Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2021-Q2

[Operator]

Good morning, ladies and gentlemen, and welcome to Western Forest Products Second 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 these 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 only 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, investors 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 & Director]

Well thank you, Paul, and good morning, everyone. I'd like to welcome you to Western Forest Products 2021 Second Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer. We issued our 2021 second 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 follow Steve's review with our outlook session before we open the call to your questions. Before I begin, I'd like to recognize our team at Western for their strict adherence to our robust COVID safety protocols. Their dedication to safety has delivered another quarter with no COVID workplace transmissions or downtime. This result is a testament to our strong safety culture and the commitment of our people. Our second quarter results were a record for Western. Our safety performance, solid operating execution allowed us to capitalize on stronger markets to generate record second quarter adjusted EBITDA of $120.4 million. This result's almost double the EBITDA we delivered in the first quarter this year. During the quarter, we continued to leverage our flexible operating platform by redirecting production from export markets to higher-margin product lines for North America. Our strong operating results, combined with the proceeds from asset sales, has allowed us to reposition our balance sheet. We ended the second quarter of 2021 with almost $100 million in cash, while at the same time, returning more than $33.5 million to shareholders through dividends and share buybacks. Over the last 12 months, we generated more than $325 million in cash from our operations and asset sales. And so far this year, we've returned about $50 million to our shareholders through dividends and share repurchases. In conjunction with these excellent results, we've also continued to demonstrate our leadership in advancing our ESG commitments. During the second quarter, we released our 2020 sustainability report, which confirms Western's net positive carbon impact. And we became the first North American publicly traded forest company to transition to a sustainability-linked credit facility, linking the interest rate we pay to the achievement of certain sustainability goals. We advanced mutually beneficial First Nations relationships by completing the next phase of the TFL 44 Limited Partnership transaction with the Huu-ay-aht First Nations for $22.4 million. And we established sustainable forest management planning processes with a number of First Nations, which will support their increased participation in the full spectrum of forestry planning within their territories. We recognized nonexecutive employees with a COVID-related safety bonus to show our appreciation for their commitment and dedication during the pandemic. And we supported communities which have been stated by recent forest fires with a donation to the Canadian Red Cross BC Fire Appeal campaign. And in addition, we've increased our other community donations in conjunction with our strong results. So I'm proud of what our team at Western has been able to accomplish and look forward to continued success and growth together as we move forward. 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 second quarter of 2021 with comparison to the second quarter of last year. We reported second quarter adjusted EBITDA of $120.4 million as compared to $29.5 million in the same quarter last year. Results in the quarter benefited from record lumber prices and growth in lumber shipments, leveraging our flexible operating platform to redirect volume to capture incremental margin from strong North American markets and higher byproducts revenue from increased lumber production and improved chip price realizations. Results were partially offset by increased secondary processing costs as we shifted production to North American commodity markets, lower external log shipment volumes as we redirected logs to our sawmills to capitalize on strong North American markets, and higher performance-based compensation expense related to our record financial results in a 17% share price appreciation in the second quarter of 2021. Lumber revenue increased 87% compared to the second quarter of 2020 on increasing shipment volumes and higher prices for our products. North American commodity lumber shipment volumes represented 72% of total commodity lumber shipment volumes during the second quarter of 2021 as compared to 16% in the same period last year. Our second quarter average realized lumber price was a record $1,598 per 1,000 board feet. Log revenue was lower in the second quarter of 2020 compared to the same quarter last year due to reduced sales volumes. We directed log inventory to our sawmills to support lumber production and capitalized on the strong North American lumber market. Byproduct revenue increased by $8 million as compared to the same quarter last year, benefiting from higher production volumes and improved chip realizations from a higher NBSK pulp price. Freight increased by $6.7 million as compared to the same quarter last year. Increased lumber shipment volumes and container costs were partially offset by reduced export log shipments. Second quarter results included $10.8 million of export duty expense as compared to $7.6 million in the same quarter last year. Increased U.S.-destined lumber shipments were only partially offset by a reduction in cash deposit rates. At the end of the quarter, we had approximately USD 109 million of duties on deposit. Lumber production increased 45% compared to the same quarter last year. The redirection of production to the North American markets contributed to improved recovery while also increasing secondary processing requirements and costs. Log production in the second quarter of 2021 was 17% lower than the same quarter last year. Harvest activity impacted by a heavy snowpack early in the second quarter, followed by extreme heat curtailments at the end of the quarter as well as harvest permit delays. We ended the quarter with approximately 860,000 cubic meters of log inventory, which is slightly lower than historical levels for the end of the second quarter. Our BC coastal per unit harvest costs increased by 17% from the same period last year driven by higher stumpage costs, lower volume and a mix of operations. From a profit and loss perspective, second quarter net income was $78.3 million as compared to $8.5 million in the same quarter last year. Looking at second quarter cash flow and capital management. Cash provided by operating activities after changes in noncash working capital was $113.3 million in the second quarter as compared to cash used in operating activities of $6.8 million in the same quarter last year. Cash provided by investing activities was $19.4 million during the second quarter of 2021 as compared to cash utilized of $3.9 million in the same quarter last year. Capital expenditures in the second quarter of 2021 were more than offset by proceeds from asset sales of $26.7 million. We returned $33.5 million to shareholders during the quarter via dividends and share repurchases. Year-to-date, we have returned over $50 million to shareholders. We ended the quarter with $98 million in net cash and $341 million in available liquidity. In July, we completed the amendments to our $250 million credit facility, which included transitioning to sustainability-linked credit facility and extending the maturity to July 2025. The amended credit facility will continue to include an important feature, which allows Western to increase the aggregate available amount up to $350 million, subject to lender approval. Don, that concludes my comments.

[Donald Eugene Demens, CEO, President & Director]

Great. Thanks, Steve. So let me start off our outlook section by touching on third quarter seasonality. Typical third quarters can be challenging operationally as hot, dry weather can restrict logging activity, reducing harvest volumes and impacting costs. And at the end of the second quarter of this year, both our timberlands and mills took downtime due to excessive heat. While our mills returned to regular operations in early July, our harvesting activities continue to be impacted by earlier-than-normal hot and dry conditions. While we've not experienced any significant forest fires in our areas of operation, the combination of hotter and drier conditions, combined with potential harvest permit delays, may impact near-term log availability and could result in operational downtime. We'll continue to monitor the situation as we move forward and adapt operations as necessary. As we look to our markets, despite strong demand from the new home construction segment in North America, commodity lumber prices have declined from the record levels reached in May. As COVID restrictions were relaxed and people began to travel, there is less demand for lumber from the do-it-yourself segment. The decline in activity has caused the supply and demand for lumber to rebalance. In the past couple of weeks, our customers have indicated that demand from the DIY segment appears to be improving, which, along with the recent supply curtailments due to extreme fire conditions, could support the market in the near term. But as we wait for the North American commodity market to stabilize, we've been redirecting lumber back into the export markets where inventory levels are low and pricing has improved. We began this process late in the second quarter, increasing shipments into Japan, and we expect to continue to do this through the third and fourth quarters. We've attempted to mitigate Asian market logistics challenges by reintroducing the use of break bulk carriers to deliver some of our products to market. As we look forward, we will continue to leverage our flexible operating platform to match production to market demand and logistics capacity. In our log business, we expect domestic sawlog prices to remain elevated due to limited supply, and pulp log prices remain stable. Longer term, we believe the combination of low mortgage rates, an aging U.S. housing stock and years of underbuilding, work from home, and growth in the use of mass timber construction will support increased demand for our products. All this, while supply remains relatively constrained due to the effects of the mountain pine beetle in British Columbia. Going forward, the new demand-supply dynamic should support elevated product pricing over recent trend levels. Turning to capital allocation. We remain committed to a balanced approach to capital allocation, returning cash to shareholders while maintaining the flexibility to support growth initiatives. Our balanced capital allocation approach includes: paying a regular quarterly dividend, investing strategic and discretionary capital in our mills or through acquisitions that will grow long-term shareholder value, and returning any excess capital to shareholders. We continue to make progress on the $10 million in strategic capital projects currently underway. These projects are focused on reducing costs and improving efficiency. We're also looking at some larger projects in our existing facilities that will further improve competitiveness by reducing costs, improving recovery and enhancing value extraction. Overall, we plan to remain balanced and disciplined in our approach to capital allocation. And as you've seen, we've announced the renewal of our NCIB that provides us the opportunity to purchase up to 10% of our public float for cancellation over the next year. 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. 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. And with that, operator, we can open up the call to questions.

[Operator]

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

[Hamir Patel]

Don, I wanted to start on the R&R side. I was just wondering if you could share any data points you guys might have about what you're seeing on demand in the big box channel. And if you're noticing any differences between maybe the DIY buyer and contractors for cedar had been.

[Donald Eugene Demens, CEO, President & Director]

Sure, Hamir. Yes. So I mean I think if you go back at the start of the quarter, we saw a really strong demand in the R&R channel. I would say probably the combination of the media coverage every day about record high lumber prices and the reduction in the COVID restrictions led to a reduced demand for lumber, especially as you've identified in the home centers. It's our view longer term or the next few months, we're going to expect to see that trend reverse just because of the age of the housing stock and this work-from-home dynamic. Answering your question directly, in the last couple of weeks, our customers are indicating things are getting better, and those are customers that supply product into the home centers. Our recent calls directly with the home centers indicate the same, that they're taking some aggressive action to spur demand. And I think that's all positive. So I think this is a short-term blip. R&R is a real important segment, as you know, in the consumptional lumber and lumber products, and we see kind of what's happened as a short-term kind of issue that should work itself out and we're hoping things are going to get better through Q3 than Q4.

[Hamir Patel]

And I just wanted to turn on the cost side. You've seen stumpage in the BC interior move up July 1. And a couple of the interior companies are pointing to an additional increase in October. What is your expectation for the coast? I believe it's a December vision. Or what scale of the increase are you expecting?

[Donald Eugene Demens, CEO, President & Director]

Well, yes, I mean -- and I think you -- you started off the question well. There are 2 different equations for stumpage in BC; 1 that applies obviously the interior, 1 that applies to the coast. Coastal stumpage is -- there's other variables in the equation that are different than the interior, and there are variables that pertain specifically to coastal activity. I think, first and foremost, what's going to happen right in front of us, we're expecting to see a stumpage increase from Q2 to Q3 based on the strong lumber markets and the lag in stumpage. And as we look forward, I would expect to see kind of a -- when we do the full update in the beginning of December, the stumpage is likely to be higher than the base established last year. As you know, Hamir, every quarter, there's an update on stumpage based on market. So I think a lot of that change we're going to see in December may be adjusted as the markets come down and we get to a more stable environment here. So just to summarize, I think stumpage is going up Q2 to Q3. We'd expect the reset in December to bring things to a higher level, and that reset will likely be offset somewhat by the changing market and the changing prices.

[Operator]

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

[Paul C. Quinn]

Lumber price have been pretty volatile, but you guys operate much of a specialty mix. Just wondering what you're seeing so far to date in Q3 in terms of a price drop from the 2Q average?

[Donald Eugene Demens, CEO, President & Director]

So as you've indicated, we operate in different markets. So I think we were pretty heavily skewed just going back to Q2 into North America and into commodities. Going forward, I think you're going to see us return to more historic norms on our mix between specialty and commodity. On the commodity side in North America, we're not seeing anything different than anyone else is seeing with the significant repositioning of the price levels. And lots of challenges getting sales right now as buyers wait to see once the bottom's established or once some stability returns to the market. When we look to the export markets, they didn't rise as much as the North American market did, but we've seen really good strength in Japan. We have worked hard with our customers who have been really looking for a lot of lumber. And we've adjusted our production schedules to try to meet customer demand into a stronger and a higher-priced environment in Japan. And China's been pretty stable. So we'll be moving volume there as well. So I think to summarize, Paul, we're not seeing anything different in the commodity space in North America. Some of the specialty items still maintained pricing. And when we look at export markets, Japan and China have been relatively strong, and we're redirecting volume that way right now.

[Paul C. Quinn]

Okay. And then on the log inventory side, you mentioned a 860,000 cubic meters at the end of Q2. With this early sort of fiery season here and dry conditions on the coast side. In fact, logging's been suspended periodically. Just wondering where it sits currently. And you said slightly lower than average. Is it still the same?

[Donald Eugene Demens, CEO, President & Director]

Well, yes. So you're right. We're at 860,000 at the end of the order. Logging operations on the coast have been interrupted to less harvesting and just load and haul to get logs up to market. So we really haven't seen a significant impact on inventories as of yet. However, I would say that we entered the market -- or ended the quarter -- the third quarter, kind of 150,000 meters lower than we would kind of traditionally think I would think of. And there's been a significant amount of downtime. Couple that with some permit challenges right through the piece in -- across the coast for all operators. And I think the logs are going to be pretty tight going forward here.

[Paul C. Quinn]

Okay. Given your balance sheet, you've got ability to do some M&A, what's out there in that? Is there anything that looks promising?

[Donald Eugene Demens, CEO, President & Director]

Well, yes. So we continue to remain focused on growth. We are cognizant of valuations currently. And I think some of the some of the valuations are $40 and higher or have been recently on acquisitions. And we're going to continue to value all the growth opportunities. Our focus, as you recall, is mostly the Pacific Northwest and in specialty manufacturing, along with we're really working hard on developing a strong 2-way relationship in Japan as we start to expand our product lines and expand our cedar product lines, including Japanese cedar. So these things take time. Current valuations are, I would suggest, elevated, and we're going to be really prudent about where we invest from an M&A activity. Focus remains U.S. Pacific Northwest and specialty manufacturing, and working really hard on our Japan business.

[Paul C. Quinn]

Okay. And lastly, every day goes by, there's always an article in the news paper about old growth logging. How -- is there any of your areas that you're currently under operations that are subject to blockades? And what percentage of old growth logging are you doing?

[Donald Eugene Demens, CEO, President & Director]

Yes. So I think on the old growth front, maybe I'll expand it to the BC government policy front. You're right. I think there's -- it feels like every day or every second day, there's something going on. Current deferrals as related to old growth have not impacted our business, although the issues in Southern Bank around are close to operations and close to our joint venture limited partnership with the Huu-ay-aht First Nation TFL 44. I think we maintain real consistent and regular dialogue in all levels of government. And I think we're pretty well-positioned to support their initiatives and to work around the old growth issues based upon our long history of area-based tenures and sustainable forest management. So we've got a great success story there, and we've got a great success story working with First Nations and the ownership template we've developed in TFL 44. So I think there's a story a day, but I like our positioning relative to -- certainly, relative to others, and I think we can be successful even in this kind of challenging environment.

[Operator]

[Operator Instructions] The next question is from Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

I wanted to follow up on one of the previous questions. And you touched on repositioning the sales mix back a little bit more away from the commodity grades. And I think the suggestion, Don, was you can do that over the back half of the year. And I'm trying to gauge, should we be thinking about commodity as a percentage of shipments going from mid-50% range down to, I think a year ago, it was towards the 36% range. Do you have that much flexibility in the sales mix that you can move back quickly this quarter? Or is that a gradual progression over 2, 3, 4 quarters?

[Donald Eugene Demens, CEO, President & Director]

Yes. Well, I think, Sean, I think when you talk about going back, the 35%, 36%, I think that was coming out of the strike and our focus on custom cutting and high-value production. So I think -- and what we were restricted to do. I think you should consider it more in the 50-50 range, right? And so we'll probably drop back to 50-50, and the mix will be -- we're going to try to increase our shipments into Japan, where, as you know, there's a premium for high-quality products. And so I think that's the plan going forward. We're really focused on building order file through Japan and really encouraged by our work with our customers who were looking for supply support, and I think we've delivered that for them. So you'll see us getting back into Japan for sure.

[Sean Steuart, Research Analyst]

And I wanted to dial in a bit more on Western Red Cedar. All the grades we track would suggest that prices are hanging in really well. And I know when markets are volatile, sometimes the prices hang in, but you're not able to move -- not you specifically, but the industry is not able to move as much volume into those strong prices. Can you comment on the resilience of that market in North America and your ability to sustain strong shipments into that price strength right now?

[Donald Eugene Demens, CEO, President & Director]

Yes. There's a few things happening in cedar, and you're exactly right. For the most part, pricing has been resilient. We're entering into the third quarter here where the market does typically take a break in cedar. Historically, it's a slower quarter, where we see demand decline and then pick up right at the end of the quarter as the hot weather, especially in the middle part of the United States, gets a little cooler and people can get back to projects. So nothing different than normal. Pricing has hung in there so far. Demand is probably weaker, but it's a seasonal thing. Overall, we expect the volumes to be -- our volumes to be there. Maybe to just expand for you, Sean. I think we're seeing less harvest of cedar on the coast this year year-to-date than past years. And our focus has been mitigating the impact of less cedar for our customers by increasing production at yellow cedar and bringing in more Japanese cedar and developing new product lines of Japanese cedar. So I think we're well-positioned longer term in Cedar. And as you know, there's no real non-natural substitute for Cedar and Cedar in high-quality outdoor applications. So short term, yes, we're seeing a little less demand. That's seasonal. Pricing has hung in there. And longer term, I think we've got positioned well in the outdoor living segment.

[Operator]

There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Demens.

[Donald Eugene Demens, CEO, President & Director]

Well, thanks, Paul, and thanks, everyone, for your continued support. Appreciate your interest in our company and your time on the call today. Steve and I are both available if you have any follow-up questions, and we look forward to sharing our third quarter results with you in November. Have a great day. Thanks a lot.