Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2018-Q1

[Operator]

Good afternoon, ladies and gentlemen, and welcome to Western Forest Products' First Quarter 2018 Results Conference Call. During this conference call, Western's representatives will be making certain statements about potential future developments. These forward-looking statements are intended to provide reasonable guidance to investors, but the accuracy of these statements depend on a number of assumptions and are subject to various risks and uncertainties. Actual outcomes will depend on a number of factors that could affect the ability of the company to execute its business plans, including those matters described under Risks and Uncertainties in the company's annual MD&A, which can be accessed on SEDAR and are supplemented by the company's quarterly MD&A. Accordingly, listeners should exercise caution in relying upon forward-looking statements. I would now like to turn the meeting over to Mr. Don Demens, President and Chief Executive Officer of Western Forest Products. Mr. Demens, please go ahead.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Thank you, operator, and good afternoon, everyone. I'd like to welcome you to Western's 2018 first quarter conference call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer. Before we begin today, I'd like to acknowledge and thank Barrie Shineton for his contributions to Western as a director. As we announced in the press release on April 11, Barrie chose not to stand for reelection at our Annual Meeting. I'm grateful for the guidance that Barrie has provided our management team and wish him the best in his retirement. I'd also like to welcome Suzanne Blanchet who was elected to the Board of Directors today. We're fortunate to have her join Western, and I'm looking forward to working with her as we execute Western's growth strategy.We issued our 2018 first quarter results yesterday. I will take you through some introductory comments and then ask Steve to take you through our summary of our financials. I'll then share our near-term outlook and provide an update on our margin improvement and capital initiatives. We'll then open the call up to your questions. In the first quarter, we delivered record first quarter adjusted EBITDA of $43 million, we capitalized on strong demand, improved pricing and lowered manufacturing costs to overcome the application of U.S. softwood lumber duties and rising stumpage costs. In our timberlands, we took advantage of more normal winter operating conditions to deliver strong log production volumes, which allowed us to rebuild our log inventories ahead of the spring building season. We also grew log purchase volumes despite limited market supply. In our manufacturing operations, we increased production by 14% from the fourth quarter of 2017. In addition, we produced 14 million board feet of lumber for a third party, which allowed us to avoid log supply-related downtime.Through the quarter, we continued to make progress on our margin-improvement initiatives, combined the savings from our margin-improvement programs in timberlands manufacturing and now delivering $25 million in margin improvement that we had originally targeted on an annualized basis. Also in the quarter, we completed the acquisition of a distribution and processing facility in Arlington, Washington. And yesterday, we continued our balanced approach to capital allocation by announcing a 12.5% divide increase in our quarterly dividend, payable in June. I'll now turn it over to Steve to review our key financial results.

[Stephen Williams, Executive VP & CFO]

Thanks, Don. My comments will focus primarily on our financial results for the first quarter of 2018 by a comparison of the first quarter of last year. As Don discussed, we achieved a record first quarter adjusted EBITDA of $43 million as compared to $34 million in the first quarter of 2017. Improved product realizations and lower operating costs more than offset rising stumpage costs and export lumber duty expense. We incurred $9.7 million in U.S. softwood lumber export duties in the first quarter as compared to none in the same quarter last year. Improved lumber and byproduct revenue offset reduced log revenue. Average lumber price realizations approved by 6%, offsetting a 4% reduction in shipments and a higher commodity mix. Average realized log pricing decreased by 2% on a lower value sales mix as we suspended export log sales in favor of supplying our domestic mills.We reduced our manufacturing costs through our margin-improvement initiatives, increased commodity lumber production and improved sawmill reliability. Harvest cost rose 5%, as returns from margin-improvement initiatives were more than offset by unexpectedly high stumpage rates and the increased logging activity in our higher-cost operations. We also incurred incremental road building and truck-hauling costs in the quarter to overcome barge availability issues in our West Coast operations. Freight expenses were significantly reduced due to the current suspension of export log sales, the geographic mix of lumber sales and the strong Canadian dollar. From a profit and loss perspective, net income was $21.7 million or $0.05 per diluted share, as improved margins offset increased restructuring and income tax expenses. This compares to net income of $16.2 million or $0.04 per diluted share in the first quarter of 2017.Looking to first quarter cash flow and capital management. Cash provided by operating activities, excluding noncash working capital was $40.4 million as compared to $33.1 million in the same period of 2017, as we improved operating margins. Q1 2018 capital expenditures increased to $24.7 million versus Q1 2017 capital spend of $9.4 million. Included in quarter 1 2018 was an investment of approximately $12 million for the acquisition of our Arlington, Washington distribution and processing facility. We distributed $7.9 million of capital to shareholders by way of our quarterly dividend in the first quarter, consistent with last year. As Don mentioned, the company implemented a 12.5% increase in our quarterly dividend, effective for the upcoming June distribution. We also repurchased common shares for $1.6 million under our normal course issuer bid at an average price of $2.59. We increased liquidity in the first quarter of 2018 to $281 million. We continue to explore opportunities to grow our business, and we are committed to continuing our balanced approach to capital allocation. Don, that concludes my comments.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Well, thanks, Steve. I'd like to begin our outlook section by touching on second quarter seasonality. Typically, in the second quarter, our harvest volumes increase as snow recedes and we're able to access higher elevations and expand operations across a complete timber harvesting land base. As our harvest activity moves further up the hillsides, our costs tend to rise, as steeper, more difficult terrain increases harvesting complexity. From a marketing perspective, lumber consumption typically increases, as we move into the more active spring building season. Our market outlook remains positive. We except global log and lumber demand to continue to rise, supported by increased U.S. new home construction, a strong repair and renovation market and a growing use of lumber in China. We've seen strong lumber prices entering the second quarter, and we expect that to continue. The domestic log market is expected to remain firm despite seasonal increases in production, and we anticipate continued strong pulp log demand as a result of robust pulp markets.As mentioned earlier, we suspended export log sales in the first quarter to support additional lumber production from our mills. With the provisional government having recently raised concerns with respect to the volume of export logs leaving the coast of BC, we anticipate a policy response in support of domestic manufacturers. In the meantime, we remain focused on delivering on our timberlands margin-improvement initiatives, which include a significant focus on cost containment to offset rising stumpage costs.Our manufacturing operations will benefit from higher mill log inventories. The competition for logs from the export market and a robust pulp market is likely to continue. Despite the intense log market competition, we expect to grow lumber production this quarter. From a logistics perspective, our operating location in the West Coast in North America provides Western with competitive access to global markets. Our new U.S. distribution facility is serviced by Burlington Northern. In respect of our capital program. We continue to reinvest and consolidate our operating base to position our mills and timberlands as the most cost-competitive operations on the coast of BC. Through the first quarter of 2018, we continue to invest in our people through to targeted safety and financial training, and our management information systems to lay the foundation for improved operations and to create a platform for future growth.First quarter capital achievements were highlighted by progress in ramping up the autograder at the Duke Point planer and the Chemainus timber deck. In the fourth quarter of 2017, we completed the $4.8 million Chemainus timber-handling upgrades. Early progress has exceeded expectations, and we're already producing a greater percentage of targeted products, mainly premium-priced, appearance grade cedar timbers for delivery to our selected customers.In January 2018, we completed the acquisition of the distribution and processing center in Arlington. In the first quarter, we invested capital in site and structural improvements, while we finalized the engineering and the construction plans for processing equipment upgrades.Last month, following the completion of foundational safety, operations and systems training, we began receiving and shipping products to Arlington. And we have plans to grow that volume through the second quarter of 2018. Secondary processing should begin on-site late in the second half of 2018. Looking to what's next. We're evaluating all opportunities to grow our margin-focused business and reduce exposure to the U.S. lumber duties. We believe that our ongoing reinvestment in and consolidate of -- consolidation of our coastal operating base, steady improvements in our operating performance and a strong balance sheet have positioned Western to produce -- pursue external growth opportunities.With that, operator, I can now open it up for questions.

[Operator]

[Operator Instructions] The first question is from Hamir Patel of CIBC World Markets.

[Hamir Patel]

Don, I wanted to get your thoughts about -- in the strong commodity lumber market, how much of your commodity business is getting sold to the U.S.? Has that increased this year as prices have run up? Because I was under the impression that, that had been largely going to China, but I'm just curious if that's changed at all?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes, that -- definitely, Hamir. Good question. So at -- right currently, a vast majority of our commodity business is directed to -- I believe it's connected to China with seasonal demand taking more volume into Canada, especially in the treaty market. We are actively working on increasing the volume of kiln-dried material that we produce, both for higher-value end users in China as well as targeting specific high-margin opportunities in the United States. And those would include long lengths. They also include specific tallies and so I think you're correct currently. Most of the volume is going to China with the seasonal increase into Canada. But going forward, we'd expect to be shipping more lumber into the United States in a kiln-dried form.

[Hamir Patel]

And Don, maybe just based on current prices, what's that sort of pricing delta between what you might be able to realize?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Well, I think, fundamentally, we look always to direct lumber or logs to the highest margin alternative. We're fortunate to be located where we are, where we can access world markets as well as the U.S. market with limited constraints. So I can -- the question is, we continue to direct lumber to the highest margin, and if the U.S. market poses the highest margin based upon our conversion cost, we'll direct more and more volume there.

[Hamir Patel]

Fair enough. That's helpful. And Steve, maybe just a question for you. I know the release mentioned that you expect to fully utilize the loss carryforwards this year. Should we assume that you'll be paying cash taxes next year and sort -- maybe sort of, the 27% level?

[Stephen Williams, Executive VP & CFO]

Yes, I think that's a good assumption.

[Operator]

Your next question is from Sean Steuart of TD Securities.

[Sean Steuart, Research Analyst]

Couple of questions. Don, your comments with respect to potential policy change regarding BC log exports, maybe any context you can provide on dialogue you've had to this point, how that might play out in terms of timing, any more detail you can provide us on that front?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Sure. So Sean, our view is that the provincial government has come out a number of times stating their concern about the level of log exports in the coast of BC. And we would anticipate, although we can't guarantee and have no insights other than from discussions, as to what their policy changes might be, but if they're going to have an impact, we'd expect to see a policy change to -- in order to have an impact to -- even the playing field for domestic producers vis-à-vis the export markets.

[Sean Steuart, Research Analyst]

Okay. Second question, can you review the options you're thinking about for the Somass site as it remains down? I think the wording in the press release was, you're considering a number of different alternatives. Any details you can provide on that front?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Well. Sorry, Sean, I'm not relating right now, the site is indefinitely curtailed. That said, we will -- we'll -- and it remains indefinitely curtailed. We will be looking -- and the future, complementary solutions for the site. But there's nothing more I can add to it than that.

[Operator]

The next question is from Paul Quinn of RBC Capital Markets.

[Paul C. Quinn, Analyst]

Just maybe following up on Sean's question on the change in provisional policy on log exports. Can you give us some metrics about your log exports relative to the base of the coast? Are you guys one of the, I guess, proponents that BC government that worries about or are you one in the minority?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Well, I can't honestly tell you what they worry about or don't about. What I can tell is that our volumes as a percent of what we -- of the logs we handle will be on the very lowest end of the volumes of export. And the other thing that I can tell you is that from a lumber capacity perspective, we have the largest lumber capacity or conversion capacity, sawmilling capacity on the coast of BC. So we export less than almost everyone, and we consume more logs internally, making more lumber on the most than anyone. To answer the other part of your question, which is policy change and I think, I refer back to what I said to Sean is, I can't speculate on what type of policy change the government might choose to do or might not choose to do, however, I go back to registered a concern with the level of log exports, you've seen from our release that we have temporarily curtailed log exports in order to ensure our mills have enough fiber and we believe that the only way they'll have an impact on adjusting the volumes of log exports is to change policy.

[Sean Steuart, Research Analyst]

Okay. So just reading in the answer, I guess, to the first part of my question, does that -- do you anticipate the change in policy being a net benefit to you guys?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Well, again, I think you've got to consider the fact that we have the largest investment sawmilling capacity in the coast. And anything that drives additional supply and availability towards coastal sawmills I think given the investments we have made in our cost structure, we should be able to consume more logs and I think that will be where the benefit would come in. Higher consumption, increased -- higher consumptions of logs, increased production, lower costs and more sales to -- of targeted products towards selected customers.

[Paul C. Quinn, Analyst]

Okay. And then just on the area of CapEx. Is there -- what's left in terms of your manufacturing base in terms of big opportunities or step-change opportunities in lowering your lumber manufacturing costs?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes. So I think we're really encouraged by the small, high-return capital projects and debottlenecking. I think that's a good way to describe what the opportunities are out there. We have guided that at about $80 million of capital for our core businesses. We might -- given the environment we're seeing with increased cash generation, I think we extend up to $90 million this year. You have to add to that, the acquisition of Arlington and then an additional $10 million to be invested in that facility over the period just to get you to where we think we're investing. Project-specific, I said, debottlenecking relatively small projects that can be implemented, higher return. Large projects that might reposition the businesses would be further investments in kiln-dried capacity and we are looking at those as we sort of ramp up our production of kiln dried products.

[Paul C. Quinn, Analyst]

Okay, and just one thing you referenced in terms of harvesting cost was -- that was up, part of it was stumpage and part of it was higher cost harvesting opportunities, I guess and that kind of perplex me, because most of the winter logging is generally on lower sides and generally those are cheaper to harvest. So I'm just trying to understand, in terms of the harvesting cost increases, the vast majority of that due to stumpage?

[Donald Eugene Demens, CEO, President & Non Independent Director]

Yes, yes. Significant portion is due to stumpage and that came about with higher than anticipated Vancouver log market pricing. So when the update was done due to the Vancouver log market pricing, the prices were higher than we had anticipated. With respect to operating costs yet you know the coast well and that's exactly right, we tend to be in lower elevations although we have tried to get across the profile as much as possible and get into all of those stands as much as possible, but I think the other big component that may not be as clear is the mix of operations and as we're moving back into higher cost operations like Alberni, that is probably having, well, that is having an impact on our overall cost. So it's -- well it's a higher stumpage driven by the Vancouver log market, which is a market reaction. So that's one point. The second point is the mix of operations, including Port Alberni, that is increasing our cost.

[Operator]

There are no further questions registered at this time. I would now like to return the meeting back over to Mr. Demens. You may proceed sir.

[Donald Eugene Demens, CEO, President & Non Independent Director]

Thank you, operator. Well to close, I'd like to thank all of you for your attention and support of Western. We continue to be encouraged by our most recent results and look forward to sharing our second quarter results with you in August. With that, operator, we can close the call. Thank you.

[Operator]

Thank you, Mr. Demens. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.