Interfor Corp

TSX:IFP

Earnings Call Transcript 2017-Q4

[Operator]

Good morning. My name is Chris, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Interfor Fourth Quarter Analyst Call. [Operator Instructions] Mr. Duncan Davies, President and CEO, you may begin your conference.

[Duncan K. Davies, Chief Executive Officer, President and Non]

Thanks, Chris, and good morning, everyone. Thank you for joining us. We're here to discuss Interfor's fourth quarter and 2017 year-end results, and provide some comments on the outlook for the first quarter of 2018.Joining me, as usual, are John Horning, who formally stepped aside yesterday as our Chief Financial Officer; Marty Juravsky, who was appointed Chief Financial Officer yesterday; and Bart Bender, our Senior Vice President of Sales and Marketing. I'm going to keep my comments brief and will turn the meeting over to you for questions as soon as we can.First things first, I'd like to take a few minutes to review our results for the quarter and for the full year 2017. For Q4, net earnings were $36.2 million and EBITDA was $89.5 million on sales of $532.8 million. And we're, obviously, quite pleased with these results. It would only be fair to point out that $3.7 million of the reported EBITDA figure was a true-up of Q2 and Q3 duty expenses to reflect final duty rates versus the preliminary rates that were booked at the time.For the year, net earnings were $97.2 million, and EBITDA was $287.8 million on sales of just under $2 billion.The results for the quarter and the year set new records for Interfor. They reflect a combination of strong operating performance, good progress on our internal management initiatives and strong product prices.Production in the quarter was 655 million board feet, up 10 million board feet versus the prior quarter. Production in the U.S. increased 16 million board feet quarter-over-quarter to 436 million board feet, while production in Canada fell by 6 million board feet to 219 million. For the quarter, operating rates amounted 46% in the B.C. Coast, 97% in the Interior, 88% in the Northwest and 89% in the South. These figures compare with 49% on the Coast in the third quarter, 99% in the Interior, 87% in the Northwest and 85% in the South.For the year, production increased 4% versus 2016 to just under 2.6 billion board feet, with the U.S. accounting for 66% of the total and Canada for 34%. As I mentioned, product prices were strong across the board in the fourth quarter, with the Yellow Pine Composite up $30, the SPF Composite up $35 and dry Hem-Fir studs up $4. The strength of prices in the quarter reflect a combination of active takeaway levels, tight supply chain inventories and ongoing production constraints. Prices for specialty grades, which represent approximately 10% of Interfor's production, were relatively flat quarter-over-quarter. Taken together, Interfor's average selling price increased $39, or 6%, to $650 per thousand board feet versus the third quarter.The fourth quarter was another strong quarter from the standpoint of cash flow and debt repayment, with $87 million in cash from operations after working capital changes, approximately $25 million in capital spending on a variety of different projects and $59 million in debt reduction.At the end of the quarter, net debt stood at $119 million, or 12% of invested capital.For the year, net debt was reduced by $171 million, bringing the total for the last 24 months to more than $330 million of debt reduction. At the end of the third quarter, we announced our intentions to move forward with a multiyear strategic plan designed to capture the opportunities within our current operating platform and to pursue further opportunities for growth. This plan is entirely consistent with the strategy we've employed on a number of occasions in the past, most recently in the B.C. Interior, which has delivered very attractive returns for us on capital employed and significant free cash flow post the investment phase.Planning for the first 2 projects at Meldrim, Georgia; and Monticello, Arkansas, is well underway, with both projects scheduled for completion in the first quarter of 2019, and incremental production expected of 150 million board feet post those projects.At the same time, we're working actively on the second phase of the plan to identify the mills and projects, which will follow the completion of Meldrim and Monticello, and I have -- expect to have more to tell you about that as the year progresses.We're also continuing to work on the greenfield opportunity identified previously with a decision expected mid-year.Let me turn now briefly to the outlook for the first quarter of 2018. All things considered, product markets have performed very well in the first few weeks of the year in spite of the challenging weather in many parts of North America. Tight inventory levels, concerns over available supply and logistics issues are the primary factors impacting the market.We're also seeing strong activity levels in our offshore and specialty products businesses. I would, however, add a bit of caution to people's expectations and remind everyone that final duties are now in place, and there won't be any duty true-ups in the first quarter, as was the case in the fourth quarter of last year. We're also seeing signs of log cost inflation in a number of our operating areas, especially where timber supply is constrained for one reason or another.Finally, I'd like to publicly acknowledge the dedication and support of John Horning, who stepped down yesterday as our CFO in anticipation of his retirement later this year. John's been at my side and has had my back for more than 20 years now, and I will be forever grateful for his support.I'd also like to acknowledge Marty Juravsky, who was appointed CFO yesterday; and also Ian Fillinger, who was appointed COO yesterday. Both Marty and Ian have made significant contributions to our company, and I expect them to continue to do so in the years ahead, just as I expect big things from Bart Bender in our sales and marketing area and from Mark Stock in our HR and IT group. We're fortunate to have such a dedicated and talented group driving our agenda.Chris, at this point, what I'd like to do is open the session for questions and -- so I can respond to points of interest from our guests.

[Operator]

[Operator Instructions] Your first question comes from Hamir Patel.

[Hamir Patel]

First question I had was about some of the capacity announcements that we've seen in the U.S. South. Just curious to get your thoughts on perhaps the amount that could actually realistically come on, indeed, the next couple of years just given some of the labor and equipment constraints that we hear about.

[Duncan K. Davies, Chief Executive Officer, President and Non]

Well, I don't know exactly how much is going to come on, on stream, Hamir. But our expectation is the market demand for lumber in the U.S. is going to grow at somewhere in the range of 2 billion to 2.5 billion board feet this coming year as housing starts continue to improve. And our sense is, it will be very difficult for the industry to increase supply at a rate anywhere close to that level, whether it's through capacity creep or through new mill additions. There's limitations in available equipment supply. There's limitations on labor availability. There's limitations on byproduct off-take opportunities that are all big factors in the industry's ability to add new capacity. And that's one of the -- those are 3 of the items that we're looking at very closely when it comes to any additions that we look to make in our facilities, whether it's incremental expansion on projects like Meldrim or Monticello or the greenfield opportunity that we're looking at. And we're seeing whether it's equipment lead times or what have you. I think it's going to be a much longer period of time for any significant increases in capacity to happen in the industry and especially relative to the increases in demand that we're seeing here over the last couple of years and expect to see this year and the next few years after that.

[Hamir Patel]

Great. That's helpful. And Bart, I had a question for you on the markets. Some of your competitors recently have been talking about Southern Yellow Pine penetrating sort of nontraditional regions or markets that hasn't historically gone. Just curious what you're seeing in terms of substitution.

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

Well, yes, I would add, definitely, there is arbitrage taking place within North America, as customers are facing supply constraints and looking for alternatives. So yes, we have seen that. But I would take it a step further and even include the export markets, which are really coming to the marketplace and paying more attention to what's available out of the South. Certainly, our results have shown a great increase. And in particular, we've got mills that are very well positioned strategically to access the ports. And the logistics costs to get to Asia out of the Southeast are very reasonable.

[Hamir Patel]

And then, Bart, how large do you sort of think the Asian export opportunity is? And does that maybe cannibalize Canadian exports out of B.C.?

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

I don't think so. I think it's additive. I think that the applications are slightly different between the 2 products. So just looking at the Southeast, it's very real. We had significant growth there in this year -- sorry, in 2017. And we're targeting again similar growth in 2018. So yes, no, I think it's real, and I would say -- I'd add even further that the export markets have been competitive in accessing that supply as well.

[Operator]

Your next question comes from Sean Steuart.

[Sean Steuart, Research Analyst]

Congratulations to John, Marty and Ian on the transition. A few questions. First, on capital allocation. Appreciate you have a lot on deck with respect to discretionary CapEx and maybe a greenfield sawmill you'll be building over the coming years. I just wanted to get your views on your outstanding debt. Can you confirm that you're able to prepay any of those secured debt series at any time?

[Duncan K. Davies, Chief Executive Officer, President and Non]

Yes.

[Sean Steuart, Research Analyst]

And do you have any thoughts on that front, Duncan? How do you balance, I guess, capital structure optimization with potential returns of capital to shareholders?

[Duncan K. Davies, Chief Executive Officer, President and Non]

Yes. We look at those things all the time. We do have lots of thoughts. But we haven't got to the point yet where we've made a decision on it, Sean. So stay tuned as we work through things. A lot of it will depend on how 2018 unfolds. We've got -- I think I indicated it in the last meeting that we expect to be able to fund our activities -- our strategic activities out of our operating cash flow. But to the extent that we need to dip into our available credit lines or into the cash balances that exist currently, we've got the ability to do that, all the while ensuring that we've got a balance sheet that's structured conservatively, leaving us with the capacity to take advantage of opportunities that might come our way that we hadn't initially foreseen.

[Sean Steuart, Research Analyst]

Okay. Bart, a question for you. You referenced the offshore export opportunity. Just thinking on the other side of that though, can you comment on what you're seeing with respect to imports coming into the eastern seaboard? And at what price do you start to worry that, that becomes more of a factor in the market?

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

Yes. I -- Sean, I don't really see the imports playing a significant role. I think that their ability to ramp up to any level of significant imports is limited. And I'd even add on top of that, that the experience to date, it's not always smooth running when you're importing products in from Europe. And I think that the recent situation where we've got some pretty significant volumes of miscreated 2x4 product at the dock that's interrupted the flow that some of our customers have been accepting is -- or expecting is problematic. So I think right now we're, what, imports are rating around 1.4 directionally. And I think that if you look forward, I'm not seeing that volume change significantly.

[Operator]

Your next question comes from Paul Quinn.

[Paul C. Quinn, Analyst]

I guess, the affiliation is RBC. Just a couple of questions. I guess, really, just maybe you can outline at a high level the CapEx spend in '18 and '19, if we include the go-ahead on the sawmill.

[Duncan K. Davies, Chief Executive Officer, President and Non]

Well, in 2018, we're working at somewhere in the range of CAD 150 million. And in 2019, it would be the same or a little bit above that, not including the greenfield facility.

[Paul C. Quinn, Analyst]

Okay. If we had a go-ahead decision on the greenfield, what kind of spend do we -- when is that -- that would start in '19, right? But of the $150 million in spend, would it be half in '19, half in 2020?

[Duncan K. Davies, Chief Executive Officer, President and Non]

We haven't got to that point yet, Paul. But that's probably a pretty good working hypothesis.

[Paul C. Quinn, Analyst]

Okay. And then just following up, I think, Hamir's question on capacity in the industry. What do you guys estimate creep to be in the industry?

[Duncan K. Davies, Chief Executive Officer, President and Non]

I don't think we estimate it, but you look at, I don’t know, 1%, 2% kind of a creep. It's harder -- it's a lot harder than a lot of people think. It's not easy to add shifts and not easy to add significant hours in the business just because of the pool labor availability. I want to go back to your previous question. Don't assume that if we do a greenfield facility that the amount of money will be strictly additive to the $150 million capital plan. One of the things that we're looking at is if we do greenfield, how does that affect the schedule of other projects we've got on the drawing board. So to a point, it would be -- it would displace other spending that we would do internally.

[Paul C. Quinn, Analyst]

Okay. And then just on the labor availability issue. Are you seeing a lot of cost inflation on that side?

[Duncan K. Davies, Chief Executive Officer, President and Non]

A bit, and I think you've got to be cognizant of some of the other things that are happening in the U.S. South, whether it's in the distribution field or in the car business or in retail, where there's demand for labor that we need to be competitive with. And looking at those environments, our expectation is, going forward, that we're going to see some inflation on the labor side of things in the Southern region, which has traditionally been a lower-cost region relative to some of the others in North America.

[Paul C. Quinn, Analyst]

Okay. And just last question just on M&A. It seems like you and a bunch of others are turning to greenfield opportunities because, I guess, the last acquisition in the U.S. South was at a pretty hefty valuation. Have you seen any tick-down in the ask from some of the sawmills that, I guess, are on the market right now? Or in fact, given the rise in lumber prices, have they actually moved up their ask?

[Duncan K. Davies, Chief Executive Officer, President and Non]

Well, I don't know if people have moved up their ask. I mean, there's expectations -- transactions always set expectations. And we're relatively agnostic going one way or the other. It's all about how do you position the facility to be first-class facility in the marketplace, and what are the relative economics of one option versus another. And our sense is, a well-structured, risk-mitigated greenfield opportunity has more attractive economics than a high-priced acquisition of a modestly efficient facility.

[Operator]

[Operator Instructions] Your next question comes from Mark Wilde.

[Mark William Wilde, Senior Analyst]

Bank of Montréal. Duncan, do you think that the change in the tax code down in the U.S. with the more rapid expensing of CapEx, do you think that's pivoting people's decision-making toward, say, build versus buy at this point? Or is it just too early to tell?

[Duncan K. Davies, Chief Executive Officer, President and Non]

It's -- Mark, it's too early to tell. It's, obviously, something that we've taken note of. It's -- obviously, it will encourage investment. And it hasn't changed our plan in any way, shape or form. We were going to go in this direction anyway, but it's obviously advantageous with those changes that have been made.

[Mark William Wilde, Senior Analyst]

Okay. And can you just help us understand sort of the kind of critical issues you're looking at, or you're going through as you make this decision about the new mill? You mentioned some of them, chip off-take, labor issues. I assume you're also talking with kind of local and state governments about any incentives. So what are the sort of the critical factors for you as you make this decision?

[Duncan K. Davies, Chief Executive Officer, President and Non]

You hit them all -- you hit the nail on the head on all of those. The only other one that you -- I'd add to that would be timber basket. You need an attractive timber basket. You need a community there where you can attract the management personnel and the skilled trades that you want -- you'll need in a facility like that. You want a pool of available labor that's sufficiently robust that you know you can staff a facility. You need to be able to mitigate the risks associated with byproduct off-take. In simple terms, I've said this before, if byproduct revenue is 10% to 15% of the total revenue of a facility and you're running with a margin of, let's just say for the sake of argument, 25%, that means that your byproduct revenue is 50% to 60% or 70% of the total profitability of the plant. So you've got to make sure that, A, you've got a market or markets for that product; and you've got markets with creditworthy customers, which is a huge, huge consideration, whether it's incremental expansion, day-to-day operation of your existing facilities, or most certainly, with respect to a greenfield development. You want to make sure those things are in place. So we've had very strict criteria in all those things all the way through the piece. And we think we've got one situation identified where those are going to fall into place for us. But there's also some other opportunities, too. And we've talked to a number of people in the last while about other opportunities that might make some sense for us to consider.

[Mark William Wilde, Senior Analyst]

Okay. All right. That's fair. You mentioned log cost pressures, and I wondered if you could just quickly walk us around your various regions in terms of what you're seeing in terms of log cost pressure, log cost availability.

[Duncan K. Davies, Chief Executive Officer, President and Non]

Yes. I don't want to be overly specific about it, Mark. But if you look at the B.C. Coast, which is -- there's lots of trees, availability of fibers constrained for other reasons. And so we continue to see some pressure both from a supply and availability standpoint on the B.C. Coast. It's log availability, which is the reason those plants run in the 45% to 50% range as opposed to higher levels of capacity utilization. The B.C. Interior, where we've had the effects initially of mountain pine beetle and more recently the fires of last summer, have put pressure on log supply. And we haven't seen capacity rationalization at the same rate that we've seen declines in available timber supply. And that's all is an equation for -- put pressure on pricing. And in the Pacific Northwest, we have a relatively concentrated timber land ownership base and other factors. When you get the kind of pricing that we see in North America now, it's going to translate fairly quickly into product price increases or log cost increases in that region. So we're seeing -- in those areas, we're not seeing much, if any, inflation in the U.S. South just because of the log supply-demand equation that exists in that area. There's some pockets where it's flat, some pockets where it's up a few cents or a dollar or so. But generally, it's pretty flat.

[Mark William Wilde, Senior Analyst]

Okay. All right. That's really helpful. Finally, just -- can you just touch on the trade issue for us and give us kind of an update as best you can from where you're sitting?

[Duncan K. Davies, Chief Executive Officer, President and Non]

Which trade issue is that?

[Mark William Wilde, Senior Analyst]

Which one you think?

[Duncan K. Davies, Chief Executive Officer, President and Non]

I don’t pay much attention to it anymore. I don't think anything's happening. I think the focus of the people both in Canada and the U.S. more -- at the government levels, they're more focused on the NAFTA discussions than they are on the Softwood Lumber discussions. I think the whole thing, and as I've said this for years, I think it's all bogus. But Canada -- the various problems of Canada -- the industry in Canada is going to do -- we've always done when we face these challenges, we're going to fight it, and we're going to -- I suspect we're going to win just simply what was won.

[Operator]

[Operator Instructions] And looks like there are no more questions at this time. I'll turn the call back over to the presenters.

[Duncan K. Davies, Chief Executive Officer, President and Non]

Great, Chris. Thanks very much, and thank you, everybody. Appreciate your questions, appreciate you attending the call, appreciate your interest in our company. Marty and I are available over the next bit if you want to talk to us directly. And I'm sure we can probably twist John's arm, if you want to chat with him, too. So thanks, everybody. Look forward to talking to you at the end of the first quarter. Take care now, and have a good day.

[Operator]

This concludes today's conference call. You may now disconnect.