Interfor Corp

TSX:IFP

Earnings Call Analysis

Interfor Q3 Results Show Resilience Amid Challenges

Interfor navigated a challenging third quarter, posting $32 million of adjusted EBITDA despite wildfires and volatile lumber prices. The company's strategy in the U.S. South is flexible, adapting to market conditions. The strong balance sheet saw reduced leverage and increased liquidity. Total sales were $828 million, with the wildfires causing increased production costs and a 10% decrease in shipments. Financial position strengthened, with net debt to capital dropping below 29%. Despite short-term uncertainties in the lumber market, medium-term outlook looks promising with strong demand indicators, including housing fundamentals, although recent rate hikes have made buyers cautious. Capital expenditures remain focused on strategic U.S. initiatives, and lumber prices are expected to hover around breakeven for the remainder of the year.

Interfor's Resilience Amidst Market Volatility

In a challenging quarter marked by wildfires and fluctuating lumber prices, Interfor demonstrated notable resilience, generating an adjusted EBITDA of $32 million. The company made progress on its capital projects, particularly in the U.S. South, and took actions to enhance its balance sheet by decreasing leverage and boosting liquidity.

Navigating an Uncertain Housing Market

Despite the robust housing demand countering rising interest rates, the latest hikes are beginning to bite, with buyers noticeably cautious and constraining purchases to immediate necessities. With low inventory levels maintained by producers and in the supply chain, there's an expectation of industry-wide curtailments should current price levels persist. The forecast for lumber prices remains close to the industry's breakeven point for the rest of the year.

Operational Challenges and Financial Highlights

Interfor's third-quarter sales tallied $828 million, with a slight uptick in lumber prices offset by a significant 10% decrease in shipments, largely due to operational disruptions from British Columbia's wildfires. Despite these hurdles, the company's overall financial health improved, signified by a net debt to invested capital ratio falling below 29%, driven by a strong cash flow from operations.

Capital Expenditure and Strategic Investments

With a forward-looking view, Interfor plans robust capital investments estimated at about $210 million for 2023 and a projected $140 million for 2024. These investments, concentrated on strategic mill enhancements in the U.S. South, align with the company's commitment to optimizing operational efficiency and returns.

The Lumber Demand Outlook: Short-term Haziness vs. Medium-term Optimism

While the medium-term outlook remains positive, bolstered by indicators like underbuilt housing and household formations suggesting increasing lumber demand, the short-term view is clouded by affordability issues linked to high home prices and mortgage rates. This conundrum causes volatility in new housing starts. However, the repair and remodel sector remains a stable consumer of lumber, mitigating some immediate market unpredictability.

Stable Repair & Remodel Demand in the Face of Varied Inventories

Despite a backdrop of short-term uncertainty, steady consumption for repair and remodel purposes has been reported, offering a glimmer of stability. In-market lumber inventories are on the low side, indicating tight supply, although inventory management remains strategic to combat the inherently sensitive demand and supply dynamics of the lumber market.

European Imports and Market Adaptation

European lumber imports into the U.S. experienced a tapering off after an abnormal start to the year. It is expected that by year-end, the import levels will approximate those seen in 2022, as the market adjusts and settles into more familiar patterns.

Earnings Call Transcript 2023-Q3

[Operator]

Good day, ladies and gentlemen, and welcome to the Interfor quarterly analyst call. [Operator Instructions] This call is being recorded on Friday, November 3, 2023.

I would now like to turn the conference over to Mr. Fillinger. Please go ahead.

[Ian Fillinger, executive]

Thank you, operator, and thank you, everyone, for joining us this morning.

With me today on the call, I've got Rick Pozzebon, Executive Vice President and Chief Financial Officer; and Bart Bender, Senior Vice President of Sales and Marketing.

Before we get into our normal course call, I'd like to welcome Geoffrey Evans to our Board of Directors, and we look forward to working with Geoffrey and his 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 on to Rick and Bart.

Turning to our quarter. We generated a positive $32 million of adjusted EBITDA during a very challenging quarter that was impacted by both wildfires and price -- lumber price movements. We advanced our capital projects in the U.S. South and remain flexible to adjust our plans in line with market conditions. Our balance sheet remains well-positioned. During the quarter, we reduced our leverage and improved our liquidity.

With respect to our outlook, we feel housing demand has been relatively strong in the face of rising interest rates. But the most recent round of hikes appears to be having an impact. And combined with this lower -- slower time of year, it has resulted in buyers being extremely cautious and limiting purchasing to immediate needs only.

On the supply side, inventories at both the producer and supply chain level are low and operating on a just-in-time basis for shipments. And production curtailments are anticipated from the industry if the current prices continue.

In closing, barring any winter transportation issues or unforeseen events, lumber prices are expected to remain at or near industry breakeven levels for the remainder of the year.

I'll now turn the call over to Rick, who will run 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 Q3 MD&A.

From a high-level perspective, Interfor's Q3 results reflect the ongoing lumber market uncertainty, driven by the higher interest rate environment and delayed supply side responsiveness. Regardless, Interfor remains well-positioned to successfully navigate through this environment, with its high quality and regionally diverse portfolio of operations.

In terms of Q3 earnings, Interfor generated adjusted EBITDA of $32 million, on total sales of $828 million. Compared to Q2, revenue benefited from a slight 2% increase in the average realized price on lumber sales, which was more than offset by a 10% decrease in shipments. The lower lumber shipments were mainly due to temporary operational disruption caused by wildfires in B.C.

Production costs on a per unit basis were higher quarter-over-quarter, due mostly to Q2 costs benefiting from a $28 million reduction in the reserve against inventories, whereas Q3 only benefited from a $3 million reduction of the same. The operational disruption in B.C. caused by wildfires also contributed to higher costs in the third quarter.

From the balance sheet perspective, financial flexibility improved in Q3, with a net debt to invested capital ratio dropping to below 29%. This improvement was driven by cash flow from operations totaling $107 million, including $71 million of income tax refunds related to the prior year. A portion of this cash flow was used to fund capital expenditures totaling $39 million, of which the majority was on the strategic mill improvements in the U.S. South.

Looking ahead, we still expect to receive an additional USD 25 million of income tax refunds before the end of this year. And we'll continue to execute on monetization of our coastal B.C. operations to further bolster the balance sheet.

In terms of capital allocation, our key priority is to continue managing our balance sheet leverage towards our target range, while also continuing to invest in select U.S. sales operations, where attractive opportunities exist to optimize returns. We continue to anticipate capital expenditures for 2023 to total about $210 million. For 2024, we estimate capital expenditures will total about $140 million.

To wrap up, we will continue to focus on operational excellence to maximize margin on each segment, while conservatively managing through the ongoing market uncertainty.

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

[Barton Bender, executive]

Thanks, Rick. As usual, I'll provide comments on our market outlook. In general, the outlook varies whether you're focusing on the medium term or the short term.

In the medium term, the market fundamentals remain encouraging, buoyed by tailwinds on several key factors, such as underbuilt housing, demographics, age of housing inventory, household formation rates, et cetera. All of these indicators support increased lumber demand in the future.

In the short term, the market outlook is less certain. Affordability, a combination of both the price of the house and mortgage rates, is impacting the demand for homes and consequently, build our confidence. This is causing some volatility in the housing starts and within housing starts, the percentage of multifamily versus single-family.

With new home construction accounting for approximately 30% of lumber demand and single-family construction consuming 3x out of multifamily construction, this volatility is impacting lumber demand. With that being said, recent data in the last few months has been encouraging, with the percent of single-family starts stabilizing closer to 70% of total U.S. starts. This will be a key item to focus on going forward.

On the Repair & Remodel component of end-use, which accounts for approximately 40% of lumber demand, takeaway remains stable. With many existing homeowners remaining in place, remodeling opportunities have increased. This is helping to keep repair and remodel lumber demand steady.

When you combine all the lumber demand sectors in one and consider current supply dynamics, including the impact of European imports, the short-term outlook for 2023 and into early 2024 shows few signs of improvements from current levels.

Our market intelligence suggests in-market lumber inventories are stable on the low end of the spectrum. It's important to recognize that the lumber market is very sensitive to demand and supply dynamics. As you work through these short-term uncertainties, we know that markets can improve quickly.

We will continue to manage our business accordingly, matching our production demand as we work through the short-term headwinds and move closer to medium-term tailwinds.

With that, back to you, Ian.

[Ian Fillinger, executive]

Okay. Thanks, Bart. Operator, we're ready for questions.

[Operator]

[Operator Instructions] Your first question comes from Roshni Luthra from BMO Capital.

[Roshni Luthra, analyst]

Could you talk about some demand trends that you're seeing in [ new HC ] and R&R just since the end of Q3? And also just what you're seeing in the channel, like in terms of inventory?

[Barton Bender, executive]

Sure. I'll answer that. It's Bart here. Our best indicator on the repair and remodel side comes through our actual programs that we have with the customer base that services predominantly that end-use sector.

So we've got weekly indications of the kind of demand that we're seeing. And I can tell you that they -- the consumption that we're seeing through that portion of our customer base has been steady, and it's been steady for some time actually.

And so we're not seeing any indication based on actual business done, that's -- the inning is going to change from where it's been at. So we've been actually encouraged by the amount of business that we're getting on that side of it.

Moving over to inventory levels. It's always difficult to put your finger exactly on where the sort of the in-market industry levels are. However, the intelligence that we have through conversations with customers, through some reporting that is available, suggests that the inventory levels are sort of in that bottom 1/3 of, I would say, historical norms. Those are the in-market levels.

So I can tell you on the inventory levels, on our side of the equation, we continue to be very diligent in how we manage those. We work very hard to make sure that our in-process and finished goods inventories are kept at strategic levels, which that is the case for us.

[Roshni Luthra, analyst]

Sorry, go ahead.

[Ian Fillinger, executive]

No, go ahead.

[Roshni Luthra, analyst]

I was just going to -- just on top of that, speaking of inventories, probably do you have a better sense of what's going on with the European lumber import? What's sitting at the U.S. ports or what you're expecting for the next 3 months?

[Barton Bender, executive]

Yes. I mean, obviously, the year started out a bit differently, I think, than historical trends. We saw quite a volume come in from the European importers. But I would say from February on, we've just seen a steady ratcheting down of those numbers. And I think we'll end up -- in 2023, we'll end the year at fairly similar to 2022.

However, the pace of the last, call it, 6 to 8 months has been at a lower level, which would suggest that 2024 overall inventories will be coming down to kind of more historical levels of what we saw maybe in -- I think 2020 is a good indication, maybe even 2021. So in and around that high 2 to low 3 billion board feet annually.

[Roshni Luthra, analyst]

And then just the last question for me, [ Bart ] or Rick. I saw your preliminary CapEx program for next year, $140 million, I believe. Just where's the pullback coming from? Is there like a rethink on the multiyear CapEx program? Or just any color you can provide there.

[Ian Fillinger, executive]

This is Ian. I'll take that. Yes, our CapEx program, as we've continually advertised, is flexible. We have a CapEx team in place. We're, I think, distinctly different than some others in our industry where our capital projects are managed, engineered, supervised and executed on with an internal team largely based out of the South.

That gives us the ability at different points in time for a multitude of different reasons, which could be market conditions, it could be labor availability, it could be scheduling or moving projects to support start-ups of other projects.

So the genesis behind us moving those around has a little bit to do with all of those. And I think that's the strength of Interfor that we're not tied to long-term contracts that demand projects to be done at times where the market doesn't need any extra wood coming on the market. So really, it's that more than anything.

The other thing that also changes when you lay out a plan from 2018 and then lay it out for 5 or 6 years is cost. And in some projects, it's valid and prudent to look at how costs have changed over the last 24, 36 months.

So some of that factors into possibly delaying or pushing out a project to allow the right threshold paybacks to be achieved, et cetera. So what you're seeing in our plan going into 2024 is really a combination of all of those factors.

[Operator]

Your next question comes from Kasia Kopytek from TD..

[Kasia Trzaski Kopytek, analyst]

It's Kasia on the line. Just sticking with Roshni's question. Ian, can you provide some context around the nature of the projects that are being deferred in 2024?

[Ian Fillinger, executive]

I would say that there's one project that we're doing in Thomaston. It's a large multiyear project, and our goal is to finish that in 2024. Other than that, there's a multitude of smaller projects in 2025 at a couple of mills. These are not big projects, but have great paybacks. And then there's one or two in Ontario that we're looking at for 2025, 2026. So that's the high-level Gantt chart of what our projects look like over the next few years.

[Kasia Trzaski Kopytek, analyst]

Okay. And for the project where you've indicated it's more prudent just from a cost perspective to hold back, what's the magnitude of the return compression that you've been seeing? Or the expected return compression?

[Ian Fillinger, executive]

Yes. I mean we're always shooting for that hurdle rate, 20%. So when they go north of that, we take a hard look at it and then decide, with an appropriate risk level, whether to continue?

Or like I said, we have flexibility when prices -- equipment prices get too expensive to back off. So as soon as it trips that threshold, it really gets our attention at the senior level, and then we talk about it and make the right decision. So I would kind of leave it at that.

[Kasia Trzaski Kopytek, analyst]

Great. Okay. And maybe taking it back to market, you gave some context in your prepared remarks around order files. Can you comment maybe on certain areas that are stronger on a relative basis than others? Some preliminary discussions that you're having for 2024, what that's looking like? And whether generally things are trending normally from a seasonal perspective?

[Barton Bender, executive]

Yes. All good questions. It's interesting. We've got a fairly unique perspective on the markets with the regions that we operate on. And I can tell you that the markets -- that each region has its own sort of dynamics that are involved. And it's not always one consistent region that's showing increased activity versus another, it does move around. The market is fairly dynamic that way.

The business, as we get into 2024, right now is the time that you talk about partnerships and programs and working with our customers and getting set up for next year. The interest to partner with Interfor remains high. We've got a very strong customer base that's been -- we've been servicing them for years. And a lot of them is just a bolt-on from what we acquired in the East.

So we feel like we're in a pretty solid position there. And then we just have to just see how the market goes. I mean it's -- it really is a bit uncertain right now. And -- yes, we'll just react to the demand that we see from the market given our sort of network of outreach to -- by region to the different customers.

[Ian Fillinger, executive]

I would just add to Bart's comments, and this is -- I'm putting words in Bart's mouth, but he spoke about this. But the advantage that we have, we often get asked around growth. And our last acquisition was -- about a year ago, today almost, was Chaleur in New Brunswick.

But we are seeing significant customers starting to recognize the breadth and depth of our company, and [indiscernible] that would be traditionally buying one specie in the area are now buying from all areas in our company. And so we are getting great traction with a number of very important customers that are now buying from us in different regions. So I would say that's a nice synergy that we're getting.

The other one is that we are the largest producer in the world and very heavy to MSR. So single-family homes start to improve, which if you look at FEA forecast and accept that as a trend, we should be benefiting from that going forward, given that there was some depression in single-family homes over the last 18 months or so. So we do see, as Bart's opening comments, medium term, some nice trends that we're expecting.

[Kasia Trzaski Kopytek, analyst]

Okay. Last one for me. Maybe just speak to your overall framework for thinking about where share buybacks into your broader capital allocation program?

[Richard Pozzebon, executive]

Kasia, it's Rick. Certainly, we think where we're trading today represents a significant value opportunity. As we look at our balance sheet, we'd like to be back into our target range before we start thinking about share buybacks. It's certainly high on our priority list in terms of capital allocation. So we'll be keeping a close eye on that going forward.

[Operator]

Your next question comes from Paul Quinn from RBC Capital Markets.

[Paul Quinn, analyst]

Maybe just a follow up on that targeted range. If you could remind us what that is? And when you expect to get there?

[Richard Pozzebon, executive]

Sure. Paul, it's Rick. Target range for us is 5% to 25%. We're just slightly above that today at around 29%. And there's no real time line that we can give you on guidance to get back down to 25%, but we're certainly comfortable where we're at.

We've got some cash flow opportunities in terms of monetizing the coast. That will certainly benefit us over the next 12 to 24 months. That will help bolster the balance sheet. We still have some additional tax refunds coming in, USD 25 million, that will also help. But certainly, the market weakness today is something we'll keep an eye on, and that will be the largest driver of when we'll be able to recover back down into our target range.

[Paul Quinn, analyst]

Okay. And yes, congratulations on the B.C. Coastal tenure sale. Just wondering if we can -- with the time line for the remaining balances and whether we can use those sales metrics as an indicator for what your eventual net proceeds will be from.

[Ian Fillinger, executive]

Yes, I'll take it. Paul, it's Ian. We're very pleased to be moving forward on that, kind of unencumbered, if you will. And the interests we've been working on for, as you know, probably 2 years now. Extremely high, advanced conversations with a multitude of people interested in the tenures.

We've had lots of support from the B.C. government who's behind the strategy. And so as these things progress, which we expect will be on a regular basis, yes, we'll keep you and the Street informed, but we expect these to be rolling in over the next 24 months.

[Richard Pozzebon, executive]

And Paul, if I could just add. The economics on the transaction that we announced with our press release yesterday, that's in line with what we would expect to be able to realize on average over the course of the next 24 months or so on the remaining tenure sale.

[Paul Quinn, analyst]

Okay. Great. And then just lastly, if you can give us a high level sort of update as what's happening on that softwood lumber file? Do you see any movement forward? I mean some of your competitors have talked about an increasing discussion. If we're talking 24 months of settle the coast, what's the timeline of settling the softwood lumber?

[Ian Fillinger, executive]

Yes. Paul, taking a shot at that. I've listened to the responses from others. I don't think I can add much more, other than, on the Canadian side, the cooperation from coast to coast is extremely high on what a pan-Canadian view would look like.

At the end of the day, it's -- the two governments have to come together if there's going to be a negotiated settlement which, given the political environment in both countries, might be a while. And on the court, really, the roadblock are getting the panel set for the review of the legal case, which is probably in 2025 best-case scenario. If there was a refund through the court system, it would probably be in that -- in and around that range. And if there's a negotiated settlement, it would probably be slightly before that.

[Operator]

[Operator Instructions] Your next question comes from Ariana Milin from CIBC Capital Markets.

[Ariana Milin, analyst]

I know you talked there of the R&R trends that you're seeing. But I was wondering if you could provide some color on your R&R demand expectations for 2024. Do you see volume growth there?

[Barton Bender, executive]

Yes. Thanks. I think I did mention that we expect the Repair & Remodel sector to be fairly steady. We've seen that throughout 2023. And as we look at our own results, plus what we're hearing from our customer base, we're expecting a similar trend through 2024.

[Ariana Milin, analyst]

Okay. Great. And then given your ongoing capital projects, what level of production you're targeting next year?

[Richard Pozzebon, executive]

We don't provide forward-looking production guidance, but certainly, given some of the projects that are ramping up today and over the next quarter or 2, we expect some uplift in production from where we are this year at a current run rate basis.

[Operator]

There are no further questions at this time. Mr. Fillinger, please proceed with the closing remarks.

[Ian Fillinger, executive]

Okay. Thank you, everyone, for your interest in our company. And if you have any further questions, feel free to give us a call or drop us an e-mail at any time. And this concludes our call. Thanks again. Goodbye.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Thank you.