West Fraser Timber (TSX:WFG) Q1 2020 Earnings Call

0:01 Good morning, ladies and gentlemen, and welcome to the West Fraser Q1 2020 results conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require assistance, please press star zero for the operator. Forward-looking statements 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 CDAR, and as supplemented by the company's quarterly MD&As.

0:56 Accordingly, listeners should exercise caution in relying upon forward-looking statements. This call is being recorded on Tuesday, April 29, 2020. I will now turn the conference over to Ray Farris. Please go ahead.

1:09 Thank you, Operator. Good morning, everyone, and thank you for joining us today. With me is Christopher Virostek, our Chief Financial Officer, as well as Chris McKeever, our Vice President of Sales and Marketing, and several other members of our executive team. I will make a few opening comments and then Christopher Virostek will review our first quarter results and some additional remarks. As we manage through this crisis, I think it's important to clearly communicate what our priorities here are at West Fraser. Our first priority is the health and safety of our employees and the communities that we operate in. Without delay, we aggressively eliminated travel, imposed physical distancing measures, improved cleaning and hygiene regimes, and, in collaboration with our industry competitors and regulatory bodies, developed and implemented industry-leading exposure control protocols that would protect our fellow employees should and when an event take place. It also ensured that self-quarantine expectations were effective and being followed. We adjusted our production schedules where necessary to accommodate both protocols and employee needs.

2:21 and successfully executed and having almost our entire corporate personnel working from home. These measures, coupled with strictly following the Health Authority's direction, have kept our employees and communities safe. Being designated an essential industry is not something that we take for granted and we take our community responsibilities very seriously. Our next priority is to ensure that we are operating our businesses responsibly. In the middle of March and through April, in response to the rapidly changing market demand, We significantly reduced lumber and plywood production in Canada and we continue to adjust our operating schedules in both the U.S. and Canada weekly as necessary. We're able to accomplish this while attaining our best safety performance in the history of the company, both for the year of 2019 as well as for the first quarter of 2020.

3:12 I will provide further comments after Chris's overview of our Q1 operating results.

3:18 Thanks, Ray. We reported $127 million of adjusted EBITDA in the first quarter as compared to $80 million in the fourth quarter of last year. Results improved in both the lumber and pulp segments, while demand challenges associated with COVID-19 dampened panel results, especially plywood. Operating earnings increased by $44 million from a loss of $31 million in the fourth quarter to income of $13 million in the current quarter. Turning to the drivers of the results, we saw improved lumber and pulp pricing compared to the previous quarter, which lifted results by approximately $52 million. Volume had a negligible impact overall, as changes across the various segments largely offset one another. Costs, inclusive of fiber, manufacturing, and administrative costs, were up slightly on the quarter.

4:10 On the key metrics for the quarter, lumber production was up 78 million board feet to 1.5 million board feet, Late in the quarter, we slowed SYP and SPF production as a result of the COVID-19 situation. Shipments lagged production by 75 million board feet, with the key issues being in SPF as rail blockades earlier in the quarter challenged rail car availability for a period of time. Our SYP shipments exceeded our SYP production as we lowered inventories while on the reduced schedules at the end of the quarter. With price and operational improvements, adjusted EBITDA increased by $47 million from $80 million to $127 million. Cash flow from operations was a use of $162 million as we used $195 million to build log and other inventories as is the seasonal trend.

5:06 Receivables were also a use in the quarter as shipment levels at the end of the fourth quarter were very low during the holiday period. Before the impact of changes in working capital, cash flow from operations improved by $53 million to $114 million when compared to the previous quarter. As compared to the same period in the prior year, which is more comparable from a seasonal standpoint, cash flow from operations was $106 million improved. CAPEX declined from $87 million in the fourth quarter of 2019 to $59 million in the most recent quarter. We have delayed or deferred most discretionary capital that has not been started. Our focus on maintenance capital and the orderly completion of strategic projects currently underway, which remain on track and which we believe will provide significant benefits over the long term.

6:01 Net debt increased by $274 million. and represents 33% of total capital, a slight increase from year-end, but well within parameters. At the end of the quarter, we had U.S. $407 million of cumulative duties on deposit. Last Friday, the DOC announced that it is tolling all administrative review processes for at least 50 days, which will likely extend the finalization of Administrative Review 1 rates. and any potential change in duty rates from August until September. Finally, I'd like to touch on our liquidity situation. At the end of the quarter, we had $294 million of available liquidity at a point in time when we have largely wrapped up our winter 2020 logging activities in Western Canada. On April 9th, we secured an additional $150 million revolving credit facility bolstering our available liquidity to a pro forma $444 million as of the end of the second quarter.

7:02 The new credit facility matures in 2022 and provides additional flexibility in the current uncertain times. We have no other significant debt maturities until 2024. We remain well on side with our financial covenants in the credit facilities. Additionally, we are due approximately $125 million of tax refunds on account of prior years. We have shifted now as well into the seasonal period where logging activities are limited and will be consuming the log decks we have accumulated in Western Canada. Over the past several weeks, various levels of government have also implemented a number of temporary payment deferral mechanisms that will provide a boost to liquidity during the second and third quarter.

7:47 Through the first four weeks of the second quarter, we have seen reasonable levels of demand for lumber and pulp, and while on reduced schedules, have made significant progress in reducing inventories across our operations. If the trend continues, we would expect available liquidity to improve as the quarter progresses. With that, I'll turn it over to Ray for some closing remarks.

8:10 Thanks, Chris. So there are a number of economic forecasts out in the public realm that describe anywhere from a sharp V-type recovery to one shaped like an L. The COVID-19 is an unprecedented event, and it is uncertain at best what the recovery may look like. And from our perspective, it is premature if not impossible for us to provide any credible views at this time. Saying that, in the mid-term we do expect markets for our forest products to be difficult, choppy, and lumpy. During these times, as in past recessions, both our product and geographic diversity of lumber, plywood, pulp, MDF and LVL is a strength which allows us great flexibility to adapt to the available market.

8:59 Our final priority must be to ensure that our balance sheet remains strong as we manage through this downturn and eventually prepare for a return to economic growth and growth of the company. As we look forward into the coming quarters and the impacts of COVID-19 become more clear, We will adjust as necessary all available capital allocation levers in order to maintain a strong balance sheet and ample liquidity. Finally, I want to recognize our employees that delivered strong health, safety and operational performance across our entire platform at West Fraser. We are very proud of our health, safety and productivity accomplishments and pleased to see the results of our capital and margin improvement projects coming online.

9:47 Our employees continue to demonstrate they are up to taking on any and every challenge directed to them, including COVID-19. It is our employees that I must thank for being so resilient and dedicated in making the business stronger while adapting to a rapidly and constantly changing environment. With that, thank you and I'll turn it back to the operator for questions. Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Mark Wilsey from Bank of Montreal.

10:36 Please go ahead.

10:38 Good morning, Ray. Good morning, Chris. Good morning, Mark.

10:40 Good morning.

10:42 Ray, I wondered just to start out if you could just kind of walk us kind of through the distribution channel in terms of what you see for kind of demand at the mill level, what you're seeing at the other end in terms of kind of customer builder takeaways, and then, you know, what you think is happening to just supply in the inventory channel, inventories in the distribution channel.

11:06 Well, good morning, Mark. You know, I'm going to ask Mr. McKeever to take that one if that's okay. Good morning, Mark.

11:14 Good morning, Chris. It's actually quite interesting what's happening right now. We're seeing it's pretty product-specific as far as takeaway, but I would say generally we've seen major destocking on the distribution side on the customer end, including some of the big pro dealers moving product from site to site to just reduce their total inventories. Anecdotally, we're hearing from them that business, depending on the product, is as good as it's been all year right now, but they're not buying a lot. So they're waiting to see what's going to happen. We have good orbit files pretty much in all our products right now.

12:02 Most recently, we've seen plywood beginning to come back as Eastern Canada talks about reopening. By far the best product that we have on the wood product side right now is our Southern Yellow Pine. Tremendous demand from treaters and retailers at this time. So we're reasonably well sold on all our products. And of course, pulp has been very good.

12:27 Okay. And then Chris Virostek, I wondered, you mentioned these potential deferral programs. In both the U.S. and Canada, I know a lot of this stuff has not been finalized yet, but could you just walk us through the three or four that you're watching most closely that would have the biggest impact for you in terms of helping your cash flow this year?

12:53 Yeah, and I think on these, they are just deferrals, right? So they are temporary in nature, right? Right. I think to your point, these things vary from three months to six months to a year to two years. That probably evolves on the duration of those potentially, how long this goes on. It's everything I'll say from every level of government, property taxes, sales and use taxes, corporate income taxes, payroll taxes. There's really been actually pretty good support from all levels of government to try to find ways that they can help. In the end, it is just a deferral, and we will have to pay it in the future, whether that's the third or fourth quarter or into 2021.

13:48 And as for a sort of quantification of each individual one, I think when we look across the landscape of all those opportunities, Through the second quarter, it's maybe $20 to $30 million, and then it starts to unwind in the third and into the fourth.

14:11 Okay. I know that there's a deferral that's been proposed for, I think, kind of stumpage costs in Alberta and maybe some talk about this in B.C. How big would those be for you if you had like a six-month deferral?

14:24 It would be a big chunk of the number that I just quoted, like maybe half.

14:31 Okay. All right. I guess the last one for me is if you could maybe just talk a little bit about what's going on in terms of the export market to Asia for lumber coming out of Western Canada.

14:48 Mark, maybe I'll try that one again. It's Chris. Okay. So we've, you know, as you know, we've been in the export market on lumber for you know primarily Japan and China for some time but what most recently what we've done is we're increasing our volumes to help diversify our transportation options and you know just to make sure that we've got orders in front of our mills so Japan declared a state of emergency certainly they've slowed down some but they but they continue to buy we are seeing some builders You know, putting their shovels down for a little while. China has come back very, very strong. And we're selling pretty much all the grades we make over there right now and using various types of transportation to get there.

15:39 So we've been quite pleased.

15:43 Okay, just to kind of follow on that China question. You know, we hear about this spruce beetle wood coming into the Asian markets from China. from Europe. How much of a competitive issue has that been for you, Chris?

15:59 Certainly, I think 2019, it was quite a large competitive issue. But what we understand is most recently, you know, I mean, Europe's been through a pretty tough time, so we don't know how much manufacturing has been going on. But on top of that, their freight rates have increased dramatically and availability. So we're not seeing a lot of that product in Europe. Thank you. The next question comes from Hamir Patel from CIBC. Please go ahead. Good morning. Chris McKeever, could you give us a sense as to how demand has been faring in the R&R and industrial channels? Well, again, R&R is very difficult to get a strong feeling from, but I would say, again, it is somewhat better in the U.S., and particularly in the U.S. South on R&R. We're seeing tremendous demand down there for that.

17:09 Canada, we're less exposed to R&R as a company, but we are seeing actually surprisingly strong demand for the products we put in there. industrial we are a little concerned about industrial as manufacturing slows down you know we're a little concerned we are seeing we're certainly seeing the takeaway of our lower grades which end up in industrial fair bit but we do have some concern there okay great thanks and then Ray I want to ask about you know the pulp maintenance down time in the back half of the year

17:45 Given the ongoing precautions that you'd have to take, does that stretch out the duration off the expected downtime and the likely production impact?

17:56 That's a good question, Hamir. Here's what I would say. We're reviewing our maintenance downtime at both our MBSK mills. Of course, we moved them both into the fall. So we're really kind of going through that right now. I think our intention would be not to increase scope or time. So that probably leads us to, you know, potentially really focusing on the critical projects that we need to do and to defer things that we don't need to do. So at this time, you know, I would say we don't think there's a big change from our overall kind of pulp shutdown for the fall.

18:43 If we need to, we'll reduce the scope a little bit in order to accommodate.

18:49 Great. Thanks, Ray. That's helpful. Chris Virostek, just the last one for me. If this were to be a more prolonged downturn, what's the lowest you could take CapEx to on a full year basis, just thinking for 2021? I know you've got certain commitments for 2021.

19:10 I think probably looking back at where it's been before is a reasonable proxy for that. There's more mills now than there was in the last downturn. I think we've got out there in our public documents that maintenance capital would run, as we would think about it, is somewhere around $100 million. I think we've been fairly consistent in how we've described that. Sean Stewart from TD Securities. Please go ahead.

20:07 Thanks, good morning. Question on your lumber production near-term outlook. You guys have pulled 2020 production guidance, which makes sense. Is it fair to say, though, that May downtime will continue at a similar pace to what you took in April, where it looks like about 35% of your capacity was curtailed?

20:30 Yeah, Sean, it's Ray here. Good morning. Sean, I don't think I can answer for May, but here's what I would say is that I think you heard Chris talk that today markets were selling pretty much, but a month ago that wasn't the case. I think our view is that the market's going to be very choppy and it's going to be in and out as demand fluctuates. and potentially even unwinds more. So I think what I would say is that our intention is to make sure that we're responding to the available market as needed.

21:16 And every week is another week right now. So what's going on this week may not be what happens next week. So what I would say is that I think we're well positioned to kind of... respond to that as needed.

21:35 Thanks for that, Ray. Chris Virostek, maybe you can give us a little context on the nature of the cost as you take this temporary downtime and trying to gauge unit cost inflation over the next couple of months, I suppose, as you take the downtime. What percentage of your costs would be fixed that you're carrying over that duration? I guess I'm just trying to benchmark this against the cost benefit analysis of taking permanent or indefinite shuts versus these temporary rolling shift reductions.

22:13 Well, I think, you know, as we've done the last probably feels like 12 or 18 months now, right, as we've looked at this is, you know, when we do something that's permanent, it's permanent. And that's, you know, based on The long-term assessment of the fiber supply in the region and the economic ability to operate that mill, and that's why we made shift reductions in 2019 and announced the mill closure. For us, doing something permanent, it's got to be grounded in pretty long-term economic view about what's going on. The temporary stuff...

23:00 I think over the course of the last year, unfortunately, we've had to learn a lot about this and probably get better at it than we really want to be in the long term in terms of taking down and starting back up. But I would say our calculus involves a number of things, looking at where our order file is, looking at our investment and inventory, looking at the contribution on a variable basis, the age of the log decks, those sorts of things, all around preserving grade and the outturn that comes from the mill because if you idle indefinitely and leave the logs on the deck, you're going to have a degradation of value there too. There's a lot that would go into it.

23:50 I would say the fixed element of the idling cost are actually quite manageable in our view because the logs make up the biggest portion of the cost in Western Canada. I'm not sure if that answers your question, but that's a little bit of how we think about the approach to this.

24:14 That helps. That's all I have for now. Thanks, guys. Thank you. As a reminder, ladies and gentlemen, please press star 1 if you have any questions. The next question comes from Paul Quinn from RBC Capital Markets. Please go ahead.

24:32 Thanks very much. Morning, guys. Morning, Paul. Just a question on sustainability of SPF lumber price this year. Midweek was down $2, down to $3.30. Just wondering how sustainable you think this pricing level is given that we still have the high duties.

24:52 Well, Paul, honestly, we don't know. The demand seems to come and go. Until we get a little more stable, I think it's really difficult to say. At this time, we've seen enough demand to build pretty good ore farms.

25:17 Are you seeing any capitulation in some of the higher cost Western Canadian producers that would be maybe cozying up to some of the The bigger companies in terms of potential M&A.

25:32 I'll take a run at that, Paul. We're six or seven weeks into a crisis. I think people are trying to figure out how to operate. I can't speak for others, but I think that's probably not the top priority for most people. It's kind of figuring out what's happened in the last six or seven weeks and responding it and trying to run your business plan. You know, perhaps down the road, but I don't think that's front and center for most today.

26:05 Okay, and then just on the pulp side, you've taken some shuts at Caribou. It seems that on the fiber availability side, you know, with more of the BC Interior and other places taking some shuts on the lumber, I suspect fiber will get even more acute. Do you see caribou up and down all the way through the year as a result?

26:30 I guess we'll have to wait and see. Paul, I would say that our focus would be to take as little downtime as possible. At this time, we're certainly not planning any additional downtime at caribou. It's hard to predict exactly what will happen on the fiber side, so there's potential, but I think our plans are to Thank you for joining us.

27:23 Well, I think, you know, given the uncertainty that's out there right now, It's tough when you don't have an idea of what the next three, six months or 12 months looks like to take a view on that relative to how you want to manage your liquidity and continue to keep your mills in operating condition. I think until there's greater clarity, it's pretty tough to see a case for doing something there.

28:00 All right, that's all I had. Best of luck, guys. Thanks.

28:03 Thank you, Paul. Thank you. Your next question is a follow-up from Mark Wilde from Bank of Montreal. Please go ahead.

28:13 Yeah, I have just a couple of follow-ons, one just following on Paul there. In the MD&A, you're pretty specific about kind of maintaining flexibility to kind of pursue kind of growth opportunities that might arise. I'm just curious. If you're going to grow in lumber, is it a fairly safe assumption that the focus will continue to be the southern U.S.?

28:37 So, Mark, you know, I mean, certainly, you know, if you look at, you know, kind of what we've done in the last number of years, I think that's probably a pretty good indication of a kind of, you know, kind of if you look at the past. But saying that, you know, Mark, I think Thank you for joining us.

29:24 Okay, that's fair. The other one I had is just kind of a question on the pulp market. There have been some reports out recently suggesting that there's some pressure on the paper producers in China and that the Chinese pulp buyers are starting to push back, particularly on NBSK pricing. I'd like to just get your perspective on what you see in the market right now.

29:49 Yeah, Mark, I mean, printing and writing for sure has taken a hit. Worldwide, and China is no exception on that. We are somewhat fortunate that we are much bigger in tissue and packaging for all our mills. We are still seeing good demand, not tremendous pushback on any product. We have seen some price increases as well. We could see a slowing going into the summer, which is seasonal. It's not unusual. and sooner or later we do believe that printing and writing will have some effect in demand.

30:28 Okay, that's helpful. Thanks. Good luck the rest of the year.

30:32 Thanks, Mark. Thank you. There are no further questions at this time. You may proceed.

30:39 Well, I just want to thank everyone for joining the call and listening to us today and we look forward to talking to you again in the next quarter. Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.