West Fraser Timber Co. Ltd. (WFG) Q1 2016 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Q1 Conference Call. During this conference 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 the 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 and good morning and thank you all for joining us today. With me is Larry Hughes, our CFO and a number of our senior management team. West Fraser earned $42 million or $0.51 per share in the quarter. Adjusted earnings for the first quarter were $49 million or $0.60 per share, as compared to $30 million or $0.38 per share in the fourth quarter of 2015. Adjusted EBITDA in the quarter was $130 million or 12% of sales and it was up $40 million from the fourth quarter. The primary reason for the improvement from the fourth quarter of 2015 was due to improved profitability of our lumber business. Our lumber business generated $100 million in adjusted EBITDA, up $45 million from the fourth quarter of 2015. Lumber production was up 8% from the previous quarter due to improved operational performance. In the last few years, we rebuilt seven saw mills, invested in ten major planer upgrades, installed 22 continuous kilns and built two large bio energy plants in our lumber business. There is still more value to extract from our capital program, but we are encouraged by our operational improvements today. Our panels business generated $15 million in adjusted EBITDA, down $4 million from the fourth quarter. Lower plywood prices in our insurance deductible for the WestPine fire were the primary reasons for the decline. Our pulp and paper business generated $14 million in adjusted EBITDA, down $3 million from the fourth quarter. The primary reason was a scheduled maintenance shutdown. We are pleased with the progress we are making in our NBSK operations. Production was essentially flat with the fourth quarter despite the hit in scheduled maintenance shutdown in March. Again we have more work to do but we believe that we are turning the corner with regard to improving reliability in our NBSK business. Our outlook with respect to lumber markets is consistent with the views we shared over the past few years. North American lumber demand has been growing at 2 billion to 2.5 billion feet per year for a number of years and based on steady improvement in industrial, repair and remodel markets, as well as improving housing demand, we expect this trend to continue. US housing starts were 1.13 million in the first quarter. While we are very positive in our outlook with respect to the medium term, we have been consistent in our view that until we see 1.3 million housing starts, we’ll experience some volatility in lumber markets. Key factors such as demographics and improving US economy and low new home inventories should continue to spur new home construction. Pulp markets are expected to continue to be under continued pressures as we face a combination of new capacity and slower growth in China in terms of demand. With respect to the Softwood Lumber Agreement, we support the efforts of the Canadian government and their ongoing discussions with the US government to negotiate an agreement. While we are unable to predict the outcome of the discussions, our company has been working hard on those things that we can control. We’ve modernized our mills and we diversified into new businesses such as energy. Our geographic diversification in our lumber business is also very important as we face external issues such as the SOA. With this, I’ll turn the call over to Larry.

Thanks, Ted and thanks to everyone joining us on this call today. Please refer to the advisory contained in our MD&A concerning the use of various non-IFRS terms. These are described in various tables which begin at Page 11 of our quarterly MD&A. For the first quarter of 2016, we reported earnings of $42 million or $0.51 per share. On Page 2 of our MD&A, we identified various non-operational items, which we adjust from the quarterly earnings in order to more clearly reflect results solely from operations. The result, which we refer to as adjusted earnings, was $49 million for the quarter or $0.60 adjusted earnings per share. This compares with $0.38 for the fourth quarter of 2015 and $1.17 for the first quarter of 2015. So on an adjusted basis, we saw improvement compared to the previous quarter but the results were much weaker than those of the first quarter of 2015. On a segmented basis, operating earnings from our lumber segment improved by $46 million compared to the previous quarter due to improved shipments, pricing, and a weaker Canadian dollar. Operating earnings in lumber declined by 25% compared to the first quarter of 2015, reflecting a decline in U.S. dollar lumber prices, which were only partially offset by significantly improved shipments, and continuing strengthening of the U.S. dollar against the Canadian dollar. For our panels segment, operating earnings declined quarter-over-quarter reflecting slightly weaker MDF and Canadian plywood prices and lower plywood shipments. For the pulp and paper segment, we saw a decline in operating earnings compared to the previous quarter, mainly the result of lower NBSK pulp shipments and higher maintenance costs incurred during the scheduled minor maintenance shutdown of our Hinton pulp mill. Our jointly owned Cariboo NBSK pulp mill will have a five day maintenance shutdown in the second quarter. We used $23 million in our operating activities in the first quarter compared to $28 million in the fourth quarter, as we continue to build seasonal Canadian log inventories. Capital expenditures in the quarter totaled $49 million and we continue to expect capital spending in 2015 to be in the range of $300 million. In the quarter we repurchased just over 1 million shares under our normal course issuer bid at a total cost of $50 million. One of the non-operational adjustments to our earnings relates to the termination of our Alberta power contracts. Over the past 18 months, we have seen a dramatic change in the Alberta electricity market as the decline in oil and gas-related activities substantially reduced demand for electricity. During the quarter we took steps along with other parties to terminate our interest in two power contracts and this resulted in the loss of $19 million, which was recorded as other income. Our energy group will continue to monitor this market and consider steps to help insulate our Alberta operations, particularly Slave Lake Pulp and Alberta Newsprint from future electricity price volatility. We revalued our defined benefit pension plans as at the end of the quarter, a combination of a decrease in the discount rate which has the effective increase in the present value of plant liabilities and a lower rate or return on our plant investment assets resulting in an after-tax loss of $60 million, which is included in other comprehensive earnings. We ended the quarter with a net debt-to-total capital ratio of 26% which included operating borrowings net of deferred financing cost of $294 million, as we accumulated Canadian winter log inventories. We expect our operating borrowings to steadily decline over the second quarter as we consume the significant Canadian log inventories. And Ted, that concludes my comments. Ted Seraphim Great, thank you, Larry. And operator we are ready for questions.

Thank you. [Operator Instructions] Our first question is from Mark Wilde from BMO Capital Markets. Please go ahead.

Good morning, Ted. Good morning, Larry.

Good morning, Mark.

Good morning, Mark.

I wonder, starting out kind of you can just put a little more color around the current state of the lumber markets, both in terms of North American demand, but also what you are seeing offshore?

Well, I could do that, but I’ve also got Chris on the line. So I think we’ll have Chris jump in on that, if that’s okay.

Hi, Mark. Thanks, Ted. Yes, I would say, domestically, we are certainly in a stronger position today than we were a year ago. As Ted said, there is still a fair bit of volatility. We saw a pretty good run in March. Things have been slow recently and the second quarter could be a bit tough and then we’ve improved for the balance of the year domestically and then. Offshore, inventories are way down from a year ago. There is certainly a lot less SDF in the market in China than there was a year ago. But then that is a fair bit of Russian lumber and timber there as well. So, I would say the balance, the market is somewhat soft in China. But our shipments are steady and I think we’ll stay on that sort of – a slightly reduced level from last year for the balance of this year depending on pricing and opportunity, what’s going on in that market.

Yes, Chris, do you have any read on just sort of what the pipeline looks like within the North American lumber business?

It depends when you talk to Mark, what I am hearing is that, man of the large distributors are really not carrying a lot of inventory. There are some – as the odd analysts, they’ll tell you that there seems to be a lot of inventory in the pipeline, but we are not seeing it. And the way that they are coming back more quickly than they did a year ago tells me, A, that they are getting good takeaway and they are not carrying a lot of inventory. That’s kind of we are already.

Yes, and is it possible, Chris, to get a sense of sort of your volume and Canadian volumes into the US since the exploration of the SLA?

I don’t think it’s significantly different than prior. It would be up a bit, because of the fact that China has slowed a bit. So some of that low-grade is now going back into the US, but other than that, Canada remains relatively strong and so our clients would be similar to what they were.

Okay, and just generally, Chris, when you look across Canada last year, shipments on our production volume was pretty much top across the country which is, it kind of countered on what the conventional wisdom is ban a ban sort of production dropping in many regions of Canada over time. Can you talk about that issue?

Well, maybe I’ll handle that, Mark, if that’s okay. I think, as we look at – I mean, we are focused on BC in Alberta primarily of course. And we have seen some increase in Eastern Canada, when we look at British Columbia, we are starting to see the end of the economic shelf life of North America, over the last 12 months or so. I think that’s coming home to Rouge particularly as log cost go up. In Alberta, while we have seen some increases, again as we look to the future with issues like, we do have some client in Alberta, there is a surge cut that will eventually come down and we are also dealing with issues such as species at risk, Cariboo files, et cetera, et cetera and we expect to see some longer-term cut reductions in Alberta, not material at this point, but we don’t really – in Western Canada, our outlook is that it’s going to be balanced to down over the next couple of years. Eastern Canada, not our area of expertise, but, we don’t see tremendous growth from today there.

Okay. And then, Ted, is it possible if you can give some commentary around the log cost situation for you across the Southern US? That’s a big chunk of your production now?

Yes, I think, generally, we see log cost as being fairly flat in the south. There is always a few regional places where there is some upward pressure and there is a few places where we are seeing some minor downward pressure adjusting. So overall, really flat in US.

Okay. The last one I had is, I noticed that your LVL volume is roughly between 55% and 60% if we look on a year-over-year basis, you guys are pointing to kind of a pick up in the housing market, but there is no way the housing market is up 55% to 60%. So, what’s going on that explains that?

Well, I think fundamentally, we are a small producer. We obviously have added hours at our Rocky Mountain LVL plant, but, ultimately, we are probably getting a larger market share than others as housing demand is slowly improving.

Okay. I’ll turn it over. Thanks very much.

Thanks, Mark.

Thank you. The following question is from Hamir Patel from CIBC Capital Markets. Please go ahead.

Hi, good morning.

Good morning.

Ted, given the – I mean, 7% production growth you guys are expecting in 2016, if you were to face countervailing and anti-dumping duties next year, how much SDF volumes would you expect to be inducted by duties?

Well, it’s hard to answer that question. At the end of the day, it comes down to – are we making more cash, producing lumber than not and it has do with log cost, it has to do with lumber markets. Let’s remember in the last period of countervailing and anti-dumping in the early 2000s, lumber markets were strong and we continue to operate, but, we are not extremely concerned about that. I think, from our perspective, our biggest challenge around running our operations with the log cost in British Columbia.

Okay, thanks. That’s helpful. And just a question for Chris on the lumber market. We’ve seen very strong prices for some of the light woods grades in the south. What do you think is driving that and how sustainable are those premiums?

That’s a very good question. We – you are right. We have been noticing that recently and our view is that, that is a pick up in housing. That is primarily a single-family housing item to watch and that’s why they’ve been hit so hard. But again, we do think that’s sort of marginal plus, we think the mills have switched away from be a wide to heavier narrow that they can. So that would obviously help a bit as well. Right now, we see this just on the margin. We don’t see it as…

And then, Chris, your line is what your sort of mix of narrows versus wide in south?

I don’t think we usually comment on that, but obviously we are much heavier to narrows in Canada than we are in the US.

Right. Fair enough and just a final question for Larry on the pulp side. Could you maybe quantify what the maintenance cost was in Q1?

No, we don’t break that out, Hamir. So, I don’t have a comment on that.

Okay, fair enough. That’s all I had. I’ll turn it over. Thanks.

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

Hey, good morning guys.

Hi, Paul. How are you?

Good. Just following up on the pulp question, outlined five days shut at Cariboo, is that going to be a similar cost impact to the Hinton shut and how long was the Hinton shut in Q1?

Well, the Hinton shut was few days longer, actually seven days or so. Cariboo is five days and again we own 50% of that mill. So, we’ll have probably – quite of it was, somewhat less than half is financial exposure as we had at Hinton.

Okay, and then, just, I saw the pulp stat this morning, it looks like big revisions for earlier months shipments and it looks like there is lots of pulp out there. How do you view the markets overall and the grades that you are producing?

Well, I think there is some differences between BCT and NBSK. I mean, we are seeing more pulp capacity coming on this year and as I said in my comments, log demand has b been up this year, capacity is growing at a faster pace than demand. So, I think the Canadian dollar has strengthened quite a bit in the last 30 days and I think that’s what’s driving some of the price increases, but they are not enough to adjust for the strengthening of the Canadian dollar. So we are fairly – I think we got a pretty muted expectation about pulp markets for the remainder of this year in terms of a broader markets. BCTMP, we’ve seen over the last 12 months, a bit more price decline there than we have seen in other markets and I think that is like – is primarily because we’ve seen a bit more BCT and peak capacity come on out in New Zealand and a little bit out of Europe. And it takes a little while to absorb that, because it’s not a big market. So, we actually expect and that’s starting to get absorbed now. So, our expectations about BCTMP is, we are – maybe more hopeful than predicting, but we are hopeful that we’ll start to see the price differentials between BCTMP and kraft pulp start to narrow a little bit, but overall, I’d have to say that we don’t have great expectations around pulp markets over the remainder of the year.

Okay, and then, just switching over to lumber you made an interesting comment about SLAs supporting a reasonable negotiated settlement, but, also you are prepared for alternative outcomes and I am just curious how you prepare for that and what alternative outcomes you are foreseeing?

Well, I mean, that’s one or two things, either a negotiated settlement or we are going to see litigation. And so, when I say we’ve been preparing, I mean, there is a number of reasons we grew our business in the US. So, the SLA was one of them. So, given that about 40% of our lumber production is in the US sales, that’s part of it. The second part of it is, we’ve been working hard to modernize our mills on both sides of the board over the last five years. So, at the end of the day, we also believe that our relative cost position is very important as we deal with potential litigation or a potential settlement. And frankly, that we’ve also been putting the time I referred into our other businesses, whether it’s panels or our pulp business or our energy business. So, I mean, yes, it’s going to be an issue, but, I think we perceive it as less of an issue than potentially lot of folks outside our company perceive it to be.

All right.

And that’s about it. In terms of the outcome, I can’t predict what’s going to happen or I mean, it really is it to government to government negotiation right now and our Prime Minister and I guess, the President of US on March 10 said, let’s see where we get to in 100 days, I guess, we are half way through that, well, let’s see.

Great. Thanks so much.

You bet, thanks, Paul.

Thank you. The following question is from Sean Steuart from TD Securities. Please go ahead.

Thanks, good morning guys.

Hey, Sean.

Couple questions. You touched on your comments and also on the MD&A expected log cost inflation in BC as we really make the transition away from the beat, Could you guys talk to any expectations mid-term in terms of expected inflation on that front?

Sure, I mean, I think, given what we’ve seen in the BC timber sales in that market, the bid prices, we’ve only seen log cost move up quite a bit and we are probably going to see another $4 to $6 a cubic meter in July and that’s on top of the $1.50 that we received in terms of stoppage increase and they go on so. That’s not insignificant and as we go forward, as I said earlier in the call, I mean, the industry in BC, I mean we don’t have enough timber to support the capacity that’s – the capacity that the industry has. So, we really do see that log cost inflation will continues as – because we do have the view that lumber markets are going to continue to improve. So, I think we are going to continue to face margin pressure in the BC interior. But at least through July, I think we are pretty certain where costs are going.

Okay, and so you guys reiterated your 2016 CapEx guidance. Any thoughts on spending into 2017 and I guess, I am wondering about your thinking around scaling back spending, preserve balance sheet strengths in the event that US does proceed with countervailing , anti-dumping duties, given your initial views on how 2017 spending is shaping up.

Well, let me just back-up on the second part of your comment. I think, we’ve got a very strong balance sheet. The SLA is one issue and of course there are things that happen that are beyond our control and that’s one of the reasons we manage this company with a very conservative balance sheet. But, we are very focused on looking at capital projects and that’s something materially significant occurs, we are going to continue to invest capital in the projects. Our run rate should be around $200 million or so, on a long-term basis, but, given the size of our company, we have 40 operations. We are going to continue then have a fairly robust capital program. We haven’t really got our mindset around 2017 yet. But I think it will be likely that $200 million or probably more.

Okay. Thanks very much, Ted.

Okay, you bet, Sean.

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

Well, thanks. Good morning guys.

Good morning,. Daryl.

Most of my questions have been answered. Just following a bit on Sean’s question on capital. If you look at that, roughly $300 million that your intend has been on 2016, is there any guidance with respect to kind of large buckets where it might go versus segments or regions?

Well, I think, we are again, we’ve got, there is capital that we are completing. We’ve got more accounts going in. We’ve got some energy projects, we are looking at and we’ve got some sawmill upgrades in the south. We are looking at, at least one, but we haven’t finalized or approved some of those projects yet. But I expect we will, in the next few months. So, it’s really, throughout the company, primarily in our wood products business.

Thanks, Ted. That’s all I had.

Okay, you bet. Thanks, Daryl.

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

Okay. Well, thank you very much and if you got any follow-up questions, feel free to give Larry or me a call today. Thanks very much.