Western Forest Products Inc

TSX:WEF

Earnings Call Transcript 2020-Q4

[Operator]

Good morning, ladies and gentlemen. Welcome to the Western Forest Products Fourth Quarter 2020 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, 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 & Director]

Thank you, Laurie, and good morning, everyone. I'd like to welcome you to Western Forest Products' 2020 Fourth Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President and Chief Financial Officer.We issued our 2020 fourth quarter and full year 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 take your questions.So let me begin. 2020 was an extraordinary year for Western. Through the year, we successfully managed the safe restart of our operations after the lengthy USW strike, effectively reengaging our workforce. We overcame the challenges of the COVID-19 pandemic in our operations and our markets.We responded to the divergent pricing in our markets by leveraging past capital investments in our mills, redirecting production from relatively weak export markets into higher-margin product lines for North America. And we did all this while delivering improved safety performance in our operations and continuing to advance our sales and marketing strategy.The successful management of these significant challenges supported us in delivering $117 million in EBITDA for the year, despite our BC operations being largely curtailed in the first quarter due to the strike. We successfully levered our repositioned product lines, capitalizing on strong North American markets to deliver EBITDA of $71 million in the fourth quarter, including a duty recovery in what is traditionally a slower quarter seasonally for us.So I'd like to recognize our operations team for successfully executing a safe restart of our operations, including a positive reengagement with our employees after the long USW strike as well as our strict adherence to our new safety protocols to manage the impact of COVID-19 in our operations. I'm pleased to say there were no COVID-related transmissions in any of our operations in 2020.During the year, we also benefited from our investments in our core operating systems to support a seamless transition to work from home during the pandemic. We advanced our strategic partnerships with First Nations as we continue to reposition our coastal tenure assets. With the announced sale of an additional interest in our TFL 44 Limited Partnership to the Huu-ay-aht First Nations.We expanded our ESG disclosure with the release of our latest sustainability report. We provide one of the most sustainable building products in the world and are committed to defining a higher standard in our sustainability practices and ESG reporting. And we successfully concluded long-term collective agreements with key labor unions, providing labor certainty for the next several years.And our Columbia Vista division, which we acquired in 2019, continued to exceed expectations in 2020, generating adjusted EBITDA above its long-term trend levels despite a weaker Japanese market. Our results confirm that we have successfully reestablished the earnings capacity of the company, and together with our new view on markets and strong balance sheet, has provided us the confidence to reinstate our dividend.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 fourth quarter of 2020 with comparisons to the third quarter of this year. Our results from the fourth quarter of 2019 are less comparable due to the impacts of the USW strike.We reported fourth quarter adjusted EBITDA of $71.1 million as compared to $33.7 million in the third quarter of this year. Results in the quarter benefited from improved lumber pricing and shipment volumes, lower harvesting costs, a noncash recovery of $31.6 million in export tax related to the finalization of the 2017 and 2018 softwood lumber duty rates, and continuing to leverage our flexible operating platform, redirecting volume to capitalize on strong North American markets and capture incremental margin.Results were slightly offset by higher manufacturing costs due to lower production volumes, incremental secondary processing costs associated with certain products destined for the North American market, and higher selling and administrative expenses due to health, safety and IT-related costs associated with COVID-19 as well as higher incentive compensation expense related to our improved financial performance and appreciation of our share price.Lumber revenue increased 23% compared to the third quarter of 2020 due to higher shipment volumes and improved pricing. We took advantage of strong North American lumber markets by maintaining Western Red Cedar volumes during a traditionally slower period and by redirecting production and sales from weaker export markets. Specialty lumber shipments represented 48% of fourth quarter shipments compared to 59% in the third quarter of 2020.A greater commodity weighting of our lumber sales mix and a stronger Canadian dollar to the U.S. dollar reduced our average realized lumber price compared to the third quarter. However, benchmark pricing for the majority of our products continued to rise.Log revenue was lower in the fourth quarter of 2020 compared to the third quarter, consistent with seasonal trends. We directed the majority of our export log inventory to our sawmills to capitalize on strong North American lumber markets.By-product revenue increased $0.6 million as compared to the third quarter of 2020 due to higher by-product volumes and moderately improved chip pricing. Freight increased by $2.5 million as compared to the third quarter of 2020 due to higher shipment volumes and an increase in container shipping rates.Fourth quarter results included $12.1 million of export duty expense compared to $11 million in the third quarter of 2020. We recognized a $31.6 million export duty recovery in the fourth quarter of 2020 related to the finalization of the '17 and '18 softwood lumber duty rates. At the end of the quarter, we had approximately USD 95 million of duty on deposits.Lumber production decreased 6% compared to the third quarter of 2020 as we balanced lumber production with remanufacturing capacity. We have continued to lever our flexible operating platform by redirecting production from relatively weak export markets in the strong North American market. In early February, we added a second shift to our Ladysmith sawmill as lumber markets in China began to improve as well as to increase production of products destined for the North American market. Log production in the fourth quarter of 2020 was 21% lower than the third quarter of this year, consistent with typical seasonal operating conditions. From a profit and loss perspective, fourth quarter net income was $34.4 million as compared to $11.5 million in the third quarter of 2020.Looking at fourth quarter cash flow and capital management. Cash provided by operating activities after changes in noncash working capital was $60.4 million in the fourth quarter as compared to $40.3 million in the third quarter of this year. Cash used in investing activities was $5.5 million during the fourth quarter of 2020 as compared to $4.6 million during the third quarter this year.Capital expenditures in the fourth quarter of 2020 were partly offset by $2.5 million in cash proceeds from the sale of noncore assets. We successfully reduced our net debt by $50.2 million in the fourth quarter on the strength of our operating results. Our liquidity at the end of the third -- fourth quarter was at $178.3 million, and our net debt to capitalization ratio was approximately 12%. We expect sufficient liquidity will be available to meet our ongoing obligations.Don, that concludes my comments.

[Donald Eugene Demens, CEO, President & Director]

Well, thanks, Steve. So let me start off our outlook section by touching on first quarter seasonality. In typical first quarters, our timber harvesting activity can be periodically interrupted by winter weather. Harvest volumes are typically skewed to the end of the quarter when the weather and light conditions support greater activity. From a market perspective, sales typically accelerate through the quarter.As we look to our markets, I'm very encouraged by the positive North American market fundamentals and the improvement we've seen in our export markets of late. In North America, the lumber price rally that began in the middle of the fourth quarter has continued through the first 6 weeks of 2021. Unseasonably strong demand from both the new home construction and repair and renovation segments, combined with constrained supply, have led to higher pricing.As we look to the near term, while some volatility may linger, we expect demand to remain strong for commodity lumber as we enter the spring building season, which should further support pricing. Demand and pricing for our cedar and niche lumber product lines are expected to continue to improve as we benefit from the strength of the North American Repair and Renovation segment. And the fundamentals in our export markets have improved as inventory levels have rebalanced, and we expect pricing to increase in both Japan and China in the coming quarters.That said, we may be faced with some logistics challenges, getting our products to our customers due to container shipping constraints. In our log business, we expect domestic sawlog prices to continue to rise, supported by the strong lumber markets and greater competition from export log markets. Improving pulp markets should support higher chip prices and a slight improvement in pulp log prices.So moving on to the softwood lumber dispute. Effective December 1 of last year, the combined countervailing and antidumping duty rates for Western were reduced by 56% from 20.23% to 8.99%. The new combined duty rate will continue to apply until a final determination is complete as part of the Department of Commerce's second administrative review. We expect the new rates from the second administrative review to come into effect later this year.Given strong demand for and our leading position in key product lines and markets, we have thus far been able to capture the benefit of the reduced duties in our sawmill realizations. Currently, Western has over USD 95 million on deposit with the U.S. Treasury, which at the current exchange rate is approximately CAD 123 million. Turning to our capital allocation priorities. We remain committed to a balanced approach to capital allocation, returning cash to shareholders, while maintaining a conservative balance sheet and the flexibility to support growth initiatives.Our first priority is to return a portion of our operating cash flows to shareholders through the payment of a regular quarterly dividend. We announced the reinstatement of our quarterly dividend as part of our fourth quarter results.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. Near-term opportunities may be focused on reducing manufacturing costs or addressing secondary process and capacity constraints on the BC Coast to support growth of our targeted product lines.In addition, we may also look at acquisition growth opportunities that complement our current specialty products focus. 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 through share repurchases under our normal course issuer bid. We plan to remain disciplined in our capital allocation approach and ensure we maintain financial flexibility.Looking to what's next. Our top priority remains the health and safety of our employees, contractors and communities. We'll continue to adapt the procedures and protocols as necessary to ensure we keep our people safe. With the successful repositioning of our balance sheet, and reestablishment of our earnings capacity, we'll now look forward to resuming our growth strategy, while we continue to capitalize on the investments we've made in our new product line brands.Longer term, we're excited about the potential growth opportunities for wood products and mass timber building technologies. In addition to increasing the demand for wood products, mass timber will further help 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.So we remain committed to strong ESG policies and practices, and we'll publish our third annual sustainability report in 2021. We'll continue to engage with our employees, First Nations, government and stakeholders, working together to develop mutually-beneficial relationships to support jobs and communities in which we operate, while also ensuring we're creating long-term value for our shareholders.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 the first question is from Hamir Patel.

[Hamir Patel]

Don, we've been hearing more about Alaska Yellow Cedar being milled into decking. How do you see that competing with Western Red Cedar going forward? And is there maybe an opportunity there for you to participate in some fashion there as well?

[Donald Eugene Demens, CEO, President & Director]

Yes, Hamir. So you may have noticed some of our commentary has kind of changed recently. We're talking more about Cedar. I think when we look at Cedar products, as everyone knows, Cedar is the premium softwood product growth or applications. That goes not just for Red Cedar, but Yellow Cedar.And so I think you're probably hearing more about Alaskan Yellow Cedar because we're promoting it. We'll be one of the largest suppliers, probably the largest supplier of Yellow. And we have instituted a program recently where we have launched the decking and trim line into the market late last year, and I think we're seeing really great uptick in interest as Red Cedar is kind of limited in supply.So long and short, we are continuing to promote and provide the market with products that suit the end uses, and that includes Red Cedar, Yellow Cedar, and it will also add Japanese Cedar, which we had also launched. Again, an absolutely durable specie directed mostly to the fence business.So I think we're really excited about the opportunity that Yellow -- Alaskan Yellow supply affords the company.

[Hamir Patel]

And Don, kind of related to that, can you speak to how -- just given the stronger balance sheet, how you think about M&A at this point in the cycle? And has this given some of the changes, have you -- what categories are you considering?

[Donald Eugene Demens, CEO, President & Director]

Well, sure. So I mean, we remain focused on our growth strategy. And as you pointed out, and we -- I think we've talked about our desire, first and foremost, to reposition our balance sheet. And we've done that. We achieved that by getting down to about $69 million in debt at the end of Q4. Our target was between $80 million and $100 million. And I'm really pleased we were able to take the opportunity to reinstate the dividend that we had suspended.It is now time to look for growth, and we're excited about the potential opportunities. We continue to think about the long-term opportunities that are going to complement and grow our business. I think from an M&A perspective, our focus is going to remain in the U.S. Pacific Northwest or in other opportunities that add value to product lines that we want to be in.Our focus has been to differentiate our products and to create differentiation in an undifferentiated market. And so anywhere we can, whether that's adding capacity in product lines or adding new product lines that support our core business is where we're going to focus our efforts.

[Operator]

The next question is from Sean Steuart.

[Sean Steuart, Research Analyst]

A couple of questions. I guess, first on the production profile expectations this year. It sounds like you're getting back closer to full speed other than Duke Point, I suppose, at this stage. Any context or guidance you can give us on your expectation for overall 2021 lumber volumes?

[Donald Eugene Demens, CEO, President & Director]

Yes. So I think -- Sean, good question. So you're right, we are starting to ramp back up to previous levels. Going forward, I think you can expect us to look to add some hours of production. Probably targeting Saltair at the start and potentially getting Duke Point back up. We're going to have to do this in balance with our processing constraints and capacities.I think you can think of us overall, at somewhere around that 800 million foot level. We will do what we can to lever additional shifting opportunities, and we are doing that currently, and we'll try to leverage our position in the custom cut business to add more production. So I think 800 million is probably a pretty good number to think of for the year.

[Sean Steuart, Research Analyst]

Okay. And you referenced in your comments, Don, and in the MD&A, the mass timber opportunity set. It feels like the industry has been talking about this for a long time now. And clearly, some ESG tailwinds, but can you give us broader thoughts on what that market could ultimately look like? And what piece of your business that could take up over the long run?

[Donald Eugene Demens, CEO, President & Director]

Yes. So I think there's been lots of -- as you pointed out, there's lots of publications and lots of analysis and really good quality analysis done on trying to articulate how big the market might be. I think we'll see how that unfolds going forward. Some people say 4 billion or 5 billion feet is the potential.For Western, I think the opportunity is to try to figure out where our products best fit in the production of mass timber building technologies. We have -- and I think that's got to focus mostly on hemlock. Hemlock is -- I think we would recognize it or talk to people about it being underutilized from an appearance perspective and strength perspective.So our focus will be on leveraging the strength characteristics potentially in laminated lumber, which is a key component of mass timber building technologies and where we can lever the inherent strength qualities and appearance and visual qualities of the product to create the most value.I think in the near term, I think there may be some challenges in this sector just because -- I think COVID has probably taken a little bit of -- has delayed a lot of projects. And therefore, there could be some growing pains here. But as the -- as that rectifies itself and building gets back up and going, I think more and more people are going to want to build with wood. So it's a really bright future. And our participation will likely be in the glulam side of the business.

[Operator]

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

[Paul C. Quinn]

I guess, maybe start with your mix. Yes, your mix did drop in Q4. What do we expect seasonally going through '21 here on mix?

[Donald Eugene Demens, CEO, President & Director]

So you're right. I mean, the mix did drop as we increased the production of commodity lumber. And in that commodity segment, there is, of course, our volumes to the treating segment. So I think that 50-50, somewhere between -- and it may oscillate between 45%, 55% of specialty lumber is the mix you can consider that we're going to probably operate through the year.As you're well aware, Paul, we obviously get a benefit when we start cutting lumber into the North American markets from a nominal net perspective. So we're picking up volume there.And I think just maybe one other point I'd like to make is when we talk about commodity lumber for Western, it's not typically construction lumber. We're focused on the treating segment. And it's because treating and cedar kind of go hand-in-hand in outdoor applications. And we saw some really great growth in our treated segment. We did over 35 million feet, I think, in treated lumber in Q4. And it probably represents about 50% to 60% of our commodity lumber now so -- for North America. So I think we're pretty excited about it.I think maybe to leave the last point with you is we're going to continue to toggle back and forth, specialty, commodity depending on where the margin is. And that's sort of one of the opportunities we have, which may differentiate us from our lumber peers.

[Paul C. Quinn]

Okay. Maybe just on mass timber. Are you expected to be a supplier of mass timber or producer?

[Donald Eugene Demens, CEO, President & Director]

I think initially, as I said in the last answer, I think our focus is going to be in trying to lever hemlock and our product. And this doesn't mean we're not going to be doing fir or Yellow Cedar. But I think mostly hemlock, we'd like to be a supplier of the products rather than a supplier into the product mix.

[Paul C. Quinn]

Okay. And then just trying to understand the flexibility you've got here, if you could describe your log inventories at the end of the year and what you've seen in the first 6 weeks of '21 here?

[Donald Eugene Demens, CEO, President & Director]

Yes. So good question. I mean, as you know, log inventories can be pretty variable in the coast. We're in pretty good shape coming out of the fourth quarter, over 900,000 meters, I think, was the number. And well positioned on the small log side of the business. Large logs are a bit of a challenge. And so we're trying to work through that right now.As you are well familiar, large logs are always a challenge at this time of the year going into the first quarter and early second quarter. So it's nothing unusual. We think there's some more log volume available in the market, and we'll be active participants in the open market to ensure we've got log supply in front of our mills.

[Paul C. Quinn]

Okay. And then in terms of some of the CapEx projects that you're contemplating here. I mean, the BC government is seeing some of the regulation around that and you're having to pay a tax. Is that facilitating some of these CapEx decisions?

[Donald Eugene Demens, CEO, President & Director]

Well, I mean, maybe just to go back, I mean, typically, we target about $30 million to $40 million a year in maintenance of business CapEx through our timberlands and our mills. We'll be looking at adding an incremental amount to that, maybe upwards of $10 million in more strategic capital, quick payback volumes.I think we will target that into probably our -- reducing our costs in our operations and I think improving our processing capacity. Does it have a direct impact on what the BC government is doing? Is that driving us to this? Not really. We're market-driven. I think one of the challenges we've got, and we share the government's desire to increase value-added production and then going up the value chain.And so we're continually working at ways to do that, and we're working with the government to figure out ways we can do that. It just so happens that these investments targeted for specific product lines is perfect -- is a good example of how well aligned we are with the government.

[Paul C. Quinn]

Okay. And then just on, I guess, M&A potentials. It sounded like you guys were saying you're pretty focused on the Pacific Northwest in the U.S. as opposed to BC, is that true?

[Donald Eugene Demens, CEO, President & Director]

Well, I think so. I think the Pacific Northwest in the U.S. provide some of the same opportunities that we have in BC on the coast, right, which if you can differentiate product lines, you can differentiate qualities within the products, and you can make more specialty products and become more valuable to the final customer.So yes, I think long and short answer, yes, we're probably more focused on the U.S. Pacific Northwest. That said, if we can -- if there's opportunities for investments in specific product lines in BC, we would not shy away from that.

[Paul C. Quinn]

Okay. And then just lastly, just trying to understand this total cedar market and what the size potential is. You mentioned that Red Cedar is limited, I guess that's the ability to harvest. But you've got this new opportunity in Yellow Cedar. How big is that Yellow Cedar opportunity relative to Red Cedar and relative to the stuff you're bringing in from Japan?

[Donald Eugene Demens, CEO, President & Director]

Well, certainly, the largest component of any kind of cedar business will be Red Cedar. And that's a combination of BC Coastal, BC Interior and then the northwest of the U.S., which are the 3 supplying regions for Western Red. Yellow for us is about 7% of our standing inventory in logs and creates a growth opportunity for us that -- as Yellow is not being used as much in Japan, we have an opportunity to redirect it into North America.So I think we're going to work really hard at trying to expand the use of Yellow Cedar. As I said, we're pretty excited about the opportunity. We've already got product lines going into the home centers as well as some distribution. And we'll see what the uptick is over this quarter, and that will kind of determine how big we can get in Yellow. I think we're the only company investing in the marketing, branding and increased production at Yellow Cedar, and we expect to have -- it's become a bigger part of our cedar business.

[Operator]

[Operator Instructions] There are no further questions registered at this time. I'll turn the meeting back over to Mr. Demens.

[Donald Eugene Demens, CEO, President & Director]

Well. Great. Thanks, Laurie, and thanks, everyone, for your continued support. We appreciate your interest in our company and your time on the call this morning. Steve and I are going to be available if you have follow-up questions. We look forward to sharing our first quarter results with you in May. With that, have a great day. Thank you.

[Operator]

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