West Fraser Timber's (WFTBF) CEO Ted Seraphim on Q2 2016 Results - Earnings Call Transcript

| About: West Fraser (WFTBF)

West Fraser Timber Co. Ltd. (OTCPK:WFTBF) Q2 2016 Earnings Conference Call July 22, 2016 11:30 AM ET

Executives

Ted Seraphim - President and Chief Executive Officer

Larry Hughes - Chief Financial Officer

Chris McIver - Vice President, Lumber Sales and Corporate Development

Rodger Hutchinson - Vice-President, Corporate Controller and Investor Relations

Analysts

Mark Wilde - BMO Capital Markets

Hamir Patel - CIBC Capital Markets

Sean Steuart - TD Securities

Paul Quinn - RBC Capital Markets

Operator

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Q2 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.

Ted Seraphim

Thank you. Good morning, everyone and thank you for joining us today. With me is Larry Hughes, our CFO and a number of our senior management team. Larry will review our financial results with you shortly. I would like to make a few comments regarding our operational performance. I will also briefly comment on lumber and pulp markets.

We continue to make progress in our lumber business as we are seeing the benefits of our extensive capital spending program. Excluding the acquisition of Manning Forest Products, which we acquired in October of 2015, we have increased production by approximately 200 million feet over the first six months of 2016 compared to the same period in 2015. We are seeing improvements in manufacturing costs, recovery and grade as well. Our panels business continues to be a strong performer for the company, with production up from 2015 across our operations, with the exception of our West Pine MDF plant, which has been down since the middle of the first quarter. We are in the process of repairing the mill and are looking forward to its restart late this year.

We are experiencing better operational results in our pulp and paper business as compared to 2015. We have had a strong operating history in our BCTMP mills and our joint venture Newsprint mill. We continue to be pleased with the performance of these three mills despite challenging market conditions in the second quarter for our BCTMP business. We are making progress in our NBSK operations as production is up 7% from the same period in 2015. Our Hinton mill continues to show improving results. What is particularly encouraging is that we have set a number of short-term production records at the mill this year. Nevertheless, mill reliability issues are not yet behind us and we continue to focus a significant amount of management focus on this operation.

Our outlook with respect to lumber markets continues to be very positive with respect to the medium-term. For some time, we have been consistent in our view that until we see 1.3 million U.S. housing starts, we will experience some volatility in lumber markets. This week’s release of U.S. housing starts and existing home sales is very encouraging and further supports our optimistic view. U.S. housing starts were just under 1.2 million in June. U.S. existing home sales achieved a new post-crisis high in June at $5.57 million, the highest level dating back to the first quarter of 2007. Key factors such as demographics and improving U.S. economy and low new home inventory should continue to spur new home construction. Our business in China is quite strong as we look out for the remainder of the year.

BCTMP markets have been under significant price pressure for the first half of 2016 due to challenging operating conditions in China. BCTMP prices hit bottom in the second quarter. We have seen them increase by approximately 15% over the past few months and expect that BCTMP markets will remain strong for the remainder of the year. NBSK pricing has been relatively flat.

With this, I will turn the call over to Larry.

Larry Hughes

Thanks, Ted and thanks everyone for joining us today as well. I will be referring to several non-IFRS terms in my comments this morning and so please refer to our MD&A under the heading non-IFRS measures for definitions and descriptions of how these terms are calculated.

For the second quarter of 2016, we reported earnings of $98 million or $1.22 basic earnings per share. Beginning on Page 3 of our MD&A, we identify various non-operational items, which we adjust from earnings in order to more clearly reflect the results from our operations. The result, which we refer to as adjusted earnings, was $64 million or $0.80 adjusted basic earnings per share. This compares with $0.60 per share in the first quarter of 2016 and $0.15 per share for the second quarter of 2015. The most significant adjustment to earnings in the quarter was a $30 million gain related to equity-based compensation.

Operating earnings from the lumber segment improved compared to the previous quarter by 24%. And for the first half of 2016, we have seen a 45% strengthening in operating earnings compared to the first half of 2015. These improvements reflect improved pricing and increased shipments. In the quarter, we expensed Canadian woodland costs directly through earnings due to spring fall conditions which reduces the volume of logs that we acquired during the quarter. In the first, third and fourth quarters, these costs are included in log inventory costs. The impact was to reduce earnings by approximately $25 million compared to the first quarter.

Our panel business benefited from improved plywood prices and increased plywood shipments compared to the previous quarter and achieved operating earnings of $18 million compared to $12 million in the previous quarter. Our West Pine MDF plant did not run for the entire quarter as we continued to repair the facility following the fire-related closure in the first quarter. We recorded $6 million against cost of products sold for West Pine in connection with the business interruption insurance proceeds. And as Ted mentioned, we anticipate restarting West Pine late this year.

Our pulp and paper operating earnings declined compared to the previous quarter as U.S. dollar price improvements were more than offset by a strengthening Canadian dollar. Our Cariboo NBSK mill underwent a scheduled minor maintenance shutdown in the quarter. We experienced some operational disruptions at our Quesnel BCTMP mill, which combined with the Cariboo shutdown, resulted in higher maintenance costs compared to the previous quarter.

Cash flows from operating activities were $281 million as we consumed our Canadian log inventories built up during previous quarters. Capital expenditures were $57 million in the quarter, resulting in first half total capital spend of $106 million. We are now projecting to spend approximately $250 million in 2016, mainly on sawmill upgrades in the U.S. and in Canada. In the quarter, we spent $62 million on share buybacks. And for the year-to-date, we have spent $112 million.

Our normal course issuer bid continues to be in effect. In the quarter, our Board declared our normal $0.07 per share dividend, representing a total distribution of approximately $6 million. This is the 121st consecutive quarter since we became a public company in 1986 that we have declared a dividend. We revalue the funded position of our defined benefit pension plans at the end of each quarter and this resulted in a $45 million after-tax actuarial loss this quarter as a lower discount rate increased the present value of our liabilities, which was only partially offset by a higher rate of return on our planned assets. Our balance sheet as at the end of the quarter remained strong with a 21% net debt to total capital ratio.

And Ted, that concludes my comments.

Ted Seraphim

Thank you, Larry. So, we are ready for questions.

Question-and-Answer Session

Operator

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

Mark Wilde

Good morning.

Ted Seraphim

Good morning, Mark.

Larry Hughes

Hi, Mark.

Mark Wilde

I got a few questions for you. First, I wondered if you can quantify in the pulp and paper business, the impact from Quesnel and Cariboo in the second quarter?

Ted Seraphim

We usually don’t disclose that type of information. I think really the biggest impact is not so much from an operating standpoint. It really is what’s going on with – what was going on with BCTMP markets, to be honest with you Mark. So that’s the biggest delta when we look at changes from quarter-to-quarter.

Mark Wilde

So Ted, if I just if I think about bridging over into the third quarter then, can you give us some sense of sort of where kind of maintenance expense would move second quarter to third quarter and also whether there were any carryovers from these late second quarter issues that you talk about?

Ted Seraphim

Well, I think we don’t really comment. I hate to say this Mark, but we don’t really comment on cost. But again, that’s not going to be the significant difference. In terms of operations, four of our five mills are running very well on a consistent basis. We had a little bit of a blip at QRP, but really didn’t have a material financial impact in the second quarter. Hinton is a work in progress and we are producing about 100 tons more a day this year than we were last year. We are actually on plan for our expectations. But as I said in my comments, the potential of that mill is quite significant. We set some significant records where our production was up 300 tons, 350 tons a day over last year’s average. We don’t expect to sustain those types of peaks at this point, but we are very focused on improving that operation. And we still are dealing with periods of instability as we move forward. Maybe I am not giving you everything you want, but our primary focus here is improving our operations at Hinton pulp and we are encouraged by what we are seeing in BCTMP markets. And if you want more color on that, I know Chris can provide that for you.

Mark Wilde

Okay. I guess the one other question I would just have I mean it’s basically 2% EBITDA margin in the whole segment this quarter, so would it be fair to say that the BCTMP operations might actually be running slightly EBITDA negative?

Ted Seraphim

We don’t comment on any of our operations. We are very confident we have the low cost BCTMP mills in the industry. I will leave that with you. And as I said, we have seen a significant improvement in BCTMP prices over the next – over the last 35 days, 40 days. And again we don’t focus too much on our BCTMP operations quarter-to-quarter. I can tell you this that our costs are down and our production is up in our BCTMP business for the first half of 2016 versus 2015 and that’s what we focus on.

Mark Wilde

Okay, alright. I have got a few other issues away from pulp and paper then, can you just give us a little color on this $11 million inventory write-down in the second quarter?

Rodger Hutchinson

Mark, it’s Rodger. I mean the write-down primarily relates to lower grades of lumber. And we have a write-down. We have had pretty much every quarter from the low grades of lumber. And it’s just a typical accounting adjustment we do at each quarter end.

Mark Wilde

Okay. And then is it possible to get some sense of what you are seeing as we move into the second half of the year here, just in terms of log costs there in BC?

Ted Seraphim

Well, I think as we look at log costs in BC, I think we are expecting probably a $3 to $4 increase in the second half of the year.

Mark Wilde

Okay, alright. And then can we get any color – additional color on that spring breakup costs, I think you mentioned $25 million in the – between the first quarter and the second quarter?

Larry Hughes

Yes. As I – it’s Larry, Mark. I had tried to describe it in my remarks, but we expensed one quarter of the costs in this quarter, whereas the other three quarters we capitalized the expense into the cost of our logs. So the second quarter, we treat that cost differently and it has a – not a doubling impact, but it has a heavier impact in the second quarter. We have done that for a long, long time and every once in a while, it shows up as a distinctive difference because investors and analysts aren’t picking it up.

Mark Wilde

Was it bigger Larry, this year than normal would you say that $25 million?

Larry Hughes

No, I think it’s relatively the same. We get – it relates to our woodland costs, so as our business in Canada expands, it will become a bigger number, but not significantly increase year-over-year.

Mark Wilde

Okay. Then as the last issue I want to turn to is just capital allocation, I wondered if you had Larry, any sense of where capital spending is likely to move in ‘17 and ‘18. And then also, you have been more aggressive than normal this year in terms of share repurchase activity?

Larry Hughes

Yes. I think that we have still got some capital to spend. I think we are seeing a slowdown, but I think it’s – we are extending the spend. So we are going to look closely. We do it later this year. We develop our capital plan for 2017. But I would predict something similar to what we are doing right now in the $250 million range for 2017. It will start to come down. We don’t see any major energy related projects. Those are virtually all behind us now. What we guide kind of at trend that our capital spending is between $175 million and $225 million. And I think that we are going to be getting to trend over the next couple of years. So that’s our number one focus always is making sure we are improving what we have got. Our second priority is to make sure that we are ready to grow when we get opportunities and that’s why we maintain a strong balance sheet. And right now, I would say the M&A possibilities, there is not a huge pipeline. And – but we are looking at opportunities all the time. And then thirdly, if we view that we are going to generate what we believe is truly excess cash then as you have seen, we will favor share buybacks. We have got the modest dividend and we were in the market on share buybacks. We did think that, that was the best investment for the cash that we were generating over the last couple of quarters.

Mark Wilde

Okay, well, I agree with you on that Larry. I will turn it over.

Larry Hughes

Thanks Mark.

Operator

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

Hamir Patel

Hi, good morning. Ted, can you give us a sense as to where you think you are in the sort of Hinton curve and when do you expect that mill to reach its full potential?

Ted Seraphim

Well, good morning. I think we have – we are probably – if you look at where we were 2 years ago and where we are today and where our expectation is to be, our expectation is based on the capital we spent there and also on how we performed there for periods of time. It could be for three weeks at a time, a month at a time. I would say we are halfway there in terms of production. But we are less than halfway there in terms of cost improvement, because really we are spending money on maintenance. We are really focusing on improving our reliability. And that incremental tonnage that we are going to see has a much bigger impact on costs than what we have achieved so far. Production and costs don’t exactly go hand-in-hand. I think that’s the point I am trying to make.

Hamir Patel

Right. Okay. So I mean on those sort of two avenues, when do you expect sort of reach steady state the whole mill?

Ted Seraphim

Well, it’s not really good for me to make a prediction here. Our expectations here are – I mean we have to perform. At the end of the day, we have to perform. We have to have, in my view, a couple of really good quarters behind us. We are making progress. I mean I would like to see us there for 2017. I would have liked to seen us there much earlier than we are today, but it is a huge focus for us. We know that we have the capability of doing it. And it’s just relentless efforts. So, for me to make a prediction is a challenge, but we are putting a lot of pressure on our pulp group to get there. And my expectation is we are going to be much closer as we look at 2017, but it’s – this is not a short-term process. But again, as I said earlier, we are encouraged by the progress we are making. I do want to make sure I am saying that.

Hamir Patel

Okay, thanks. That’s helpful. And Larry, could you maybe give us an update as to what are the next sort of planned maintenance outages in the pulp and paper side over the next 12 months?

Larry Hughes

Yes, we don’t have anything for the balance of 2016. Cariboo has a major shut in the second quarter next year and in Hinton, in the third quarter. So, we have two major shuts in 2017.

Hamir Patel

Great, okay. And just sort of final question on lumber markets, we have seen sort of the stats from Russia into China and it seems like volumes are up 40% year-to-date. Just curious what your sense is on the ground there about when that Russian supply is going to get capped out and what the impact is on pricing right now?

Ted Seraphim

Well, I think Chris is on the line, Chris McIver who manages sales for the company. Maybe Chris could comment on that.

Chris McIver

Thanks Ted. Hi, Hamir. It’s kind of interesting. We are – certainly, Russia has had a big effect this year and into the second half of last year for sure, but it feels like they must be getting tapped out. We have seen pretty significant price increases and also demand increases, particularly moving into the third quarter here. Pricing is much stronger than it was earlier in the year. So again, we are not intimate with what the Russians are doing, but it must be that they are getting sort of tapped out. And I think the market in China is improving. So, this is probably the strongest market we have seen there in well over a year. So, it’s encouraging.

Hamir Patel

Thanks, Chris. That’s helpful. I will turn it over.

Ted Seraphim

Thank you very much, Hamir.

Operator

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

Sean Steuart

Thanks. Good morning, everyone.

Ted Seraphim

Good morning.

Sean Steuart

Couple of questions. First, on lumber price realizations, when I back out the chip sales and log sales, it looks like your average Q2 lumber price realizations were up about 3% quarter-over-quarter, which was about half of what we expected when you factor in the stronger Canadian dollar. Can you guys speak to mix at all this quarter? Was there any change in mix or is it order filed timing lags? Any context you can give us on that front?

Ted Seraphim

Well, again, I think Chris is the best person to answer that question.

Chris McIver

Hi, Sean. Yes, it’s – there is – we have talked about it before, but there is always a lag effect between – and it can be 3, 4, 5 weeks. As prices improve, we don’t see the realizations improve as quickly as prices have and I think we have seen that in the second quarter. And I think the other thing too is that it’s been a bit of a different story between SYP and SBF. I think we have seen a quicker improvement in SPF than we have in SYP. And particularly on the benchmark pricing, where 2x4 is a bigger factor on the SPF business than on the SYP. So, I think that, that’s really what we have seen and our expectations are moving forward that you are going to start to see some improvements.

Sean Steuart

Okay. And then, Chris for you or Ted, the recent improvement we have seen in BCTMP prices, are you guys chalking that up to just tighter markets in the back of the Chetwynd shut or are you seeing better takeaway from China? Any context there?

Chris McIver

Yes, I think particularly on the BCTMP side, China is very important to us and in particular, the board market. And the board market was – they certainly were not running our capacity earlier in the year. They are today and it looks pretty promising moving forward. So, that’s been the biggest change there for us.

Sean Steuart

Okay. And last question for Larry, just further to your prior comments on capital allocation, is it safe to assume that given the uncertainty we still have in the trade file outcome, the bias is still towards keeping low leverage ratios and abundant liquidity position, is that the right way to think about it?

Larry Hughes

I think that we are – I would say we are not heavily influenced by that issue, but that attitude has been our attitude forever. So, we will continue to maintain a strong balance sheet, where we don’t take risks with the balance sheet and we are pretty conservative group. So, I wouldn’t say that the expectations with softwood lumber trade file are heavy influencing factor to us.

Sean Steuart

Okay. Thanks, Larry. That’s all I had guys.

Larry Hughes

Thank you very much, Sean.

Operator

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

Paul Quinn

Yes, thanks very much and good morning gentlemen.

Ted Seraphim

Good morning.

Larry Hughes

Hi, Paul.

Paul Quinn

Yes. Just a question on log costs, you referenced some concern in Canada and B.C. up $3 to $4 in the back half of the year. I guess, I got a couple of questions. One is on the Canadian side, is there a thought within the firm of slowing down production to ease the pressure on logs in B.C. at all? And then secondarily, what are you seeing on log costs in the U.S. sub?

Ted Seraphim

Well, I think, first of all, we don’t really comment on our production plans other than to say that we believe strongly in competition. And we are – and so that’s about all I would say on that. But in terms of the U.S. sub, it’s relatively flat. There is always a few drains where there is some log pressure, but overall, log costs in the U.S. are relatively flat.

Paul Quinn

Okay. And then Larry, you referenced sort of, I guess, a small pipeline of M&A possibilities. Is that – I am just wondering what’s driving that? Is that just because of what’s happening with the SLA file right now or is it just a pause in the marketplace?

Larry Hughes

Well, it’s hard for me to – there are some opportunities out there, but not a lot, but I would say it’s been like that for several years. And whether it’s influenced by the trade file, I couldn’t say that, but I would say it has not been a robust pipeline for several years. I think owners are expecting strong lumber markets and they are hanging in there waiting for better than we are today and then we may see more activity at higher levels.

Paul Quinn

Okay. And just lastly on the SLA file, we had the 100-day negotiations, it sounds like the two governments are still talking, just a high-level comment whether you are happy with the progress of that file and hopeful on a resolution?

Ted Seraphim

Well, it’s – this is the file that it’s difficult for us to handicap, because this is government-to-government negotiations. What I can say is a couple of ones. One, there has been tremendous communication between our provincial government and our federal government. There has been great communication between government and industry. So, our governments definitely understand what our issues are. And what I mean by that is we are very supportive of the federal government’s attempts to come up with a reasonable settlement, but we are also encouraged by the fact that we don’t expect them to settle at any cost. And I think there is a commitment between industry and government that no deal is better than a bad deal. But we are continuing to work with government, and I know our governments are working hard to see if they can achieve something. And we also know there is a commitment from the U.S. government to continue to talk to Canadian government right through the standstill period into mid-October.

Paul Quinn

Okay. Maybe a bonus question for Chris, because he is on the line. What are you seeing in Japan there, Chris? Is that looks like the consumption tax increase will get pushed out. So, maybe 2016 isn’t as good as you maybe thought at the beginning of the year, is that fair to say?

Chris McIver

Actually, Paul, it’s – well, hi there by the way. It’s kind of interesting. We – pricing in Japan has been somewhat depressed compared to what you would usually have seen relative to North America. And I think that’s driven a number of producers out of the market. The bigger guys are there all the time. So it’s actually improved the marketplace for us and we are seeing some price improvement and certainly demand improvement. Probably more than what we would have thought we would see. But I would say pricing is probably not as good as we had thought six months ago where we would be at. So I agree that – I mean consumption in Japan is going to be flat at best, but it continues to be a pretty good market for us. And I think you are going to see prices improve over the next half year or so.

Paul Quinn

Great. Thanks very much guys.

Ted Seraphim

Thanks Paul.

Operator

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

Ted Seraphim

Well, thanks everybody. Enjoy the rest of your summer and we will talk to you in the fall.

Operator

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

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