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Executives

Henry H. Ketcham - Chairman and Chief Executive Officer

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

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

Christopher D. McIver - Vice-President of Lumber Sales and Corporate Development

Edward R. Seraphim - President and Chief Operating Officer

Analysts

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

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

West Fraser Timber (OTCPK:WFTBF) Q3 2012 Earnings Call October 30, 2012 11:30 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the West Fraser Timber Co. Ltd. Third Quarter 2012 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. Hank Ketcham, Chairman and Chief Executive Officer. Please go ahead, Mr. Ketcham.

Henry H. Ketcham

Okay, thank you, operator, and good morning, and welcome to West Fraser's third quarter conference call. Joining me today are Larry Hughes, our CFO, who will make some comments following my remarks, and several of our key management personnel.

As you know, West Fraser reported third quarter earnings of $55 million or $1.27 per share on sales of $772 million. EBITDA was $102 million. This is a 24% increase in EBITDA versus the second quarter.

Our panels sector was the biggest contributor to our improved EBITDA due to a 17% increase in plywood prices during the third quarter.

Our lumber and pulp and paper divisions recorded more modest improvements in EBITDA versus the second quarter of 9%, and 8%, respectively.

Benchmark 2x4 prices for SPF lumber and Southern Yellow Pine lumber increased 2% and 4%, respectively, quarter-over-quarter. Compared with the third quarter of 2011, however, SPF prices are up 22%, while Southern Yellow Pine prices are up 34%.

SPF shipments to China continue to be strong despite reports of slowing economic growth there. Lumber production was down 5% versus the second quarter, reflecting fewer operating hours and slightly lower productivity.

In addition, ongoing capital projects at several of our Canadian and U.S. mills interfered with production during the quarter.

We continue to suffer the effects of the Mountain Pine Beetle epidemic at our B.C. mills. Our grade recovery, productivity, and lumber recovery, all continue to suffer from our degraded timber base. We are continuing to invest in our B.C. mills to mitigate the effects of the Mountain Pine Beetle. We expect timber availability in the B.C. Interior to decline over the next 5 to 10 years as economic reavailable [ph] beetle-killed wood declines, and we transition back into green timber.

Our panel business performed reasonably well in the quarter. Plywood prices increased significantly reflecting strong Canadian demand. MDF prices were up 3% versus the second quarter.

Our pulp and paper business had mixed results in the quarter. Our mechanical pulp mills continued to meet or exceed production targets as did our joint venture newsprint mill.

Production at our kraft pulp mills was below target due to continuing operational difficulties at one of our mills. We've completed our $88 million of green transformation projects and have been almost fully reimbursed for these projects from the federal government. The projects are expected to contribute to lower costs, better quality, and better environmental performance at all of our mills.

NBSK benchmark pricing declined 5% versus the second quarter and 14% versus same period last year. Pulp prices, which may increase slightly in the next couple of months, will remain under pressure for the near-term due to high Hardwood kraft inventories, new capacity coming onstream in the fourth quarter, and a continuing weakness of the global economy.

Yesterday, we announced an agreement to acquire a sawmill in Edson, Alberta from Sundance Forest Industries. This mill supported by a basic annual allowable cut of approximately 795,000 cubic meters, including a temporary uplift of 375,000 cubic meters until 2017.

We expect this transaction to close at the end of this month. We're very pleased with this acquisition as it will add to our strong asset base in Alberta and further support our integrated model there.

We're encouraged by the developing recovery in the U.S. housing market. Most metrics continue to improve, suggesting that the longest and deepest housing recession since the 1930s is finally coming to an end.

The recovery may be slow and bumpy, but we believe the worst is behind us.

Thank you, and now I'll turn this over to Larry Hughes, our Chief Financial Officer.

Larry S. Hughes

Thanks, Hank, and thank you, everybody for joining us today. There's an advisory contained in our quarterly MD&A concerning the use of terms that we will refer to on this call such as EBITDA, adjusted earnings or loss, and adjusted basic earnings per share.

For the third quarter, we reported earnings of $55 million or earnings per share of $1.27. The table on Page 3 of our MD&A describes and quantifies several nonoperational items, which affected our results. In this quarter, we had 2 counterbalancing items, a $10 million expense on account of equity-based compensation, and a $10 million gain on account of U.S. dollar long-term debt, and so our adjusted earnings were the same as our earnings, $55 million, or $1.27 per share. Results of this quarter were stronger overall than those of the previous quarter. From an operating earnings and EBITDA perspective, our panels segment showed significant improvement compared to the previous quarter, and our lumber and pulp and paper segments showed modest improvement.

As mentioned in our MD&A, the improvement in pulp and paper operating earnings was largely attributable to lower Alberta energy costs, as both shipments and the NBSK benchmark declined compared to the previous quarter.

Our defined benefit pension plans were revalued as at the end of the quarter, resulting in a charge to comprehensive earnings, net of income taxes of $60 million. This actuarial gain or loss will fluctuate with changes in long-term interest rates, and the return on plant assets.

For this quarter, the main contributor to the adjustment was a lower discount rate, as long-term interest rates continue to be at historically low levels. Cash provided by operating activities during the quarter after working capital changes was $108 million.

Capital expenditures for the quarter totaled $31 million, and as Hank mentioned, we have now received all but $5 million of the Green Transformation Program reimbursements.

We ended the quarter with a net debt-to-capital ratio of 8%. And Hank, that concludes my comments.

Henry H. Ketcham

Okay, thank you, Larry. And operator, I think we're now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question is from Paul Quinn of RBC Capital Markets.

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

Just a couple of questions here. One on Sundance, I'm just wondering if you could align the purchase price -- some financial metrics around? And sort of what your plan is with the mill? It looks like a small mill, but it seems like it has lots of wood available to it.

Henry H. Ketcham

Great. Paul, so, thanks. So we're not -- we haven't really announced a purchase price and we won't do that right now. But in terms of the mill, it's a mill that's been supplying chips to our hit [ph] and quote [ph] mill for some time. And it's a mill that we just have to evaluate. We haven't really spent much time in it, so we're going to have our team go in and work with the people there, who are doing a really good job. We've got a good timber position and we'll be doing what we normally do, evaluating the flow, et cetera, and deciding whether we need to do some work there. We do believe that we're going to have to spend some capital there.

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

Okay. And then, just on the -- Hank, you made the comment on the Mountain Pine Beetle being -- your timber availability in B.C. will decline over the next 5 to 10 years. Have you looked at your own sawmills and which ones would be at risk with that? And then maybe, you could make a comment on sort of the discussions that are going around with regards to the rebuild of the Bee [ph]?

Henry H. Ketcham

You know, we've seen this -- everybody in the Interior has seen this downfall coming for several years. So I think all of us have worked in our own companies to determine how we best mitigate the effects on our own company, so I'm sure everybody's doing that. In our case, we've invest heavily in our mills, and we continue to invest heavily in our mills to ensure that they are competitive. Obviously, there's going to be some rationalization over the next 5 or so years, but I'm not in a position, really, to talk about our plans or anybody else's plans. And with respect to the Bruins Lake situation, I'm really not in a position to discuss that, either. That relates to another company.

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

Okay, just lastly. Just relating to West Fraser. Just looking at your lumber margins, they seem to have sort of, on a comparative basis to another B.C.-based company come down. And I'm just wondering if West Fraser's lost its groove or whether it's going to be a little while before the CapEx spending that you've done at your mills is going to come through to the bottom line?

Henry H. Ketcham

Yes, I know. I think the competition is very tough throughout our industry. We continue to focus on what we can do, and I don't really have any more comments on that.

Operator

Our next question is from Daryl Swetlishoff of Raymond James.

Daryl Swetlishoff - Raymond James Ltd., Research Division

Hank or Larry, could you give us just a bit more color on the energy change in Alberta? And how that affected your earnings? And -- I'm just a little unclear about how that -- the mechanism that, that works?

Henry H. Ketcham

I might toss that one over to Peter Rippon who runs our pulp operations.

Peter A. Rippon

Sure. So energy in Alberta during the quarter and market price is -- it's a market price-based system in Alberta. And we have energy hedges that -- related to our mechanical pulping operations and our newsprint operations. And those hedges perform very well, as well as the mills respond when prices are high. So we take a little bit of a hit on production, but we also reduce our cost significantly. So it -- the net power costs are very low in that case.

Daryl Swetlishoff - Raymond James Ltd., Research Division

I see. And so could this be repeated? Basically, the cost structure that's evident in these earnings, should we be moving that forward? Or is it will be variable based on hedges and other items?

Peter A. Rippon

Well, it's variable based on the market price for electricity in Alberta.

Daryl Swetlishoff - Raymond James Ltd., Research Division

Okay. Hank, I was wondering, could you just give us a bit of a update on where you're at your U.S. South capital plan? Like how far are we through the spend? And what's been the -- give us some color on -- are you pleased with the capital spend so far and the results?

Henry H. Ketcham

Well, we're pleased with what we've done so far and with the results, for sure. But it takes, it's obviously, taking us longer than we had anticipated. To do a lot of stuff down there, you have to get environmental permits, which take a long time. So we've got -- we're backed up on our capital a little bit down there. So I think we're -- I think you have to -- to kind of fully finish the job down there, I think we're looking at 3 years, roughly. But I think we've done a pretty good job on several of our mills already. We've got some very good mills down there now.

Daryl Swetlishoff - Raymond James Ltd., Research Division

So in terms of the total amount, what percent are you through that spend, do you think?

Henry H. Ketcham

Maybe 35%.

Daryl Swetlishoff - Raymond James Ltd., Research Division

35%. Okay. Helpful. And lastly, just with the terrible storm we've seen, what sort of impact do you think is that going to have on U.S. south harvesting? Or is it too soon to tell?

Henry H. Ketcham

Yes. I don't really know. I can't really answer that question. It's too soon to tell. I haven't even talked to the guys down south yet.

Operator

Our next question is from a Sean Steuart of TD Securities.

Sean Steuart - TD Securities Equity Research

Couple of questions. Hank, hoping you can talk on -- I guess, Southern Yellow Pine markets in general. We've seen a widening spread premium for those grades. In recent weeks, and, I guess, following on Daryl's question, can you just speak to the CapEx you have spent down there? Your ability to ramp up operating rates over the midterm? And, I guess, you're running at about 80% of capacity down there right now. How do you expect that ramp and operating rates to move forward over the midterm?

Henry H. Ketcham

Well, I think we expect to get back up to 100%, obviously. And it's, in some cases, CapEx is keeping us from running full out and in other cases, we're just watching the market. We're going to respond to the market. But I might just let Chris McIver, who is our -- who runs salesforce just make a couple of comments on the Southern Yellow Pine market.

Christopher D. McIver

Thanks, Sean. We've really seen the market begin to pick back up after sort of mid-September to mid-October, it really slowed down for us. And the one thing we are seeing that is sort of a negative is that the spread between wides and narrows has not changed. Narrows continue to be quite strong and wides against the usual tradition, continue to be quite weak and we see that probably continuing for some time. But overall, the market is -- for this time of year, is pretty good shape.

Sean Steuart - TD Securities Equity Research

I guess, Hank, or maybe, Ted, if he's there. Could you just touch on -- you mentioned some ongoing pulp productivity issues. Can you give a little more context there? And I think last quarter, you'd suggested there's no maintenance downtime expected through the end of this year. Is that still the case?

Henry H. Ketcham

I'll let Ted answer that.

Edward R. Seraphim

Okay, Sean, and -- I think fundamentally, the mill we've been struggling with has been Hinton. And I know we did a major capital upgrade there late last year. And we thought we had it behind us. We've seen a good run for the last couple of weeks, but we're still not quite where we want to be. And it did impact our results in the third quarter. We still believe very strongly that we're going to get the results over that project. But until we really prove it on a sustained basis, we're not ready to get -- to really get too excited about it, but we do have some issues there.

Edward R. Seraphim

And in terms of maintenance, we have no maintenance plans, major maintenance plans for the rest of this year.

Operator

Our next question is from Mark Kennedy of CIBC World Markets.

Mark Kennedy - CIBC World Markets Inc., Research Division

I guess, my first question just on the bioenergy side. Just wondering if you could give us an update as to, a, how the start up at Cariboo has gone? I think that tied into the grid in September. And then secondly, just how the Chetwynd and Fraser Lake projects are coming along as well?

Henry H. Ketcham

Peter Rippon will answer that.

Peter A. Rippon

Sure. So the project in Cariboo just actually went online last night. So it's now -- it's performing. I just went through our acceptance test with BC Hydro, so that's all on, and we expect to see the results of that in the fourth quarter. There'll be a small or a short ramp up period to that, but we do expect it to come on very quickly. It's been running well for the last little bit here. As far as Chetwynd and Fraser Lake, both of those projects are moving ahead as per plan, so no concerns so far. And we expect them to come on in -- by mid-2014.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And then Chris, if I can just ask you a question. Just on the lumber markets, in general. I'd just be curious to know, what are your largest customers saying right now? And are they giving you any indication on sort of how they see 2013 unfolding?

Christopher D. McIver

Yes, Mark. It's -- I would say that most of the customers are still quite cautious. They are keeping their inventories low. But they are seeing a lot more business for this time of year than we traditionally would. We usually are in a pretty slow period through U.S. Thanksgiving, and then things start to pick up again in December, generally on the lumber side. But -- so everybody is running pretty lean inventories and they keep having to come back and buy more lumber. So that kind of tells us that we're seeing a little more demand than was expected. With regards to next year, I would say that we, as most of our customers believe, we're going to see a gradual recovery. We're not looking for a huge recovery quickly, but we think we are on the right direction.

Mark Kennedy - CIBC World Markets Inc., Research Division

Okay. And then, can you just tell us again what percentage of your lumber shipments this quarter went offshore, I guess, in total? And then to China, as well?

Christopher D. McIver

Yes. Sure, Mark. Sorry -- just checking to see if I could tell you that, but -- yes, no, it's about 30%. And we're seeing Japan pick up a little bit. For us, I know there's a lot of talk around China, but we're finding China to remain as strong or stronger than we've seen, certainly this year. And we don't see a slow down from 2011, and 2013 looks pretty robust, too.

Operator

[Operator Instructions] Our next question is from Stephen Atkinson of BMO Capital Markets.

Stephen Atkinson - BMO Capital Markets Canada

In terms of Sundance, given the surplus private [ph], are you able to expand? Or do you have plans for expansion?

Henry H. Ketcham

All right. So I think, Stephen, again, we've got a good solid base of timber there. It's really good timber. And so it's too early for us to say, but we do hope to work with management at Sundance and find opportunities to -- we hope that we'll find opportunities to grow production and to reduce costs.

Stephen Atkinson - BMO Capital Markets Canada

Yes. The reason why I was asking, of course, was that, if you were able to then, potentially, could you lower the chip costs going into Hinton?

Henry H. Ketcham

If we can produce more residual fiber, for sure, that will be the case, because that will be one of the closest mills to them -- that will be the second closest producer to the pulp mill.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And in terms of your 65-megawatt power project, where are you on that one?

Peter A. Rippon

It would be the project that our Alberta newsprint operation that you're referring to?

Stephen Atkinson - BMO Capital Markets Canada

Yes.

Peter A. Rippon

It is moving forward.

Stephen Atkinson - BMO Capital Markets Canada

Okay. So should I put it in 2014?

Peter A. Rippon

Yes.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And sorry if I missed the answer to this one. But are you able to tell me your outlook for B.C. wood cost this quarter? Or where you're at right now?

Henry H. Ketcham

Well, wood costs are going to -- we think in B.C., probably go up slightly, due to a small stumpage increase overall.

Stephen Atkinson - BMO Capital Markets Canada

Okay. And -- yes, another question. The -- in terms of the profitability of the South versus B.C., I'm assuming they're relatively close now, it looks like the pricing has moved up a bit in the South, but maybe you can answer that one better?

Henry H. Ketcham

I could answer it better internally. But externally, I'd say it goes back and forth.

Operator

There are no further questions registered at this time. I would like to turn your meeting back over to you, Mr. Ketcham.

Henry H. Ketcham

Okay, well, thank you. And thank you, everybody, for joining the conference call and we'll talk to you in February. Bye.

Operator

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

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