Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2021-Q1

[Operator]

Good morning, ladies and gentlemen. Welcome to the Western Forest Products First Quarter 2021 Results Conference Call.During this conference call, Western's representatives may make forward-looking statements within the meaning of applicable securities laws. These statements can be identified by words like anticipate, plan, estimate, will and other references to future periods. Although forward-looking statements reflect management's reasonable beliefs, expectations and assumptions, they are subject to inherent uncertainties and actual results may differ materially. There are many factors that could cause actual outcomes to be different, including those factors described under risks and uncertainties in the company's annual MD&A, which can be accessed on SEDAR, and is supplemented by the company's quarterly MD&A. Forward-looking statements are based on information currently available to Western and speak only as of the date on which they are made. Except as required by law, Western undertakes no obligation to update forward-looking statements. 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. Please go ahead.

[Donald Eugene Demens, CEO, President & Director]

Thank you, Justina, and good morning or afternoon, everyone. I'd like to welcome you to Western Forest Products's 2021 First Quarter Conference Call. Joining me on the call today is Stephen Williams, our Executive Vice President and Chief Financial Officer.Before we get into our first quarter results, I'd like to extend our heartfelt thoughts to the family, friends, colleagues and communities impacted by the fatality of a contractor's employee working on our Gold River operations in March. We are saddened by this tragic event and have offered our support to the family, contractor and those impacted by the incident. We'll work with authorities as appropriate to understand how this incident occurred and endeavor to ensure an incident like this does not happen again. Safety and security of our employees has always been and will continue to be our highest priority. I'd like to thank the emergency responders and all those who attended the incident. We are humbled and appreciative of their support.Turning to our financial results. We issued our 2021 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 will then share with you our outlook, and then we will take your questions.First quarter of 2021 was another exceptional quarter for Western. We continue to manage successfully through the ongoing COVID-19 pandemic. Our team's adherence to our robust COVID protocols resulted in no COVID workplace transmissions or downtime during the quarter. Our safety protocols, solid operating execution and stronger markets enabled us to generate a record first quarter adjusted EBITDA of $62.9 million, an increase of about 60% compared to our operating EBITDA in the fourth quarter of last year.During the quarter, demand for our products continued to outpace supply, driving higher pricing across all of our product segments. We continue to leverage our flexible operating platform by redirecting production from export markets to higher-margin product lines in North America. Our strong operating results, combined with the sale of noncore assets, drove our balance sheet into a net cash position at the end of the quarter. The strength of our balance sheet provides significant financial flexibility to continue with our balanced approach to capital allocation and to support growth initiatives.Year-to-date, we've returned $11.3 million to shareholders via dividends and share repurchases. We also continue to advance our commitment to ESG. We'll be releasing our next sustainability report in the coming weeks, which will include our first full life cycle carbon assessment. And last week, we completed the sale of an incremental 28% of our TFL 44 Limited Partnership to the Huu-ay-aht First Nations. This has increased the Huu-ay-aht's ownership stake to 35% while we retain 65% of the LP. We believe this transaction is a great example of how the business can participate in First Nations reconciliation and that how, by working together, we can extend benefits from our business activities to more people.Overall, I'm very proud of what our team at Western has been able to accomplish together. We're well positioned as we head into the second quarter, which is typically the strongest quarter of the year for our business.Now I'd like to 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 2021 with comparisons to the fourth quarter of last year.Our results from the first quarter of 2020 are less comparable due to the impact of the USW strike. We reported first quarter adjusted EBITDA of $62.9 million as compared to $39.5 million in adjusted EBITDA, excluding the noncash duty recovery, in the fourth quarter of last year. Results in the quarter benefited from improved lumber pricing, lower harvesting costs as we managed road expenditures and by increased harvest levels on our private land and by continuing to leverage our flexible operating platform, redirecting volume to capture incremental margin from strong North American markets.Results were offset by higher performance-based compensation expense related to our improved financial performance and a 41% appreciation of our share price as well as incremental selling and admin expenses due to health, safety and IT-related costs associated with COVID-19.Lumber revenue increased 8% compared to the fourth quarter of 2020 on the strength of higher prices and increased North American shipments. We were successful in maintaining shipment volumes compared to the fourth quarter of last year despite global logistics challenges. Our North American commodity shipment volumes represented 64% of total commodity shipment volumes during the first quarter of 2021, well above our historical average of approximately 30% to 35%.Our first quarter average realized lumber price was $1,356 per thousand board feet despite a weaker sales mix and a stronger Canadian to U.S. dollar exchange rate. Log revenue was lower in the first quarter of 2021 compared to the fourth quarter of last year, consistent with seasonal trends. We continue to direct the majority of export-quality logs to our sawmills to capitalize on the strong North American lumber market.By-product revenue increased by $3.9 million as compared to the fourth quarter of 2020, benefiting from an increase in the NBSK pulp price and higher production volumes. Freight decreased by $2.1 million as compared to the fourth quarter of 2020. Increases in shipping rates were more than offset by lower export log shipment volumes.First quarter results included $8.2 million of export duty expense compared to $12.1 million in the fourth quarter of last year. Increased U.S. destined lumber shipments and higher price realizations were more than offset by lower duty rates. At the end of the quarter, we had approximately USD 101 million of duties on deposit.Lumber production increased 11% compared to the fourth quarter of 2020. We achieved higher production from increased operating hours, improved production efficiency and a shift to more domestic lumber production. Log production in the first quarter of 2021 was 24% lower than the fourth quarter of last year. Consistent with typical seasonal operating conditions, we ended the quarter with approximately 745,000 cubic meters of log inventory. This is slightly lower than our historical levels for the end of the first quarter, but we are comfortable with our log inventory as we head into the spring part of the season. From a profit and loss perspective, first quarter net income was $53.8 million as compared to $34.4 million in the fourth quarter of 2020.Looking at cash, our first quarter cash flow and capital management. Cash provided by operating activities before changes in noncash working capital was $66.3 million in the first quarter as compared to $38.7 million in fourth quarter of last year. Cash provided by investing activities was $33.4 million during the first quarter of 2021 as compared to cash utilized of $5.5 million in the fourth quarter of last year. Capital expenditures in the first quarter of 2021 were more than offset by $37.7 million in proceeds from the sale of noncore assets. First quarter noncore asset sales included $36 million from the sale of certain properties and their underlying rights related to the Orca Quarry.We returned $6.1 million to shareholders during the quarter via dividends and share repurchases. Subsequent to the end of the quarter, we returned an additional $5.2 million to shareholders via share repurchases. Year-to-date, we have returned $11.3 million to shareholders. We successfully reduced our net debt by $70 million in the first quarter. As a result, we ended the quarter in a net cash position on our balance sheet and have liquidity of $244 million. Subsequent to the end of the quarter, we completed the sale of the next phase of our TFL 44 LP transaction for $22 million, with the Huu-ay-aht First Nations.Don, that concludes my comments.

[Donald Eugene Demens, CEO, President & Director]

Well thanks, Steve. Let me start off 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 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 season. So as we look to our markets, our lumber markets in North America are being supported by strong fundamentals, including low mortgage rates, housing supply deficit and a strong repair and renovation segment, as more people will work from home. At the same time, supply has been constrained due to permanent production curtailments in the BC Interior from the Mountain Pine Beetle and COVID-related manufacturing labor constraints. In the near term, markets are likely to be further supported by higher seasonal demand.Specifically into our segments, demand and pricing for our Cedar and Niche products has improved across all product categories on the strength of this robust residential repair and renovation market. And the fundamentals in our export markets have also improved. Low inventory levels, combined with a lack of supply, should support improved pricing over the next couple of quarters. That said, we may be faced with some logistics challenges due to container shipping shortages.In our log business, we expect domestic saw log prices to continue to rise, supported by the strong lumber markets and increased competition from export log markets. Improving pulp markets should support higher chip and pulp log prices. Currently, our second quarter lumber order file extends through mid-June, and we anticipate pricing to be 10% to 20% better than the first quarter. Actual performance could be impacted by production logistic issues that we currently do not perceive.Turning to capital allocation. We are committed to a balanced approach to capital allocation, returning cash to shareholders while maintaining the flexibility to support growth initiatives. Our first priority continues to be the payment of our regular quarterly dividend. Our second priority is to invest strategic and discretionary capital in jurisdictions that will grow long-term shareholder value and meet our desired return thresholds.We currently have approximately $10 million in strategic capital projects in process. We've identified an additional $20 million to $25 million of capital projects, which could be implemented over the next 18 months. Strategic capital projects will be focused on reducing manufacturing costs or addressing secondary processing capacity constraints on the BC Coast to support growth of our higher-value targeted product lines. Strategic capital investments may also include acquisitions, which complement or grow our specialty product lines. Any acquisitions will need to make financial and strategic sense through an entire lumber cycle.To the extent there are limited near-term internal and external investment opportunities with appropriate returns, and we have excess capital available to deploy, our third priority is to return additional cash to shareholders. We plan to remain disciplined in our capital allocation approach and ensure we maintain financial flexibility.Turning to what's next. Our top priority remains the health and safety of our employees, contractors and communities. Our strong balance sheet has given us financial flexibility to continue with our balanced approach to capital allocation while also supporting the execution of our strategic growth priorities. We continue to progress with our sales and marketing initiatives, including our Japanese Cedar fencing product line, growing our wholesale lumber volumes and growing our volumes to home centers.We remain encouraged that the long-term growth opportunity for our hemlock products in the specialty treating sector. Given the reduced supply of SPF lumber from the BC Interior due to the Mountain Pine Beetle, treating companies in Canada and the Pacific Northwest are looking for volume to support business growth and offset the SPF supply gap. Western's hemlock products are well positioned to fill this supply gap.Longer term, we remain excited about the potential growth opportunities for our wood products in a low-carbon future and in mass timber building technologies. In addition to increasing demand for wood products, we see mass timber as further helping solidify wood as one of the world's most sustainable building materials. We continue to evaluate how we may best participate in this potential growth opportunity.Our long-term focus remains the same: to successfully and sustainably implement our strategic initiatives, to strengthen our foundation, grow our base, grow our business and deliver long-term shareholder value.With that, operator, we can open up the call to questions.

[Operator]

[Operator Instructions] And our first question is from Sean Steuart.

[Sean Steuart, Research Analyst]

A few questions to get through. The 64% of the commodity product that you moved into The States last quarter versus, I think, you said the long-term average is 30% to 35%, what's the sustainability of that ratio? And is there even upside into these spectacular Q2 markets where you can move even higher?

[Donald Eugene Demens, CEO, President & Director]

Sean, thanks for the question. So maybe a little more context for you when we think about North American shipments and this transition we have made from the export markets. Compared to Q3 '20, North American shipment is up about 50% overall and up about 65% into the U.S. So it's not just the U.S., Sean, it's Canada as well. So overall, I think when you look at commodity business, as you rightly pointed out, we were kind of 70-30 export. We're now sort of 60-40 North American. How much more can we do? I think 5% or 10% is certainly possible.When we talk about how sustainable this is, we think it's sustainable. We think there's been a permanent shift in the supply base into -- especially into the Western North America due to the Mountain Pine Beetle. NAFTA has actually done some analysis on this, and the number can be anywhere from a 3.6 billion to 5.5 billion foot gap in supply coming from SPF but also coming from reduced supply over the years from the coast and also the inland region.So we believe it's sustainable. We think we've got the flexibility and the flexible operating platform to seize the opportunity. And we think we've got a product line that is actually sought after in the treating segment. So we're pretty excited about the transition we've made. As I said, we think it's sustainable. That said, if markets change and margins are higher going back into the export markets, we are well positioned to do that.

[Sean Steuart, Research Analyst]

Excellent detail, Don. Second question. You guys logged the Orca Quarry land before the sale. And there was reference to stumpage savings, logging the private land. Can you put a number to that? How much did that contribute to EBITDA this quarter?

[Donald Eugene Demens, CEO, President & Director]

Yes. I think like the stumpage benefit of the Orca Quarry private lands, it would not be material. But maybe I can answer the question on stumpage this way. I mean I think our stumpage formulas on the coast, they're different than the interior. So the drivers of the formula are different. However, they're both consistent in one phase and one point, which would be, as lumber markets move up, you'd expect to pay more stumpage. So I think we were somewhere around $13 or $15 a meter in Q1. And I think your logical question will be what's it going to look like. And I would say, I could see another $5 or $7 over the next few quarters in stumpage increases. That said, it will be dependent upon what our species mix is and the blocks that we are harvesting and if there's anything unforeseen that we don't see in our harvest profile. So I hope that kind of answers the question. I just don't think that the stumpage benefit from logging the Orca Quarry lands would not have been material.

[Operator]

[Operator Instructions] Our next question is from Paul Quinn.

[Paul C. Quinn]

Good results. Just Steve, you brought up the higher SG&A cost. Maybe you can give us an expectation for what do you think it will be in total costs in 2021?

[Stephen Williams, Executive VP & CFO]

Yes. So maybe I'll just help you out quarter-over-quarter to give you a better sense of the full year. So the majority of the increase relates to performance in incentive-based compensation as a result of a significant improvement in our results and the 41% increase in the share price. So approximately $3.9 million was performance-based comp, another $3.1 million is mark-to-mark expense on long-term compensation liabilities due to the appreciation of the share price of another $0.5 million quarter-over-quarter on the -- pertaining to COVID protocols. So again, a big driver will be the change in share price going forward.

[Paul C. Quinn]

Okay. And then just, I guess, with pulp prices rallying here, how mature will be the increase in by-product revenue going forward here?

[Donald Eugene Demens, CEO, President & Director]

Yes. I mean so as you know, like our -- as you know, Paul, our chips are tied to the pulp pricing. As we see any incremental increases in pulp pricing, that's going to fall to the bottom line. I think Steve highlighted, it was a $3.5 million or something in Q4 to Q1. You might see about half of that again this quarter. It also depends, of course, on how much organic growth we are able to drive out of our businesses. The more lumber production, the more chips we make, the more on a total dollar basis we're going to receive. So on an organic growth perspective, we're looking at -- I guess it grew 11% Q4 to Q1, another 5% to 7% this quarter would be a good number to consider. And through the year, I'd like to see us grow kind of 10% to 15%. And that's going to be on the basis of additional hours in our mills in both the U.S. and Canada.

[Stephen Williams, Executive VP & CFO]

And Paul, I would just add pulp log pricing has essentially stayed flat during the period. We don't expect it to change materially either.

[Paul C. Quinn]

Okay. And then I guess, just seasonally, I mean it should -- Q2 generally is your best quarter. It should be a pickup from what we've done in Q1. Just on the capital allocation side, you've been buying back shares, still feel confident buying back shares at this price. And what does the M&A pipeline look like?

[Donald Eugene Demens, CEO, President & Director]

Sure, good point. As we said, our first priority in the capital allocation perspective is the quarterly dividend, providing that to the shareholders. Second will be investing in our current business and to drive down costs, improve value extraction or acquisitions, as you pointed out. And then, of course, the third priority, if we've got excess capital, we'll return that to the shareholders.On the acquisition front, we're always on the lookout for businesses that are accretive to ours and especially in product lines we really like. We've said in the past, we're looking in the Pacific Northwest as the first priority. But I think -- and we're going to continue to do that. So we'd expect to see opportunities present themselves over the near term, we're going to continue to look at ways to expand our business, especially given our strong balance sheet. And time will tell because we don't -- we often -- we don't control the time lines that others have when it comes to what they would like to do with their existing businesses.

[Paul C. Quinn]

Okay. And then just lastly, just on that $22 million sales to the Huu-ay-aht, just wondering what the financial drag on that is. Do you consider a 4x multiple business or a 6x multiple business? What is the subsequent drag?

[Donald Eugene Demens, CEO, President & Director]

Well, I think when you think of TFL 44 and you know well, over time, the business -- we believe we're getting fair value for the business. In addition, we've got a long supply agreement for our mills. So in any of these transactions on the -- with the tenures, we're always looking at ensuring that we're receiving fair value. I think there's a real positive story here in working with First Nations as the business can on opportunities to have them invest in the business and for us to pursuing reconciliation and make the business stronger. So kind of to sum it up, I think we're getting fair value for the business, and we're retaining log supply to support our mills where we also make margin. And I think we're making the business stronger.

[Operator]

[Operator Instructions] And there are no further questions registered at this time. I would like to turn the meeting over back to Mr. Demens.

[Donald Eugene Demens, CEO, President & Director]

Great. Well, thank you, operator, and thanks, everyone, for your continued support. Appreciate your interest in our company and your time on our call today. Steve and I are both available if you have any follow-up questions. And we look forward to sharing with you our second quarter results in August. With that, have a great day. Thank you.

[Operator]

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