Norbord Inc. (NBRXF) Q1 2016 Earnings Conference Call April 29, 2016 2:00 PM ET
Peter Wijnbergen - President & CEO
Robin Lampard - SVP and CFO
James Armstrong - Vertical Research Partners
Sean Steuart - TD Securities
Paul Quinn - RBC Capital Markets
Ketan Mamtora - BMO Capital Markets
Andrew Kuske - Credit Suisse
Good day everyone. Welcome to Norbord Inc. first quarter earnings conference call. As a reminder, today's call is being recorded and webcast on Norbord’s at www.norbord.com.
Norbord’s discussion today may include certain projections and forward looking statements regarding Norbord’s business, future actions and expected results. These statements are subject to known and unknown risks and future results may differ materially. For further information on known risks, please see the caution regarding forward looking information statement on Norbord’s January 27, 2016 annual information form and the cautionary statement contained in the forward looking statements section of Norbord’s management’s discussion and analysis dated April 28, 2016.
I'd now like to turn the call over to Peter Wijnbergen, President and Chief Executive Officer. Please go ahead sir.
Well, thank you Michelle and good afternoon everyone. Welcome to our Q1 2016 conference call. I'm joined today by Robin Lampard, our CFO and Heather Colpitts, our Senior Manager of Corporate Affairs
We held our AGM this morning, so my prepared remarks today will be brief. I will quickly comment on the first quarter before I turn the call over to Robin to review our financial performance and operating numbers.
The momentum we started to see last year continued into the first quarter of this year with North American benchmark of OSB prices 17% higher than Q1 of 2015. As a result, our first quarter adjusted EBITDA of $61 million was almost four times better than the same quarter last year. It was also a 7% increase versus the prior quarter despite 7% lower North American benchmark OSB prices.
Our mills both in North America and Europe delivered strong operational performance despite winter being a more seasonally challenging time from a line speed and material usage perspective. As a result, our Q1 unit manufacturing costs declined both year over year and quarter over quarter and we generated margin improvement gains of $9 million.
In addition to our excellent operating performance, I'm also pleased with the significant progress we made towards realizing the benefits of our merger with Ainsworth. We've captured $22 million in synergies to date or $32 million annualized which represents 70% of our $45 million target.
Corporate synergies are fully realized and we continue to focus on the remaining sales and logistics and operating synergy opportunities. I remain confident we will deliver our full synergies targets by year end.
As I'm sure you saw on February 19, we dual listed Norbord shares on the New York Stock Exchange. Our US investor base is growing and we want to make investing in Norbord as easy as possible for all shareholders. The NYSE listing expands access to US investors who might not otherwise buy Canadian listed stocks. We believe this will add liquidity and value for our shareholders over time. Still early days but we have been encouraged by the trading volumes we have seen so far.
We also changed our ticker symbol on the TSX and the NYSE to OSB. Hopefully some of you had a chance to listen to our AGM today. If not, the presentation is posted on our website and the replay and transcript will be available shortly.
I spent some time this morning going over the favorable market conditions in our two key markets: North America and Europe, and our growth and value creation strategy in each. 2015 was a pivotal year for our company and we believe it’s a great time to be invested in Norbord.
Now over to Robin to review the financials and after that, we will take your questions.
Thanks, Peter. I'll make a few brief comments on our financial performance in the first quarter. A greater level of detail of course is still available in our MD&A and financial statements which are on our website and summarized in the accompanying quarterly earnings presentation which I will reference in my remarks this morning.
I'll begin with a few comments regarding market. The US housing market continues to gradually recover and has further running room. While the March housing starts headline number was below expectations, we are actually encouraged by the detail.
On Slide 4, you'll see that the March seasonally adjusted annual pace of US housing starts was up 14% over the same month last year. But more importantly for OSB demand, single family building activity was up 23% with the more volatile multi-family component almost flat. The US homebuilders are reporting Q1 building backlog that are on average 14% higher than the same time last year, which is a positive forward looking indicator of demand. Housing economists are forecasting approximately 1.23 million starts for 2016, which would be an 11% increase over last year.
Moving to Slide 5. As you can see, Q1 average benchmark prices in all our key North American regions were down quarter over quarter but significantly higher year over year. Also of note, the regional spreads in North Central have narrowed, particularly in the Southeast where a third of Norbord’s North American capacity is located. Benchmark OSB prices moderated somewhat in February, before recovering in March as the spring building season ramped up. As of today, the North Central benchmark spot price is $247, $21 higher than the Q1 average.
In Europe, our core UK and German markets showed strong demand growth. First quarter average panel prices were 4% lower than the same quarter last year and in line with the previous quarter.
As you can see on Slide 6, European OSB prices continue to recover on the continent and are almost back to where they were a year ago. OSB prices are now also starting to turn up in the UK. MDF and particleboard prices are still under a bit of pressure due to increased import competition. However the recent weakening of the pound sterling due to the uncertainties surrounding the Brexit referendum is starting to make imported panel less attractive in the UK market.
Next to our results. On Slide 7, you'll see our sales and segmented adjusted EBITDA, as well as the summarized reconciliation of reported earnings to adjusted earnings.
In Q1, Norbord reported adjusted EBITDA of $61 million and adjusted earnings of $0.23 per share, significantly improved over Q1 of last year. This is the last quarter I have to remind you that our compared numbers for Q1 of 2015 have been restated to include Ainsworth’s results.
On Slide 8, you can see the main drivers of our improved results. Year over year adjusted EBITDA improved by $45 million, primarily due to higher North American OSB prices and shipment volumes as well as lower resin prices, improved raw material use and the weaker Canadian Dollar. Quarter over quarter the $4 million increase was mainly driven by fewer maintenance shutdown days and the related costs, as we took 40 mill days down in North America in Q1 compared to 140 in Q1. This positive volume impact was partially offset by the negative volume impact of Q1 having fewer fiscal days than Q4.
I will just take a moment to explain the fiscal day count differences and it is quite extreme this year. We work on a 13-week fiscal calendar each quarter and always cut off on a Saturday, except for year-end which is always on December 31 regardless of which week day it falls on. So Q1 of 2016 had 12 fewer fiscal days than Q4 of 2015, which means sequentially fewer available days for production and hence, shipment. Our fiscal calendar will reach that for next year, so the difference will be more muted. So net-net our Q1 North American shipments were down 8% versus Q4.
You can also see our continued progress on controllable through year-over-year increased volume and lower raw material use, which along with merger synergies was the primary driver of our $9 million in margin improvement program gains this quarter.
Turning now to our balance sheet and cash flow on Slide 9. As you can see, we were operating cash flow positive this quarter despite our usual seasonal working capital build. The quarter-over-quarter working capital increase is due to seasonal log inventory build in our northern mills, as well as the impact of higher North American shipment volume on receivables.
Working capital increased year over year due to the impact of higher North American prices and shipment volume on receivables, as well as better weather this year for building our seasonal log inventories at our Northern mills and the continued ramp up of production at our High Level, Alberta mill. Working capital remains well controlled across the company and we continue to manage it at minimal levels.
Capital investments totaled $11 million in the first quarter and our regular CapEx budget for 2016 is $75 million. This does not include the strategic reinvestment in our Inverness, Scotland OSB mill which I will elaborate on for a moment. Project execution began immediately after our announcement in January, including site preparation and equipment procurement.
As you've seen in our press release, we have made the decision to move the never-used continuous press from our Grand Prairie, Alberta mill over to Inverness. This will enable us to shorten our construction timetable which will positively impact the already compelling economics of this project. We expect to start up the extended mill in the second half of 2017 and will continue to run the existing production line until the new line ramps up, ensuring we can serve our customers without disruption. Capital spending for the Inverness project is expected to be $45 million in 2016, against the total budget of $135 million.
Finishing up on Slide 10. Our balance sheet is strengthening alongside our improving financial results. As we met with investors over the past several months, they have told us they were concerned about our financial leverage, even though we have over $300 million in liquidity and the rating agencies have all reaffirmed Norbord’s solid double B credit rating.
Net debt to trailing EBITDA is a key leverage metric investors look at. This ratio had been admittedly high at almost 12 times immediately following our Ainsworth merger. But we have already cut in by more than half, just under five times as of Q1 despite funding our usual seasonal working capital build. And if I use the street consensus EBITDA estimate, we will be down to three times by next quarter.
As you can see, we continue to have significant headroom versus the financial covenants that govern access our undrawn revolvers with tangible net worth of $740 million and net debt to total capitalization of 50%. And finally, you will have seen that our board declared another $0.10 Canadian per share dividend for the quarter, payable on June 21.
And with that, we will jump right into questions today. So I'll turn things back over to Michelle who will open up the lines.
[Operator Instructions] Our first question comes from James Armstrong of Vertical Research Partners.
Good afternoon and congrats on a great quarter. My first question’s on the realizations. Just want to make sure that I got this right. They were higher than the benchmark North Central would imply. Is that just due to be the regional spread tightening up or was something else happening here?
Well, that was a significant factor in that, yes.
Especially as I pointed out, Southeast was particularly narrower versus North Central which is an important region for us.
Okay. And then on inventories, they've been described as tight in the trade press but they are still describing it as shipments or purchases are really only to demand, and everybody is living off of lower inventory levels. Is that what you're seeing out there and do you expect that to continue for the foreseeable future?
Yes, it is. I think at least Norbord never holds any inventory and the motivation for our pro dealer customers to hold lower inventories, which is really to help reduce their working capital commitment and inventory so that they can expand their – and fuel their growth. I think those factors remain true. And we are seeing no indication of anybody taking a position on the market.
Okay, that's extremely helpful. And then lastly, could you just go through what you're thinking about your debt level? You mentioned it a little bit. And could you discuss your priorities on capital?
Sure, James. So as we’ve said for a couple of quarters now, we are focused on de-leveraging the company with our free cash flow. And it is our aim to use free cash flow and if necessary temporary draw on some of our liquidity lines, to permanently repay our $200 million 2017 bonds when they come due in February next year. So that remains a priority of ours.
In terms of our overall prioritization of capital allocation, first and foremost is to invest in our assets. And we've already gone over our regular capital budget for this year as well as strategic investment in our Inverness mill. But that continues to be our first priority. We will, as I said, prioritize debt reduction with the $200 million bonds pay down and then beyond that, where we have surplus cash we will return it to shareholders. And at this point that’s under our variable dividend policy.
Thank you. The next question comes from Sean Steuart of TD Securities.
Thanks, good afternoon everyone. Couple questions. The productivity gains, I gathered most of it's just from lower maintenance this quarter than Q4. How concentrated were those gains and I guess more specifically, can you talk about where High Level is running right now in terms of operating rates?
Hi Sean. Thanks for dialing in. First of all, I should start by saying or reminding everyone of the fact that Norbord produces only what we can sell in the market. And the High Level mill is very much focused on selling specialty products for the overseas markets. And so that's what we’re sticking with. The mill is running still only a partial – or at, let’s call it, somewhere between 50% and 60% of its rated capacity. I didn’t actually do the math here for this quarter but so that's same range. And we can be EBITDA positive at that kind of a run rate. So as our ability to sell those products that that mill can produce continues to increase, that’s how we will further ramp up that operation.
And second question on your European mill nets, you guys indicated modest improvement in euro denominated, because of mainland OSB prices. But if we adjust for currency and try and net everything else out, it looks like you'll get a pretty steep decline in your European mill nets. And wondering if you can speak to divergent trends in particleboard and MDF or mix or other factors that might have contributed?
Yes, Sean, I think you are referring to the year over year.
Yeah, quarter over quarter as well, I think – but –
Yeah, it was a little bit of a decline quarter over quarter, which is really still driven by particleboard and MDF. But we're still on a year over year basis, OSB prices are still significantly lower. But as we said, we started to see that reverse on a sequential basis. And on the continent, as I said OSB prices are almost back to where they were a year ago. So that’s kind of a trend that we're seeing. Year over year, it’s that OSB price declined and more recently we're seeing that come back.
Thanks, Robin, and just one last question. Just with respect to the maintenance CapEx, or sorry, maintenance downtime, that you took a lot less this quarter, which is normal versus Q4. But how should we think about the rest of the year unfolding, is the overall maintenance plan in terms of mill days similar to last year, a little bit less, how should we think about it?
Well, I mean, so we always try to time our big annual maintenance shuts at the time when OSB demand is going to be the quietest and typically that’s the fourth quarter, particularly towards the end of the fourth quarter. But as Peter has said a moment ago, our philosophy and policy is that we will only produce what we can sell. And so we'll continue to – and our production levels continue to be guided by that every quarter. But normally you would expect the least amount of down-days in the second and third quarter for us.
Thank you. The next question comes from Paul Quinn of RBC Capital Markets.
Yeah, I guess it's a good afternoon for you guys.
Good morning, Paul.
It seems like forever here given the serene season. But let me ask a couple of questions. One, just on that $10 million quarter over quarter operating and foreign exchange benefit, how do you split between FX and op cost reductions?
That's really a maintenance cost story, Paul, quarter over quarter. That's the big driver there. We actually had -- we had almost no impact from FX in the quarter, because rates on average were barely moved from Q4. So that's a maintenance cost story.
And then we’ve seen pricing sort of ramp up nicely in February, March, it’s slowdown of late. What do you attribute that to? Is that slowing demand, is that or just the expectation the marketplace that there's an adequate supply out there?
Do you mean why has that price slowed down?
Yes, why has it gone flat?
Well, I mean recall that our expectation for this year and I think most forecasts or expectations for this year were for a trend like year. Trend, however you want to define that is in the sort of range where we probably are at the moment. But more specifically, I think buyers are reluctant to buy at longer lead times which, when our order files start to lengthen. Longer lead times at these prices until they realize that, that price increase is real. So we saw our order files grow significantly. Right now it's quarter end for most people who are on the calendar quarter end. And so our expectation is that we'll start to see some activity in the market again, more actively over the next two weeks.
And then applaud your decision to move that GP2 press to Scotland because it reduces that capacity overhang in North America. But maybe you could just walk us through the steps of what's involved there and then what you've got lined up in terms of any kind of start-up guarantees by the vendor?
Well, the vendor will take control of that process. We expect to dismantle package, or create and ship all of that stuff by, I believe it is July. So they will have some time for when our foundations in Scotland are dry in October. And they will start the process and reverse over there. We’ve got a full guarantee on the equipment as if new, in part also because we are using this opportunity to upgrade that press through a state-of-the-art, as state-of-the-art is today. So even though the press has shown this seven or eight years old, nonetheless there are advances that have been made between then and now.
Thank you. The next question comes from Ketan Mamtora of BMO Capital Markets.
First question, how much have you spent on Huguley so far?
So far, Ketan, against our broad approved capital budget we’re getting that mill ready for restart of $45 million, we've only spent about $15 million of that as of this year. And so we're on a very slow spend, and we’re really only dealing with a very long lead time items, the rest of that we wouldn’t expect to start spending until we’ve made the decision to actually restart it.
And remind us how you are thinking in terms of timing on the restart and what will determine that, whether it’s the level of housing starts and anything else that you are looking at?
Ketan, as I just mentioned earlier, we have a policy to produce only what we can sell to our key customers. So our decision on restarting that mill will be guided by the demand we're seeing and the forward looking demand indications that we will get from our key customers.
And then just switching to your Val-d'Or, Quebec mill, in the past you've mentioned other alternative products that could be used, at that mill like siding. Any updated thoughts around that?
Nothing, yet. I mean I think that indication is still a realistic way to think of it. We spend a lot of time -- or I spent a lot of time during the AGM talking about our specialty products strategy, and we think that Val-d'Or mill is potentially very suited to help realize some of that specialty products strategy that we outlined.
And then just can you briefly talk about how your business is doing in Japan?
Our sales -- overseas sales are up about 15% over last year quarter over quarter, sort of more in line with what we saw the year before. And more recently we have seen a little bit more of an upsurge in demand from Japan. I believe there was one of the six or eight whatever the number is, domestic i.e., Japanese domestic plywood mills had a significant fire. As far as I know luckily no one got hurt. But obviously that does have an impact on local supply of plywood which is our main competition for the sort of traditional use of OSB in Japan.
Thank you. The next question comes from Andrew Kuske of Credit Suisse.
Thank you, good afternoon. Just on moving the mill to Inverness. When you look at that equipment, if you didn't have it sitting there idled and unused, what would have it cost you to buy brand new and drop new equipment into Inverness?
So from a cost perspective, ultimately the difference would not have been significant. The main benefit is the press is traditionally the longest lead time item. And so the main difference that we're counting on is our ability -- using that press as our ability to shorten the timeline off to construction.
And then maybe just for clarity sake. As you expand Inverness, the old lines are still going to be operational when the new one is up and running?
Yes, but there will -- at some point there will be a moment when we'll have to take the old lines offline as it were, once the new line reaches sort of a ramp -- a part of it’s ramped up where we are past into, let's call it. 50% mark.
And then maybe just a bit more granular on the remainder of the synergies. I think this is mentioned in the commentary at the start of the call. Is it really just logistics and revenue type synergies, is that what we're looking at for the remainder to get to -- what you've guided to on the 45?
Some of that, and there is still, we believe -- or we know there will still be more cost energies at the operating levels as well.
End of Q&A
Thank you. There are no further questions at this time. We'll turn the conference back to Mr. Peter Wijnbergen. Please go ahead.
Thank you, Michelle and as always Robin, Heather and I are variable to respond to further questions. Thank you for dialing in today and we look forward to reporting on our continued progress next quarter. Have a good weekend everyone.
Ladies and gentlemen this does conclude the conference call for today. You may now disconnect your line and have a great day.
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