Weyerhaeuser Company (WY) Q1 2019 Earnings Report, Transcript and Summary

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Weyerhaeuser First Quarter 2019 Earnings Conference Call. [Operator Instructions]. I will now turn the call over to Ms. Beth Baum, Senior Director of Investor Relations. Please go ahead.

Thank you, Dennis. Good morning, everyone, and thank you for joining us today to discuss Weyerhaeuser's first quarter 2019 earnings. This call is being webcast at www.weyerhaeuser.com. Our earnings release and presentation materials can also be found on our website. Please review the warning statements in our press release and on the presentation slides concerning the risks associated with forward-looking statements as forward-looking statements will be made during this conference call. We will discuss non-GAAP financial measures and a reconciliation of GAAP can be found in the earnings materials on our website. On the call this morning are Devin Stockfish, Chief Executive Officer; and Russell Hagan, Chief Financial Officer. I will now turn the call over to Devin Stockfish.

All right. Thanks, Beth. Good morning, everyone, and thank you for joining us today. This morning, Weyerhaeuser reported a first quarter GAAP loss of $289 million or $0.39 per diluted share on net sales of $1.6 billion. This loss was driven by a previously announced $0.47 noncash special charge related to the transfer of pension assets and liabilities through the purchase of a group annuity contract. Excluding special items, we earned $80 million in the quarter or $0.11 per diluted share, an improvement of 14% compared with the fourth quarter. Adjusted EBITDA totaled $365 million, $19 million more than the fourth quarter. I'm proud of our first quarter results as each of our businesses delivered strong operating performance and increased EBITDA despite the slower-than-expected pace of U.S. housing starts in the first quarter. We also continued to demonstrate our commitment to disciplined capital allocation as we repurchased $60 million of our common shares, reduced our pension liabilities by $1.5 billion through the annuity purchase transaction and refinanced our 2019 debt maturity at a very favorable rate. In a moment, I'll dive into our business results. But first, let me set the stage with some brief comments on the housing market. U.S. housing activity has rebounded slowly from low fourth quarter levels as the spring selling and building seasons have been slow to gain momentum. First quarter housing starts averaged approximately 1.2 million on a seasonally adjusted basis. This is an improvement of 1% compared with the fourth quarter but lower than the first quarter of 2018. Several factors appear to have contributed to the softer first quarter activity. An unusual and lengthy stretch of severe rain, snow and cold across much of North America, particularly in February, deterred prospective buyers at the start of the spring selling season and curtailed construction activity in many regions. Higher inventories of new homes for sale entering 2019 delayed the demand for housing starts as builders sold through completed inventory. And buyers were slow to reenter the housing market following the fourth quarter's financial market volatility. Activity has picked up as the year has progressed. Builders report that buyer traffic and new home sales are improving monthly, and we are seeing signs of momentum as winter weather clears and we move deeper into spring. First quarter new home sales were 15% above fourth quarter levels, and March sales were the highest in nearly 18 months. Western housing starts increased 30% in March compared with February as rain and snow receded. And we are hearing of increased demand for cement and rebar in a number of areas, signs that foundations are being poured. Our customers also tell us that builders continue to adjust product offerings to increase the proportion of affordable product in response to market demand. Near- and long-term economic fundamentals remain supportive of increased building activity. Mortgage rates are approximately 75 basis points below their November peak, and mortgage purchase applications are near 10-year highs. Permit activity remains solid, averaging approximately 1.3 million through the first quarter, and overall economic fundamentals remain positive with increasing real wages, unemployment at 50-year lows and strong job growth in key housing markets. Repair and remodel spending, which comprises about 40% of lumber demand, also remains strong and is forecasted to rise 6% to 7% this year. These favorable signs are balanced however by continued constraints around labor and lot availability. The supply of construction labor remains tight. Although construction activity has some capacity to catch up for delayed first quarter starts, it will be challenging to recover all of that activity this year. As a result, we have tempered our 2019 housing start expectations to be slightly below 1.3 million starts. We continue to expect year-over-year growth in housing, with that growth primarily attributable to increased single-family activity. Turning now to our first quarter business results. I'll begin the discussion with Timberlands, Charts 4 through 6. Timberlands contributed $120 million to first quarter earnings and $193 million to adjusted EBITDA. EBITDA increased $5 million compared with the fourth quarter as results improved in each of our geographic regions. Western Timberlands EBITDA increased by $3 million compared with the fourth quarter. Lower average realizations were more than offset by lower costs, primarily for forestry and roads. We typically do less forestry activity and roadbuilding during the cold winter months. We also deferred some silviculture activity due to unusually severe winter weather. In the Western domestic market, log demand remained moderate through most of the first quarter due to continued low lumber prices. Log availability was adequate early in the quarter but decreased in February and March due to strong storms, which brought several feet of snow and heavy winds to many parts of the Pacific Northwest. Our teams did an excellent job of flexing harvest plans so that we could maintain production and capitalize on pricing, which improved throughout the quarter. I will note that the weather in Southern Oregon was particularly severe, and we lost several days of harvest activity and incurred some storm damage on our property in that area. We don't expect this to have a material impact on us, but we will see some modestly higher logging costs in the second half of this year as we bring the affected wood to market. Moving to the export markets. In China, sales volumes and realizations for our logs declined modestly compared with the fourth quarter in connection with the typical slowdown in construction activity during the Lunar New Year. Log inventories at Chinese ports increased significantly during the Lunar New Year period and remained elevated through the first quarter as demand was slow to pick up coming out of the holiday. Over the last several weeks, however, we have seen log takeaway increase and return to more normalized levels. In Japan, post-and-beam housing starts have increased 3% year-to-date through February and demand for our logs remains steady. Our export log sales volumes to Japan were comparable to the fourth quarter. This was a higher sales volume than we had initially expected and was attributable to the timing of vessels during the quarter. Average sales realizations for our Japanese export logs declined moderately. Overall, first quarter export revenues were lower than the year ago quarter due to lower realizations for our Japan and China logs. Moving to the South. Southern Timberlands EBITDA increased by $1 million compared with the fourth quarter. Average realizations for our Southern logs increased approximately 3% as extremely wet weather limited log supply and drove improved realizations for sawlogs and pulpwood across most of the South. Fee harvest volume decreased 5% as higher log sales volumes were offset by seasonally lower stumpage sales. On the export side, Southern log export volumes decreased slightly and average realizations were roughly flat. Comparing overall Southern Timberlands results with the year ago quarter, EBITDA declined due to lower harvest volumes and slightly higher harvest and haul costs. In 2018, we harvested a greater proportion of our annual volume during the first quarter. Northern Timberlands EBITDA increased by $1 million compared with the fourth quarter. Fee harvest volume was comparable and average realizations improved modestly due to mix as we harvested a greater proportion of hardwood-grade logs. Compared with the year ago, EBITDA from Northern Timberlands increased by $1 million due to the timing of harvest volume. Real Estate, Energy and Natural Resources, Charts 7 and 8. Real Estate and ENR contributed $55 million to first quarter earnings and $106 million to adjusted EBITDA. EBITDA was $16 million higher than the fourth quarter and $65 million higher than a year ago. As we indicated during our fourth quarter earnings call, although buyer traffic is typically slower during the winter months, strong real estate activity in the fourth quarter of 2018 allowed us to pursue additional transactions that closed in the first quarter. The number of acres sold in the first quarter increased over 20% compared with the fourth quarter and was up over 75% compared with the year ago. Average price per acre was comparable to the fourth quarter on a generally similar geographic mix. First quarter Real Estate sales included a slightly higher portion of Southern acres and fewer Western and Northern acres. Compared with the year ago quarter, average price per acre increased significantly due to a much smaller proportion of sales for Montana where Timberland prices are regionally lower. Wood Products, Charts 9 and 10. Wood Products contributed $69 million to first quarter earnings and $115 million to adjusted EBITDA. Compared with the fourth quarter, earnings and EBITDA increased significantly despite flat to lower pricing for our commodity products. EBITDA for lumber increased $41 million compared with the fourth quarter. This was almost entirely attributable to lower log and manufacturing costs. Lumber prices were flat through most of January and improved moderately in February in anticipation of the spring building season. With building activities slower to materialize, prices stabilized and then eroded slightly toward the end of the quarter. The framing lumber composite price averaged 2% higher for the first quarter compared with the fourth and our average realizations increased 1%. Lumber sales volumes increased 3% in the first quarter. Our log costs decreased substantially in the first quarter as Western and Canadian log costs declined and the benefit of lower fourth quarter log costs was also included in our financial results. Unit manufacturing costs also decreased significantly compared with the fourth quarter as our lumber system achieved the lowest first quarter controllable manufacturing cost per unit that we have ever reported. This comes despite several days of downtime at one of our Oregon lumber mills due to severe snow and wind. First quarter EBITDA includes $3 million of charges for countervailing and antidumping duties on Canadian softwood lumber. Comparing our first quarter results with the year ago quarter, EBITDA decreased significantly due to lower average realizations, partially offset by lower log and manufacturing costs. OSB EBITDA decreased $12 million compared with the fourth quarter due to lower average realizations. OSB pricing entered the first quarter below the fourth quarter average and remained flat at that level. First quarter benchmark North-Central pricing averaged 13% below the fourth quarter, and our average realizations declined $29 per 1,000 square feet or 12%. Sales volumes increased 8% compared with the fourth quarter, and operating rates and manufacturing costs improved as our Grayling mill returned to full production following a press replacement that was completed in late October. Comparing our first quarter results to the year ago quarter, EBITDA was significantly lower due to a 29% decrease in average sales realizations. Engineered wood products EBITDA increased by $21 million compared with the fourth quarter. Average sales realizations for solid section products increased 4%, and average realizations for I-joists increased by 1%. Sales volumes for solid section and I-joists products decreased due to sluggish first quarter construction activity, particularly in the West as well as continued efforts by dealers and builders to maintain lower product inventories. Fiber costs declined due to lower cost for logs and oriented strand board web stock, and unit manufacturing costs improved due to higher operating rates. Compared with the year ago quarter, higher average realizations and lower cost for logs and oriented strand board were largely offset by lower sales volumes. Distribution EBITDA increased by $2 million compared with the fourth quarter due to improved product margins and was lower than a year ago due to lower sales volumes. I'd like to now turn to operational excellence. Our businesses are making good progress against our collective 2019 operational excellence target of $80 million to $100 million. During the first quarter, our biggest OpEx benefits in Timberlands came from initiatives related to logging and hauling efficiencies in our Southern operations as well as our continued marketing and bucking for value improvement efforts. In Wood Products, our greatest benefits came from our ongoing initiatives to reduce controllable manufacturing costs for lumber and OSB. Our Real Estate business is also on track to meet or exceed its targeted 30% premium to timber value. I will now turn it over to Russell to discuss some financial items and our second quarter outlook.

Thanks, Devin, and good morning. Key outlook items for the second quarter are presented on Chart 13 of the earnings slides. In our Timberlands business, we expect second quarter earnings and adjusted EBITDA will be approximately $25 million to $30 million lower than the first quarter. About half of that is due to seasonality around our forestry and road spending, and the other half relates to the timing of our export shipments. At our Western Timberland operations, we expect second quarter harvest volumes will be comparable to the first quarter. Domestic log inventories are at normal levels, with supply and demand largely balanced as supply returned to the market following first quarter's severe storms. We anticipate our second quarter average domestic sales realizations will be modestly higher than the first quarter average. Forestry and road spending will also increase as we enter the spring and summer months. In Japan, housing starts are expected to remain healthy, driven by strength in the high-end post-and-beam construction market that we serve. We continue to see strong demand for our Japanese export logs and expect average log sales realizations in the second quarter to be similar to the first quarter. Average sales realizations for our Chinese export logs are expected to be lower than the first quarter. Although inventories at Chinese ports are relatively high, we expect them to trend downward over the next couple of months as construction activity and log takeaway have ramped up to more normal levels following the Lunar New Year holiday. We expect our Western export log sales volumes, both Japan and China, will be lower in the second quarter due to the timing of shipments at the end of the first quarter. In the South, we expect second quarter average sales realizations will be comparable to the first quarter. Fee harvest volumes should be slightly higher and we expect a greater portion of pulpwood as we shift to more thinning activities in the second quarter. Forestry spending in the South is expected to increase, which is typical coming into the spring. In the North, we anticipate second quarter fee harvest volumes will be significantly lower than the first quarter as we enter the spring breakup season. Turning to our Real Estate, Energy and Natural Resources segment. Second quarter earnings and adjusted EBITDA will be lower than the first quarter but approximately 30% higher than the second quarter of 2018, driven by favorable Real Estate activity. We expect second quarter land bases as a percentage of Real Estate sales to be approximately 60%. Markets remain active and we continue to see strong interest in Real Estate from high-net-worth individuals, recreation and conservation buyers. As a result, the cadence of our Real Estate sales would be more heavily weighted to the first half of the year compared with the usual seasonal pattern. In our Energy and Natural Resources operations, we anticipate that second quarter royalties will be comparable to the first quarter. For the full year 2019, we now expect approximately $270 million of adjusted EBITDA for our Real Estate, Energy and Natural Resources segment. We anticipate that land bases as a percentage of Real Estate sales will be between 45% and 55% for the full year 2019. For Wood Products, we expect second quarter earnings and adjusted EBITDA will be higher than the first quarter due to seasonally higher sales volumes and improved operating rates across all product lines. This is before any benefit from improving prices. For lumber, second quarter to date average sales realizations are approximately $15 higher than the first quarter average, and current realizations are approximately $10 higher than the first quarter average. Many of our builder customers who were delayed by adverse weather conditions in the first quarter are eager to resume a normal construction schedule. In areas of the country where wet and wintry weather conditions have receded, we're seeing improved demand. As a reminder, every $10 change in lumber realizations is approximately $11 million of EBITDA on a quarterly basis. In late March, we started up our newly expanded sawmill in Millport, Alabama. And when ramp-up phase is completed over the next 12 to 18 months, our capacity will increase by 250 million board feet. For oriented strand board, second quarter to date realizations are comparable to the first quarter average, and current realizations are approximately $10 below the first quarter average. As a reminder, every $10 change in OSB realizations is approximately $8 million of EBITDA on a quarterly basis. Chart 11 outlines the major components of our unallocated items. Adjusted EBITDA for this segment decreased by $51 million compared with the fourth quarter 2018. In the first quarter, we had noncash charges from elimination of intersegment profit in inventory and LIFO, foreign exchange and share-based compensation. Fourth quarter included income from these items. First quarter pretax special items include a $455 million noncash pension settlement charge and a $20 million legal charge. Excluding the pension settlement charge, our first quarter noncash nonoperating pension benefit cost was lower than the fourth quarter. We continue to expect to record approximately $60 million of expense for the full year 2019. Now I'd like to update you on our key financial items, which are summarized on Chart 12. We ended the first quarter with a cash balance of $259 million. Cash used in operations during the first quarter was $14 million. The first quarter is usually our lowest operating cash flow due to inventory and other working capital build as well as higher quarterly interest payments. Capital expenditures for the first quarter totaled $59 million. We continue to expect total CapEx for 2019 will be approximately $400 million, $120 million for Timberlands inclusive of reforestation costs and $270 million for Wood Products and $10 million for planned corporate IT system investments. As discussed on our last conference call, during the first quarter, we received $250 million of cash proceeds from the maturity of a note held by a variable interest entity that was established as part of a timber installment sale in early 2000s. Turning to financing activities. We repurchased 2.3 million shares of common stock in the first quarter for a total of $60 million. At the end of the first quarter, we had $440 million remaining on our share repurchase authorization. Moving on to debt, we ended the quarter with approximately $6.4 billion of total debt outstanding. And during the quarter, we issued $750 million of 4% notes due in 2029. Subsequently redeemed, the $500 million 7 3/8% notes that were due in October 2019 and incurred a $12 million pretax charge due to the early redemption. This charge for early extinguishment of debt is included in our results as a special item. Excluding that special item, first quarter interest expense was $95 million. We now expect full year 2019 interest expense will be between $370 million and $380 million, excluding special items. Moving on to taxes. For the second quarter and full year 2019, we now expect the effective tax rate will be between 7% and 10%, excluding special items. We expect minimum cash taxes in 2019 due to a $90 million federal income tax refund associated with the $300 million pension contribution that we made in the third quarter of 2018. We expect to receive that refund later this year. Now I'll turn the call back to Devin and look forward to your questions.

Thank you, Russell. Looking forward, we anticipate modest year-over-year U.S. housing growth and expect that building activity will accelerate as we move into spring and summer with improved weather and continued macroeconomic stability. We remain focused on delivering operational excellence and industry-leading performance to fully capitalize on a wide range of market conditions and drive superior value for our shareholders. And now I'd like to open up the floor for questions.

[Operator Instructions]. Your first question is from the line of Mark Wilde with the Bank of Montreal.

Really nice quarter, much better than we expected. I wondered, Russ, if you could just help us peel the onion a little bit on the quarter-to-quarter gains and in performance in both lumber and EWP. I know you mentioned kind of log costs, but those costs must have been down even more than we would have anticipated. And you also mentioned in EWP, part of it is always big. But if you could just put a little more color on that, that would be helpful.

Sure. So for lumber, as you mentioned, we did have lower log costs coming out of the fourth quarter so that was very much beneficial coming in the first quarter. And we also had improved operating performance coming into the first quarter. And similarly to EWP, we had a lower cost structure, they ran very well coming into the first quarter, and that really contributed to their overall improved performance.

And then I wondered, Devin, can you give us any perspective on what you guys see in terms of inventory sitting in the distribution channels right now?

Yes. Sure, Mark. Well, so it's -- I'd say for lumber and OSB, the inventories through the channel are probably a little on the full side. And so I think as we saw the building activity be -- start off the year a little slower than we had expected, you did see inventory levels build up a little bit. Our view is that as we see the construction activity really start picking up, that's going to flush through probably a little bit quicker on the lumber side than the OSB side just because we did see a little bit more supply coming online at the end of 2018 and 2019. On the EWP side, I'd say probably inventory levels are at reasonable levels. And some of the customers may be even keeping a little bit lower inventories than normal. But I'd say on balance in EWP, it's probably about normal for this time of the year.

Okay. Last thing for me. Just any sense from your perspective on sort of where mills in both the Northwest and up in Canada are sitting relative to cash costs right now, because it looks to me like pretty much everybody must be under water.

Yes. So Mark, I can't really comment on what our competitor is doing other than just to note, obviously, we've seen the announcements, as you have, on some of the curtailments and closures in those regions. For us, the way we've been really approaching our business in general is that we're really focused on OpEx and getting our cost structure in place so that we can be cash flow positive or breakeven even under these types of pricing environments. And so that's generally where we sit at this point.

Your next question is from the line of George Staphos with Bank of America Merrill Lynch.

I guess my first question, Devin, if you could comment -- what's your current estimate of operating rates this year, if you could provide one, for -- across your Wood Products businesses? And also, do you think that, switching gears to the OSB market, it can be in balance this year with your current estimate of housing? And if not, what do you think needs to happen there?

Yes, sure. So on your first question, in lumber, we're -- our operating rates for Q1 were in the low 90s. In OSB, they're in the mid-90s and EOP, they were in the kind of low 80s for operating rates. With respect to OSB, my sense is that it's going to take a little time for us to have the demand catch up with the supply with the new mills coming online and really getting up full. There's probably going to be a little bit more inventory in the system this year until we catch up from a demand perspective. Now that being said, I do think if we see the continued housing construction activity build into the spring and summer season and demand gets back up to where we think it ultimately will be, that should come back into balance over the course of the year and into 2020.

Okay. And coming back to EWP again, Mark hit on this as well. I mean we were very impressed with your performance there. I took from your comments, there was nothing one-off in nature. Obviously, had a little bit better pricing realization too. But is there anything in the first quarter performance in EWP that's not repeatable in the second quarter over the course of the year?

I think the answer to that is really no. Obviously, we got some benefit across all of Wood Products, including EWP, from lower log and fiber costs. And so we would expect that to continue really into Q2 on some extent. And then the other piece is just improved unit manufacturing costs, and we are hyper-focused on that with our OpEx initiatives. And so not only do we think that, that will carry over, we would expect that to even improve over the course of the year as we continue to focus on operating costs across the system.

Okay. My last question and I'll turn it over. Kind of one is more of a confirmation point. I took from your guidance on Timberlands again that you're not seeing anything other than normal seasonal increases in harvest costs and that's part of what is driving the sequential decline 2Q versus 1Q, but I want a confirmation on that. And then there was a legal charge of $20 million in the quarter, if I saw that correctly. Could you remind us what that was around?

Yes. Maybe I'll take the first one and then Russell can take the second one. Just in terms of the quarter-over-quarter, really, on the Timberlands segment basis, it's really a couple of things. It's about half of that relates to the ordinary cost increases that you see in Q2. So we build more roads, we have higher forestry expenses, we did defer a little bit of silviculture in Q1 that's going to get pushed to Q2. So that's about half of it. The other half is really just around timing of vessel shipments. And so we had a couple of ships that ordinarily, we are -- going into the quarter, we thought would ship out in Q2. They moved up a little bit into Q1. So that's the other piece. And then the last piece, which is a smaller piece of the puzzle is just, as you know, in the northern business, we go through spring breakup and so you see the volumes come down. And so that's really the driver of Q2 versus Q1.

And George, on the $15 million after-tax legal charge, that's just for potential settlement of various legal matters.

Your next question is from the line of Anthony Pettinari with Citi.

Devin, on the homebuilding front, you talked about builders adjusting their offerings to bring some more affordable product to market. And I'm just wondering, should we interpret that as a move from larger formats to smaller formats or single family to multifamily? And I guess as you kind of lower your estimates for full year starts a little bit, is there also potentially kind of a change in mix that could impact kind of aggregate demand for wood products?

Yes. And so really, when we're talking about the more affordable price points, that's really in the single-family space, so it's not a comment on mix from single to multis. I think it's really -- it's a host -- a whole host of things, Anthony. It's maybe smaller footprints in some geographies, it's different amenity packages, all the things that they can do to really meet that lower price point where a lot of the demand is. And so we are seeing some of that. You saw some of that, I think, on our earnings calls for various homebuilders. And certainly, that's what we're hearing out in the market. In terms of overall wood demand, my view is it's much better for us to the extent that the builders can make more houses, even if they're a little bit smaller. On aggregate, that's better for wood demand.

Okay, that's helpful. And then earlier this month, WTO issued a ruling on U.S.-Canada lumber dispute that was maybe a little mixed for U.S. producers. I was wondering if you could just give your take on it. And then just today the trade issue, we're kind of hearing rumblings of maybe potentially a resolution to the U.S.-China trade dispute. Is that something that your customers are anticipating or potentially buying -- impacting buying behavior or any kind of thoughts on U.S.-China trade as well?

Yes. Sure. With respect to the WTO decision, I think from a U.S. perspective, it was moderately positive. But again, just kind of stepping back, our view now is really that this is something that's going to play through the various channels of appeals through WTO and NAFTA over a course of several years. I think we're still early in that process. But at some point, I assume that we will come to some sort of agreement, which we believe should be quota-based. But I think we're still a ways off from that. In terms of the China agreement, obviously, there's a delegation going over to China early in May. We're optimistic that they're going to make continued progress there. I think on balance, the feeling with our customers is probably more optimistic and positive than it was a few months ago. But it's really hard to tell exactly how those talks are coming along. We're optimistic that it will get resolved at some point. And I think importantly, we're really well positioned if and when those tariffs do come off to reaccelerate the growth out of our Southern business. And I think in the West, it's really not had a big impact on us out of our Western export business, which is the 5% tariff. But that being said, we certainly would like to see that go away so we can get back to a completely normalized environment.

Your next question is from the line of Brian Maguire with Goldman Sachs.

Thanks for all the comments on the 2Q outlook. I know you guys don't give guidance, but just putting it all together, does it sort of seem like in the ballpark of sort of being in line with the 1Q number, sort of flat quarter-over-quarter, assuming current Wood Product prices?

I mean you're right. We don't give specific guidance, but I think if you kind of add it up, absent change in pricing, we give you some relative parameters around what the pricing impact would be looking quarter-over-quarter. You can probably piece it all together and then factor in the pricing.

Yes. And I would just add to that. From a Q2 perspective -- and you're talking about Wood Products specifically, Brian?

No. I was hoping the company as a whole.

Well, so just a couple of additional comments there. On a Q2 versus Q1 basis, we do think that Wood Products is going to be higher EBITDA. And that's -- even putting pricing aside, it's largely a reflection on continued improved operating rates and continued focus on costs. And so that in and of itself, we think, is going to be the driver. Pricing will just be an upside to that. And then again, the other piece just on Timberlands, as we said, that's going to be down versus Q1, but that's primarily just a reflection on timing and some seasonal cost.

Okay. Got it. And then it was good to see the Southern log price realizations tick up a little bit in the quarter, and I guess the outlook for 2Q implies that we stay at similar levels. Just wondering if you could parse out how much of that is maybe due to weather impacts or mix versus the long-awaited sort of tightness in that market that we've been predicting for many years?

Yes. And so we absolutely saw a healthy increase in pricing. And I'll tell you, I think the majority of that is due to weather. We had a really, really wet Q1 and that kept inventory levels low. It kept supply levels moderated, and so that was really reflected in the pricing that you saw. That being said, I do think we are starting to see some of those pockets that we've been talking about for years really start the tension where we have the new capacity coming online and running full. And certainly, we've seen that in areas of Central Mississippi, some areas in Arkansas, a few geographies in Alabama and most recently in Northern Louisiana. And so as we said, when that new mill capacity comes online and gets up and running full in that geography, that micro region, we are seeing some pricing tension. So on balance, I think the price increase was largely driven by weather, but we are starting to see the early signs of some tensioning in some of those micro markets.

Okay. Last one for me. Just thoughts on cash flow this year? I know you give some components like CapEx there, and I think that some of that is maybe discretionary over the long term. But how do you think about this year's free cash flow, ability to fund the dividend, continued share repurchases? Because it does seem like obviously, we're at sort of challenged levels of profitability and for sure, the Wood Products business, if not, Timberlands a little bit. How -- and it does seem like you've got a couple of onetimers in the cash flow this year that may not recur in future years. But how should we kind of be thinking about the dividend and the ability to fund that at these levels?

Yes. So let me just start off with a few comments on cash flow and then I'll move to the dividend. As you think about our FAD for 2019, a few things to keep in mind. So first, as Russell alluded to earlier, Q1 is typically our lowest quarter from an operating cash flow perspective, largely because of inventory build, et cetera. That generally will work itself out over the course of the year as it typically does. And so I don't think you should look at Q1 cash flow really and annualize that. That wouldn't be a typical way to do it. The second point that I would make is we are expecting minimal cash taxes this year because of, as Russell mentioned, just the pension transactions that will substantially reduce the cash taxes this year. But the other thing I would say is we're still optimistic that you're going to see some upward pricing pressure on commodity prices. As you see that construction activity really start to take hold, as we get into the spring, I think we're seeing early signs of that now. We do think you're going to see some upward pricing pressure as well. So we're still optimistic at this point in the year that we're going to have a healthy cash flow for the full year. Now that all being said, with respect to the dividend, as we said repeatedly, one of our core priorities around capital allocation is the sustainable dividend that grows over time. And so when we set the dividend at 85% of FAD, we really look at that over a cycle. And so we understand in commodity businesses, in cyclical businesses, sometimes, you're going to be a little bit above that, sometimes you're going to be a little below. And in those instances where we're over 100%, we don't look at that as a cause for panic. We've got levers that we can pull. There are some opportunities around CapEx. As we said, our sustaining maintenance CapEx in Wood Products is around $150 million to $200 million, and so there's some flexibility around that. There's still some things we can do around cost. As you know, we're very focused on OpEx and continuing to take costs out of the system. And then ultimately, we have a lot of liquidity. We have a strong balance sheet and so that gives us some flexibility. And so just with respect to the dividend and cash flow for the year, I think we are going to see some upward pressure on pricing, which will give us a little bit more flexibility there. But we have plenty of tools and levers that we can pull ultimately to make sure that we're continuing to meet our core capital allocation priorities.

Your next question is from the line of Mark Weintraub with Seaport Global.

First, just following up on the comment about Wood Products maintenance capital can be kind of in the $150 million, $200 million range. How much of the $400 million that you're guiding for this year is in the Wood Products business?

$270 million.

Okay, great. And then a second thing that sort of caught my attention was you has mentioned that you had run in the low 90s in Lumber and the mid-90s and OSB during the first quarter, which are pretty good operating rates. And then in the guidance, it says you're expecting to have higher operating rates across all product lines. And I guess in particular, what's striking is you're already in the mid-90s in OSB. And if prices are now $10 lower than they were on average during the first quarter, you're presumably not making much money in OSB at all, and yet you're running potentially higher than in the mid-90s in that business. And so kind of just what's the kind of the philosophy of running in OSB and Lumber relative to market environments?

Yes, Mark. So I would just comment, with respect to OSB, we did say that we're expecting to be higher in Q2. That's really a pretty small percentage relative to Q1. We were operating well in OSB, in the mid-90s already in OSB, so not a lot of uptick. The bigger uptick really is around EWP and a little bit Lumber as well. And I guess just with respect to your question around philosophy, a big part of how we look at our strategy is making sure that we have a really low cost structure so that we can continue to make money and drive cash flow regardless of pricing. And so it may make sense for us to run where it may not make sense for others to run. But again, it's a big part of our OpEx program being black at the bottom and are focused on having the right cost structure.

And so I guess as a part of that, when you say it makes sense for you to run whereas -- what would be the thought process behind making sense for you whereas for others, it might not? Is that because of your lower cost position or your smaller market position?

Having a lower cost structure so that we can continue to run profitably even at lower product pricing.

Okay. And then one last one, if I could. On EWP, great performance in the first quarter, considering the environment. What -- are there any price initiatives out there in the market? And I guess it was notable that prices were up in an environment where pricing for most of the other commodities were low. Or any more color on how that tends to play out would be much appreciated.

Yes. And what I would say on the pricing is a big piece of that was -- well, that was primarily mix. Just in context of pricing generally, there is a little bit of pricing headwind out in the market right now. But as we look forward, we're anticipating holding onto the price increases that we put into place and captured last year.

Your next question is from the line of Collin Mings with Raymond James.

First one just on OSB pricing. Can you maybe just expand on your comments in response to George's question? Do you think we are finding a bottom now in terms of OSB pricing? Or just given some of the recent deterioration, could there be some further downside from your vantage point?

I'd be hard-pressed to really try to call a bottom. What I would say is that as we see the construction activity pick up, we would anticipate that would start to drive some of the inventories down. And as we get further into the year, as long as you see that construction activity hold up, align -- along the lines of what we think is going to happen, we do think ultimately, you'll start seeing some upward pricing pressure on OSB. That's just a little bit tougher to call because that supply comes on and off in a more lumpy fashion maybe than Lumber does. And so we think directionally, ultimately, it's going to go up, but the timing is always a challenge.

Okay. All right. Fair enough. Appreciate the color there. And then just picking back up on the outlook for cash flow. Just recognizing -- you did already push your Real Estate EBITDA guidance marginally higher this quarter. Just how are you thinking about potentially ratcheting up land sales further in the current environment? And again, in the prepared remarks, pretty upbeat about kind of the demand you're seeing out there. Does it in particular make sense to maybe generate some additional cash for share repurchases just given where the stock trades relative to NAV?

So Collin, this is Russell. Again, as far as our Real Estate outlook, we increased it from $260 million to $270 million for the Real Estate, Energy and Natural Resources segment. We did come out of a strong first quarter, which is going to benefit again the second quarter. But we think the $270 million number is the right number to really capture the premium to timber value which is the key focus for that business. So I wouldn't anticipate we would increase that above our guidance to affect any other capital allocation priorities.

Your next question is from the line of Mark Connelly with Stephens Inc.

How are you thinking about freight if -- and I know it's not easy to separate from weather right now. But do you think freight costs for your system are going to moderate later this year?

Yes. What I would say is we've seen freight costs generally moderate in Q1 relative to last year. And part of that obviously is fuel prices. But I don't think, at this point, we're really anticipating a meaningful increase in freight nor are we expecting a meaningful decrease. And so it would more or less on par with kind of how we've been tracking in Q1 is how we're currently seeing it.

Okay, that's helpful. And if we could just go back to Japan for a second. If I look at Japan revenues over time, they have been slipping for a few years. But do you think we're reaching a bottom there or is there a structural reason why that may continue to slip? And certainly, as a percentage of your total, it slipped but that's really high-value stuff. So I'm just curious, do you think we're bottoming out?

What I would say about Japan is from a demand perspective, we have seen that remain pretty consistent over time, and the demand for our high-quality Japan logs remains solid now. I think what you're alluding to really is maybe a little bit more about realizations. And so as we think about Japan log pricing, there are really a couple of things to look at. So there is the correlation to the domestic market here in the West. And so you'll typically see that trade in a correlated fashion to what domestic pricing looks like in the Pacific Northwest. And then the other piece is just related to the dynamic in the Japan market. And so there is a competing product coming over from Europe that the Doug fir product has to compete against. And so those things all play together to come up ultimately with what Japan pricing looks like, and there's a foreign exchange piece to that as well. But again, just going back to the original comment, the demand has remained solid and we would anticipate that to continue.

Your next question is from the line of Chip Dillon with Vertical Research.

First question, just to make sure I heard you say -- heard you right. Did you say the industry OSB operating rate was mid-80s? Did I hear you say that or did I misunderstand you?

No. No. We just commented on our operating rate, which was in the mid-90s.

Mid-90s. So low 80s was lumped -- was EWP, is that right?

That was EWP, correct.

And you didn't give us like a guide on the Real Estate segment. Did you -- specifically like you mentioned in timber harvest, it would be down $25 million to $30 million from the first quarter. Did you give a similar guide for the Real Estate segment?

No, we gave a guide for the total Real Estate and ENR segment at $270 million for the year.

Okay. For the full year. Okay. That's helpful. And let me ask you this. One area of obviously of weakness in the Timberland segment has been in the export log area just in general, and I think the delta there is largely China. Any signs that their absence or relatively low levels of activity have started to turn around yet? Or is it just too early to know?

Yes. Here would be how I would phrase that. The Chinese demand that we've seen over the last 12 months really hasn't gone down that much. And I'm talking about specifically from the West Coast. Obviously, the South with the tariffs, the southern yellow pine demand has changed a little bit. But from the West Coast, we haven't seen the demand really fall off. Now maybe what you're referring to is during the Lunar New Year period, we do see a reduction in construction activity. And so you'll see a little bit weaker demand during that period and you'll see the inventory levels at the Chinese ports tick up a bit, and that certainly happened. But in terms of the China demand, we haven't seen a meaningful dropoff. And in fact, I do believe that construction activity in China recently has started to pick back up. That's what we're hearing from our folks on the ground. And so we would expect, as we get deeper into the spring and summer in China, you're going to see the continued activity and mostly continued good demand for our China logs.

Got you. And then the Southern log prices seem to be -- hold up pretty well, even though we're under the impression that, from the hurricane activity, it might have created a lot of salvage competition. Has that kind of worked its course? Or did it work itself out earlier than, I guess, the first quarter?

Yes. I think one of the things that may be mitigated to some of that during Q1 was just because it was so rainy across the system. Anybody that could move wood have the opportunity. And so I just -- I think the overall weather dynamics probably mitigated some of that impact. But even now across the system in the South, I would say inventory levels are moderate to low. And so from a pricing perspective, we would expect pricing to be comparable to Q1 as we think about Q2. With respect to the salvage, we don't have a whole out of ownership in that area so really didn't impact us meaningfully anyhow nor do we expect it to. But I think the fact that just because the mill inventories are low, that probably mitigated some of the downward pricing pressure in those areas.

Got you. And then last question just in terms of the operating philosophy. Certainly, in a fragmented market like lumber, it makes all the sense in the world what you guys do. But when you look at the last numbers I saw in OSB, you have basically a market construct that's similar, for lack of a better comparison, to the U.S. containerboard market where, without telling us anything, we can tell those producers are deciding not to hand inventory to their customers with which to resist future price rises until they work those inventories down. I mean could you argue that maybe in OSB, given the consolidated structure, that maybe it makes more sense to maybe operate similarly as opposed to shipping a lot at these very low prices, which again if I were a builder, that's great. That just means that when -- it's just going to take longer for markets to tighten up and longer for you guys to make money. I didn't know if you had any thoughts about that.

Yes. I really can't comment on what other folks in the industry are doing in terms of production. The way we look at it really is just we produce what we can sell at a profit. And so really, our focus is just on running our mills at a level that we think we can remain profitable and move our inventory. And so the other producers obviously will make their decisions, I think, similarly, but we really can't. We don't have visibility into that.

Your next question is from the line of Steve Chercover with Davidson.

So my first question was kind of a different spin on the whole freight issue. In 2017 and '18, I think some of the difficulties on the railroads contributed to the strength of lumber, at least the sense of scarcity. And I'm wondering this year, with lumber being weak, is that partly a function of improved efficiency on the rail network?

No. I don't think so. I mean I think without question, in 2018, that was the case. The challenges with rail particularly out of Canada created a little bit of an imbalance, particularly in the first half of the year. And when that unwound, that was part of the driver for while you saw lumber prices slide so dramatically. There were some challenges this year from a rail perspective. And so it's not as though everything went perfectly smoothly this year. But I do think the pricing environment kept people from building inventories to the same levels that perhaps they did last year. And so I don't think you're going to see the rail and transportation issues have near the effect this year that they did last year.

Okay. And then two other short ones. Were there any start-up costs associated with the ramp of your new sawmill in the South?

No, we don't have any specific start-up costs. I mean, we're clearly going to build that ramp-up over the next 18 months but, no specific charges related to that.

Okay. So I guess it'll -- the cost structure will come down. And the third one...

That's correct.

And the third one is with respect to just the commentary on running the mills for profitability. Is there any view that maybe the proper metric should be earning the cost of capital as opposed to generating a cash contribution or a modest profit?

Yes. Of course, over time, I mean, we're in business to earn in excess of our cost of capital. Now we don't look at that necessarily on a quarter-to-quarter basis. We look at that over a longer period. But without question, that's certainly our intent is to make sure that we're operating to earn returns in excess of our cost to capital, no question about that.

And today's final question will come from the line of Paul Quinn with RBC Capital Markets.

Very strong results and I think your offering rates in Wood Products are going to be the envy of the industry. But I thought I'd try to get some color on just the major CapEx projects that you're doing in 2019, that $400 million spend. Where are you spending it in Wood Products and Timber?

Yes. So remember, $120 million of that is on the Timberlands side and that's primarily reforestation. And so just in terms of the Wood Products side, that's about $270 million. And I'd say you still have some of that, that's coming on finishing up the Millport. And then beyond that, it's really just -- it's a mix of various projects across the system. So it could be CDKs, could be optimization in mills going after bottlenecks. So there's nothing that I could specifically point you to that's of the magnitude of Millport or a Dierks or Grayling. It's really a lot of projects across the system really going after improving our reliability and lowering our cost of manufacturing.

Okay. So no major projects in '19. Do you have any major projects in '20?

We're still working through that frankly, so I don't know that we're necessarily ready to comment on specifics. But as we get into the back half of the year, early part of next year, we'll provide more guidance on that.

Okay. And then just lastly, you mentioned a potential agreement with -- between the U.S. and China. Just wondering how material that would be to Weyerhaeuser?

I think it's directionally positive for us. But what I would say is if you think about our China business generally in the West, which is the much bigger piece from an earnings perspective, we haven't really seen a material impact other than some initial noise once the tariffs were put in place back last summer. So I think it would have a moderately positive impact to the West, maybe a few million. I think the bigger opportunity over time, although it's not a big earnings impact now, is the opportunity to grow the Southern export business. And so that business is not a meaningful percentage of our harvest in the South right now, but we had some good momentum going last year on building that program before the tariffs came into place. We've continued to have conversations with our customers in China, and we think there's a good opportunity for us there. But that's something that would grow over time, not meaningful probably in the very near term. It's more of a midterm opportunity from a magnitude perspective. All right. Terrific. Well, I think that was our last question. So thank you to everyone for joining us this morning and thank you for your interest in Weyerhaeuser Company. Have a good day.

Ladies and gentlemen, thank you for joining today's conference call. You may now disconnect.