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Executives

Edward R. Seraphim - Chief Executive Officer, President and Director

Larry S. Hughes - Chief Financial Officer, Vice President of Finance and Secretary

Peter A. Rippon - Vice-President of Pulp and Energy

Analysts

Daryl Swetlishoff - Raymond James Ltd., Research Division

Sean Steuart - TD Securities Equity Research

Mark Kennedy - CIBC World Markets Inc., Research Division

Stephen Atkinson - BMO Capital Markets Canada

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Pierre Lacroix - Desjardins Securities Inc., Research Division

West Fraser Timber (OTCPK:WFTBF) Q3 2013 Earnings Call October 29, 2013 11:30 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. Third Quarter 2013 Results 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 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.

Edward R. Seraphim

Thank you. Good morning. Joining us this morning is our CFO, Larry Hughes, and a number of our senior management team. West Fraser earned $55 million or $1.29 per share in the quarter. Adjusted earnings for the quarter -- second quarter -- excuse me, adjusted earnings for the third quarter were $68 million or $1.57 per share as compared to $107 million in the second. EBITDA in the quarter was $113 million or 13% of sales as compared to $178 million in the second quarter. Adjusted EBITDA was $132 million in the quarter as compared to $166 million in the second quarter.

Our Lumber business generated $83 million in EBITDA, a decrease of $42 million from the second quarter. We produced just under 1.3 billion board feet in the quarter. Lumber production was down approximately 5% from the second quarter due to fewer operating days and the impact of a number of our capital projects on production.

For the year, we've increased our lumber production by 200 million board feet compared to the same period last year, split equally between Canada and the U.S. South. After dropping approximately $100 during the second quarter, lumber prices improved from the end of June to the end of September by approximately $50. Last week, we announced our 3-part Mountain Pine Beetle plan, which included the exchange of timber rights with Canfor; the closure of our mill in Houston, B.C.; and capital upgrades at our Smithers and 100 Mile mills.

We completed the rebuild of the Chetwynd B.C. sawmill during the third quarter. We started up the new plant, our Edson mill, this month and we expect to rebuild the sawmill over the winter with the startup in the first quarter of 2014.

We've restarted the McDavid, Florida mill on one shift in October. As we have mentioned on our calls, we have a significant capital plan in our Lumber business for the remainder of 2013 and 2014. Our panels business generated $9 million in EBITDA, a decrease of $1 million from the second quarter. Higher plywood and MDF prices were offset by higher log cost and lower MDF production. Our pulp and paper business generated $40 million in EBITDA, an increase of $9 million from the first quarter. Improved earnings this quarter reflect improved NBSK prices, improved NBSK operational results, as well as higher BCTMP and newsprint production due to lower electricity prices in Alberta.

U.S. housing starts were relatively flat in the third quarter. To the end of July 2013, North American production increased by 7%, compared to the same period of 2012, or approximately 4 billion feet on an annualized basis.

Lumber demand has been relatively strong in October, nevertheless, we're still early in the recovery of the housing market and, as such, we should expect some volatility in lumber and panel markets over the winter.

Pulp markets are fairly balanced and prices have improved in October. With the onset of new capacity in Latin America, we do maintain a tempered outlook as we look into 2014.

With this, I'll turn the call over to Larry.

Larry S. Hughes

Thanks, Ted, and thanks to everyone joining us today. Please refer to the advisory contained in our quarterly MD&A concerning our use of terms such as EBITDA, adjusted earnings and adjusted basic earnings per share.

As Ted indicated, for the third quarter, we reported earnings of $55 million or basics earnings per share of $1.29. The table on the third page of our MD&A describes and quantifies several nonoperational items which affected our results.

If we adjust the $55 million earnings to add the $19 million expense related to equity-based compensation and subtract the $6 million gain related to the translation of U.S. dollar-denominated debt, the result on an after-tax basis is adjusted earnings of $68 million or adjusted basic earnings per share of $1.57 for the quarter.

The equity-based compensation expense reflected the strengthening of the company's share price over the quarter and the gain on the U.S. debt resulted from a strengthening of the Canadian dollar against the U.S. dollar as at the end of that period. On a similarly adjusted basis, results of this quarter were lower than those of the previous quarter, with adjusted earnings of $107 million and adjusted basic earnings per share of $2.49.

From an operating earnings and EBITDA perspective, our lumber results declined from the previous quarter due to lower prices, offset partially by our pulp and paper results, which benefited from higher prices. Our defined benefit pension plans are revalued as at the end of each quarter and the result this quarter was an actuarial gain of $66 million or $50 million after tax.

This actuarial adjustment will fluctuate with changes in long-term interest rates and the return on our plan assets. For this quarter, the gain was due to an increase in the applicable discount rate and higher earnings on the plan assets.

Cash generated by operating activities during the quarter, after working capital changes, was $128 million. Capital expenditures for the quarter totaled $96 million, bringing our total at the end of the third quarter to $219 million.

We are projecting capital expenditures this year to exceed $300 million, which will include approximately $100 million related to power production projects. During the quarter, we acquired 32,277 common shares for $3 million, pursuant to our normal course issuer bid. The normal course issuer bid allows us to repurchase for cancellation up to 1 million common shares during the period ending September 16, 2014.

Our balance sheet remains strong with a net debt-to-capital ratio of 3% at the end of the quarter. Last week, we announced the Mountain Pine Beetle plan, which includes the closure, next year, of our Houston, B.C. mill. The financial implications of the closure will be reflected in our fourth quarter results.

And, Ted, that concludes my comments.

Edward R. Seraphim

Thanks, Larry. So operator, we are now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Daryl Swetlishoff from Raymond James.

Daryl Swetlishoff - Raymond James Ltd., Research Division

First off, I'd like to say congratulations on the good news, dealing with the dead pine. Ted, now obviously, this is a difficult decision that affects employment and I know how important employee culture is to you. First off, what measures is West Fraser taking to mitigate some of the impacts?

Edward R. Seraphim

From an employee standpoint?

Daryl Swetlishoff - Raymond James Ltd., Research Division

Yes.

Edward R. Seraphim

Daryl, thanks for asking, and then again, it's a decision that we had to make. But I got to tell you, we don't feel very good about it. But in terms of where we're going, I mean, we were up -- a number of us were up in Houston last week, talking to our employees. And as you can imagine, it was quite a shock for them. Even though people knew something was coming with the Mountain Pine Beetle epidemic. So our focus now is really on transition. And, first of all, we're going to run the mill probably until May of next year, that's 7 months, gives the employees some time to think about what their options are. We are putting out relocation packages to all our employees this week, so that if they apply for jobs and get them in our mills, whether it's salary, trades, production employees, that we will be providing some assistance for them as they look to move to other West Fraser locations. And we are working with government. In fact, the provincial government is in Houston today. We already met with them yesterday and I expect we'll have job fairs and a number other events that will help employees look for other opportunities in the area and probably within British Columbia. Obviously, there'll be issues around retraining and a number of different things, and I just think we're going to be very active. One other thing we're doing, and we did this -- and we don't want to get good at this, by the way, but we did this when we shut Eurocan down, is we put together productivity and safety bonus incentive plans for all of our employees, whether they're hourly or salary at the mill. And we'll be communicating the specifics of that, probably in the next week or so, to our employees. And again, that will help people keep their eye on the job, keep safe and, hopefully, give something in addition at the end of -- when we shut the mill down. So there's a lot of productivity, we've got people up there and we're going to be very, very well -- very engaged. And given the fact that we've got over 70 jobs just opened on our job website today, we're hopeful that a number of those will be filled by folks in Houston. But again, one thing is having a job opened, second thing is having to move your family. So we're not kidding ourself, this is not going to be an easy thing to do. So -- but I appreciate you asking the question.

Daryl Swetlishoff - Raymond James Ltd., Research Division

That's great. Now when we redirect employment, and obviously you have new tenures, the first-run impact is somewhere around 3% of your capacity just -- if you just shut the mill. What sort of mitigation do you see in terms of this to your volume as you ramp up production at other mills?

Edward R. Seraphim

Well, I think, earlier -- in my comments, we have increased production, I guess, on an annual basis, by close to 300 million feet this year versus last year. And we are going to be further increasing our production in Alberta and we've completed our projects at the 3 large mills and we'll be completing the project at Edson. So we'll be getting increased capacity there next year. Our production in the U.S. South is going to be up this year over last year by 130 million, 140 million feet and we expect that to continue to increase by about a similar amount next year with the ramp up from our capital projects, as well as the start up with the McDavid mill. So as a company, I would expect that our production, overall, into next year, once we shut Houston down, our overall production will be higher in 2015 than it was in 2013. That's the best way of answering that.

Daryl Swetlishoff - Raymond James Ltd., Research Division

Okay, that's helpful. And then last thing, you mentioned U.S. South. A lot of the timber REITs are reporting their third quarter and some of them are suggesting that they're starting to see signs of tightening solid log prices in the U.S. South. Are you experiencing that in any of the timber drains in which you're operating?

Edward R. Seraphim

We've really seen, really, a very flat pricing for us, overall. There are 1 or 2 exceptions to that, where we've seen a slight increase, but we're talking $1 a tonne, that kind of thing, Darryl. So it's been very, very modest.

Operator

The following question is from Sean Steuart from TD Securities.

Sean Steuart - TD Securities Equity Research

A few questions. Ted, can you speak to your lumber sales mix this quarter and, I guess, how it might have changed from Q2? And I asked because lumber price realization pressure was a little more significant than we expected, but costs were also down at the sawmills and I would assume some of that's related to mix? Maybe you can just offer some context there?

Edward R. Seraphim

Well, Sean, I think there were really wasn't any major shift in our mix from quarter-to-quarter. Our volumes in Japan and China continued to be strong and held up very well. So I think part of it is likely the lag that you see in terms of what we reported as the cash price versus when we ship the product. So it's really more a lag, if anything, Sean.

Sean Steuart - TD Securities Equity Research

Okay. And then you did see the stumpage hikes in the B.C. interior flow-through as expected. You talked about the 5 to 7 per cubic meter starting July, that was what you guys saw in your results?

Edward R. Seraphim

Well, again, there's a bit of a lag there as well, but those increases have gone through.

Sean Steuart - TD Securities Equity Research

Okay. And then, Ted, just lastly, I guess with respect to growth ambitions beyond your CapEx program, which as you guys have detailed, is going to be very aggressive the next 2 to 3 years. Wondering if you have any updated thoughts on, I guess, scope for potential M&A activity? And, I guess, specifically I know you guys are focused on growing in the U.S. South, but if the opportunities aren't there, can you speak to your appetite for anything beyond lumber and the wood product space, and maybe speak to potential scale you might look at.

Edward R. Seraphim

Well, generally, as Hank has taught me, we don't talk too much about M&A activity. But in all honesty, I think we're looking at it today. You commented on our capital. We're always looking to grow, but our focus is really on solid wood, whether it's lumber or other solid wood products. We're continuing to look at growth but it's definitely a real challenge. I mean, everybody has got very strong balance sheets, valuations are strong and people's expectations, in terms of sellers, are very, very high. So we are going to continue to look at it and whether we can grow over the next year, over the next 5 years, that's our goal, but we can't tell you when or how, but we're definitely focused on trying to grow this company at the right valuation.

Operator

The following question is from Mark Kennedy from CIBC.

Mark Kennedy - CIBC World Markets Inc., Research Division

So first question. Just in terms of pulp price increases heading in here into Q4. We got a couple of announcements on the NBSK side, do you expect to see similar movements on your BCTMP? Just wondering if you can give some context there of what you're expecting in Q4 on those grades.

Edward R. Seraphim

Thanks, Mark. I think, fundamentally, in fact, today, I think you saw that the world inventories came up for chemical market pulp and they're down I think by about 4 days, so I think that's pretty encouraging at least in the short-term. And we've seen the same type of price movement in our BCTMP business, as we've seen in NBSK. We've got very strong BCTMP order books at this point.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay, all right. And then coming back to your Lumber segment. You talked a little bit about this lag defect on your -- possibly, on your log costs as well, so does that suggest then that your fiber costs, your log costs will be as high if not a bit higher than in Q4 compared to Q3?

Edward R. Seraphim

We expect them to be relatively flat. I think -- Mark, I think there's been a small drop in stumpage, there has been in B.C. in the fourth quarter, $2 to $3 depending on where you're at. So I think, overall, we're expecting flat.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And then any CapEx guidance yet on 2014?

Edward R. Seraphim

I think, fundamentally, as Larry said, we're expecting to over $300 million this year. And I think we'll be in the similar ballpark next year.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And then finally, as far as the Houston closure goes, can you give us sort of what your book value or carrying value was there? And have you determined sort of other closing costs? Or is that going to come later?

Edward R. Seraphim

I think we'll be reflecting that in our fourth quarter results.

Operator

The following question is from Stephen Atkinson from BMO Capital Markets.

Stephen Atkinson - BMO Capital Markets Canada

In terms of overall B.C. production, how do you see it like 2013? Let's say going out a few years, with the beetle progressing as it is, how do you see your overall B.C. production?

Edward R. Seraphim

You're speaking just West Fraser's production?

Stephen Atkinson - BMO Capital Markets Canada

No -- I mean, West Fraser. Yes.

Edward R. Seraphim

Yes. Well, I think, as we look at it, I think as we look at 2015, because Houston will be running next year, so I think that's what you really want to compare it to. I think, fundamentally, our plan is to track Houston's production. And I think we'll be -- we'll see some slight increases in Chetwynd as we ramp that mill up by maybe 100 million feet over the next year or so, but I think, overall, will be flat to slightly up once you take Houston out.

Stephen Atkinson - BMO Capital Markets Canada

Okay.

Larry S. Hughes

I mean, we're going to be spending money at Smithers and 100 Mile. So overall, we're going to have -- basically, all our mills will be fairly modern and a lot of them -- hopefully, have completed our capital spending at 100 Mile and Smithers late next year or early the year after.

Stephen Atkinson - BMO Capital Markets Canada

So in terms of the beetle, what is your percentage right now of bettle wood?

Edward R. Seraphim

Look, it is dropping, Stephen. I think it depends where you are in the province. But I don't want to be too specific, but I think we're probably 10% or 15% lower beetle as a percentage of our fiber than we were, say, 2 years ago. So it is dropping fairly quickly.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And can you talk about sales to China? How that is going? That lumber?

Edward R. Seraphim

Well, actually, we just completed -- I wasn't able to go on the tour, I went to Japan. But Chris McIver was in Japan and China, and he was with the rest of the industry there. And demand is very strong in China, we've continued to see strong, strong demand there, particularly through the summer and through the fall this year, so very strong at this point.

Stephen Atkinson - BMO Capital Markets Canada

And in terms of your major projects, the power projects, are you able to give me an update of where you are and where you would like to be or where you plan to be? Let me put it that way.

Edward R. Seraphim

Well, I think we are where we'd like to be.

Stephen Atkinson - BMO Capital Markets Canada

Yes, I agree.

Edward R. Seraphim

And, actually, we've -- we're starting up the -- at our joint venture, Alberta Newsprint, mill in Alberta. We're starting that up late this year. Probably late December, early January we're going to be starting up the 63-megawatt gas-fired power plant. In terms of our 2 power projects at Chetwynd and Fraser Lake, I think we're looking at May or so, June. Peter Rippon is right here beside me, correcting me. Peter runs our pulp and energy business. So we're looking at June of next year. And then the Slave Lake -- let's call it biogas project, we're looking at starting that up kind of mid-next year.

Peter A. Rippon

A little towards the end.

Edward R. Seraphim

He says towards the end. I'm more ambitious than he is.

Operator

[Operator Instructions] The following question is from Paul Quinn from RBC Capital Markets.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Just a question on, well, I guess, tough decision on the Houston closure, but with your -- would it be fair to say, under your Mountain Pine Beetle plan, that, that's -- it'd be accounted for all the potential closures that you're going to have? Or is that just what you can see at the current moment?

Edward R. Seraphim

I think, in terms of that, I think we've basically -- we've made our plan. That doesn't mean that all our problems are behind us. We still have significant competitive issues as we look at the Cariboo. So we've decided where we're going to invest. We've invested in Quesnel, we have invested in Williams Lake, we've invested in 100 Mile. Our [indiscernible] mill, I think we modernized that 8 or 9 years ago. So a lot of it is going to really depend on how our competitors react and their competitive position vis-à-vis ours. We think we have a strong position but I think, Paul, there's no guarantees, that's for sure, but I think that's what our plan is for now.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Okay, fair enough. In terms of U.S., now that you've got McDavid up, what's the plan on Folkston?

Edward R. Seraphim

Well, I think, in terms of Folkston, we continue to assess that. We've got a lot on the go into U.S. South. I think we want to get McDavid up and going. And then we'll look at Folkston, part of that is market and part of that is fiber availability as well. We have to get very comfortable around that. So we haven't -- we're not ready to make a decision on that. I don't see that being something we'll look at this year.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Okay. And then just -- you signaled a higher log cost for the panel side. Is that a temporary issue or is that something that's going to recur going forward?

Edward R. Seraphim

Well, I think, it's just -- overall, it's all really due to stumpage, movements on stumpage. So I think it will really fall where overall stumpage costs go.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Okay. And just on the pulp and paper side, if you could give us an indication of maintenance schedule going forward?

Edward R. Seraphim

Sure. We're looking at a mini-shut at Cariboo next May, for 6 days and then we're doing our -- a large shut at Hinton, which we do every 3 years a large shut, we do a mini-shut every 18 months. We'll do a large shut 16 days next September.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

And you can confirm that Peter is in agreement with that?

Edward R. Seraphim

He hasn't hit me too hard on these questions. He hit hard on Stephen's but this one -- I think I'm doing a good job on that one. Yes.

Paul C. Quinn - RBC Capital Markets, LLC, Research Division

Just kidding. Okay, and lastly, we expected some pretty significant cost inflation, especially on your lumber side. And taking a look at those lumber costs, you did a great job keeping it down. Is that -- and it kind of surprised us, is that what you're expecting going forward, that your CapEx spend will offset any kind of cost inflation you're seeing?

Edward R. Seraphim

Well, I think, we're hoping that it will more than offset that. I mean, we're looking at spending the kind of capital we're spending on our Lumber business. And the types of paybacks we're looking at, we should -- it should more than offset any inflation.

Operator

The following question is from Pierre Lacroix from Desjardins.

Pierre Lacroix - Desjardins Securities Inc., Research Division

Ted, just one follow-up on what you commented on your growth. Going forward, you said that you'll try to grow at the right valuation. Just -- I was hoping to get a bit more comments versus what the transaction we had in the industry in the last 12 months versus where do you stand versus the valuation that is being paid right now in the market?

Edward R. Seraphim

I'm not sure what transactions you're referring to. If you're referring to the acquisitions by Canfor and Interfor in the U.S South, just want to remind you that we've been there for a long time. And we've been very focused on spending capital out -- down there. Those valuations look appropriate to us. But expectations, I think, probably from the independents are maybe a little higher than they should be today.

Operator

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

Edward R. Seraphim

Well, again, thanks for joining us, and we'll look forward to talking to you next year. Thanks. Have a great day, everybody.

Operator

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

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