Interfor Corp

TSX:IFP

Earnings Call Transcript 2018-Q4

[Operator]

Good morning, my name is Jody, and I will be your conference operator today. At this time, I would like to welcome everyone to the Interfor Corporation Fourth Quarter Analyst Conference Call. [Operator Instructions] Duncan Davies, CEO, you may begin your conference.

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

Thanks, Jody. Good morning, everyone. Thanks for joining us. We're here this morning to discuss Interfor's 2018 financial results and to look specifically at our results for the fourth quarter of the year. Joining me, as usual, is Marty Juravsky, our CFO; and Bart Bender who's responsible for our sales and marketing efforts, and who will provide comments on the current state of the lumber market in a few minutes. I'm going to keep my remarks brief, and we'll turn the meeting over to you for questions as soon as I can. From a bottom line standpoint, 2018 was the best year in Interfor's history. Net earnings were $112 million or $1.60 per share and sales of $2.2 billion. These results reflect the strength of the lumber market in the first half of the year as well as the gains made and the performance of our Southern operations over the course of the year. EBITDA during the year adjusted to exclude the effects of share-based compensation totaled $280 million. And cash from operations before changes in working capital amounted to $275 million or $3.95 per share.Net cash flow after changes in working capital was $255 million or $3.70 per share. Capital spending in 2018 was $139 million, and $37 million was spent on share buybacks, leaving the company with net debt of $64 million at year-end, reaching slightly more than 6% of invested capital. Available liquidity was $506 million at the end of December. Turning now to the results for the fourth quarter. It's clear that the pace of the first half of the year was not maintained in the second half as the collapse in lumber prices that began in June had a direct and significant impact on our profitability.In the fourth quarter, Interfor posted a loss of $13.2 million after tax on sales of $469 million, compared to net earnings of $28.1 million on sales of $570 million in the third quarter. EBITDA was $6 million in the fourth quarter versus $69 million in the third. Results in the fourth quarter include an $8.2 million NRV adjustment on inventory values that will self-correct as prices recover this year. The drop in sales returns in the fourth quarter accounted for the full drop in EBITDA versus the third quarter. Average sales values fell by more than $100 per thousand board feet quarter-over-quarter on 647 million board feet of sales. The series of factors, including lower duty expenses, favorable FX rates and lower G&A expenses helped to offset the impact of lower shipment volumes and higher log costs, which together, had a small positive impact on our results in the fourth quarter.Production in the quarter fell to 607 million board feet from 674 million board feet in the third quarter, reflecting a combination of market-related downtime, primarily in the B.C. Interior, project-related curtailments in the U.S. South and normal holiday downtime across the platform. Capacity utilization rates were 42% on the B.C. Coast, 75% in the Interior, 81% in the Northwest and 86% on the South, coming in at 78% overall compared to 87% in the third quarter. The decision to curtail operations in the B.C. Interior in the fourth quarter was taken partly in response to the drop in sales returns and partly in response to the rapid increase of log costs in the region during the second half of the year. In contrast, net log costs in the Northwest and U.S. South were either flat or down in the second half of the year. Cash from operations in the fourth quarter, after changes in working capital, was $18 million. Capital spending in the quarter came in at $59 million as the Phase 1 projects in the U.S. South gained momentum. The projects at Monticello, Arkansas and Meldrim, Georgia are on track for completion in the second quarter of this year, with the gains we've seen to-date, and productivity and great outturns, in line or above expectations. The Phase 2 projects at Thomaston and Eatonton, Georgia and Georgetown, South Carolina are in the detailed planning stage, with construction scheduled to commence in all 3 projects midyear this year. During the fourth quarter, we took advantage of our strong balance sheet to acquire 1.7 million of our common shares at a cost of $25 million, bringing the total for the year to 2.3 million shares at a cost of $37 million. The shares were cancelled on purchase. We believe that share repurchases, in a manner -- in this manner, represented a very attractive use of capital and will create value for shareholders in the years ahead. Looking forward from here, we've seen a significant uptick in lumber prices in recent weeks. It will have a positive impact on our results in the first quarter. At this point, I'd like to call in Bart Bender, our Senior Vice President of Sales and Marketing to provide some comments on the state of market and our outlook for the balance of the quarter. Bart?

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

Thanks, Duncan. I would comment on the current state of the lumber market. Year-to-date, we have seen a marked improvement in the demand for lumber. Consequently, pricing has started to improve. Inventories in the marketplace are at historical lows, putting us at levels below this time last year. We don't believe any significant inventory changes at the producer level. There have been a number of curtailments announced in recent months, primarily from the B.C. Interior, and to a lesser degree, the Pacific Northwest. The reduced lumber supply related to these curtailments is well-known and significant. On the demand side, we continue to be optimistic. Market fundamentals, such as employment, wage growth and pent-up housing demand remain positive. New home construction, albeit in the process of addressing affordability concerns, forecast growth through 2019. Repair and remodel, and new sector, the most significant consumer of lumber, has shown continued strength as consumers increasingly are investing in their existing homes. We maintain that repair and remodel, and new sectors are benefiting in 2 distinct ways. Firstly, an average home age of 40 years in the U.S. requires an increased level of updating; and secondly, from consumers who opt out of the move-up market for new homes and invest in their existing homes instead. Our export markets remained relatively steady. Our volumes to Japan and China remain consistent quarter-over-quarter. In other Asian countries, we've seen encouraging growth. Our customers are reporting strong lumber consumption so far this year, with many citing better activity year-over-year. All of this considered, we believe the stage has been set for an active lumber market in early 2019. We expect continued price volatility and remain optimistic for 2019. Thanks, Duncan. I'll leave it at that and turn it back over to you.

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

Great, Bart. Thanks. Well, the fourth quarter 2018 was nothing to write home about, we're firmly in the view that the pricing environment we experienced was an anomaly, so I've described that the overreaction to the overreaction we experienced in the first 5 months of last year, and will self-correct as 2019 moves ahead. As Bart said, we're seeing those signs now. All of which will have a positive impact on our results as well as Phase 1 capital projects and other initiatives we have underway as they ramp up over the course of this year. At this point, Jody, I think what I'd prefer to do is turn the meeting over to our questions -- over to our guests so we can answer their specific questions.

[Operator]

Certainly. Your first question comes from the line of Sean Steuart.

[Sean Steuart, Research Analyst]

Two questions. A number of your competitors have disclosed decisions to continue ahead with some temporary shots in D.C. in the first quarter. Are you guys extending any of your curtailments that you took in Q4 into the first quarter as well?

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

Yes. We're in a pretty good position from a log standpoint, Sean. But we're operating one of our big facilities in the B.C. Interior at a slightly lower rate than we would normally operate in response to the market. And I think what we've seen -- one is a bit more discipline on the part of producers. You're looking at aggregate levels of demand. But the biggest issue in the B.C. Interior is the log cost issue, and log availability and log prices. And it's a combination of the reductions and available harvest levels, resulting from reductions in allowable cuts associated with the mountain pine beetle but also exacerbated by the fires that we saw in 2017 and 2018, limiting some of the standing timber inventory that people had planned for harvest. All of which, in turn, has been resulting in some rapidly escalating log costs due to -- whether it's train issues or haul distances or other factors, increasing log costs, combined with higher stumpage rates. And the equation between log cost and lumber prices continue, and even though they're starting to recover at levels that we think are a little low for what our expectations would be, given the strength of the market. We're seeing lower -- more disciplined and lower production levels as a result of those factors. And so we are as well as others, moderating our production levels.

[Sean Steuart, Research Analyst]

Got it. And following on that, Duncan, I'm guessing we'll see some significant cost relief in B.C. in the first quarter with sounds like more rational bidding for the market logs. Any guidance you can give us on putting -- qualifying or quantifying the relief that you would expect on log costs in the first quarter?

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

Yes. That's a bit of a mug screenshot. I think we're seeing some -- the way this lumber system works, you get some quarterly adjustments based on your current lumber prices but there's also annual adjustments that take place that could counterbalance that. So our expectation for 2019 will be there's some moderation early in the year, but by and large, we're not going to see any significant relief until there's more rationalization of the capacity and the rebalancing of the equation between available demand and supply.

[Sean Steuart, Research Analyst]

Got it. And then just a quick one for Bart, southern pine pricing, in particular. We've seen, I guess, varying degrees of momentum in that region. It looks like some of the wire dimensions the last few weeks, prices starting to move, lack of traction for 2x4s. Can you give us some context on the dynamic between dimensions in the South? And what's feeding into some of that relative performance gap?

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

Yes. Well, there's a couple of factors. First of all, the weather that we're seeing down there can play with the dimension of logs that are getting pulled into the mills, and that can have an impact of whether it's narrows or wides. But I would say, in general, we're seeing a fairly typical seasonality that treaters are now starting to step back into the market. They're generally purchasing the wider dimensions, so we're seeing an uptick in demand as they prepare for their spring needs. The truss side, albeit it's been very active, it was fairly consistent through fourth quarter as well. I think it has remained so. I think it's just mostly the treater side of the marketplace that has kind of stepped in the most recent past.

[Operator]

Your next question comes from the line of Mark Wilde.

[Mark William Wilde, Senior Analyst]

Duncan, I wondered if you could talk about sort of plans over the next couple of years in terms of capital allocation, especially given sort of this uneven pattern that we've seen in kind of both the housing and the lumber markets?

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

Yes, sure. We've announced over the course of, I guess, the last year a bit, the investments in the Phase 1 and Phase 2 strategic projects in the South. There's a third phase, which includes some additional high-return projects in the South and also some high-return projects in other regions as well. So everything that we see tells us that the returns available to us on those projects are, by far and away, the best uses of capital for us. But we also saw an opportunity, in the last half of 2018, with the dislocation in our share price relative to what we think the inherent value of the company is and what our long-term prospects are. But to be able to step into the market to acquire shares at what we thought was a pretty attractive price, certainly an attractive price, relative with some of the other alternative uses of capital that might be available. We continue to look for tuck-in acquisitions or other types of acquisition opportunities, but our view is that price expectations are still out of whack with reality. So we're not widely motivated to buy stuff at high prices just so we can be bigger. It really needs to be a value-creating exercise for us. It needs to fit strategically with what we're doing. So while we continue to look, we just haven't seen -- been able to find anything that fits our criteria and meets our price requirements. And I guess, lastly, Mark, with the question of greenfields, it's still one of the things we are looking at but it still in deferral as we look at -- as we focus on our own internal projects and the potential for share buybacks. Just one last thing on that. Just to put it into context, I know you the way he runs our models, our expectations is that the capital spending in 2019 will be in the CAD 200-million-a-year range.

[Mark William Wilde, Senior Analyst]

Okay. All right. That's helpful, Duncan. I appreciate that. I wonder if you can give us some sense of what you're expecting in terms of kind of log cost in the Northwest and down in the South? And then if you might just kind of compare, given where log costs are now, just the competitiveness and the returns across your 3 producing regions?

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

Yes, sure. I made the comment in my remarks that we've seen some very significant inflation in log costs in the B.C. Interior. Our log costs in the Pacific Northwest, if anything, moderated a little bit and in the U.S. South is flat. I don't see anything in the South in the near term that suggests that you're going to see any kind of significant inflation in log costs in that region. Timber supply, relative to demand, even with some of the capacity additions, is still significant and I think will create a moderating effect on log pricing. In the Pacific Northwest, there's a relative balance between available supply and available demand. Then there's some of the pressure on export volumes, given some of the trade issues that exist. What we've done is pricing has been pretty responsive to what's happened in the lumber markets. So right now, looking at it, we see conditions in those 2 regions have been more favorable than they are in B.C., which is working its way through a significant reduction in harvest levels, and we haven't had capacity to rationalize as quickly as timber supplies rationalize. And until that happens, I think you're going to see pressure around log prices and probably some pretty erratic behavior that's going to take place -- and some erratic pricing that's going to take place on log costs. It's one of the things that's receiving lots of our attention. And we're probably the first out of the gate saying, in a lumber market that's weak, there's not enough a lot of sense, stretching lumber prices, and we felt that it made more sense, at least for us, to back away on production and try to bring some rationality to the lumber market.

[Mark William Wilde, Senior Analyst]

Okay, that's helpful. Last one I have is, maybe one for Bart. Over the last few years, you guys have talked about trying to develop more of a lumber export business out of the Southern U.S. And I'm just kind of curious about kind of how that effort is going right now and particularly, how that effort might be going in China versus other locations, given the tariffs?

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

Right. Well, the tariffs for lumber heading to China certainly had their impact. And the net result is that we have sold less to that market out of the South this year than we did last year. That said, the other Asian markets have been encouraging. We've increased our sales to those areas, places like India, or the Philippines, Taiwan, those have all seen a marked uptick in the volumes that we're selling. Are we on pace to -- or were we on pace to equal our 2017 results? No. The China tariffs definitely had an impact, and we're working through those now and hopefully, we land ourselves in a spot where we're not encumbered by a tariff like that.

[Operator]

[Operator Instructions] Your next question comes from the line of Hamir Patel.

[Hamir Patel]

Duncan, I heard the Phase 1 project is coming on in Q2. I imagine there might be some production disruption as that comes on. So how do we think about annual volumes for 2019?

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

So that's a good question. And there will be -- there'll be a few disruptions in the South as those projects do come on board. There'll be some downtime as we're tying in new pieces of equipment and things like that. Our expectations -- I think we produced a little over 1.2 billion board feet in the South last year. Our expectation is, all things considered, downtime plus the ramp-up in productivity post-project implementation, we think our volumes will be up slightly in the South next year and our volumes for the company overall -- sorry, Marty's pointing at me and saying this year. We think the 2019 volumes will be up slightly compared to the 2018 volumes. And we expect the total volume for the company will be up compared to what it is this last year, which is 2.635.

[Hamir Patel]

Great. That's helpful. And just one for Bart. Can you tell us the length of your order files today? And how does that compare for SPF and Yellow Pine?

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

Well, okay, so order files today are in the range of 2 to 3 weeks, pretty much across the network. When you see a marked turn in the marketplace on pricing or demand, you tend not to run out your order file right away. So our strategy has been to keep fairly tight, and we'll continue to keep fairly tight in that range of 2 to 3 weeks.

[Operator]

Your next question comes from the line of Paul Quinn.

[Paul C. Quinn, Analyst]

It's been a while since we talked about Canada-U.S. trade, so I know there's a couple of NAFTA and a couple of WTO challenges working their way through the system. I suspect they'll be up at the end of this year or early 2020. Is that your expectation? And do you think that recalculation of the duties will get both sides together? Any hope on a longer-term deal?

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

Well, I'm always hopeful that the parties to this industry are going to take a more professional, rational approach to these kinds of matters. I remain ever hopeful that -- history tells us it takes time. We are moving forward with the legal cases. We think our cases are very strong. You will have heard my comments earlier about what's happened with log costs in the various regions. I think a fact-based or an objective assessment of the situation would support the view that there's no subsidy provided to Canadian producers. And I fully expect that the Canadian producers are going to be successful with their legal challenges. And that will take some time but, so be it. And at the end of the day, there'll be some kind of a discussion, but I'm not expecting it to happen anytime soon.

[Paul C. Quinn, Analyst]

Okay. And then just on, I guess, lumber exports. Given the tariffs in place on your shipments into China, are you able to make up that volume from Canada?

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

We've seen a marked increase in volume from Canada, but we're still -- just to be clear, we're still active on some products in the South to China. We've tried to keep our shipments fairly consistent to that market. So the combination of the 2, we think Canada is a net benefactor of those tariffs. And our volumes have shown so.

[Paul C. Quinn, Analyst]

Is there a big difference in shipping costs out of the U.S. South over to China versus, I guess, Vancouver to China?

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

Yes, fairly significant. It's lower cost to ship out of the south to China. I'd say 50%.

[Paul C. Quinn, Analyst]

50%?

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

That's correct.

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

Less from the south, Paul.

[Operator]

Your next question comes from the line of Benoit Laprade.

[Benoit Laprade]

Duncan, just curious, based on what you know from Phase 2 at this point, would you be able to give us a preliminary number for capital in 2020?

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

Probably pretty close to what 2019 will be as the Phase 2 project ramps up, Benoit.

[Benoit Laprade]

Great. And just curious, have you been active on your NCIB so far in 2019?

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

I think in the early stages, yes. So we're currently blacked out. But we have -- we've put in place an automatic share purchase program prior to the blackout and under specific criteria, and we've been buying some of that -- some stuff during that period of time.

[Operator]

And there are no further questions in the queue. I turn the call back over to Mr. Davies.

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

Thanks, Jody. Thanks, everybody. Obviously, the fourth quarter of the year wasn't what we'd hoped it would be, but I think we certainly take a longer-term view. And if you look at 2018, in total, it was a pretty good year for us, a year of 2 distinct parts. And I think as we recover through this early part of 2019, we'll back to a normalized type of market environment. A number of the things that we've had either way, both in terms of management initiatives and our CapEx programs are going to deliver the kind of results that we expect. So we continue to be very optimistic about how our company's positioned. We're very optimistic about the marketplace and think our programs are on track to build significant value as we move our business forward. So we very much appreciate your interest in our company, appreciate you coming on the call this morning. Marty and I are both available if you have follow-up calls. And in the meantime, if we don't chat with you, we look forward to talking to you at the end of the first quarter. Thanks, everybody and have a good day.

[Operator]

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