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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

Analysts

Sean Steuart - TD Securities Equity Research

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

Mark Kennedy - CIBC World Markets Inc., Research Division

Daryl Swetlishoff - Raymond James Ltd., Research Division

West Fraser Timber (OTCPK:WFTBF) Q4 2013 Earnings Call February 14, 2014 11:30 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. Fourth 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, Mr. Seraphim.

Edward R. Seraphim

Thank you, and good morning. Joining us today is our CFO, Larry Hughes, and a number of our senior management team. Larry will discuss our fourth quarter earnings shortly. I'd like to focus my comments on our performance in the fourth quarter, our key activities during the year and our outlook for 2014.

With respect to the fourth quarter, we faced a number of challenges that impacted our results. In terms of lumber markets, we were impacted by higher discounts on our Southern Yellow Pine wide sales. We expect those discounts to improve as U.S. housing ticks up.

We also had a very busy quarter with a number of capital projects in progress, as well as a number of startups in both Canada and the U.S., most notably the startup of the Williams Lake and Edson planers, the shutdown of the Edson sawmill and the ramp-up of our sawmill rebuild at our Chetwynd facility.

In the U.S., we started up a number of continuous kilns and worked through the ramping up of our new plant in Henderson. In addition, we restarted our McDavid sawmill, which also had a negative impact on earnings.

Our panel business had a somewhat weaker quarter due to lower production in shipments. But overall, this business was a strong contributor for the year.

Turning to our pulp and paper business, results were impacted by lower earnings in our joint venture newsprint mill due to scheduled shutdown to connect our 63-megawatt power plant. The power plant is expected to start up towards the end of the first quarter.

The key contributor to the decline on our quarterly earnings was operational difficulties in our 2 NBSK mills. There's no question that we're all disappointed with the fourth quarter results in our NBSK business. We've invested the capital and have a good cost structure in place.

Cariboo Pulp has been a very reliable performer, but we did struggle operationally in the quarter and, at times, during the year. The mill is running well in 2014, and we look forward to better operational results going forward.

Our Hinton mill has faced greater challenges. And as such, our #1 operational priority is to improve mill reliability at that site.

As we look back on 2013, we view the year as a turning point in the housing recovery. We still appear to be in the early stages of the U.S. housing recovery. As housing starts in 2013, we're up 20% from 2012 to 930,000 starts. Our expectation is for some volatility through the early stage of the housing recovery, but we continue to be optimistic about the prospects for the medium term.

Improving North American demand has been supported by continuing strong lumber shipments to China. North American production increased by approximately 5% to 55 billion feet. While this is up from the trough of 42 billion feet in 2009, we're far off peak production of 75 billion feet in 2005.

Our outlook for plywood in MDF markets is fairly positive as demand for these products continue to improve. The weaker Canadian dollar should also benefit our plywood sales given our exposure to the Canadian market.

Pulp markets have remained fairly balanced, but we expect that they will be under pressure as new capacity ramps up this year.

At West Fraser, we continued to grow productive capacity in Alberta and the U.S. South, while we wrestled with the impact of the Mountain Pine Beetle in British Columbia.

In October, we announced our Mountain Pine Beetle plan, which included the shutdown of our Houston sawmill in the second quarter of 2014 as well as announcing capital upgrades for Smithers and 100 Mile.

We look forward to the startup of our Edson sawmill at the end of the first quarter, the startup of a number of kilns, planers and sawmill upgrades in the U.S.South during 2014 as well as the startup of 4 power projects during the year.

We're in the midst of the most comprehensive capital spending program in our company's history, and while it's creating short-term operational challenges, we're very encouraged by the quality of our projects and expect to achieve the planned paybacks.

We spent approximately $360 million on capital projects in 2013 and expect to spend in excess of $300 million in 2014.

I'd like to take this opportunity to acknowledge our employees, who continued to demonstrate their commitment to the effort required to drive superior long-term results.

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 the use of terms such as EBITDA, adjusted earnings and adjusted earnings per share.

Also, all per-share amounts that we refer to have been adjusted to take into account the stock dividend, which we announced in December and completed on January 13, 2014.

For the fourth quarter of 2013, we reported earnings of $118 million or $1.37 a share. As we have done in the past, on Page 10 of our MD&A, we have adjusted those earnings for nonoperational items, which, for this quarter, included the normal equity-based compensation charge and the U.S. dollar-denominated debt but also included a restructuring charge related to the announcement in the quarter of the closure of our Houston, B.C. mill, and a gain on the sale of tenure relating to the timber harvesting rights exchange that was completed in the quarter.

These items produced, on an aftertax basis, a $33 million favorable adjustment. However, we had an additional significant adjustment for the recognition of U.S. loss carryforwards, which produced a negative adjustment of $101 million, resulting in a cumulative aftertax negative adjustment of $68 million.

After all of these adjustments, our adjusted earnings were $50 million or $0.58 per share. This represented a decline in adjusted earnings compared to the third quarter of 2013 of $18 million, a decline of 26%.

On a quarter-to-quarter basis, operating earnings for each of our 3 segments declined with lumber off by $25 million, although that was substantially the effect of the Houston restructuring charge. Panel's off by $4 million, and pulp and paper off by $16 million. We analyze these changes in detail in the MD&A, but in general, results were affected by lower lumber and plywood shipments, a weakening of wide-width Southern Yellow Pine prices and continuing operational difficulties at our NBSK mills.

For the full year 2013, our earnings were $349 million, or $4.07 per share, as shown on Page 3 of our MD&A. Adjusted earnings for the full year were $328 million, or $3.82 per share, and this compares to $128 million, or $1.50 per share, in 2012. This $200 million improvement reflects the gradual improvement of lumber markets and the progress that we have made in upgrading and making more efficient our operating platform. With U.S. housing slowly mending, our outlook for the future is positive.

I won't go over the various adjustments for the year except to note that the equity-based compensation for the full year was $54 million as the trading price of a West Fraser share increased almost 48% from the beginning to the end of 2013.

As of the end of 2013, our earnings sensitivity to a $1 increase in our share price is approximately $1 million.

Cash flows from operating activities in the fourth quarter were $33 million compared to $128 million in the third quarter, reflecting seasonal log inventory buildup.

Capital expenditures in the quarter were $119 million, and for the year, capital expenditures were $358 million, including the Houston Quesnel timber exchange valued at $20 million.

As Ted mentioned, we're expecting capital expenditures in 2014 to be in the range of $300 million, which will include the completion of several energy projects that are currently in progress.

We recognized $101 million of deferred income tax assets in the quarter. These relate to noncapital loss carryforwards of $261 million generated by our U.S. operations in previous years. We're required under applicable accounting rules to recognize the benefit from the full amount of the tax assets, although for tax purposes, we are permitted to apply the loss carryforwards only as we generate positive earnings from our U.S. operations.

For the full year, the revaluation of our defined benefit pension plans, which flows through the -- through other comprehensive earnings, resulted in a $113 million aftertax actuarial gain as the discount rate used to present-value pension liabilities increased from the previous year, and the actual return on planned assets exceeded assumptions.

In 2013, we made contributions to our defined benefit plans of $92 million, and we expect to make payments totaling approximately $40 million in 2014.

Our balance sheet, as at December 31, 2013, remains strong with $162 million of cash and short-term investments on hand, as we continue to build significant log inventories at our Canadian solid-wood operations.

We ended the year with a net to debt -- net debt-to-capital ratio of 8%.

Ted, that concludes my comments.

Edward R. Seraphim

Thank you, Larry. And now I think we're ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Sean Steuart with TD Securities.

Sean Steuart - TD Securities Equity Research

A few questions. Ted, maybe just go into a bit of detail on what happened at the NBSK mills. I guess, in your MD&A, you broke out expected maintenance downtime versus unexpected hits. Maybe, again, a little bit of detail what happened to both of the operations? How things are running into the first quarter, and I guess, expectations for the maintenance schedule for 2014 of both mills?

Edward R. Seraphim

Sure. Well, I think, first of all, in terms of 2013 -- I'll talk with -- about Cariboo first and then Hinton. Really, at Cariboo, we really had no large major issues. We just had a number of reliability issues around the mill. We have spent a lot of capital there previous to that. We've put in a new cogen facility. We've put in a new chlorine dioxide facility. And I think -- and then I think to some degree, and I think this also affects Hinton, is with all those projects, I think it did affect our mill reliability programs. And I think we paid the price there. So nothing significant, Sean. And moving to Hinton, the issues we've talked about, and I've got to be honest with you, I don't like having to talk about this because we really expect these mills to run well. But the issues we had in, say, 2012, were more around the machine upgrade. We put a -- we did a complete upgrade of that machine, and so we had a lot of issues there. And I think, again, we put so much focus on the machine, and we were counting on the rest of mill, the front end of the mill, the digesters, the recovery boilers, et cetera, to run well. And we really had no issues with those in 2012 of any magnitude. And once again, I think, our reliability program, overall, for the mill suffered. And that's really where we had most of our issues last year. And again, nothing major, but very frustrating. I don't like -- I don't think I can sit here and tell you that we have a magic bullet here. I think it's really about focus, reliability, and I can tell you that our group is very focused up there. And we just got to keep working at it and -- because we do have a good cost structure. Both those mills run well. We have a very good cost structure. And so from my perspective, it's just about focus, focus, focus. In terms of how the year started, Cariboo has run well. Hinton's ran a little bit better than last year, but it's still not where we want it to be. In terms of our maintenance shutdowns, we have a short one in Cariboo in May that's about 6 days, and then we have our major shutdown in Hinton in September. That'll be 15 days.

Sean Steuart - TD Securities Equity Research

Okay. But I guess, I know it's sort have been a recurring story for you guys, intermittently, pulp downtime and unexpected. But yes, Q4 just seemed relatively pronounced, certainly to what we expected but -- okay, so maybe just a series of small issues on top of the regular maintenance stuff.

Edward R. Seraphim

Well, I've got to tell you that it was just, as you said, a series of issues, but they all added up to a terrible quarter. We're not happy, and I can tell you our folks at Hinton aren't happy. And I think we are putting a lot of effort in terms of trying to develop long-term mill reliability at that facility.

Sean Steuart - TD Securities Equity Research

Okay. Last question for me. On the sawmill side, the volume pressure you saw there. Wondering if you can break down whether it's sequential volume weakness or -- relative to your capacity. The Q4 pressure you saw there, can you give us a rough breakdown of how much of that was tied to all these discretionary projects that you're in the process of or finished off during the quarter, and how much might've just been related to normal seasonality and/or poor weather in the fourth quarter?

Edward R. Seraphim

We did experience a little bit of poor weather, a little bit more than normal, but I think the primary reason is, I mean, is the -- all the capital upgrades we're doing. I mean, I just mentioned the major ones. We have an extensive list, and we're in the process of upgrading just about every mill in our system. So I think it's really a matter of a lot of short-term pain. And you can imagine, as you're trying to run a mill and you're trying to rebuild it, you're going to have some impacts. But I think, we're very encouraged about our projects, and we're going to continue to seek progress in terms of our operations.

Operator

The next question is from Paul Quinn with RBC Capital Markets.

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

I was wondering if you could quantify the impact of the ANC shut in the quarter, just to try to understand how big the NBSK issues were.

Edward R. Seraphim

Well, I think the NBSK issues would've been, I don't know, it's definitely the majority. I'm not going to give you a number, but it's definitely more than 50%. But ANC, I mean, did impact us, maybe 20%, 25%, so I've basically given you the number.

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

Yes, that's helpful. Keep up the good work. Maybe a question on production gains. You've got a bunch of CapEx that you're spending this year and next year and probably the following year. What can we expect to see in terms of '14 production in each of the regions off the '13 base in terms of percentage change, if you could give that?

Edward R. Seraphim

Well, I think, in terms of Canada, I think you will see our production increase over the year. We're starting up the Edson sawmill at the end of the first quarter. We continue to see improvements in our 3 other Alberta mills. We did major capital upgrades, and we completed most of them late 2012, early 2013, and we continue to see improved production there. Our Chetwynd mill has ramped up very well this year from its sawmill upgrade. So I think the main negative for us this year will be the shutdown of our Houston mill mid second quarter. So I think, overall, we'll see Canada up. And in the U.S., we expect, with the McDavid startup, we're still going through that, the benefits of some of our capital upgrades. We'll see -- I think we're -- our expectation in terms of production is probably in the area of another 15% or so potentially, maybe a little bit more in terms of increase in the U.S., so -- over the year. Although the start of the year has been a challenge with weather down there, but on a run-rate basis, we expect to be up in the U.S.

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

Okay, that's helpful. And then just lastly, just on the energy side. If you could remind us of the major projects that you've got, and what your expected sort of EBITDA contribution to be from those projects by the end of the year?

Edward R. Seraphim

Well, we basically got, as I said, 4, and actually, there's probably 5. But 2 of them are the startup of the -- our 2 energy systems at Fraser Lake and Chetwynd. Those will be starting up in, I think, late second quarter and then mid third quarter. And as we said on those projects, we expect 4.5-type payback. I think we said something around that 4.5-a-year type payback. So we announced $90 million. So I think you can do the math there. There's about $20 million there. And then we're starting up the Alberta Newsprint 63-megawatt project at the end of this first quarter. Again, that's a peaking plant, so really, all we can do is estimate what that will be, but that will be a significant return. At Slave Lake, we're starting up the biomethanation plant at the end of this year. Quesnel [indiscernible] pulp, there was another project where we're reducing our energy consumption there at the front end of the mill. It's a -- I'm not going to bore you with the details, but we're reducing you -- we're reducing our energy consumption there. All in all, I think if you look at the money we're spending in energy, I think, by the end of this year, from late 2011, we're probably in the area of a couple hundred million dollars. So I think guidance on that will be somewhere 4-, 4.5-year payback, $40 million to $50 million of EBITDA generated on a run-rate basis by the end of this year.

Operator

The next question is from Mark Kennedy with CIBC.

Mark Kennedy - CIBC World Markets Inc., Research Division

First question, I think there was a discussion in your release that with your Alberta mills, ANC and Slave Lake, that at times of high-power prices, you may actually take shutdowns. Now obviously, there's going to be an offset here when this peaker plant at ANC starts up. So I guess my question is, is that do you see that as being a net gain at the end of the day, that whatever you lose on the shut, you make up on the energy side? Or is it a net loss if that happens?

Edward R. Seraphim

Well, the peaker plant, for us, isn't really any different than what we've had with our power purchase agreements for a number of years that affected both Alberta Newsprint, Slave Lake, and to a lesser extent, our MDF plant in Alberta. But at the end of the day, we are making decisions on a minute-by-minute basis whether to produce pulp or to produce power. And we've also built in capacity at the front end of these mills so that when power prices are low, we can run the mills harder. And when power prices are high, we slow down or shut down the front end of the mill and continue to produce pulp. So I don't -- I actually think high power prices are a good thing for us in Alberta.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay, all right, That's helpful. And then just a question. Obviously, we've heard a lot of chatter recently on sort of railcar reliability and availability. So I just wanted to see how much of an issue was that proving to you in Q1? And are you seeing any issues related to having to look at downtime or anything else because of transportation reliability?

Edward R. Seraphim

Well, I'll answer the second question first. We don't expect any impact on our production, given rail service or weather. It has been a challenge. We don't see this as having a material impact on our results for the first quarter, and definitely, whatever we can't ship in the first quarter, we'll be able to ship in the second quarter and third quarter. So I think, on -- and we don't really look at our business on a quarter-by-quarter basis. So as we look at the whole year, we don't see this as being really an issue at all. Yes, we have to work through it, but we don't see this being a material financial issue.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And then my last question, Ted, when I look at your segment in lumber earnings, like your realized lumber price was up about $35 from Q3 to Q4, but your EBITDA margin was only up about $10. Is that a reflection, again, of a lot of the capital projects like also impacting your overall sort of cost performance as well?

Edward R. Seraphim

Mark, I think, I'm not sure where your question's coming from because, really, what we looked at is -- I think you're talking about the benchmark price, but the big issue for us is really the discount on the Southern Yellow Pine wides.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. So that would have been impacting your numbers more than the capital side?

Edward R. Seraphim

Exactly. Yes.

Operator

[Operator Instructions] The next question is from Daryl Swetlishoff with Raymond James.

Daryl Swetlishoff - Raymond James Ltd., Research Division

Just a question more for Sean McLaren. Just looking at your operations in the U.S. South, especially focusing on the South Gulf region, we're hearing reports from timber rates that those areas are experiencing less timber cost inflation. Is that what you're seeing as well relative to the rest of the U.S. South?

Edward R. Seraphim

I don't think we have Sean on the line. We can't afford to have him on the call from a cost standpoint.

Larry S. Hughes

He's long distance, yes.

Edward R. Seraphim

Yes. So I'm going to have to handle it, Daryl. No, I think -- fundamentally overall, whether it's in the Southeast or throughout our Southern regions, we're really not seeing any material cost inflation at all in log cost.

Operator

There are no further questions registered at this time. I would now like to turn the meeting over to Mr. Seraphim.

Edward R. Seraphim

Okay. Well, thank you very much, and we look forward to talking to you in a few months.

Operator

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

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