so I would say that would be the one that we have rebuilt out of those, and it will be one of the best in our portfolio.

[Operator]

Next we'll go to Paul Quinn with RBC Capital Markets.

[Paul Quinn, analyst]

I was just wondering if we assume that 2023 is going to be a very tough year, are you going to change your upgrading plan from what we're seeing in Q4? Or is that where we're going with the next year?

[Ian Fillinger, executive]

We look at it beyond as you know, on a regular basis. So Q4, I think, it just felt and looks like we needed to match production to shipments. We'll see what Q1 looks like. We'll probably have a view of that mid-December. We would like to run our plants and keep our employees retained and keep the logging contractors and the supply chains to the markets fulfilled, but we're not shy of making decisions. We just see that building inventory is a risk that we don't want to take beyond normal threshold limits, which I would say are tight and we want to keep them that way. So yes, Paul, I would say, mid-December, we're probably going to take a view of Q1 and see how things are looking and talk with Bart and sit down as a group and figure out what that schedule looks like. But it will be quarter-to-quarter decisions.

[Paul Quinn, analyst]

[indiscernible] I understand that with the Schuler acquisition, you're taking on those deposits, how much of those deposits that you have for the company.

[Richard Pozzebon, executive]

First, it is about it's a moving target, Paul, that you are speaking, about USD 90 million of deposits.

[Paul Quinn, analyst]

Anything happening on the [indiscernible], I'm trying to get some of this lying back.

[Richard Pozzebon, executive]

Yes, Paul, I'll take that. I mean I guess the short answer is that there's not too much happening. I mean the [indiscernible] appeal process is really just getting started. We've now got the panel set up for the original investigator results. So that process is now underway, took 5 years to get that far. We do have a sunset review that's coming up where they'll take a look at it and make a determination of whether injury is still possible and whether this continues, we don't expect too much to come out of that, but it is a review process that happens at the 5-year mark. Beyond those 2 things, there's really no extensive conversations beyond the normal, I think, that would point to anything changing in the near term.

[Paul Quinn, analyst]

when is the [indiscernible] review come up? Is that a couple of months? And we're not expecting to mid-February.

[Barton Bender, executive]

That's correct. It's always at the 5-year mark. It's called a sunset review, and we'll see what that process brings, but any of the active participants in this file will be busy preparing statements and what not to present through that process. We'll see where it goes. But again, we can't really speculate, but I can tell you that generally not many people are thinking it's going to add up too much.

[Paul Quinn, analyst]

The timing on the original review that's now underway that a year-long process? Or is that longer? What is typical on that?

[Barton Bender, executive]

So I don't know that you can even look at what's typical. I mean it took 5 years to get a panel struck. So they've got a bit of a catch-up here to go on that. I actually don't know, Paul. It's one of those things that goes real time, and I wouldn't want to speculate on exactly how long that process would take. I'm just glad that it's underway.

[Paul Quinn, analyst]

Okay. And Bart while I got you, just pretty familiar with North American markets. If you just give me a recap of what's going on in offshore?

[Barton Bender, executive]

Sure. I mean, the business offshore, I would term it as average. Certainly, our exports to Japan, albeit stable, I suppose, quarter-over-quarter, but I would call them slightly depressed as that market works through what was a fairly significant inventory position. So we'll be looking for that market to improve as we move into 2023. When it comes to the other markets, there's some geopolitical issues there that you have to be mindful to. So, I believe they will be generally opportunistic markets. I think the price of lumber in North America is attractive. And so that will spur on some business. However, I'm not looking to the export markets to solve any of the demand side issues that we're going to be facing in 2023. So more of the same, I suspect.

[Operator]

Next we'll go to Hamir Patel with CIBC Capital Markets.

[Hamir Patel, analyst]

Can you give us your sense as to how your costs in BC would kind of change in Q4 and Q1, just at least in terms of stumpage?

[Ian Fillinger, executive]

Yes. Well, Rick's got hinge point now, I mean he's got the numbers. Go ahead, Rick.

[Richard Pozzebon, executive]

So just looking at BC interior stumpage in Q3, it was about $86 a cubic meter. We're expecting that to drop down in Q4 to about $45 a cubic meter. And then looking out to Q1 '23, it will be about $30 per cubic meter as an estimate.

[Hamir Patel, analyst]

Okay. Great. Thanks, that's helpful. And just the last question I had was just on CapEx. What should we expect for full year '22 and any sense yet on '23.

[Ian Fillinger, executive]

It's about 300 or so. Is that right, Rick?

[Richard Pozzebon, executive]

That's right. And looking out to 2023, we're still going through our budgeting planning process, but you can expect it to be in the same ballpark as this year, so around $300 million.

[Operator]

There are no further questions at this time. I'll now turn the call back over to Ian Fillinger for any additional or closing remarks.

[Ian Fillinger, executive]

Okay. Thank you, operator. In closing, we're focused on maintaining the health, safety and well-being of our employees. We continue to drive cost reductions across our company. We're matching our production rates to our order files and we're continuing with a balanced approach to capital allocation. I'd like to thank everyone for dialing in and participating in our call this morning and your interest in our company. If you have any further questions, please feel free to reach out to myself, Rick or Bart at any time. Thanks, and have a great day.

[Operator]

Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation. You may now disconnect.