Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2020-Q3

[Operator]

Good morning, ladies and gentlemen, welcome to the Western Forest Products Third Quarter 2020 Results Conference Call.During this conference call, Western's representatives may make forward-looking statements within the meaning of applicable securities law. 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, 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, Laurie, and good morning, everyone. I'd like to welcome you to Western Forest Products 2020 third quarter conference call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer. We issued our 2020 third 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 outlook and discuss recent developments in our industry. We'll then open the call up to your questions.So let me start the call by recognizing our employees and contractors for their commitment to health and safety during these uncertain times. The adoption of the strict health and safety protocols that our company implemented at the onset of COVID-19 has not only kept our employees, contractors and communities safe but their efforts have been instrumental in enabling us to reestablish our business after the lengthy USW strike.Moving on to our third quarter results. We capitalized on strong North American lumber markets to generate $33.7 million of adjusted EBITDA, which is a 14% improvement over our second quarter results in what has historically been a seasonally slower quarter for our business. So I'm pleased with our continued efforts to successfully reestablish our business post the USW strike, all while facing the uncertainty of COVID, and in this quarter, severe forest fires in Washington and Oregon, which impacted our operations due to poor air quality.Through the quarter, we capitalized on improved North American markets by increasing our cedar sales and by leveraging our flexible operating platform to redirect approximately 30% of our lumber production from weaker export markets to the North American market. The redirection of such a substantial amount of volume in a 2-month period was a pretty remarkable achievement. And in my view, it highlights how our sales and operations teams did a great job to recognize, adapt and capitalize on changing market conditions.The strength of our results allowed us to reduce our debt by $33 million during the quarter. So I'm pleased with our results in what has historically been a seasonally weaker quarter and I'm proud of how our employees have worked together during these unprecedented times. I think these efforts demonstrate the resiliency of our company when faced with unforeseen challenges. As we continue to navigate through these uncertain times, we'll remain focused on aligning our production volumes to match the market demand, while first and foremost, ensuring the health and safety of our employees.So let me now turn it over to Steve to review our financial results.

[Stephen Williams, Executive VP & CFO]

Thanks, Don. My comments will focus primarily on our financial results for the third quarter of 2020 with comparisons to the second quarter of this year. Our results from the third quarter of 2019 are less comparable due to the impacts of the USW strike. We reported third quarter adjusted EBITDA of $33.7 million as compared to $29.5 million in the second quarter of this year. Results in the quarter benefited from improved lumber pricing, lower sawmill conversion costs as we shifted some production to North American markets and restarted our Ladysmith sawmill, favorable coastal harvesting conditions and a reduction in our inventory LCM provision driven by higher lumber prices in a mix of our lumber production.Lumber revenue increased 10% compared to the second quarter of this year due to higher shipment volumes and improved pricing. This was partially offset by a stronger Canadian to U.S. dollar. Specialty lumber shipments represented 59% of third quarter shipments compared to 64% in the second quarter of 2020 as we redirected lumber production to benefit from stronger North American lumber prices.Log revenue increased 22% compared to the second quarter of this year. Log revenue growth resulted from increased shipments and was achieved despite a weaker sales mix and lower export log market pricing. We redirected certain export log inventory to our sawmills as a result of the strong North American lumber market.By-product revenue increased by $1.3 million due to higher volumes as compared to the second quarter of 2020. Freight increased by $2.3 million as compared to the second quarter of 2020 due to higher shipment volumes. Duty expense increased by $3.4 million compared to the second quarter of 2020 due to increased U.S.-destined lumber shipment volumes. At the end of the quarter, we had approximately $85 million of duties on deposit. Lumber production increased 34% compared to the second quarter of 2020. We restarted our Ladysmith sawmill and benefited from a full quarter of operations at our Cowichan Bay sawmill. Reported production volumes also benefited from the nominal board foot measure used in North American commodity lumber products as compared to the net board foot measure used in export lumber products. We also restarted our Cowichan Bay and Alberni Pacific planer operations during the quarter as well as increased operating hours at our Duke Point planer. Log production in the third quarter of 2020 was 7% lower than the second quarter of this year. Log production typically declines from the second quarter to third quarter due to the fire season. However, we did benefit from seasonally favorable harvesting conditions during the third quarter.From a profit and loss perspective, net income was $11.5 million as compared to $8.5 million in the second quarter of 2020. Looking at third quarter cash flow and capital management, cash provided by operating activities after changes in non-cash working capital was $40.3 million in the third quarter as compared to cash used of $7.8 million in the second quarter of this year. Lumber inventory grew by 33 million board feet in the third quarter due in large part to secondary processing constraints due to the transition in North American market.Cash used in investing activities was $4.6 million during the third quarter of 2020 as compared to $3.9 million during the second quarter of this year. We continue to manage capital spending in order to address uncertainty caused by COVID-19. We reduced our net debt by $32.7 million in the third quarter on the strength of our operating results.Our liquidity at the end of the third quarter was $127.9 million and our net-debt-to-capitalization ratio was approximately 20%. Liquidity remains a key priority and a near-term focus, given the uncertainties associated with COVID-19 and we expect sufficient liquidity will be available to meet our ongoing obligations. Don, that concludes my comments.

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

Well, thanks, Steve. So I'd like to start off our outlook section by touching on fourth quarter seasonality. In typical fourth quarters, lumber consumption declines in North America as construction slows with the onset of winter. In our timberlands, harvest volumes decline as we lose daylight operating hours. Winter weather can negatively impact operations and further limit production. The combination of weather-related curtailments and reduced operating hours can impact production volumes and can put upward pressure on log costs.So let me provide you an update now on our markets. Lumber pricing in North America reached all-time highs in the third quarter of 2020. This was driven by a combination of rising demand from new home construction, a very strong repair and renovation segment and supply constraints due to permanent mill closures in BC, and labor challenges which is limited to supply response from other North American regions.As a result of the improved markets, we redirected lumber production from relatively weak export markets to the improving North American market. We targeted our North American sales to selected customers in the treating sector where our product mix provide the most value. Despite the recent market correction, we expect commodity pricing in North America to remain above trend levels in the near term. Demand and pricing for our Western Red Cedar products in North America are expected to remain strong as our customers position their businesses for the first quarter of 2021.When looking at our export markets, we anticipate pricing in Japan will improve as inventories of North American lumber have normalized. While in China, we expect demand and pricing to trend slightly higher as we enter the seasonally more active fall and winter. In our Niche segment, we believe demand for lumber targeted to the treating segment in North America will remain strong and while demand for our appearance products is expected to improve. In contrast, we anticipate demand for timbers consumed in the industrial segment will remain weak.In our log business, we anticipate the domestic saw log market will continue to be under-supplied, and pricing is expected to remain strong through the end of the year. In contrast, we believe pricing in the export log market will continue to be competitive at the current relatively low levels.And finally, we believe pricing for pulp logs will be flat for the rest of the year. As we look forward, the potential resurgence of COVID-19 cases around the globe is leading to the reintroduction of government actions that could impact lumber demand and pricing. We plan to utilize our flexible operating platform to adjust to market conditions and will continue to align our production volumes to match our customer needs.So now let me provide you an update on a couple of developments in the industry. In September, the BC government provided additional information with respect to the Manufactured Forest Products Regulation. The regulation applies to certain exported BC Western Red Cedar and Yellow Cedar lumber products to any location outside of Canada and within 3,000 miles. The regulation requires a provincial export permit and where the fully manufactured requirements are not met, the payment of tax to be eligible for export. The amount of the tax is dependent on the extent of the processing completed prior to export and is linked to the all other softwood lumber duty rates. We'll continue to engage with government to reduce unintended consequences of the regulation, while we take all steps necessary to mitigate any potential financial impact to our business.Moving on to the softwood lumber dispute. In July, the U.S. Department of Commerce announced an extension of the first administrative duty review. As a result, the determination of the final countervailing and anti-dumping duty rates for 2017 and 2018 are not expected until late November of this year. The final duty rate for 2018 will form the new duty deposit rate going forward. Currently, Western has over $85 million on deposit with the U.S. Treasury, which at the current exchange rate is approximately CAD 114 million. Looking to what's next, our top priority remains the health and safety of our employees, contractors and communities. We will continue to adapt our procedures and protocols as necessary to ensure we keep our people safe.From a capital allocation perspective, our near-term focus remains on reducing our debt while we navigate through the uncertainty caused by the COVID-19 pandemic. We will continue to review capital allocation on a quarterly basis with our Board. Despite the near-term uncertainty, we remain cautiously optimistic heading into 2021, given encouraging market demand indicators. We also remain focused on growing our lumber production and implementing our strategic initiatives to strengthen our foundation, grow our base and grow our business over the long term.So with that, operator, we can open the call up for questions.

[Operator]

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

[Sean Steuart, Research Analyst]

Few questions, I guess for Don or Steve, to start with. Don, your comments at the end on capital allocation. So I get that the near time -- near-term priority is deleveraging and preserving flexibility. How are you guys thinking about CapEx headed into 2021? Is there room to ramp it at all versus rock bottom levels? And you've got the NCIB in place given relative underperformance for your shares versus some of your peers, how are you thinking about that and as an option at the margin to return capital to shareholders?

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

Sure. Okay, Sean, maybe I'll give it a try and answer that one. So I think, as you're aware, in the last few years we've kind of averaged about $30 million for $40 million a year in maintenance and road CapEx and about the same in strategic. I think as market conditions evolve or change, I think we have the flexibility of toggling that CapEx up or down.To provide you some direction for 2021, I think we should focus on that $40 million and as our debt levels come down and we look at other capital allocation options. And there is more visibility related to COVID. We could start targeting a little bit more CapEx to smaller strategic capital focused on cost reductions. But I think in general, to provide you guidance today, I'd stick with that $40 million as you're modeling out what our business is going to look like in the future.With respect to our focus on other capital allocation options here, for sure our near-term focus remains on liquidity and financial flexibility given the uncertainty of COVID and as we reestablish our business post the strike. Our near-term target is [ tended ] to reduce our debt to somewhere between $80 million to $100 million. And as you know, we closed Q3 at about $119 million, $120 million. So we have our ways to go there. To be clear, we continue to review the capital allocation with the Board. And I think, once we get a few more quarters, our results behind us, post the strike and the situation of COVID evolves, maybe it becomes a little more clear, it will certainly allow us to determine the capital allocation priorities going forward.You're correct, we did renew our NCIB during the quarter and I think that just provides us lots of options and flexibility going forward. But first and foremost, we are focused on getting our debt down in these uncertain times.

[Sean Steuart, Research Analyst]

That's useful detail. Don, one other question. You mentioned your expectation that Japan is set to -- start to increase or your prices for the grade to sell there start to increase. Are you seeing that floor set in yet? What's giving you that confidence that things are poised to get better?

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

Yes. So we have seen improvements in pricing going into the fourth quarter in Japan. I think that's related again to a reset in inventory levels and a realization that the market needs to be competitive on a worldwide basis. We're pretty comfortable that the pricing is going to hold going forward and probably could improve further. Just recently, export log prices out of the U.S., which forms a significant component of the competitive landscape in Japan were increased substantially by large exporters. So I think we're comfortable we've seen some price increases in the fourth quarter in Japan and the environment seems to be getting better for improved pricing there going forward. I would caution though, I think volumes are going to still be constrained until you see an improvement in housing starts. So pricing is going up in Japan, volumes are going to be a little more muted.

[Operator]

The next question is from Paul Quinn.

[Paul C. Quinn]

Just maybe you could outline sort of the financial impact of the new manufacturing regulation on your business.

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

Well, sure. As you know, the government has implemented the new policy and which requires us either to process the lumber further or pay duties. So a couple of things. There's a lot of moving parts here. A couple of things to consider, we're anticipating the duty rate to come down. And of course, that will mitigate any type of payments we have to pay in the future. I'd also like to kind of point out that Western, we do have the largest sawmill. As you know we've got the largest sawmilling and processing capacity on the coast. So I think what we understand, the government is trying to increase the amount of further processing on the coast. I think the reality is if we redirect our cedar and Yellow Cedar into our processing business, it just means there is going to be less hemlock processed and that kind of runs counter to what I think their objective is, which is to support more domestic manufacturing. And as you know, the specie that needs the most value added and the most focused on improving margin is hemlock. So I think the way we look at it, Paul, because of our positioning, we believe we're going to able to manage through the new regulation with nonmaterial impacts on our financial results. But I think we're really anxious to work with government to demonstrate that we can accomplish their objective in a way that supports the sustainable harvest and consumption of the entire coast log profile, not just cedar and that's the message that we're going to work on. So long and short of it, I think we can manage through it. We have the capacity to do it. I think there is a better way to achieve the government's results and we'd like to work with them on that.

[Paul C. Quinn]

So it sounds like you're capacity constrained on the manufacturing side, which would suggest that you would look for additional manufacturing in the Province of BC. What are the, I guess, investment criteria that you'd look to make that happen?

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

Yes. So maybe to be clear, I assume I say constrained and manufacturing, it would be processing, and so the process in kiln drying and planing. We've made some pretty significant investments already in the planing side. I wouldn't say it's just Western that's constrained. I think the entire coast is constrained on processing and that's also why it makes it a bit of a challenge to try to have our force -- the further processing of cedar. It means something is going to drop out. From a criteria perspective, I mean, it's got to hit our targeted hurdle rates and I think what we would be doing, given our location mostly in Vancouver Island, I think you might be seeing us invest or we could look at investing in additional kiln drying and additional planing processing capacity. I know, you being a local here in lower Mainland, I think you understand better than most people the challenges to see more investment in the lower Mainland given the cost of land. And it's very difficult for us to see an investment in the lower Mainland. But I think you could see us adding a bit of capacity on the processing side next to our mills on Vancouver Island.

[Paul C. Quinn]

Okay. And then if you could, the 30% export that you redirected to the North American market, if you could quantify the financial benefit you received from that in the quarter?

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

Yes. So maybe a couple of things. So the 30%, it acquainted on a production basis to like 50 million feet or so. And so that 50 million feet is -- I think that's going to flow through our sales volumes over the next couple or -- over the last quarter and this quarter, both 50-50, so you haven't really seen this come through the whole way. I mean if we were to try to put a dollar amount on it for Q3, it could probably somewhere in the $3 million to $4 million range would be a good number to put on it. And of course that is all dependent on pricing and how much more margin we're making. Maybe to close, I think the ability to move back and forth between the markets demonstrates that flexible operating platform we've talked about. And it makes us a little different than other people going forward. So we'll see where the market goes, whether that's a permanent change or whether or not we're going to move back more to the export side.

[Paul C. Quinn]

Okay. And then just lastly on capital allocation. You used to have a dividend, is that dividend look like it gets reinstated once you get that down $35 million to $40 million?

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

Well, I think what I think I'll stick to the comments I made earlier. We review capital allocation with our Board, and we look to ensure that we are putting our money into the business where it generates the highest return. If that was dividend, we'd certainly -- I think the Board would certainly consider. We had share buybacks, as we talked earlier with our NCIB, we'd look at that or capital into our business. So I think it's a wait and see until we get there, Paul. And we review it every quarter with the Board.

[Operator]

[Operator Instructions] The next question is from Hamir Patel.

[Hamir Patel]

Don, would you expect the lower duties at the end of this month to lead to a sort of step change in SEDAR prices?

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

So a good question, Hamir. I go back to when the duties were put in place, and I think we led the charge in making sure that the pricing represented the duties and we increased our prices as such. Looking forward, the market is what it is right now, strong demand for cedar products, extremely strong demand for cedar products. I think our volumes were up 20% quarter-over-quarter. We have a substantial amount of our quarterly sales done, and I think we're going to focus on what the customer and consumer is willing to pay. So our objective is to continue to sell at market, whatever the duty rate is and to continue to fill our customers' needs. As in looking forward, customers are, as I said, are looking to try to position themselves for 2021 and do not want to be cut short and I think that's where their focus is, probably not on duty -- adjusted pricing.

[Hamir Patel]

I know in the past you've talked about wanting to strengthen the sort of direct relationships with some of the big U.S. big box stores. Any sense as to how that's going to evolve in 2021? I imagine some of those discussions for programs for next year are ongoing.

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

Yes, for sure, and you're plugged into this. You know that's exactly what's going on currently. I'd say that I'm pretty pleased with our progress and directing more volume to the home center channel. We grew our North American cedar Home Centre business volumes about 17% compared to the second quarter. And currently, about 15% of our cedar sales go to home centers, which is up from about 9% a couple of years ago.As you point out, we're looking to grow our volumes in this important segment further, and I think the question is, how we are going to do that? First off, we're investing in product branding and that has been really well received by the home centers we work with. They are really pleased with our investments there because they see it as an opportunity to drive more sales and more demand through their business. And with our support, I think they are extremely pleased that we're making those investments. Secondly, we're looking to expand our product lines we supply to the home centers and I think that's something I talked about in the last call. During the quarter, our first shipments of Japanese cedar arrived and were well received by our home center partners. So I think to conclude, we're making progress in expanding sales there in the Home Centre and we'd expect that our marketing efforts and expanded product lines are going to support further increases in the future.

[Hamir Patel]

That's helpful. And anything you could share in terms of maybe how that geographic mix with the home centers, I imagine some of the states like Texas would be disproportionately larger, but where is it going?

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

Yes. So in actual fact, we've always had a position in the Mountain States, in the Home Centre business and that continues to grow and cedar is in high demand there. We've got a good position in home centers in the Canadian market. And as you point out, we're expanding our business in sort of Texas as well. And I wouldn't want to forget our positioning in the Pacific Northwest, where clearly cedar is their preferred specie, and we do some work with the home centers there. So it's pretty broad-based across the continent. But if I was to say, focus on Canada and the west is -- in the West and U.S. would be at a high level where we're focused.

[Operator]

Thank you. There are no more questions registered at this time, I'll turn the meeting back over to Mr. Demens.

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

Great. Well, thanks, Laurie, and thanks, everybody for your continued support. We appreciate your interest in our company and your time on the call this morning. Steve and I are both available if you have follow-up questions and we look forward to sharing with you our fourth quarter results in February. Have a great day.

[Operator]

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