Interfor Corp

TSX:IFP

Earnings Call Transcript 2020-Q4

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Interfor 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, Mr. Ian Fillinger. Thank you. Please go ahead, sir.

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

Thank you, operator. I'll provide some opening comments. First off, welcome to our Q4 '20 investor/analyst call. Firstly, I'd like to say that I hope you and your family are safe and healthy and doing well during this pandemic. With me today, you have Bart Bender, our Senior Vice President of Sales and Marketing; along with Rick Pozzebon, our Senior Vice President and Chief Financial Officer. Our agenda today will start off with myself providing a recap of our strategic priorities and key themes. I'll then pass the call on to Rick, who will cover off financial matters. And then Bart will cover off the markets. So turning to our strategic focus. We continue to focus on achieving greater returns on capital through our unrelenting focus on operational excellence. We continued on our CapEx improvement plans in every region. We've made considerable progress on our multiyear CapEx program since 2017, and we're really starting to hit our stride across multiple projects. We continue to work hard on our capital allocation discipline to ensure best returns for our shareholders. Our improvement efforts were again balanced across the company as we made progress in all regions. Our operating teams improved their production volumes quarter-over-quarter as COVID and capital improvement projects were again addressed and completed. Of note, we recorded one of our highest production volume quarters in Interfor's history. And we did so like two less mills in our portfolio compared to the last time that we reached these levels. Our conversion costs and overhead costs both continue to trend positively during -- sorry, during the quarter and due to our ongoing operating cost controls and increased production levels. Our capital spending program continues to advance forward as we continue to modernize all of our operations, improving not only our operating costs but also our value extraction from our logs. Last quarter, we spent $36 million to improve our plants across all regions, up from $23 million last quarter. Of note, we are seeing a reduction in our maintenance CapEx as we complete our modernization programs. Working capital and its impact on cash flows continue to be a key focus for us. We implemented a new disciplined approach earlier this year by better matching market demand to both our lumber and log inventories and also our operating schedules. This ensures we don't build excess volume into the supply chain and are as lean and mean as possible. Turning to our financial results. Our Q4 adjusted EBITDA was very strong once again, coming in at $249 million. Our lumber margins were very strong, and we continue to focus on efficiency and costs across the company. Lastly, we have significant financial flexibility to consider a number of capital deployment options, which Rick will cover. That concludes my opening remarks, and I'll now hand the call over to Rick.

[Richard Pozzebon, Senior VP & CFO]

Thank you, Ian, and good morning, everyone. Before getting started, I'll refer to the cautionary line regarding forward-looking information on the first page of our Q4 MD&A. As Ian mentioned, Interfor has generated record adjusted EBITDA of $249 million in Q4, representing a margin of 38% on sales of $662 million. Lumber shipment volume and lumber price were both significant factors in the quarter. We shipped 682 million board feet of lumber in Q4, up 11% over the prior quarter as we operated essentially at capacity despite challenges presented by the COVID pandemic. We realized an average price of $842 per thousand board feet in Q4, which is 49% higher year-over-year and down only 8% from our all-time is set in the prior quarter. Q4 lumber pricing was unseasonally strong as growing demand for new homes and favorable weather for construction was combined with relatively low lumber inventories and limited slack and production capacity across the industry. EBITDA margin per 1,000 board feet continues to benefit from our ongoing strategic capital investments, which has led to higher grade outturns, cost reductions and productivity improvements. When benchmarks against other publicly traded lumber producers, our adjusted EBITDA margin per 1,000 board feet is now consistently amongst the leading group. Included in the $249 million of adjusted EBITDA is $38 million of income to reverse a portion of softer lumber duties expense during 2017 and 2018 at preliminary rates. The Department of Commerce finalized combined rates for these years are below 9% versus cash deposits made at 20%. This $38 million amount, along with associated interest, is recorded by the deposit on our balance sheet at year-end. In terms of cash flow, we generated $205 million from operations before working capital in the fourth quarter, amounting to $3.07 per share. A reduction in working capital added another $25 million of cash flow in the quarter. In terms of CapEx, $36 million was invested in Q4 for a total of $110 million in 2020, approximately $22 million of the Q4 investment related to discretionary projects focused in the U.S. South. We also used $24 million to buy back over 1.3 million shares in the quarter at an average price of $18.40 per share. Our cash income tax obligations in 2020 were largely mitigated by the use of available tax loss carryforwards. However, our outlook on cash taxes has shifted meaningfully based on the robust Q4 earnings. We are heading into 2021 without and intact loss carryforwards remaining in our U.S. operations and expect to utilize all remaining community and tax loss carryforwards within the first half of this year. Our cash tax obligations will continue to be partly mitigated by accelerated depreciation of ongoing capital investments. Our balance sheet strengthened further in Q4 and continues to provide significant flexibility. We ended the quarter in a net cash position of $75 million with available liquidity of $788 million. Our liquidity is comprised of $457 million of cash on hand and were undrawn revolving term line. We don't have any significant debt maturities until 2024. And our softwood lumber duty non deposit with the U.S. government totaled $134 million at quarter end, which are mostly off balance sheet. Next, I'll speak to our current thinking on capital allocation, which continues to evolve based on the ongoing deleveraging of our balance sheet. The fundamental objective in managing capital for our shareholders over the long term continues to be the generation of returns above inforce cost of capital while maintaining a conservative balance sheet appropriate for the lumber industry. Our first priority in achieving this objective is to invest in and optimize the returns from our current portfolio of sawmills. Our outlook for CapEx in 2021 remains consistent with prior guidance of $150 million. Our CapEx plans for 2022 are still in development but will likely be in the range of $150 million to $180 million. Our second priority is to grow our sawmill platform through acquisitions and generate incremental value from our operational expertise, scale and portfolio diversification. We continue to believe attractive acquisition opportunities will present themselves, and our intention is to be patient and disciplined in the execution of our growth strategy. To the extent we aren't able to identify internal and external investment opportunities with appropriate returns, our third priority is to return cash to shareholders. The preferred approach for this is share buybacks under our normal course issuer bid. We will remain active in buying back shares and certain conservative and internal parameters are met. We'll also consider other alternatives to the extent that surplus capital remains after considering the aforementioned priorities. To wrap up, our Q4 earnings and free cash flow generation were both very robust. And our current balance sheet gives us the ability to continue optimizing our sawmill portfolio and execute on our growth strategy for shareholders. That concludes my remarks. I'll now hand the call over to Bart.

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

Thanks, Rick. Turning to the markets. It's hard to find a negative economic indicator these days in our business. Interest rates; subsequently, affordability; homebuilder confidence; desire for space; demographics; homes for sale; all support a favorable climate for new home construction. The parent remodel is supported by an aging housing stock, great household balance sheets and newly created desire to work from the home lifestyles. All in, these are favorable for our business and to get them all at the same time is unusual. Speaking to the market, lumber demand remained very consistent through Q4. The repair and remodel end-use sector showed its typical seasonal slowing, whereas the new home construction end-use sector continues to demand more lumber. Interestingly, lumber prices were on the move throughout the quarter. Initially, prices were under pressure as we headed into a seasonally slower time of the year at very elevated prices. This drove many purchasers to the sidelines as they look to balance significant supply chain risks with overall needs. The market needed to adjust to levels that could be seen as investment grade. Within market inventories at historical lows, lumber demand resisting at seasonal slowing, the ability for our customers to hold off from purchasing with short life. The net result was that we saw us leaving 2020 with strength. As we move into Q1 2021, it is clear that demand for lumber remains strong. U.S. housing starts and repair and remodel forecasts are strong. In particular, repairable models preparing for an active spring. We expect volatility to remain high as the supply chain manages through low inventories and high pricing rest. In terms of our overseas business, our business to Japan is improving. Last year we saw a fairly significant decline in lumber demand resulting from primarily a reduction in housing starts. Inventories have now balanced and pricing in Japan has stabilized. In the rest of Asia, our business has declined somewhat, owing primarily to a disconnect in pricing relative to North America. We expect this to improve as we move further into the year. Overall, we are encouraged with how the year started, and optimistic that 2021 will prove to be a solid year for the lumber business. I'll stop there. Back to you, Ian.

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

Yes. Thanks, Bart. Thanks, Rick. Operator, we're ready to take calls from our analyst group now.

[Operator]

[Operator Instructions] Your first question comes from the line of Sean Steuart with TD Securities.

[Sean Steuart, Research Analyst]

Ian, I'd like to discuss the growth opportunity set a little bit more. You touched on sawmills, which is obviously your bread and butter. Is the opportunity set large enough there? And I'm wondering how you guys are thinking about potential lateral moves into engineered wood potentially some other vertically-integrated building product type businesses. Is that on the radar for you at all?

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

Yes. Yes, I think there's 2 questions in there, Sean. We do think that that there is opportunity that won't present itself when the time is right in the lumber business in the regions that we operate. So we're very close to that and paying attention to that. We have a pretty robust goal and growth plan that we're working to achieve. And what we realized is that to achieve those goals and plans that we may need to, what we call, lead with lumber and our growth platform, which means that lumber is our preferable way. But if that means picking up an associated business with a lumber mill, whether it's pellets or plywood or engineered wood products that we shouldn't just confine ourselves to simply lumber. I mean our preference is that, we agreed with that, but we would also look at opportunities that would be associated with acquisitions of lumber mills.

[Sean Steuart, Research Analyst]

Second question's for Rick. You mentioned other alternatives to return capital to shareholders if so plus capital builds on the balance sheet, should we think of that as special dividends? Any context you can give us there?

[Richard Pozzebon, Senior VP & CFO]

Sean, yes, for sure, special dividends is certainly one option. We're still evaluating what that might look like in terms of surplus cash on our balance sheet and what the options are. I will say our approach will be aligned with us being a growth-oriented company in the commodity industry.

[Operator]

Your next question comes from the line of Hamir Patel with CIBC.

[Hamir Patel]

Ian, could you give us an update on the Hammond mill land sale process?

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

Yes. It's -- there's interest, Hamir. And it's currently for sale. I mean it's a valuable -- we take a valuable piece of property that would skirt to Vancouver with river and road and rail, all associated with that site. So there is interest in it, and we're working with our agent to advance on that. We're hoping that a deal is done in the next 12 months or so, but it's still in process.

[Hamir Patel]

Okay. That's helpful. And Ian, just curious, your thoughts on how COVID might be weighing on industry production. Are you seeing any differences in the South versus the U.S. and Pacific Northwest and Canada?

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

Yes. Well, internally, there is a difference, for sure. Our South team and our Pacific Northwest team had some additional challenges compared to our British Colombia team. But we're seeing some tapering of that, particularly in the South, but there was a quarter-over-quarter jump in disruptions when it came to positive cases or employees that needed to self-quarantine for exposure. So having said that, we didn't miss a beat. The teams were able to operate around those and achieve their production volumes which, as I mentioned in my opening comments, were a record. What we have heard, Hamir, is that -- and it's just more industry talk that some operations are struggling a little bit more. And examples of where our filing room would get an exposure and then all the soft filers have to go off and then you can't run your mill because you can't change your size or maintain your size. So -- but nothing massive that we're picking up, just a mill here or a mill there, but I guess I'd leave it at that. I don't have any concrete for you. I can just tell you that we did see a big increase particularly in the South quarter-over-quarter, but it appears to be leveling a little bit down.

[Operator]

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

[Paul C. Quinn]

Just maybe a few questions here. Just one of your competitors in the state, PA mills, was trying to estimate their lumber production loss due to COVID, and they put in around 4%. They thought that was pretty realistic for the whole industry. Is that something that you've kind of experienced?

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

No, we have not experienced that. Paul, the -- our guys have found creative ways, whether it's adding hours or some extra shifting or not take the thing to get around that. And in the South, even some of our management teams, in some cases, had had to really lean in on this and occasionally have to run equipment as they deal with. They come in one day and all of a sudden, 12 employees are off to exposure or something like that. So hats off to our frontline workers, both hourly and staff have managed that really well. So we have not seen or experienced that scene in [indiscernible]

[Paul C. Quinn]

Okay. And then maybe on the growth side, you guys took a look deep dive into greenfield [indiscernible]. Is that still a consideration? And if not, why isn't it consideration here?

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

Yes. So Paul, the greenfield binder is on our desk. And we have an engineered layout, we know what equipment to put in. So the design and everything is kind of shelf-ready, if you will. But the challenge that we find is -- or that's really sort of handicapped in the greenfield for us is the whole people side of it and sourcing 100 to 150 frontline employees, often without experience, does create some concern for us around start-ups and the length of those to get those going. So at this point, we're just starting to come to the last, I guess, 24 months or so of our CapEx that we launched back in 2017, you'll remember when you were down in the South, we were talking about that a few years ago. And now we're turning our attention to the next round of internal and we think we got some pretty exciting projects that we can advance on and get the engineering started earlier and the equipment orders in earlier. So we are kind of moving from that one phase that we outlined a couple of years ago. We're getting to the end of that, and we're a couple of years now out looking at what we're doing with the rest of the mills to improve them even more. So that's where our focus is. But on the greenfield, if we could figure out the people side and have some more confidence around that, I think, that would be a bit of a change in mindset for us. So we're paying attention to it. Our preference would be to go through acquisition versus a greenfield.

[Paul C. Quinn]

Okay. And then just -- you made that comment on [indiscernible] capital you spend, you've seen some reduced maintenance. What is your total company maintenance and what kind of reduction is immaterial?

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

I think -- Rick, correct me if I am wrong. Paul, I think on a trend basis, we're getting down to around $16 million or so in our maintenance, which is on a trend basis, fairly reduced, I guess, from history. And that's a direct correlation to the investments that we've been putting in, the mills are more modern, less fixed up than we have to do, and the equipment is newer, so costs are lower. It's somewhere around in there, but we could probably talk to Rick or Mike. Afterwards, we can give you that information.

[Paul C. Quinn]

Okay. And then maybe just last question, I guess, drift it at Bart. Bart, you mentioned that inventories are low. How are you measuring those? And then secondary, you said that you expect Asia to improve through 2021. And because of this price disconnect, is that a reference to North American prices lowering or Asian prices coming up to meet those North American prices?

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

Okay. No, two good questions. On the inventory side, I mean, there's always the VC-, FDA-type publications that you comment on that. Those are generally lagging, and you can tell just by communication with our customers. I mean, it's a constant question that we're asking in terms of their inventory positions. And plus you can get a pretty good feel out of the marketplace on where we're at and how critical availability and shipment times are, and it's very clear to us that the market is operating on reduced inventories. And so there's a real premium on availability. There's less discussion about price. And quite frankly, just want to make sure they get the supply. So I think that supports ours and other people's interpretation of the inventories. When it comes to Asia, we're talking about the Asian prices improving, not North American prices declining to meet the Asian market. I think if you look at the inventory positions, in the overseas markets, in China, in particular, they're declining to a stage where I think it's going to become critical to resupply and resupply regardless of where you're going to get that product from, is at elevated prices. So we expect that, that market will show that improvement over time.

[Operator]

Your next question comes from the line of Mark Wilde with Bank of Montreal.

[Mark William Wilde, Senior Analyst]

I want to just start out by saying how impressed I've been over the last year about how you guys have handled yourself. You were a very early mover in terms of pulling back on production last spring when the pandemic was set. And then I think your discipline around capital allocation has actually been quite commendable this year. So with that out of the way, I got a couple of questions, I think, mainly for Bart. Bart, there was some talk recently that a lot of this Southern Yellow Pine strength was really being driven by kind of treaters trying to get ahead of the season, maybe with a little bit of a nudge from some of the big box retailers. Can you comment on that?

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

Well, repair, remodel certainly is strong. And I think that there is an anticipation of a strong spring. And I can tell you that last year, the -- that segment was somewhat reactive when it comes to supply. And so I think there is a level of proactivity that's coming into it this year. But I would say that, that's more normal. The reactive piece would have been abnormal. So I don't see anything there that's unusual. The going outside of the treaters. Every segment -- customer segment that we have is busy, in particular, the trust manufacturers. They have strong order files that are out several quarters, and they're running at capacity. So I think this market showing us not any one particular segment as being strong. It's showing everyone as being strong. And obviously, we're seeing that in the pricing.

[Mark William Wilde, Senior Analyst]

And would you say, Bart, that you -- can you spot any places where you think these prices at these levels is actually creating some demand destruction?

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

Well, it's certainly something that we're keeping our minds open to. I think when you get into elevated prices like this, it results in higher distribution risk. And I think that, that's playing into the volatility that we're seeing in the marketplace, not necessarily driven by demand fundamentals, but more just the mental side of the market and the fact that the prices that we have, if there's ever an adjustment, it can hurt our distributor-type customers. So that's definitely playing to this market. But from a demand side, I can tell you the conversations that I'm having they don't talk a lot about price. They talk a lot about availability and supply. And our customers are looking for us to continue to service them. They want to continue to be supplied the volumes that they have been historically. And yes, that makes us feel pretty good about where we're at so far in 2021.

[Mark William Wilde, Senior Analyst]

Yes. I guess, Bart, I was thinking mainly about like, let's say, in the do-it-yourself market, folks that might build their own deck, they go out and they look at the price of lumber, and it's a lot higher than it was 18 months ago. So maybe they decide, I'll put this off for another year. That kind of behavior.

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

Yes. I mean that's certainly a factor. But I think in the U.S., you've got an aging household stock. I mean we're at an average of over 42 years now. And I think that household balance sheets are pretty spectacular right now, and there's some disposable income that isn't going into cruises and holidays and is staying at home right now. So I think a lot of that money -- and actually, the other one is just the equity that's being built in people's homes and access to that for home improvement. So yes, lumber costs a little bit more, but there certainly seems to be a number of people that are pretty focused on improving their homes.

[Mark William Wilde, Senior Analyst]

Okay. That's fair. Then over on the supply side, can you just recap for us what you see in terms of incremental supply, particularly in the Southern U.S.? And I know we've got these Klausner Mills have traded vans are the ones that I think is a pretty well-run Austrian privately-held company, we've, I think, seen at least a couple of sawmill announcements over in Mississippi, we think some announcements on debottlenecking. So if you could just recap for us what you see out there.

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

Yes. For sure. Maybe I'll take a shot at it, and if I miss anything, Bart and Rick, you guys can jump in. But we are seeing -- what you outlined, Mark, is pretty much what we're seeing also. The -- I mean, the big levers, I guess, would be the new mill capacities coming online. And the announcements are coming out. They're typically private companies. We've looked in those areas. We still think that there's challenges on the time line, particularly around the people. When we're talking or I'm talking with the major vendors to these greenfields, they're getting booked up in time lines, they are increasing. So I think there's announcements coming out with pretty aggressive budgets and headline cost to do it and time lines. And I just -- I'm not sure whether that's the headline or the actual that's really going to happen. I do think it's going to take longer. And these announcements and what is coming out, and I think they're going to be more expensive than what's being headlined. I think often, the headline is what the equipment and installation costs are versus the total cost, what the land purchase was, what the infrastructure was, the concrete, the sprinkler systems for fire suppression. I sometimes think, in my reading of those, whether those are all captured in those numbers.

[Mark William Wilde, Senior Analyst]

Okay. That's fair. And then also on the supply side, are there any thoughts on the impact of incremental imports or what you might expect in terms of incremental imports, whether from Europe or maybe from South America?

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

So they increased the imports this year -- or sorry, 2020, about 500 million feet. I think the forecast is for something similar in 2021. In my discussions with my counterparts over there, their own traditional markets are quite active. I mean this push on demand for lumber is not just in the U.S. market. It's happening in a number of markets. And so they've got lots of tension on their supply as well. And how much they direct to the North American market will be offset by them supplying them on traditional markets. So we don't see a massive response. We see a fairly consistent growth that we have recently. And we think the North American market is more than ready to absorb that incremental volume.

[Mark William Wilde, Senior Analyst]

Okay. And last question for me is just M&A. I mean we have seen a number of M&A moves over the last, like, 3 to 6 months. In the distribution area, we've seen some and the manufacturing area, notably that [indiscernible] noble combination, but not really many sawmills trading. Any thoughts on that, particularly with people's balance sheets in such good shape?

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

Yes. No doubt, Mark. I mean we have a hit list that we keep, and we stay in contact with. But you're right. I mean the conversation that was occurring at the beginning of this year and at the beginning of COVID is dramatically different today. I think a lot of mills that may have come to market are now the orders are taking the benefit of the P&L generation that they're experiencing today. And that's no -- that's good for them. But at some point, as we all know, things do change. And with Rick's deployment strategy on capital, I think, we're -- we'll be in good shape to strike at the right movement.

[Operator]

[Operator Instructions] You have another question from the line of Paul Quinn from RBC Capital Market.

[Paul C. Quinn]

Thanks for letting me sneak one in. This should be an easy one. Just given your disciplined approach to growth and where you're trading at, which is basically less in replacement value, and that's not even taken in $2.50, like you got essentially in duty deposits right now. Do you worry at night that you're going to get taken out before you're able to plan the growth out that you've got in your mind?

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

Paul, I mean, we pay attention to all the metrics that you outlined, but our focus is clearly on a pretty aggressive internal and external growth plan. We've laid out a 5-year strategy a few months ago. And have really awesome support and alignment on that strategy. So I think where the industry is at now and everybody's balance sheet and the cash generation, I think, that's a question for almost any company that you need to be aware of. But our focus is entirely on growing the company and building up our company. So I would say we're not spending much time on that at all. It's for what we're doing every day to get better.

[Paul C. Quinn]

So basically, nobody is knocking at your doors at this point?

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

No. And if there was, I wouldn't be able to tell you anyway. But we're focused on what we can control, and we're just hitting it as hard as we can.

[Operator]

There are no further questions at this time.

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

Okay. Well, just concluding remarks. Thanks, everyone, for dialing in and participating in our update call this morning and your interest in our company. And as usual, if you have any follow-up questions, just reach out to myself or Rick or Bart, and we'll be sure to get back to you. Thanks, again, everyone, and be safe.

[Richard Pozzebon, Senior VP & CFO]

Bye-bye.

[Operator]

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