Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2019-Q1

[Operator]

Good afternoon, ladies and gentlemen. Welcome to the Western Forest Products First Quarter 2019 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 depends 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 CEO of Western Forest Products. Mr. Demens, please go ahead.

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

Well, thank you, Annaliese. Good afternoon, everyone. I'd like to welcome you to Western Forest Products 2019 First Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer.Before we start today, I'd like to welcome Laura Cillis and Cheri Phyfer, who were elected to the Board of Directors at our Annual General Meeting this morning. We're fortunate to have Laura and Cheri join Western, and I am looking forward to working together with them as we execute our growth strategy.We issued our 2019 first quarter results yesterday. I'll provide you with some introductory comments, and then ask Steve to take you through a summary of our financial results. I'll then share with you our near-term outlook and provide an update on developments in our industry. We'll then open the call up for your questions.The first quarter of 2019 was challenging as we faced difficult markets due in part to poor weather across much of North America, which limited our sales, and trying operating conditions which impacted costs. Despite these challenges, we generated adjusted EBITDA of $18.1 million in the first quarter of 2019, which was lower than the $43 million achieved in the same quarter last year.Our results continue to be impacted by high stumpage costs, which are disconnected from the current lumber market pricing as well as softwood lumber duties, which have a disproportionately greater impact on specialty lumber producers than it does on commodity producers. We responded to more challenging lumber markets and supported our lumber price realizations by increasing our direct end market sales in China and by leveraging our flexible operating platform to improve our specialty product mix.In response to weaker commodity lumber markets and a coastal BC stumpage system, which is not reflective of current lumber prices, we made preparations in the quarter to start -- to restart our export log program, and we took operational downtime to manage production levels to meet market demand.Despite the challenging operating environment, I am pleased to report we continued to make significant progress implementing our strategic capital -- our strategic initiatives in the first quarter. Some highlights from the quarter include the completion of the acquisition of Columbia Vista, which will expand our Douglas fir specialty products production. This will make us more meaningful for our selected customers and particularly those customers in Japan. We advanced our strategic partnership with the Huu-ay-aht First Nations by selling an interest in our Port Alberni forest operations, further showing our commitment to building mutually beneficial relationships with First Nations and working together for the benefit of all stakeholders. We substantially completed equipment and building upgrades at our Arlington facility and have now commenced commissioning. We expect operations in Arlington to assist us in repositioning our product lines closer to the final customer.We accelerated wholesale lumber activity in the first quarter, including investing in inventory in anticipation of the spring building season. Our wholesale lumber business will allow us to offer an expanded product line, making us more meaningful to our selected customers and will further enhance the viability and success of our coastal sawmills. We published our inaugural sustainability report, further demonstrating our commitment and leadership to good environmental, social and governance practices.And despite the more challenging operating conditions, we continued with our balanced approach to capital allocation. We invested $18 million in our existing operations, while returning $16 million to shareholders via dividends and share repurchases.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 2019 by comparison to the first quarter of last year. As Don mentioned, we delivered first quarter adjusted EBITDA of $18.1 million as compared to $43 million in the same period of 2018. Results were impacted by difficult operating conditions, which led to higher operating costs as well as temporary mill curtailments, a weaker lumber environment, lower lumber shipment volumes and a change in sales mix, the mix of harvesting operations and declining coastal chip pricing. We incurred $9.2 million in U.S. softwood lumber export duties in the first quarter as compared to $9.7 million in the same quarter last year as a result of lower sales volumes quarter-over-quarter, partially offset by an improved mix. At the end of the quarter, we had approximately $71 million of duties on deposit.Lower lumber revenue was a result of a 6% decrease in shipment volumes. Specialty lumber revenue was supported by higher production from our Duke Point sawmill, which drove a 30% increase in niche product sales quarter-over-quarter. Specialty lumber represented 52% of first quarter shipments consistent with the first quarter of 2018. However, the overall mix of our specialty lumber was more weighted towards niche products in the first quarter of '19 compared to the same period in '18.In addition, the mix within the mix of specialty products was more weighted towards higher value products, which resulted in overall increase to our average lumber selling price compared to the same period last year. We lessened the impact of declining commodity lumber prices by increasing our direct sales to China by 56% compared to the same period last year. Total freight expense was relatively flat quarter-over-quarter as increased direct sales to China and a weaker Canadian dollar were offset by a decrease in shipment volumes. Byproduct revenue decreased by 30% quarter-over-quarter as a result of declining prices and lower production due to mill curtailments. British Columbia coastal chip pricing declined by 17% compared to the same period last year. A stronger domestic saw log sales mix offset declining saw log pricing. Log shipments were flat quarter-over-quarter as increased pulp log sales volumes offset lower export in domestic shipments.Coastal lumber production decreased 8% over the first quarter of 2018, partially offset by 2 months of production to Columbia Vista. Challenging commodity lumber markets led to reduced operations at our commodity-focused sawmills. We grew production at our Duke Point sawmill through increased hours and improved operating performance as we continue to see the benefits from our recent capital improvements. First quarter manufacturing costs were 20% higher from the same period last year due to challenging operating conditions, temporary mill curtailments, mix of operations and higher natural gas costs due to a temporary supply disruption.Log production in the first quarter of 2019 was 10% lower than the same period last year. Decreased log production was primarily due to curtailed Englewood operations. Our BC coastal harvest costs increased by 12% from the same period last year, primarily driven by a mix of higher cost operations, lower harvest volumes, increased mix of heavy logging and an increase in stumpage costs on a per cubic meter basis. As a result of the misalignment between the coastal stumpage system and lumber market pricing, we resumed export log sales in the second quarter of 2019.From a profit and loss perspective, net income was $1.9 million as operating margins and net income were impacted by challenging operating environment, which led to lower production and shipment volumes. This compares to net income of $21.7 million in the first quarter of 2018.Looking to first quarter cash flow and capital management, cash used in operating activities, including changes in noncash working capital, was $9.2 million as compared to cash provided of $45.6 million in the same period of 2018. In the quarter, we invested in working capital to support key strategic initiatives, including $12 million to grow wholesale lumber inventory in advance of the spring building season, and to grow export log inventory in preparation for the resumption of our export log program in the second quarter. We invested $17.7 million in our existing operations in the quarter compared to $13.1 million in the same period of 2018. We also completed the acquisition of Columbia Vista for $37.7 million, including working capital. We returned $16 million to shareholders via dividends and share repurchases compared to $9.5 million in the same quarter in 2018.Our liquidity at the end of the first quarter of 2019 was $176 million and our net debt-to-capitalization ratio was 11%. 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]

Thanks, Steve. I'd like to start off our outlook section by touching on second quarter seasonality. Typically, in second quarter, our harvest volumes increase as snow recedes, and we're able to access higher elevations and expand operations across the 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 market perspective, lumber consumption typically increases as we move into the more active spring building season. So let me take a moment to talk a bit more about our markets. Our long-term view of market fundamentals remains unchanged despite recent lumber pricing volatility due to the weaker-than-expected new home construction and a slow start to the spring building season due to weather events.In North America, we expect rising lumber consumption will continue to be driven by increased new home construction, growth in the repair and remodeling sector and the addition -- and the adoption of mass timber building technologies. We expect the lumber demand in China to continue to grow due to government commitment to housing. In the near term, in North America, prolonged winter weather has delayed the start of the spring building season. The weather in combination with weaker housing starts have resulted in reduced demand for lumber.As the weather improves in North America, we expect to see some recovery and demand. In the meantime, we will continue to manage our inventories and match lumber production with demand. Improved weather conditions should create opportunities for our Western Red Cedar products. And while we wait for improved demand, we will continue to focus on managing our product mix.In Japan, we anticipate demand will be relatively stable ahead of the proposed increase in the Japanese consumption tax. From a pricing perspective, we expect hemlock pricing to remain under pressure from subsidized Japanese domestic product substitution, while pricing for our Douglas fir products is expected to remain relatively stable. We expect volumes to continue to grow in our niche business supported by increased production from Duke Point, while pricing should benefit from enhanced product recovery as we leverage our investments in our Duke Point planer and autograder.So I now would like to take a moment to address a couple of developments in the industry. The BC government announced a framework for its coastal revitalization plan in January. As we've said, we share many of the same goals with the BC government, including a strong forestry sector on the coast, sustainable employment for communities, increased First Nations participation and strengthen domestic manufacturing. As part of their revitalization initiatives, on April 1, the government announced measures to increase the recovery of what they call avoidable waste within harvest blocks located in a new coastal fiber recovery zone.In discussions with government, they've indicated this initiative is an effort to increase fiber supply to secondary users, mostly pulp and paper companies, that are the pay for the cost of recovery. The government has indicated that this initiative is to be cost-neutral for harvesting companies and that they will change policy in the face of unintended consequences. At this time, it's not possible to determine the impact fiber recovery zones or other policy initiatives will have on our BC operations. We remain committed to working with the government to support our industry and creating business hosting conditions in an operating environment that will keep business on the coast of BC globally competitive, while avoiding policies that add costs or restrict supply to our global lumber customers.Moving on to the softwood lumber dispute. As discussed over the last few quarters, we have filed a NAFTA challenge to contest the U.S. International Trade Commission's finding that cedar lumber products were not a separate like product group from commodity softwood lumber. Through our challenge, we are seeking ITC recognition that appearance grade cedar lumber products and structural commodity lumber differ in end-use application. A successful challenge could result in separate like product classification and require the ITC to rule if cedar shipments from BC injure U.S. producers. A panel hearing is scheduled for next week, and we expect the panel could issue a ruling late in 2019. And I've just received the panel agenda this morning, and the first item on the agenda is our cedar challenge.Western Red Cedar specialty lumber products sold in the U.S. market have accounted for approximately 85% of our duty expense since April 2017. So to conclude, despite the challenging market and operating environment, we remain focused on implementing our strategic initiatives, to strengthen our foundation, grow our base and grow our business.With that, operator, we can open the call up to questions.

[Operator]

[Operator Instructions] And the first question is from Hamir Patel from CIBC Capital Markets.

[Hamir Patel]

Steve, you mentioned that you've resumed log exports in Q2. What level of volumes should we expect there going forward?

[Stephen Williams, Executive VP & CFO]

So that's correct, Hamir. So again, just to give a little color, it takes a while to build inventories and make the -- and go through the surplus tests and advertising permission -- provisions of the surplus test to get the volumes ready. We expect our first shipments to occur in May and another one in June. Volumes are going to depend on how quickly we can get the volumes through the surplus test and how quickly we can arrange shipments. So it's a little difficult to tell you exactly the total volume currently.

[Hamir Patel]

Okay. That's helpful. And just on the stumpage front, several of your peers in BC are pointing for higher stumpage in the interior in July. What are you expecting on the coast?

[Stephen Williams, Executive VP & CFO]

Yes. So coastal stumpage is different than the interior stumpage system. The coastal stumpage system is based on log pricing and the activity of BCS log bidding, rather than just a lumber component or a component of lumber. The lumber component in the coastal system is very small. The updates that have occurred recently in -- with stumpage occurred at the beginning of the year, and we don't anticipate another update or an increase in July as the interior guys are expecting.

[Operator]

The next question is from Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

A couple of questions. The comments, Don, you had on further, I suppose, near-term downside for hemlock lumber into Japan due to subsidized competition, can you give us a sense of how much further downside do you see? Is this something to expect over the next few months? Any order of magnitude you can put on that.

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

Sean, so I think you've seen in the print pricing, prices have come off for hemlock and I am not sure we're going to see significant price reductions from there. We -- there may be some, but I think our strategy is going to have to change in the market and become -- and go more direct into the home company segment and that's what we're going to have to do. So while print pricing shouldn't change a whole bunch, we may be forced to be a little more competitive going forward. We'll have to wait and see.

[Sean Steuart, Research Analyst]

Okay. Understood. And with, I guess, more difficult near-term market conditions, has your thinking on M&A ambition in the Pacific Northwest changed at all post Arlington ramping and Columbia Vista closing? Maybe speak to the M&A environment and your appetite to continue to consolidate in that region.

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

Sure. So first and foremost, we're going to continue our balanced approach to capital allocation and ensure that our balance sheet is capable of taking on additional capacity or acquisitions where we see an opportunity. For M&A activity in the Pacific Northwest, again, our view is that they will be relatively small tuck-in acquisitions consistent with our strategy of growing our specialty Products business. It's hard to determine when those opportunities will become available. The market in the Pacific Northwest in that segment tends to be 1 and 2 mill operations, privately owned. And so it will be sometime before we can -- not sometime, but we'll have to wait and see when those opportunities arise. But however, I should say that we are going to continue to look at opportunities to move up the value chain and reposition our products and our product offering to our customers as we reposition the business and continue to focus on specialty products.

[Operator]

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

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

Paul, we can't hear you. I'm not sure if you're phone is...

[Paul C. Quinn, Analyst]

Is this better?

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

That is much better.

[Paul C. Quinn, Analyst]

Good. Maybe I'll start off on this resumption of the log export program. Just trying to reconcile that with the BC government's coastal revitalization plan, which I thought was going to further make restrictions on log exports.

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

Yes. So the government certainly has a desire to increase domestic manufacturing. Our challenge in -- and I think Western's [ whitewall ] positioned to be able to support that as we estimate we have about 50% of the sawmilling capacity on the coast. However, we have a situation currently where the lumber markets are not really receptive to additional volume and the stumpage system currently is driven by log pricing. So this disconnect between log pricing and the lumber markets has driven us to make product selections and changes, margin focused or margin-based decisions. And the logical choice for us is to move back to log exports on a portion of our tenures and that's what we've done. I think the government, over time, will have to reconcile the disconnect between stumpage and the lumber business and lumber markets, and work collaboratively with industry to get cost down so we can be competitive in those lumber markets. In the meantime, Paul, we're going to continue to make margin decisions to support the operation of our company and our business.

[Paul C. Quinn, Analyst]

Okay. So over the last, I guess, 4 or 5 years, you guys have spent some money on your mills, brought them -- brought the cost down significantly and increased production. So really the export now is because you see the current production sort of the Q1 run rate is what you're going to see for the balance of '19 given the difficult market conditions, is that way I got it?

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

Yes, I think so. And I think it's important to note we've invested significantly in the specialty mills, which includes Duke Point, Saltair and some strategic investments at Chemainus. While still building the capacity and improving operations in the commodity mills, I think, that's the way you should look at it though that given the current markets, I think, a number of our peers are having difficulty moving volume as well in the current markets that one of the advantages we have is we can move back and forth between log markets and lumber markets. And I think that's a good news story because it continues to provide employment for our employees and some consistency for the communities and returns for the shareholders, so despite pretty weak commodity markets and that is really the log is being exported, it's a commodity log.

[Paul C. Quinn, Analyst]

Okay. And maybe you could comment on the sale of -- the 7% sale of your Port Alberni forest operations. Are we expecting to see more of these type of sales going forward?

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

Yes. So you're referring to our agreement with the Huu-ay-aht First Nations over in West Coast of Vancouver Island to have them participate in our Port Alberni forest operations. I think this is a really great template that we could use on all of our tenures. If First Nations in the area are willing and would like to go down that path, it provides ownership and the business opportunity to grow employment and an investment in the business, which I think is -- provides a good foundation for the First Nations, but also for our business because it creates some certainty around our ability to harvest. So yes, it is something we're really pleased with. It is something that we'd like to see occur in other tenures, and we look forward to pursuing this in the future.

[Paul C. Quinn, Analyst]

Okay. And maybe if you could share how you came up with the valuation on the tenure?

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

Yes. I think it's based on the cash flows that we can generate from these operations. I'd like to point out also it's very consistent with the compensation we received from the government when there was a treaty announced with the Huu-ay-aht, their treaty, and some of our tenures were removed from the TFL -- or some of our harvesting volumes were removed from the TFL.

[Operator]

[Operator Instructions] There are no more questions registered at this time. So I'd like to turn the meeting back over to you, Mr. Demens.

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

All right, thanks Annaliese. So thanks, everyone, for your continued support. And despite the near-term challenges, we remain cautiously optimistic for the remainder of 2019. We appreciate your interest in our company and your time on the call this morning. Steve and I are both available if you'd like some follow-up questions or you have some follow-up questions. With that, I look forward to sharing our second quarter results with you in August. Have a great day.

[Operator]

Thank you. The call has now ended. Please disconnect your lines at this time. Thank you for your participation.