Interfor Corp

TSX:IFP

Earnings Call Transcript 2019-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Interfor Corporation quarterly analyst call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions]I would now like to hand the conference over to your speaker today, Ian Fillinger, President and CEO. Please go ahead, sir.

[Ian M. Fillinger, President, CEO & Director]

Thank you, operator. Welcome to our Q4 '19 investor analyst call. With me today, you have Marty Juravsky, our Senior Vice President and CFO; also Bart Bender, our Senior Vice President of Sales and Marketing. Our agenda today will start off with myself providing a recap of our strategic priorities and Q4 themes. I'll then pass the call to Marty, who will cover off financial matters. And then I'll pass the call to Bart, who will cover off the market.So first, turning to our strategic focus. With the recent change in leadership, I thought it would be good to reconfirm our overarching priorities. Core to our company, we will continue to maintain our capital allocation discipline. Our focus isn't changing, we'll continue to manage our working capital very closely and achieving and executing on our Phase 1 and Phase 2 strategic capital programs. We'll also maintain our balance sheet integrity and our strong liquidity.In Q4, our efforts were balanced across the company in each region. We did a lot of work resetting our business for the future, particularly in British Columbia. We completed the closure of our cedar mill on the coast. We dealt with impacted employees and other stakeholders in a thoughtful way. We rightsized our Coastal woodlands division to reflect a lean marketing logging business and we reduced a significant amount of associated working capital.For our B.C. Interior, we continue to focus with the B.C. government on the timber purchase agreement for cutting rights in the Vavenby area, which is, as a reminder, near our Adams Lake division. In the U.S. South, we moved on to our Phase 2 capital with site and building work and preparation underway at our Eatonton division in Georgia.I'm now going to turn the call over to Marty, who will cover off the financial matters.

[Martin L. Juravsky, Senior VP & CFO]

Great. Thanks, Ian. Good morning, everyone. Let me begin by just referring to the cautionary language regarding forward-looking information that's on the first page of our MD&A. So the focus for the quarter was improving upon the controllable parts of the business as we navigate our way through a challenging market environment. We think that a significant amount of progress was accomplished, and there is more on the come.So a few highlights from our Q4 results. From an earnings standpoint, adjusted EBITDA was slightly higher at $17.6 million versus $16.8 million in Q3 2019. And this was achieved despite average price realizations being down about CAD 17 per 1,000 board feet in -- versus Q3. The factors that contributed to the average price realization decline include lower volumes of high-value cedar as a result of the Hammond Mill shutdown that Ian referred to before. Also as you're aware, our portfolio is weighted towards Southern Yellow Pine species, and Southern Yellow Pine prices were down in the quarter, whereas things like SPF were slightly higher. Production and shipment volumes were slightly lower in Q4 versus Q3. Again, the Hammond mill shutdown factored in as all of the regions had fairly comparable volumes in Q4 versus Q3. Net realizable value adjustments on log and lumber inventories were negative $5 million in Q4, whereas, it was a positive contributor to EBITDA in Q3. So despite those previously mentioned items, adjusted EBITDA was, as I said earlier, a bit better in Q4 over Q3 as we started to see some early-stage progress from the B.C. Coast business reconfiguration initiatives. Another notable P&L item in Q4 was the $30.4 million pretax provision for capital asset write-down and restructuring charges. The vast majority of those charges, about $29 million, are noncash. $13 million related to the write-down of legacy goodwill and $16 million related to equipment write-downs. These adjustments are based on normal course year-end analysis after incorporating our views on operating plans and other macro assumptions.From a cash flow standpoint, as Ian said earlier, a big focus for us has been on working capital discipline over the last number of quarters. More specifically, working capital declined in Q4 for the third consecutive quarter. In Q4 it came down by about $8 million despite some seasonal log building in B.C., in the coast in particular as well as the payment of $8 million in severance for Hammond employees. Year-end lumber inventories were near their lowest levels over the past 3 quarters. Accounts receivable was also down a fair amount, and a large component of the working capital decline over the last couple of quarters is related to the closure of Hammond as working capital repatriation was a fairly large factor in the shutdown decision.So I want to talk a little bit more about Hammond shutdown for a second, as it relates to the working capital component. Often working capital repatriation and mill shutdown scenarios involves a lot of risk and often results in compromises on value realization. In the Hammond situation, our team did an exceptional job on executing the plan. And as a result, we are able to maximize our working capital values very effectively. More specifically, we expect approximately $40 million of working capital back from Hammond. Most of that was achieved in Q3 and Q4, with a very small balance to go in Q1.Further on cash flow for the quarter. CapEx was $37 million in Q4, $181 million for the full year 2019. In 2019, we completed Phase 1 projects at Monticello and Meldrim and started the Phase 2 project spending. The result of this double cohort year on projects was a relatively high level of CapEx. Therefore, as we cast forward into 2020, we expect our CapEx spending to come down in 2020. It should be closer to the $140 million to $150 million range, of which approximately $100 million will be for discretionary strategic capital projects. From a balance sheet perspective, year-end net debt was $225 million, which equates to about 21% net debt to invested capital. Very strong liquidity at around $363 million. Again, as Ian said earlier, balance sheet is important, having a rock-solid financial position will continue to be a core principle for us.Lastly, I'd like to quickly mention the recent announcement by the Department of Commerce from earlier this week regarding the reduced preliminary countervailing in anti-dumping duty rates that would apply to 2017 and 2018. We recognize that these are not final and are subject to change, but reducing the combined rates from approximately 20% to approximately 8% is very sizable and very notable. To put an order of magnitude around it, we paid duties of approximately USD 94 million through to the end of 2019. The portion of the past duties paid that related to the 2017 and 2018 years is around USD 60 million. Virtually all of these amounts were previously expensed and are therefore, off-balance sheet items for us.With that being said, why don't I now turn it over to Bart to provide some market context?

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

Thanks, Marty. I'll talk about 3 general areas here this quarter. Firstly, the demand. Secondly, I'll get into a bit on the supply side. And then lastly, I'll talk a little bit about inventory and pricing. First, demand. Some positive signs, obviously. We've seen some good headline news on housing starts throughout the quarter, quite frankly, which has been very encouraging. The aging housing stocks in the U.S. and the increased equity in existing homes continue to support growth in lumber usage for home improvements. Macroeconomic factors, such as employment, interest rates, wage growth, all seen as positive. How that translates into order files for Interfor? We've got a solid order file across the network, with the vast majority of inventories that are sold in the queue to be shipped.On the supply side, low single-digit net growth in lumber production in the southeast has been more than offset by the significant permanent curtailments in Canada. The export markets are challenged by trade negotiations. However, still very meaningful volumes for the industry in the overseas markets. For us, our export business has been steady quarter-over-quarter. Imports from Europe, essentially the same year-over-year. And looking at North American lumber production, it declined in 2019 versus 2018, again primarily as a result of the massive permanent curtailments in B.C.On the inventory side, always difficult to gauge. We continuously pull the market to try and find out what the inventory situation is. Our customers are telling us in-market inventories are in the range of 30 to 45 days of consumption. I would say that that's a bit below average as we head into the spring building season. For Interfor, again, our inventory is essentially committed and tied to how fast we can ship them, quite frankly. In terms of buying patterns, I would say, they've changed in 2019. It's what I've termed as just-in-time buying, and that's encouraged by ample availability and stable logistics, which we've seen pretty much throughout 2019.On the customer side, they've been able to find what they've needed and for fairly quick shipment. So far, seasonal dynamics haven't played much of a role. I think that's beneficial from a logistics standpoint, both in terms of shipments to the market, but also in the construction activity in the market. So we're having a decent winter when it comes to producing and shipping lumber, but also consuming lumber. We're encouraged by the fundamentals that we're seeing so far in the marketplace. We look forward to these translating into higher lumber prices in 2020.With that, I'll turn it back to you, Ian.

[Ian M. Fillinger, President, CEO & Director]

Okay. Thanks, Bart. Carol, operator, we're ready to take questions.

[Operator]

[Operator Instructions] Our first question comes from Hamir Patel from CIBC Capital Markets.

[Hamir Patel]

Ian, it seems like there's been some discussions in the B.C. industry that the province may look to modify the lag in the stumpage equation later this year to make it more market-based. How meaningful could that be? And any sense as to when the likely timing of that could be?

[Ian M. Fillinger, President, CEO & Director]

Thanks, Hamir. Yes, I guess, Hamir, the way that I would answer that is there's ongoing discussions with the B.C. government, both on the coast and the interior with different dynamics and different drivers on cost and efficiencies and what have you. But there hasn't been anything significant or concrete that has changed relative to the stumpage calculation, but industry is working closely with the government to look at all those variables on how we can get cost back in line with where we think it needs to be. I mean which is as a reference, I believe that coast is operating at 30% of capacity right now. So very challenging with 70% down. So just ongoing, Hamir, I don't have any other information other than that.

[Hamir Patel]

Fair enough, Ian. That's helpful. And just one for Bart. Any sense yet as to how the coronavirus is affecting takeaway of both the lumber and logs in China?

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

Yes. Obviously, a subject that's front and center for us. It's a little hard to say. I'd say that that file is kind of emerging. We haven't got really the industry back in and working in, that's due to be next week. The biggest concern, I think, from my standpoint is the backing up of the supply chain. We've got that adding an extra week before people come back, you've got a bunch of ships that are queued up to go into port, and obviously, the efficiencies of the port day are very low. So that's my biggest concern. And I think that that could cause some delays in some shipments, not only in lumber, but in all the products that are imported into China. And so I think that's the focus item today to make sure that we're managing that and minimizing any risks on product on the water. And then in the next couple of weeks -- a couple or 3 weeks, I think we'll have to gauge what the market impact is. At this point, we're unsure.

[Operator]

Our next question comes from Mark Wilde from BMO Capital Markets.

[Mark William Wilde, Senior Analyst]

I wondered, just to start off, Ian, do you think that this change in the duties will alter kind of plans in terms of any potential further capacity rationalization or whether it might actually bring some capacity back into the market?

[Ian M. Fillinger, President, CEO & Director]

Mark, we've talked about a lot with this recent announcement, I think that the fundamentals of investment in running your operations are just going to come down to what the price outlook is. So at this point, I don't know of anything that would change. I haven't heard of anything that's going to change. And I think it's just too early to tell where this is going to go. But at the end of the day, where the lumber price is and the fundamentals are really, I think, going to drive those decisions on the outlook. I don't know, Marty, do you have anything?

[Martin L. Juravsky, Senior VP & CFO]

Yes. And Mark, remember also like when we look at the rationalization that happened in B.C. last year, there are a lot of drivers. The single biggest driver was log availability and log costs. And so the fundamentals haven't changed in terms of the contraction of log availability. So I can't speak for all of the situations. But a good chunk of the mills that have rationalized just didn't have adequate log supply. And frankly, some of them have been dismantled. So I can't see a scenario where those permits and curtailments aren't anything other than permits.

[Mark William Wilde, Senior Analyst]

Okay. Just on that, Marty. I thought in some places in the interior, there were a number of mills in the fourth quarter that were down kind of running a single shift. Are you aware of any kind of changes at any of those single-shift mills?

[Martin L. Juravsky, Senior VP & CFO]

No. No. Not at all.

[Mark William Wilde, Senior Analyst]

They seem like they would be the things that are on the bubble.

[Martin L. Juravsky, Senior VP & CFO]

Yes. And recognize also some folks will take a path to permanent rationalization in steps. And taking down a shift, taking down the line, it's not meant to be a temporary. It's meant to be a step towards something more permanent. So yes, I don't see any shift back in those that we have visibility on.

[Mark William Wilde, Senior Analyst]

Okay. And just, again, on the kind of the supply side. Can you give us a little more information on where we're at with the 10-year transfer? I see that you're still kind of pointing to first quarter resolution, but it just seems like these things often wind up getting tied up and stretched out from a timing perspective?

[Martin L. Juravsky, Senior VP & CFO]

Well, I think your last comment is a pretty accurate characterization, stretched out. We announced a deal with Canfor back in the summer of 2019, and we've gone to work very collaboratively with them, communities, first nations, various folks, the government. And so with the application is in the government's hands, they're working it through and there's continuing feedback, but we haven't had a decision yet back. So we're still awaiting that. They've indicated to us it should be shortly. Shortly is all in the eye of the beholder, I guess.

[Mark William Wilde, Senior Analyst]

Okay. And then Bart, I wondered, is it possible for you to talk about sort of the ways in which you think this Central European spruce beetle will affect the industry and affect Interfor?

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

Okay. Big topic. So there's a number of ways. I mean there's obviously the impacts on the lumber market, there's also the impacts on the log market. I think that there's -- we're hearing that there's a fairly short lifespan of these logs once they're impacted by the spruce beetle. And so I think that that's tempering the industry from spending too much money on lumber capacity -- lumber production capacity. And so I think there is a limit on how much of that can be done. Bottom line is, is that it's going to drive a higher level of low grade. And so we're going to end up competing with that low grade in our overseas markets. It will also I think encourage the producers to target the U.S. market on dimension. And I think they've been doing that. So we're seeing the impacts of that today already. And I'd say, so far, those volumes have been -- while they've been steady year-over-year, essentially the same, and the growth that certainly is being forecasted for next year is fairly moderate.It's the log side, I think that's probably the bigger impact as they try to get some economic value out of that timber. And so I think that the primary market for that is China and that's where we'll see the most impact. For us, at Interfor, that's fairly small, I mean that's not a huge part of our business. But for other countries, it's a lot more significant.

[Mark William Wilde, Senior Analyst]

Yes. I guess like a New Zealand?

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

Correct.

[Mark William Wilde, Senior Analyst]

Yes. I'm just curious, does the beetle-damaged wood, does that compete directly with a lot of the stuff that you guys had been exporting into China? So sort of your own lower-grade stuff, some of it may be still beetle damaged from B.C.?

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

Well, I mean the low grades, a lot of that's used in, whether it's packaging or concrete farming or things like that. I would say that the low grades that you'd see out of Europe would be similar in terms of how they'd be used. So that's -- yes, we expect some impact. Their ability to ship into certain parts of China, a little bit different than ours. And so I think the markets will sort all that out on where we're able to compete and where we're not.

[Ian M. Fillinger, President, CEO & Director]

Just as a reminder, Mark, it's Ian. I mean our -- as you know, our southern interior mills are really green fiber with no beetle-kill aspect. So our great offering to China is different than Northern B.C., caribou area, we just have higher quality fiber in the southern interior.

[Mark William Wilde, Senior Analyst]

Okay. And then finally, Ian, just how it's -- I guess what your -- in your second month in the chair there, can you just talk with us about what we might see shift even if it's a kind of a subtle shift at Interfor under your leadership?

[Ian M. Fillinger, President, CEO & Director]

Mark, I mean obviously, we've thought about this a lot. And internally, have communicated what I believe and my team believes is our outlook, and frankly, it's not a lot. I think we've got a good strategic plan that has been refined over all of the years. I think it's always an opportunity to take a fresh look at the portfolio and what needs to be invested in and what opportunities might be out in the field. So the great thing about -- I think our company is, particularly over the last decade or so we've got a playbook. We feel comfortable with it, and there's not a lot of changes. As I -- in my opening remarks, I mean capital allocation is something that we think about a lot and maintaining that focus is probably the biggest thing that we're always talking about is are we doing right when it comes to use of capital. And so I think -- I don't know if that -- it sounds boring, but I don't see a lot changing.

[Operator]

Our next question comes from Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

Follow-up question on the timber 10-year acquisition. Hypothetical, I suppose, but if the deal isn't approved, how long do you envision Adams Lake being able to sustain 2 shifts? How is that thinking evolving?

[Ian M. Fillinger, President, CEO & Director]

Yes. So the Adams Lake mill, it was built -- it's super competitive. It was built to compete on the open market for fiber. And with the rationalization in that area of Southern B.C. -- what was the number, Marty, in the area, 1...

[Martin L. Juravsky, Senior VP & CFO]

About 1 billion board feet.

[Ian M. Fillinger, President, CEO & Director]

About 1 billion board feet of capacity has been permanently taken out around that area. So yes, the timber transfer is very important for us for the long-term view of Adams Lake, but it also is the most competitive mill in the region. And over the last year or so we've obviously, had the benefit of a few tough decisions that other companies have made in that area with rationalization. So we feel very, very good about Adams Lake running on full shifting.

[Sean Steuart, Research Analyst]

Got it. Question for Bart. Just wanted to touch on the Southern Pine market in a little bit more detail. It's been a relatively sluggish start to the year. And you mentioned European imports being a factor to the margin. Can you talk a little bit about capacity growth in the region, your sense of all the greenfield mills that were built, how those are ramping brownfield expansions, including some of the work you've done, how is that affecting the operating rate environment in the region?

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

Okay. If you look at the information that's published by the Southern Forest Products Association, they talk about year-to-date shipments out of the south being 2% above the same period in 2018. So really, it's the expansion of volumes has not been that significant. And I think there's a couple of things. One is that when you're allocating capital and putting in equipment down in the south, mills are not as productive through that process. And then also when you ramp-up, I think, take a little bit longer than I think people anticipate. And so we just really haven't seen the -- I suppose, that the production come online compared to all the announcements that were made. And I think we'll see some of that continue in 2020. It's a little uncertain to say.In terms of the south, it's -- I talked earlier in my comments, this whole just-in-time buying. I think it's probably most evident in the south, predominantly truckload shipments. So the order files are generally fairly low, and the shipment's very quick. So I think that the buyers down there have gotten used to being able to get what they want. And I think the weather, so far this year, it has been a little bit wet down there, but you're seeing some of the bigger markets really pick up. And so we're -- quite frankly, we're a little bit surprised that the south hasn't come -- hasn't seen a little bit more tension, especially when you compare that to the west. I mean in particular, the stud market in the west is very strong. And so if you look at the historical trends, I won't make any sort of forecast. But if you look at the historical trends, the south has really shown an ability to respond to the price increases in the west. There have been disconnects every once in a while, we have one right now, but historically, they don't last very long. So hopefully, that answers some of your questions. I mean it's a big topic, big discussion item.

[Operator]

[Operator Instructions] Our next question comes from Paul Quinn from RBC Capital Markets.

[Paul C. Quinn]

Just following up on this SLA potential reduction in August. What's your view on an implication if we get the 20% down to 8%, the effect of that on lumber prices?

[Martin L. Juravsky, Senior VP & CFO]

Okay. Over to Bart.

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

Yes. So that's -- I've been asked that question a lot in the last little while. And really, it's a cost item, just the same as logs are a cost item. And when you look on the revenue side, the price is obviously an impact as well. And the magnitude of the reduction, although meaningful, it doesn't really change how we would approach the market. I mean our efforts in the marketplace are to price our lumber at the highest possible price that the customer is willing to pay. And so we've tried to keep that duty influence out of it. I think it does bring a little bit uncertainty from the buy side. But really, if you consider all of the inputs and variables that are involved on the cost side of lumber, this is just one of many that, quite frankly, have been very volatile over the last one.

[Paul C. Quinn]

Okay. So net-net, do you think it'll go down?

[Martin L. Juravsky, Senior VP & CFO]

Well, let me chime in on that one. You're asking what the market's going to look like in the month of August. There's all kind of variables. So in some ways, you almost have to strip away the softwood lumber duties and just say, given the cost curves that exist does the current price environment make sense. The current cost and price environment doesn't make sense, given the cost environment. So you sit back and say, okay, something's going to change, something will change at some point. We just don't know exactly what the path is. So trying to predict what things look like in August is probably a bit of a mug's game, Paul.

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

Yes. I -- just to add to that, the only thing right about a forecast is that it's wrong.

[Paul C. Quinn]

That's my job. Maybe to flip over, Ian, you mentioned the coast operating at 70%. What Interfor's coastal operations -- are they running right now?

[Ian M. Fillinger, President, CEO & Director]

Yes. Yes, they are, Paul. So our Coastal woodlands is operating and our Acorn mill is operating on its normal operating cadence.

[Paul C. Quinn]

Okay. And then just -- I know you guys are focused on executing on Phase 1 and Phase 2 capital projects. But just wondering about the M&A side, whether this year has got off to a sluggish start, especially in the U.S. South? Just wondering if you see more opportunities to acquire mills or mill owners actively marketing their facilities.

[Ian M. Fillinger, President, CEO & Director]

Yes. Hard to answer, Paul. Yes, I don't know. I think it's -- the environment is going to dictate that one-offs, but we're -- we monitor that, and there's always inbound calls, but I don't know.

[Martin L. Juravsky, Senior VP & CFO]

I mean the reality is, we've looked at lots of situations all the time. So just the current environment doesn't really change the fact that there's always stuff that's out there. There's a pretty strict set of criteria that we have. So sometimes you get buyer and seller who have alignment. And sometimes we see situations that don't meet our criteria, and we don't spend an awful lot of time on those situations. So it's pretty hard to handicap other than to say, we look all the time and have been looking all the time, but we're going to stick to our criteria.

[Operator]

And I have no further questions in queue at this time. I'll turn the call back for closing remarks.

[Ian M. Fillinger, President, CEO & Director]

Okay. Well, I'd like to thank everybody for dialing in and participating in our update call this morning and your interest in our company. If you have any further questions, please feel free to reach out to myself or Marty anytime. And thanks, again, and have a great day.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you once more for participating. You may now disconnect.