Interfor Corp

TSX:IFP

Earnings Call Transcript 2022-Q4

[Operator]

Good morning, ladies and gentlemen, and welcome to Interfor Quarterly Analyst Call Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we'll conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Friday, January 10, 2023.

I'd now like to turn the conference over to Ian Fillinger. Please go ahead.

[Ian Fillinger, President and Chief Executive Officer]

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

With me on the call, you have Rick Pozzebon, our Executive Vice President and Chief Financial Officer; and Bart Bender, Senior Vice President of Sales and Marketing.

Our agenda today will start off with myself providing a recap of our accomplishments in 2022 and our strategic positioning. I'll then pass a call to Rick, who will cover off our Q4 financial results, and then Rick will pass the call to Bart, who will cover off the markets.

Starting with our accomplishments this past year, 2022 was a solid year for Interfor. We generated adjusted EBITDA of $1.1 billion with industry-leading margins. We completed two acquisitions that substantially increased our capacity, expanded our footprint into new operating regions, and diversified our product mix. We continued to optimize our existing portfolio, selling our last mill on the BC Coast, while investing over $300 million in capital improvements mainly in the U.S. South.

In addition to our growth and reinvestment, we also returned almost $330 million to shareholders via share buybacks, reducing our share count by a further 15%. And last, but not least, the combination of all of these initiatives resulted in Interfor being able to generate industry-leading returns on capital, extending our multi-year track record on this all important metric.

The key takeaway I want to leave with you is that our strategy is working as we intended. The steps we have taken as a company and the ongoing initiatives give us great confidence in the future value creation potential. To our strategy and positioning, our acquisitions in the last two years have expanded our footprint in existing key regions in the U.S. South, the U.S. Northwest, planted our flag in Ontario and Quebec, and most recently added New Brunswick as we closed out the acquisition of Chaleur Forest Products during the fourth quarter.

At the same time, we've continued to trim and optimize the portfolio in regions where we see less potential. Underscoring our decision to sell the Acorn facility in British Columbia, as well as continuing to monetize options for the remaining BC coastal timber tenures.

We are now the only publicly traded pure-play lumber producer of scale and the only lumber producer with operations in all major timber producing basket in North America. We have also recently grown and become the largest producer of studs and MSR lumber in the world, and we are actively working to leverage this position to improve margins and increase market share.

Our growth has been well timed and the integration has been smooth, and we have now placed veteran Interfor executives to oversee operations by country, Andrew Horahan for Canada and Bruce Luxmoore for the U.S. Andrew and Bruce have deep expertise and will continue to advance our Interfor culture of operational excellence and capital discipline. Scale has also allowed us to realize significant synergies as we leverage our core lumber expertise across larger network.

In addition to operating synergies, we also see opportunities in areas such as working capital. The previous owners had a much smaller scale and took a different approach than we can. We are running down the inventories, and we are keeping them lower, which will free up cash and ultimately improve returns on capital.

We have also grown our SPF volumes by expanding into Eastern Canada, and this has enabled us to meet the demand left as some of our competitors have curtailed and continue to curtail SPF production in British Columbia. SPF is in limited supply, both in North America and globally, and our Eastern Canadian growth has positioned us well to benefit from these trends. Rick will cover off our financial details shortly. But from a balance sheet perspective, we continue to have significant financial flexibility to execute on our CapEx plans across the U.S. South and pursue other value creation opportunities.

Underlining our entire strategy is our track record on returns. As I mentioned earlier, Interfor is now the clear leader among peers for returns on capital. We are responsible and strategic with our investments in our capital allocation decisions. In summary, we feel very confident about how we are positioned for the medium and long-term.

Turning to the market. We have taken proactive steps to address the conditions over the last several months. We all know that volatility is given in our sector. And, of course, we're no strangers to the up and downs of the lumber market. One step we have taken is downtime, and we've been an industry leader in matching our supply to the market. During the last two quarters, we reduced our lumber production by a total of 300 million board feet, which represents about 25% of our quarterly capacity. Another step we have taken is our capital spending.

We had recently guided towards 2023 CapEx at approximately $300 million. However, considering the market conditions, we are now planning to reduce our strategic CapEx plans by $60 million throughout 2023.

I will note that we were able to quickly make mid-plan adjustments of this scale because we have an extremely capable internal CapEx team that oversees and implement our projects. If we invested based on turnkey projects and relied on external personnel, we'd have much less flexibility to pivot.

Finally, we have also developed a comprehensive downturn playbook that has been refined over many years. This plan involves empowering all frontline managers from every business unit and work stream across the company and making them accountable to deliver on a wide variety of risk reduction, capital preservation and efficiency initiatives. These initiatives all have hard targets with a clear focus and discipline on all aspects of our business. We see these proactive steps as an opportunity to make our new company even stronger.

With respect to the outlook, we remain positive on the medium to long-term outlook demand going forward. As demographic trends in years of under-building will continue to provide strong tailwinds, we believe that the underlying fundamentals remain favorable.

On the supply side, we think that volume needs to continue to come out. And we expect that our competitors will follow our lead, both on a temporary basis and on a permanent basis, particularly in British Columbia.

To sum things up before I turn it over to Rick and Bart, our guarding principles are always operational excellence and capital discipline. We believe that this is always a path to success and also very important in challenging markets. Over the last several years, we have built what is in many ways a new Interfor. Our Interfor team has used a recent downturn well, and we are stronger because of the efforts across our company. We are extremely enthusiastic about the months and years ahead and firmly believe that now is a great time to be invested in Interfor.

With that, I'll turn it over to Rick, who will walk through some of the detailed financials. Over to you, Rick.

[Rick Pozzebon]

Thank you, Ian and good morning. First off, I'll refer you to cautionary language regarding forward-looking information in our Q4 MD&A.

As Ian mentioned, 2022 was another transformative year for Interfor in several respects. With respect to earnings, 2022 is the second best year in Interfor's history, with EBITDA of nearly $1.1 billion and earnings per share of nearly $11.

Robust lumber markets in the first half of 2022 easily outweighed the impact of weakened demand in the second half of the year. This lower demand is mostly attributable to the negative housing affordability trend due to lack of supply from over a decade of under building combined with significantly higher mortgage rates as central banks took action to cool inflation.

With respect to returns, 2022 saw Interfor continued to build on its track record of generating industry-leading returns with EBIT return on capital employed of nearly 30%. Successful capital allocation has underpinned this growing track record, including well executed capital projects, well-timed acquisitions at attractive valuations and significant returns of surplus capital to shareholders.

Turning to Q4 financial results. Interfor generated an EBITDA loss of $69 million. This figure includes $59 million of expense from being required to write-down log and lumber inventories under accounting rules to reflect the depressed lumber prices at year-end. Also included is $8 million of non-recurring expense related to purchase accounting for the Chaleur acquisition. Excluding these two items, Q4 EBITDA would have been near a breakeven level.

Our Q4 earnings result reflects significantly lower lumber prices across all products and species, combined with the lag in log costs adjusting down to reflect the lower lumber prices. The lumber price declines near quarter-end appear to have been exacerbated by inventory destocking from the distribution channel in an attempt to reduce risk.

Despite the earnings result, we managed to generate positive cash flow from operations of about $10 million in the fourth quarter, benefiting from over $100 million of working capital being released, largely from lumber inventories and receivables.

From a balance sheet perspective, we ended the fourth quarter in a comfortable position with a net debt to invested capital leverage ratio of 26%, which is well below our internal management threshold of 35%. To better reflect Interfor significantly increased scale, we bolstered our available liquidity in the quarter by securing additional fixed rate long-term debt financing and expanding our revolving credit facility. Available liquidity was $486 million at year-end, which is more than sufficient as we look forward.

It's worth noting that the year-end balance sheet includes a current tax receivable of $104 million from over installments in 2022, which is expected to bolster our balance sheet leverage and available liquidity as it's recouped throughout 2023. Looking longer term, it's worth noting that Interfor softwood lumber duties on deposit totaled US$512 million at year-end, representing about $10 per share on an after tax basis.

Regarding capital allocation going forward, Interfor's priorities and focus on a balanced approach remain unchanged in conjunction with maintaining conservative leverage on our balance sheet. We currently anticipate capital expenditures of $240 million for 2023, of which about $140 million relates to discretionary projects, largely focused in the U.S. South. While we've already reduced our planned 2023 expenditures for conservatism, given the current market, we maintain significant flexibility to reduce spend even further if appropriate.

To wrap up, Interfor's transformative year of significant growth, combined with leading returns on capital has left us well-positioned for long-term success through all market conditions. Our focus going forward will continue to be on operational excellence and balanced capital allocation decisions that maximize returns on capital for our shareholders.

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

[Bart Bender, Senior Vice President, Sales & Marketing]

Thank you, Rick. Good morning everyone. I'll provide an outlook on lumber markets through Q1 and into Q2, 2023. Lumber markets are navigating through sizable shifts in demand and supply, which in the short term have resulted in volatility in lumber prices.

Majority of the lumber demand shifts have occurred in the new home construction and use segment as affordability, combination of house price and mortgage rates pushed some buyers out of the market resulting in a reduction of housing starts. The resilience of the repair and remodel and the use sector has been a highlight for us. Our shipments in this end-use sector are stable and consistent.

The lumber supply side it has and is in the process of responding to adjusting to lumber demand through curtailments, both temporary and permanent. Interfor's position remains consistent and that we adjust our production rates to the market's demands. This market situation is short-term. We continue to be optimistic as the fundamentals on lumber demand growth remain largely unchanged.

Employment rates remain high, demographics favor increased household formation rates, aging housing stocks encourage increased repair and remodel work, household balance sheets remain solid, led by equity in their homes. Under-built housing market suggesting demand should exceed household formation rates for the foreseeable future.

On top of these, there are a couple of other areas that I'd like to highlight that bring further optimism. Builder confidence is on the rise with current sales, buyer traffic and the outlook for sales all improving in January over December, suggesting a bottom may have been reached. Mortgage rates are declining from a peak of over 7% to the high 5% range and are forecasted to continue to decline.

Housing prices have declined and are declining and overall affordability is increasing. Existing home for sale inventories remained low, providing new homes for a sale a greater access to the overall housing market. Housing starts have not fallen to the degree to which some have expected.

On the lumber inventory side, both manufacturers and distribution have remained disciplined. It's our perception that both are operating at historical lows for lumber inventory. We believe the last several months have seen downward inventory adjustments to the lower end of the consumption range, and we are signaling that as markets stabilized through Q1 2023 and into Q2 2023, tension on supply as the opportunity to increase.

Lastly, we welcomed our Atlantic operations to our network of Interfor mills. We now have production from four Canadian provinces in eight U.S. states giving us North American wide coverage. Our ability to service our customers with high-quality interfere lumber has never been better.

With that, I'll turn it back over to you, Ian.

[Ian Fillinger, President and Chief Executive Officer]

Okay. Thanks Rick and Bart. Operator, we can open the line for questions at this time.

[Operator]

Thank you. Ladies and gentlemen, now we will begin the question-and-answer session. [Operator Instructions]

Your first question comes from Sean Steuart with TD Securities. Please go ahead.

[Ian Fillinger, President and Chief Executive Officer]

Good morning, Sean.

[Sean Steuart, TD Securities]

Thanks. Good morning, every -- good morning. Thanks everyone. A couple of questions. With respect to the leverage and your management around that and you touched on the 26% debt to cap being in your comfort range but arguably higher than some investors want to see it at this point in the cycle. Beyond the CapEx reduction, I just want to focus on a couple of other levers you might be able to pull. Working cap at this point, other than the tax receivable that's coming in, do you guys have further room to bring that down at this point from your perspective?

[Rick Pozzebon]

Good morning, Sean. It's Rick speaking. Yeah. Absolutely, that's a lever we're looking to pull. As Ian mentioned in his remarks, we've got opportunities across our platform to reduce inventories further. And we've got some solid targets in place and we're working towards those in the first half of this year largely. So, both on logs and lumber inventories. So, at year-end, we probably had around $400 million of log and lumber inventories roughly and there's significant opportunity there to reduce that further on a permanent go-forward basis.

[Ian Fillinger, President and Chief Executive Officer]

Yeah. Sean, I'll just jump to add that -- Ian here. The legacy Interfor mills ran within our thresholds. But as we acquired our Ontario, Quebec and New Brunswick operations, it's clear to us that the previous ownership had a different look on inventories and the EACOM assets have been coming down and the New Brunswick assets are coming down. So, we're not all the way there yet. There's definitely room in Eastern Canada to bring those log inventories in particular down to the risk level and the threshold levels that exist in the other operations that we've owned for a long time.

[Sean Steuart, TD Securities]

Thanks for that, Ian. The timber tenures on the coast, can you give us a little bit more detail on how you expect to manage that process. There was mention in the MD&A of working with First Nations communities. But from a broader perspective, the monetization of what you have there, can you give us any context on timeframe you expect to unwind those assets?

[Ian Fillinger, President and Chief Executive Officer]

Yeah. Sean, I mean, we have NDAs on most of this. So, it's going to be a little bit vague. But I guess the most important thing is that there's interest, significant interest in the tenures that we want to monetize. So that's very positive. We have monetized some already in 2022, as you know. We have over a dozen term sheets that have been executed and we're in purchase agreement details. But underpinning all of this is the BC government and obviously, approval there. And the team led by Andrew and others in the company have done a great job over the last year partnering with the BC government who are 100% supportive of the strategy that we're implementing.

So, A, we've got very solid interest at attractive deal metrics for both parties. And we've got a very supportive BC government around this strategy. So, I would say we -- our confidence level is fairly high on some significant transactions this year and probably more to come over the next 24 months also. It's probably about as much, I think, as we could say just given that much of this is in process right now.

[Sean Steuart, TD Securities]

Understood. Okay. Guys, thanks. I will get back in queue.

[Ian Fillinger, President and Chief Executive Officer]

Thanks Sean.

[Operator]

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

[Ian Fillinger, President and Chief Executive Officer]

I thought we lost her there.

[Paul Quinn, RBC Capital Markets]

Good morning, guys. Just a question on where are you at on your integration of all these new assets you've got, you just acquired Chaleur, but I'm also talking about the GP mills, the start-up as well as EACOM. Is that going to take the balance of 2023 and then you'll be ready to rock in 2024? How are you approaching that?

[Ian Fillinger, President and Chief Executive Officer]

Yeah. Sean, Ian, in here -- or sorry -- Paul, in here. Yeah. The GP mills, essentially, we're through that. They're we feel fully integrated, both operationally, financially in our sales systems, all green lights there. In fact, we're looking at some opportunities to make those mills even better. So, they're sort of being papered up now from a concept standpoint.

The EACOM acquisition, I would say, largely we're not completely done, but we've got systems integration that we need to do. That's midyear to cut everything over that way. So, the back shop is I guess, six months away. And then on the operations side, we've made definite progress. But under Andrew's leadership and the team that we have in the East and the team that's being formed, I would say we're making progress every day. But as you know, for standards and operating expectations are fairly high, and it's going to take a little bit of time to get those where -- I think where the other ones are.

And I often look at the East, Paul, is kind of when we think about the South or other regions that we've gone into from an operating standards and up time, it takes a bit longer. But we're confident we're making progress. The mills are getting better every day and great outturns are improving. We've made, I would say, significant improvements and pulling value out of the log that the previous ownership just for some reason wasn't achieving, but we're making really solid progress in those areas. And of course, pulling great outturn is the greatest lever you can do to make a change. I'm missing anything, guys?

[Rick Pozzebon]

Hi, Paul. It’s Rick. I just jump in and add that with both EACOM and Chaleur we identified $30 million of synergies, and we're well on our way that we're more than halfway through realizing that. We'll expect to achieve the balance of that by the end of this year.

[Ian Fillinger, President and Chief Executive Officer]

Yeah. And then turning to Chaleur, Paul, that's gone extremely well. So, we took it over at the beginning of December. I would say internally, obviously, there's little things to do. But the majority of the work they're integrated, they're on our systems. The mills have not missed a beat and they're performing very well. And we're very pleased with that acquisition. Of course, it's a much smaller scale than EACOM. EACOM was an entire business sales, accounting, HR, what have you and Chaleur with the two mills and Woodlands profit center was a smaller scope. But I would say we obviously got a little bit of work to do. But largely, it was a plug and play, and I should say, contributing positively in this market.

[Paul Quinn, RBC Capital Markets]

Good to hear. Just lastly on -- you guys mentioned the US$512 million you've got on your deposit. What are you guys doing to get that back? And then we heard President Biden to the Union address to buy America this week. How do you think that's going to affect your Canadian operations?

[Ian Fillinger, President and Chief Executive Officer]

Yeah. Paul, the -- I would say that the Canadian side is spending time discussing probably at a greater degree than we've seen in years. And so, I would say alignment across the Canadian operations and mills and order ships are much closer than they ever have been. And I think the key will be reaching to the U.S. side and seeing if we can achieve a similar -- I guess, similar feeling of trying to bring this forward and putting it on the agenda of federal government. So, there is more discussions than we've seen over the last months than we have in years. So, I think that's positive. I just don't have a read on the U.S. -- good read on the U.S. side at this point.

[Paul Quinn, RBC Capital Markets]

All right. And then any comment on the finance approach to Biomerica [ph].

[Ian Fillinger, President and Chief Executive Officer]

No, not really. We haven't paid too much attention to that.

[Paul Quinn, RBC Capital Markets]

All right. Thanks very much. That’s all I have.

[Ian Fillinger, President and Chief Executive Officer]

All right.

[Operator]

Your next question comes from the line of Ketan Mamtora from BMO Capital Markets. Please go ahead.

[Ketan Mamtora, BMO Capital Markets]

Thank you and good morning. First question, maybe coming back to CapEx, I'm curious how much flexibility do you have within that $140 million, should the markets turn out to be weaker than what you guys are expecting? I know you talked about kind of having some flexibility, but order of magnitude, what kind of room you have.

[Ian Fillinger, President and Chief Executive Officer]

We have another tranche that as the year goes on, you kind of lose that flexibility just because equipment starts to get manufactured in facilities and delivered. So, month-by-month, that flexibility kind of diminishes as it goes. So that's the process, Ketan, but it's significant. And for us, to kind of share that at this point, the only hesitation is that -- if we kind of share that at what ends up happening is the equipment manufacturers and contractors would hear that. And then may get a little nervous with that. So, we don't think we're going to have to do that. The market is -- seems to have improved a bit. The outlook from what we can see looks much stronger than it was in December. So, we think the $240 million is going to stick. But I would say it's significant if required. However, we don't see that at this point. I guess that would be my answer.

[Ketan Mamtora, BMO Capital Markets]

Got it. No, I think that's fair. And then, switching to low cost. Can you give us some -- just a quick update on kind of what you are seeing in the low cost trends in the different regions, BC Canada, North West and South?

[Ian Fillinger, President and Chief Executive Officer]

Yeah. Of course, as Bart said, in four provinces in eight states, we've got a bunch of unique log cost shifts here and there. But I would say, generally, in all regions, it's a downward trend in 2023 and some more significant than others. But we do see our forecasts all indicating that log costs will moderate through 2023 in all of the regions, in all four provinces and in most of our states. So, overall, for Interfor log costs, we see a trend downwards.

[Ketan Mamtora, BMO Capital Markets]

Got it. And Ian, in BC, how much do you expect cost to come down as we move through Q1 and Q2?

[Ian Fillinger, President and Chief Executive Officer]

I think Rick's got the number, but I'm not sure if he's going to share the specific maybe the range or something like that.

[Rick Pozzebon]

Yeah. It's roughly going to come down by about 25% from Q1 and going into Q2 here in terms of stumpage in the BC Interfor.

[Ketan Mamtora, BMO Capital Markets]

Understood. Okay. That’s helpful. I'll turn it over and jump back into queue. Thank you.

[Ian Fillinger, President and Chief Executive Officer]

Thank you.

[Operator]

[Operator Instructions]

Your next question comes from Sean Steuart with TD Securities. Please go ahead.

[Sean Steuart, TD Securities]

Just one follow-up, Ian.

[Operator]

I'm sorry, the line was disconnected. Your next question comes from Ketan Mamtora with BMO Capital Markets. Please go ahead.

[Ketan Mamtora, BMO Capital Markets]

Mentioned about further opportunity to reduce working capital. Can you give us sort of some sense of order of magnitude in terms of what we are talking about here in terms of opportunity?

[Rick Pozzebon]

Hey, Ketan. It's Rick speaking. So, if we think about lumber inventories in particular, we're carrying about 19 days of production on hand. We think there's at least a few days there that we can take out permanently going forward. And we're working on plans to achieve that within the first half to three quarters of this year. So that will be quite meaningful from a dollar standpoint. And then on logs, we're looking -- at operating with, say 10% to 20% less log inventories overall.

[Ian Fillinger, President and Chief Executive Officer]

Yeah. And sustainable thought.

[Ketan Mamtora, BMO Capital Markets]

Yeah. Got it. Okay. That's helpful. And then perhaps can you give us a quick update on what you guys are seeing on the export side?

[Bart Bender, Senior Vice President, Sales & Marketing]

I'll take that one, Ketan. I would say overall, the markets overseas are improving. The Q4 period was a lot of uncertainty over there, I would say, overall high inventories, some currency fluctuations that were unfavorable. Things like that. I mean, China, obviously, with their zero COVID policy made doing business difficult. Some of that stuff is cleared out. I think we're still dealing with some high inventories, particularly on the log side in China. So, I expect that to be a factor going forward. But our markets in Japan are improving. So, we're expecting that to show signs of more business as we get further into 2023.

[Ketan Mamtora, BMO Capital Markets]

Got it. And then just last one from me. Do you expect any change in the price relationship of SPF and SYP? And this is not just sort of a 2023 question, but as we move through the next few years, do you expect any change at all?

[Bart Bender, Senior Vice President, Sales & Marketing]

Yeah. It's -- I guess, the bottom line is yes. I mean, to a degree, they're very different markets. Some are -- SPF is a little more railcar driven in terms of sales and Southern Yellow Pine more trucks. So, there are some fluctuations that happened because of that in this type of a market. But I would say, in general, if you look at where the curtailments are taking place in the species that are being curtailed, you're going to see the overall, I suppose, volumes of SPF available to the market start to tighten. And so, we're thinking that we should see some tension. And quite frankly, have seen some tension so far this year on the SPF side versus Southern Yellow Pine. But when you get into these kinds of markets where demand kind of moves around and shifts around, it's a little hard to predict exactly where it's going to reside. But, in general, I think that SBF is under more pressure from a supply standpoint than Southern Yellow Pine.

[Ian Fillinger, President and Chief Executive Officer]

Yeah. I think about the capital investments in the industry generally being in the Southern Yellow Pine basket, that potentially is going to grow a little bit over the next little while. And then the massive sort of curtailments in British Columbia and more to come in the SPF volume, the tension on that is going to be pretty great. And we think given our platform and our strategic move into Ontario, Quebec, New Brunswick to capture that volume was very timely and will benefit us as these dynamics play out over time.

[Ketan Mamtora, BMO Capital Markets]

Got it. That’s very helpful perspective. I'll turn it over. Thank you.

[Operator]

There are no further questions at this time. Please proceed.

[Ian Fillinger, President and Chief Executive Officer]

Okay. Well, thank you everybody for your time and your interest in our company, and we'll talk to you next quarter. Have a great day.

[Operator]

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