West Fraser Timber Co. Ltd. (WFG) Q2 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Company Limited Second Quarter 2015 Results Conference Call. During this call, West Fraser’s representatives will be making certain statements about potential future developments. These forward-looking statements are intended to provide reasonable guidance to investors, but the accuracy of these statements depends on a number of assumptions and is subject to various risks and uncertainties. Actual outcomes will depend on a number of factors that could affect the ability of the Company to execute its business plans, including those matters described under Risks and Uncertainties in the Company's annual MD&A, which can be accessed on West Fraser's website or through SEDAR and as supplemented by the Company's quarterly MD&As. Accordingly, listeners should exercise caution in relying upon forward-looking statements. I would now like to turn the meeting over to Mr. Ted Seraphim, President and CEO. Please go ahead.

Thank you. Good morning and thank you all for joining us today. West Fraser earned $14 million or $0.17 per share in the quarter. Adjusted earnings for the second quarter were $13 million as compared to $100 million in the first quarter. Adjusted EBITDA in the quarter was $72 million or 7% of sales, down from 17% in the first quarter. Lower product prices were the main reason for the decline in earnings. Our lumber business generated $45 million in adjusted EBITDA, a decline of $72 million from the previous quarter. The causes of lumber price continued to fall through the first half of May and was down at 1.5, almost $75 from the beginning of the year. There was some strengthening in the market in June but prices are still $40 below where they were at, at the beginning of the year. The scope markets were partially offset by improved operations and the early benefits of our capital program. Our second quarter production was 70% higher than in the first quarter of the year. Our two energy projects at Fraser Lake and Chetwynd were operational by the end of the second quarter. Our panels business generated $21 million in adjusted EBITDA down $5 million from the first quarter. Lower plywood prices more than offset higher shipments of plywood. Our pulp and paper business generated $8 million in adjusted EBITDA, a decline of $22 million from the first quarter. Although list prices for NBSK were down only 2% for the quarter, actual transaction prices for NBSK and BCTMP fell further, which accounted for approximately 50% of the decline in our results. Major maintenance shutdowns that occurred with joint venture NBSK mill and our Quesnel River pulp plant impacted results as well. Our Hinton Pulp Mill continues to show improving operational performance. 2015 will be another significant year for capital spending as we conclude an ambitious five year capital spending program in excess of $1.3 billion. Over the past nine to 12 months, we started up ten new continuous kilns for new planters, two major saw mill upgrades, as well as four major energy projects. While we are at different levels in the start-up curve for each project, we are very encouraged by the current and projected improvements in cost, productivity and revenues associated with each project. After a poor first quarter, we saw the resumption of the US housing recovery in the second quarter as US housing starts average 1.15 million units in the quarter. Despite slowing demand in China, our business remained strong in the quarter. We continue to be optimistic regarding medium-term demand for among our products in both North America and Asia. An improving US economy is supported by low new home inventory should continue to spur new home construction. Pulp markets are expected to be under continued pressure as we faced a combination of new capacity and slowing demand in China. Despite the market challenges we have seen thus far in 2015, we are very encouraged about the future outlook for the company as we continue to focus on investing in capital and people to ensure that we are driving industry-leading margins. I am very proud of all our employees in their efforts to improve operation while executing largest capital program in the company’s history. With this, I’ll turn the call over to Larry Hughes.

Thanks, Ted, and thanks to everyone joining us today. Ted and I are making reference to several non-IFRS terms during today’s call and so I would refer you to our MD&A under the heading non-IFRS measures for definitions and descriptions of how these terms are calculated. For the second quarter of 2015, we reported earnings of $14 million or $0.17 basic earnings per share. Beginning on Page 3 of our MD&A, we identify various non-operational items which we adjust from earnings in order to more clearly reflect the results from our operations. The result which we refer to is adjusted earnings, that’s $13 million or $0.16 adjusted basic earnings per share. This compares to $1.19 for the first quarter of 2015 and $0.77 for the second quarter of 2014. I am not going to go over all of our non-operational earnings adjustments, but I will mention the adjustment to our electricity purchase contracts. Beginning in the fourth quarter of 2014, we’ve been required to record an adjustment for any change in the fair value of our two electricity purchase and sale contracts and at the end of the fourth quarter of 2014, this revaluation produced an unrealized loss of $2 million and at the end of the first quarter of 2015, we recorded a further unrealized loss of $30 million, mainly the result of projected significantly lower electricity prices in Alberta. As at the end of the second quarter, the outlook for electricity prices had improved, although partially offset by projected cost increases with the net result being an unrealized gain of $18 million. And so on a year-to-date basis, in 2015, we have an unrealized loss of $12 million. In the quarter, we saw a significant deterioration of SPF, and southern yellow pine lumber prices which had a significant effect on our quarterly results including lumber and log inventory write-down of $21 million. These significant inventory revaluations are the result of the sharp fall in lumber prices at a time when log and other costs have tended to reflect the gradual recovery of US housing construction and lumber markets in general. Lower lumber prices also triggered the imposition of export duties under the 2006 Softwood Lumber Agreement and we expensed $12 million in export duties during the quarter. We’ve provided more details about these duties in our MD&A. The basic duty rate but not including surge penalties for July is the highest under the agreement at 15% which is the first time in three years that the basic, the highest basic duty rate has applied. Despite the relatively weaker financial results, there were some encouraging operational results from all three segments as lumber production increased by almost 7% compared to the previous quarter. Our panel mills ran well and in the pulp and paper segment, we continue to see improvement at our Hinton Pulp Mill. There are no scheduled maintenance shutdowns at our pulp mills for the balance of the year, each of our NBSK mills are scheduled to have five day maintenance shutdowns in 2016 and each will have a major maintenance shutdown in 2017. Cash flows from operating activities were $194 million as we consumed the seasonal excess Canadian log inventories during the quarter. Capital expenditures were $49 million in the quarter reflecting a gradual slowdown in the pace of our capital spending as we complete several of our energy projects that have been in progress over the past few years. We are still projecting to spend more than $250 million in 2015 as we continue to upgrade saw mills in the US and in Canada. Our normal course issuer bid continues to be in effect, but we made no share purchases during the quarter. We revalue the funded position of our defined benefit pension plans at the end of each quarter and this resulted in a $54 million after-tax actuarial gain this quarter as the higher discount rate reduce the present value of our liabilities, which was only partially offset by a lower rate of return on our plan assets. Our plans continue to be well funded. Our balance sheet as at the end of the quarter remains strong with a 15% net debt-to-total capital ratio. And Ted, that concludes my comments.

Okay, thank you, Larry. And I think we are now ready for questions.

[Operator Instructions] Our first question is from Sean Steuart from TD Securities. Please go ahead.

Thanks, good morning everyone. I’ll start with the pulp and paper segment. I am just trying to – I guess reconcile the changes in your unit costs quarter-over-quarter, Q1 to Q2, you guys gave us detailed downtime tonnage figures for the second quarter. Do you have those figures for Q1 as well? Just as I tried to reconcile it.

Well, first of all, good morning, Sean. I think we had no scheduled maintenance downtime in the first quarter.

Yes, I guess it was the Hinton hiccup some, I am wondering about lost tonnage in Q1 there, but, I mean, I guess the other question is, it sounds like Hinton ran better this quarter, but in the MD&A, there was some reference to maintenance expenses still incurred there. Can you put a dollar figure on that number?

It’s - first of all, we don’t really comment on it, it’s not really material, but I think overall, to look at our overall NBSK production, it was basically flat from quarter-to-quarter and so I can tell you that we have seen improved production that Hinton given that we had our major maintenance shutdown at Cariboo.

Okay, thanks, Ted. And then, I mean it sounds like there not much scheduled, or there are nothing scheduled through the latter half of the year. Is everything running well in the pulp side into the third quarter?

Yes, yes and as Hinton continues, I mean, it’s still early in the third quarter, but we made a step gain in the first quarter, another step in the second quarter and we are continuing to make a step again in the third quarter. I mean, we need a long run rate before we still completely can’t, but we are moving in the right direction. And then, in terms of our major maintenance, it’s really is in our NBSK mills. We had to do some at QRP but we don’t have – it’s not that significant, it’s normally four or five days and we are basically on a three year major maintenance schedule at Hinton. So, the next one will be 2017 in the fall and every second year for Cariboo. So our next one will be again in the spring at 2017 but we have to do minors at those two kraft pulp mills every year at Cariboo and every year-and-a-half at Hinton. So, really nothing until the second quarter of next year, Sean, as long as we run them.

Okay, thanks, Ted. And then just one last question and I’ll get back in the queue.

You bet.

The Alberta power crisis this quarter, trying to gauge, I guess the sequential impacts in your results, I know it varies quarter-to-quarter with your – the agreements you had set up, but can you give us any impression of how much that might have affected Q2 results?

Well, I think it was really not that material. I think, when you look at our evaluation of our power purchase agreements that’s more about the longer-term fuel price went up. So that was, so that doesn’t really reflect what happened in the quarter. It was a pretty – power prices are fairly low during the quarter.

Okay, okay, I’ll get back in the queue. Thanks.

Okay, thanks, Sean.

Thank you. The following question is from Paul Quinn from RBC Capital Markets. Please go ahead.

Yes, thanks very much. Good morning guys.

Good morning, Paul.

Thanks, Ted. Just on pulp just following up on Sean’s maintenance question, just you don’t have any major maintenance in 2016. Can you ballpark sort of a cost difference between 2016 and 2017 given the major maintenance in 2017 that looks enough?

Well, it should probably defer this to Larry, because I don’t think to disclose this, but I’ll leave it to Larry to comment on that.

Yes, Paul, we haven’t – we don’t give that kind of detail in terms of what specific maintenance costs are, but, it’s the minor shuts don’t really have a material effect and you see what the major shutdowns can have the significant impact as we saw in Cariboo this quarter.

Okay, so it sounds like more than $10 million but less than $20 million?

Well, as we said, the Cariboo and the QRP shutdown account for half of the $22 million decline in the quarters and Cariboo was the bigger part of it. I think that’s probably all we are prepared to disclose, but, we are giving you a pretty good hint there.

Okay, thanks for the hint.

Okay.

Trying to figure out where lumber prices are going forward here. It sounds like the – curious as what you are hearing from your customers for the back half of the year, but, just the customer impact as well as export volumes and then expiry to the SLA in dollar for the year?

That’s a good question and I think we all have our own views on it and we said many times, we don’t spend a lot of time predicting the next quarter or the next six months. And I think about a year-and-a-half we didn’t say, until we get to 1.3 million housing starts and I don’t know, we don’t know that’s a right number, but we’ve been saying that for a while that we will expect volatility. So, I think that’s all we can say right now so you can expect volatility. I think customers are trying to figure out how to deal with the expiry of the SLA, but remember that we will be in a standstill period from October 12 of this year for another year. So I think there is a bit of uncertainty. In terms of – and so that really Paul, I am not helping you with that, I mean we really don’t spend a lot of time predicting where markets are going. In terms of exports, our volumes continue to be strong. There is price pressure in China given the weaker currencies that we are competing with Russia and New Zealand whether it’s logs or lumber. But from a demand standpoint, and I think we’ve been saying this for quite sometime which appears to be contrary to the expectations of some of the forecasters but we continue to see stable demand in China and our expectation is really for the same for the third and the fourth quarter this year. So, demand standpoint, there aren’t any big curve balls that we see come out as how people manage, how customers manage markets around the expiry to SLAs really more up to them than up to us.

Okay, and last question I had, Ed, just log inventories in front of your lumber mills, especially in BC with – BC and Alberta with I guess forward season here, is that in normal levels or are you experiencing any issues there?

We had not been impacted directly by any of the fires, but that being said, our inventories generally are in good shape. We’ve got one or two mills where that are little bit on the low side, so we are still concerned about with the rest of the summer looks like, but, at this point, we are feeling pretty confident about log inventories overall.

Okay, that’s all I had. Thanks guys.

Thanks, thanks, Paul.

Thank you. The following question is from Mark Wilde from BMO. Please go ahead.

Good morning, Ted, good morning Larry.

Good morning.

Ted, I wondered if you could talk a little bit about the other side of sort of the lumber trade equation, we talked about sort of exports to China and elsewhere. What are you seeing in terms of the imports coming into North America, especially into the US given the strength of the dollar?

Well, I mean, imports to the US has increased a little bit over the last year given the currency, but there is still, I think there is still 15 or so percent where they were at the peak. So they are really not material at this point, Mark. So, we really haven’t seen any real impact on our business in terms of lumber imports. We really do believe that were to be material, prices got to be well north of $400 US.

Okay, all right. And then, Ted, I guess, just you’ve been in the Southern US now for about a decade. You’ve invested a lot of capital down there. What have been your biggest surprises about sort of doing business in the southern US but rather than doing business out in Western Canada?

Well, that’s a long question. I am not sure if I can answer that, you know, in this call. But fundamentally, it’s not so much surprises, but it’s a different way of doing business. I think the best that ever happened to us is that, we looked at our capital program probably in 2005 down there, we would have looked at it quite a bit differently than we do today. And so, in Canada, the mills are large. In the US, to be competitive, our footprint is much smaller, because we want to make sure that we are competitive in each timber grain. So I think that really is the biggest one and as we developed our capital program over the last three or four years, we really focused on, a bit of a different structure down there than in Canada. Other than that, really no big surprises. I’ve got to tell you we are delighted to be down there and it’s tremendous diversification for the company.

Yes and I guess, typically kind of Southern US mills have only run one or maybe two shifts. Have you been able to change that at all to kind of move more to get how you operate in Western Canada?

No, we typically, we typically run our mills down there at – we are not a one-shift company. We typically run two shifts down in the US sometimes up to a 100 hours, sometimes a few hours more at one to two mills. But, generally it’s really all based on ensuring that we’ve got the right workforce and that we are in the right competitive position in the timber grain. I think that’s really part of the tradition in the US, so, most – and we tend – a lot of the independents are run one shift but we tend to run – we run much more hours than the independents.

Okay. And is it fair to say, you are still looking for kind of further opportunities in the Southern US?

Well, we are a company that wants to grow. But we want to be very disciplined about it and we have a very much of a long-term view. So, ultimately we want to grow in the US, but, it really will depend on valuations and our view on our ability to develop top second or first quartile mills down there. So, we looked at every thing and there is opportunities that we passed on or opportunities at other companies we think are more valuable than us but, we want to continue to grow down there for sure. But it is the one significant growing timber basket in North America.

Okay. All right. That’s helpful. Good luck in the second half of the year.

Mark, I appreciate it.

Thank you. [Operator Instructions] The following question is from Daryl Swetlishoff from Raymond James. Please go ahead.

Well, thank you. Good morning guys. Ted, West Fraser has been running CapEx at multiple to depreciation for an extended period of time here. As you guys look ahead through 2017, 2018, can you foresee a time when you get back to that $175 million to $100 million run rate?

Yes, we continue – first of all good morning. First, we continue to look at opportunities. But, again, we want to be very prudent about it. We have to – earn a good return on our capital. We still have more capital spend that I think, by the time we get to 2017, I am not – I would expect that we will be much closer to our depreciation and you know that it’s not our depreciation, but kind of a run rate what Roger has mentioned many times of a $175 million to $225 million. So, I don’t think it’s too far out there when we will be back to that range.

Okay, and I mean, given that, and given some of the returns on the investments that you’ve had, we see free cash flow improving over this period. What would be some of the priorities for that free cash flow from the management point of view?

Well, I will make a few comments and then I’ll ask Larry to make some as well. But, at the end of the day, it comes down, as people call balance sheet allocation and we fundamentally continue to look for ways to improve our existing asset base. And it’s not just traditional approach but, it’s approaches that should add further integrated value to the company. I mean, five years ago, we weren’t spending money on energy. So we continue to look for new opportunities and we continue to look for technologies that will reduce our cost and increase our margin. So I think that’s really a never ending quest. Of course, we want to grow and I mentioned that to Mark. And then, finally, we have the ability to do share buybacks. So, those are really the three areas, but, Larry may have some further color on that.

Yes, not much Ted. Daryl, the internal improvement is our major focus, but we are growth-oriented, so we are – we want to always have enough dry powder available to take advantage of growth opportunities. Share buybacks, we were in the market a year ago. We took the opportunity there and we have a modest dividend that we consider and our Board considers every quarter the dividend level. But, the key thing is that we are not going to get ahead of ourselves. What we’ve seen is it’s a very volatile pricing and still pretty fragile market. So we are looking forward to managing the balance sheet in the future, but, we are going to continue to be quite conservative in our approach. And lastly, I think we will not be shy about carrying some cash on the balance sheet if we – I think we are going to opportunities in the future.

Okay. Thanks a lot guys.

Okay.

Thank you. The following question is from Mark Kennedy from CIBC. Please go ahead.

Good morning. First question I guess, Ted, on, just on the bioenergy front, do you expect your two ORC plants to start generating a contribution here in Q3? Or how should we be thinking about that as we look into Q3 and Q4?

Yes, I mean, we expect to – we are generating the contribution today and my expectation will be at full run rate going into the fourth quarter of the year, because we’ve been through the start-up for a little while now and we are very encouraged by the performance of these plants. So, I think we’ll see a contribution in the second half of this year.

Okay, okay. And then just a question on the Softwood Lumber deal. I am certainly not holding my breath that we’ll have a deal by this October. But I am just curious on your views assuming we went to the – period, do you think we’ll have a deal by October of 2016?

Well, I don’t have my crystal ball with me. But, what I can say, is that, we have assets on both sides of the border and from our perspective, this agreement has worked well for the US. We are dealing with issues like the federal election this fall. So there is a number of issues that are outside of our control of TPP or the Trans Pacific Partnership that, which has really taken all the attention of the Canadian US governments. So I think, once that you start to focus close to election on our industry, my expectation is there is a lot of goodwill between Canada and the US both at the government and at the industry level. So, my expectation is that, we have a good opportunity to find a solution over the next 15, 18 months.

Okay, that’s fair. Thanks very much.

Thank you. There are no further questions registered at this time. I would like to return the meeting to Mr. Seraphim.

Well, first of all, thank you everybody for joining us. Enjoy the rest of your summer and I know that Larry and Roger are more than happy to take any of your individual questions if you want to give them a call after this. So, thank you very much and we’ll sign off.

Thank you. That concludes today’s conference call. Please disconnect your lines at this time and we thank you for your participation.