WFG Q4 2018 Earnings Call
Operator: Good morning, ladies and gentlemen and welcome to the West Fraser Fourth Quarter 2018 Results Conference Call. [Operator Instructions] This call is being recorded on Wednesday, February 13, 2019. 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 risk 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 the 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 will now like to turn the conference over to Ted Seraphim, Chief Executive Officer. Please go ahead.
Ted Seraphim: Good morning and thanks for joining us today. I've Ray Ferris, Chris Virostek and Chris McIver with me. We prepared a PowerPoint presentation which you can follow along which has been webcasted. 2018 was a year of volatility in lumber markets and a year when weather impacted our operations, transportation capabilities and quarterly financial performance in an unprecedented fashion. Chris Virostek will review of your fourth quarter lumber results as well as providing a high level summary of our full year results. Prior to that we thought it might be helpful to provide our view regarding lumber markets and to review our long held thesis that at 1.3 million U.S. housing starts we would experience balanced supply and demand fundamentals. With that, I would like turn to Slide 3. Housing starts, housing starts were on pace for the first six months of the year to bring us in line with 1.3 million housing starts for the year. While we haven't seen the results for December we expect that housing starts will come in at approximately CAD 1.26 million for 2018. What is encouraging is that repair and remodeling activity continues to outpace GDP growth and we expect that pace to continue. Consequently, as you look out at the next three to four years our view really hasn't materially changed from the beginning of 2013 when we projected demand to grow at an annual growth rate of close to CAD 2 billion fee or approximately 3.3% per year. This is lower than the annual demand growth rate of approximately 4.5% from 2011 through 2017. While demand growth may be somewhat lower going forward, we think that the same can be said regarding our outlook for supply growth over the next few years. And with that let’s move to slide 4. For some time we've been saying that the two key factors that will govern North American supply will be the impact of the mountain pine beetle epidemic on BC production and that a number of factors will present challenges to growing U.S. self-lumber production. The competition for timber has been fierce in British Columbia and we forecasted that the day would come when it would be uneconomic for all our mills to run at our historical run rate given the decline in the annual allowable cut. For that reason we made the difficult decision last year to permanently eliminate our third shifts at Cornell and Fraser Lake in 2019. Although we can't predict the timing, the future industry's supply reductions, it's been known that the reductions in the annual allowable cut for will force further reductions in lumber production in British Columbia. Aside that knowledge has driven our strategy to expand in Alberta and in the U.S. South. With respect to the U.S. South we do believe capacity growth will be slower and potentially lower than anticipated a year or 18 months ago due to the factors that we present at the bottom of the slide. As a result, the potential somewhat lower demand growth over the next few years will be balanced by materially lower supply growth than we had experienced through the last number of years. We've been asked by a number of investors to provide our view with regards to the volatility in lumber markets and financial results in 2018 perhaps slide 5 will provide some visibility on this. During the first four months of 2018 whether an unprecedented transportation challenges resulted in West Fraser undershipping production by 200 million feet and we believe the industry as a whole undershipped production by approximately 1 billion feet in that period. From May through August we overshipped the corresponding volume on a 60 billion board foot North American market. That means that we undershipped by 5% in the first four months on an annualized basis and overshipped by 5% in the next four months, a 10% net difference in shipments over this period was bound to result in volatility. And this was exacerbated with a slowdown in U.S. housing. As we mentioned during a few of our calls last year we plan to make this a catalyst for change in how we manage our transportation efforts. We've made great strides and while we can't rule out some volatility due to weather with a much more robust transportation plan today and it's paying dividends. With that I will pass the call to Chris.
Chris Virostek: Thanks Ted. Turning to Page 6, we'd like to spend a couple of minutes talking about the fourth quarter and in particular our lumber business. As Ted mentioned, it was a challenging quarter on a number of fronts. Relative to the prior quarter lumber production was down 5% and shipments were off approximately 10%. SPF production was in line with the year ago quarter but down slightly from Q3 as we took some market related curtailments over the holiday period. SYP production was lower than Q3 as persistently wet weather in our operating areas in the U.S. South led to challenges in log availability. We were also working on the ramp up of our new saw mill at Opelika Alabama and we're executing on some other planned maintenance downtime during the fourth quarter. Lumber shipments declined from the prior quarter by almost 200 million board feet. In SPF, our shipments in Q3 were relatively higher as that quarter included some shipment of backlog from Q1 as we worked through our earlier delays that Ted just described. In respect of SYP, softer market conditions contributed to the shortfall in shipments relative to production. On the whole, our lumber shipments in Q4 were in line with production and similar to the fourth quarter of last year. SPF benchmark 2/4 pricing was off just over 30% in the quarter as pricing retreated from higher levels earlier in the year when it was influenced by the supply issues. SYP benchmark 2/4 did not decline as significantly however wider dimensions of SYP suffered a significant correction in the fourth quarter. Despite these factors, our lumber segment managed to produce an adjusted EBITDA per 1,000 board feet of CAD 43. Turning to the reconciliation of Q3 to Q3 earnings for the lumber segment, of the decline in adjusted EBITDA of CAD 271 million, we estimate that approximately CAD 200 million is due to price and product differentials. The change in the premiums between narrow and wide dimensions we estimate had an impact of approximately CAD 31 million and the remaining CAD 170 million was due to price declines in SPF and the other products. The 10% decline in lumber shipments reduced earnings by a further estimated CAD 35 million, and the impact of higher costs which was most significantly fiber in Western Canada represents the balance of CAD 35 million. Turning to the year, we grew our lumber shipments by nearly CAD 500 million board feet, largely representing the carryover impact of the Gilman acquisition. For the year 42% of our lumber production was SYP in the U.S. South, up from 38% in the prior year. Pulp production was slightly off the prior year by 2%, and remains a focus area for us in 2019. Higher prices across all commodities led to a 33% year-over-year increase in adjusted EBITDA to just over CAD 1.5 billion. Cash flow from operations was similar to the prior year at CAD 909 million as cash taxes, pension funding and duties all consumed a higher portion of adjusted EBITDA than in 2017. To date we have US$244 million of duties on deposit with the Department of Commerce. We increased our capital expenditure by 10% to CAD 370 million and completed two major sawmill rebuilds, five continuous kilns and several upgrades in our pulp business among other projects across our mill network. As stated in our MD&A, we are anticipating capital expenditure in 2019 of between CAD 350 million and CAD 450 million as we continue to action a high return projects across our network of operations. Net debt to capital was healthy at 17%, and available liquidity remains strong at CAD 651 million as we closed out the year. Strong in our conviction in the medium term fundamentals for lumber supply and demand we executed on our share buyback throughout the year, reducing our share count by 10% and returning CAD 675 million of capital to shareholders while retaining a significant amount of financial flexibility for growth. The balance that we have applied to our capital allocation strategy has been in our view key to creating value, in the past four years we have generated nearly CAD 3 billion in cash flow from operations. We have put roughly 43% of that back into the business to maintain our leading position as the low cost lumber producer. At the same time we have put CAD 600 million or 20% of the cash flow from operations to work growing the business and expanding our platform in the U.S. South and Alberta as two cost advantage regions. Finally we have returned 38% of the cash flow from operations back to our shareholders in the form of dividends and share repurchases. We have executed that balance strategy while not compromising liquidity or constraining our financial flexibility to pursue attractive internal investment options or external growth opportunities. Cumulatively through the end of last week we have repurchased nearly 1.1 billion in shares and at the same time our trading liquidity has improved since we started the repurchase program in 2013. With that I'll turn it back to Ted for some summary comments.
Ted Seraphim: Thanks Chris. Turning to our summary slide, despite a myriad of challenges in 2018 West Fraser continues to execute on our long-term strategy to be the leading wood products manufacturer in North America. We’re able to build on our leading North American lumber margins in 2018 and we believe that the geographic diversification of our lumber business with the attendant capital opportunities will continue to support margin growth. What we also want to stress is that operational excellence continues to be our core priority as we run the business. It's clear that we have more work to do. But I know we have the assets and the people to realize our goals. With that, we'll open the call up for questions.
Operator: [Operator Instructions] And your first question is from Hamir Patel from CIBC. Please go ahead, Hamir.
Hamir Patel: Ted, when you – when you purchased the Gilman Mills, know I think you pointed to the lumber recoveries at those mills lagging your existing facilities by 20%. Have you started to close that gap there? And if those mills had, I think it was 700 million board feet of capacity when you bought them. What's the potential capacity growth you could see if you close that recovery you have?
Ted Seraphim: Well, I think I'll have Ray Ferris, our President comment on that.
Ray Ferris: Hamir, so to Ted's point, we still have that gap to increase, so we're really just getting started on our capital strategy at the Gilman facilities, and that would be something that really over the next couple of years, that we're going to be able to kind of execute on that plan. So that opportunity is still front and center, and we're looking to capture that.
Ted Seraphim: You know I think just to add to Ray’s comments, I mean, I don't think we want to give a number in terms of capacity growth but you know I think where your question is coming from in here is that, in our recovery, lumber recoveries 20% more than the rest of our U.S. assets. So you know we can't give a number but we see material opportunity to grow our, our footprint there with capital over time.
Hamir Patel: And had you guys completed Opelika last year. You know do you have any similar projects like that underway that might come online in 2018?
Ted Seraphim: Well again I think Ray could probably give you a better detail than I would on that one.
Ray Ferris: Hamir, we have what I would say is a pretty good runway of similar projects like that that we plan on rolling over the next several years. Specifically to 2019, I would say more specifically we would be beginning one or two of those projects but we may not see the benefits of those until 2020.
Hamir Patel: And just a final one from me, it's worrying if you guys can give your sense as to where, where you think inventories are in the, in the channel for the lumber?
Ted Seraphim: Well Chris McIver is probably the best one to answer that question as well.
Chris McIver: Yes I mean again it's, it's not clearly evident but everything we hear and, and what we're seeing from our customers is it’s still pretty lame. You know they’re, they're starting to buy again, they’re starting to build certainly in SYP the takeaway has been really good this year so far and, and is being consumed and put out into the market. So I would say they’re, they’re you know they've probably gone up a little bit from year end but are still in really good shape.
Operator: Your next question is from Sean Steuart from TD Securities. Please go ahead, Sean.
Sean Steuart: A few questions. The $31 million in sequential EBITDA pressure related to price differentials, I guess. And I take it most of that was inordinate pressure on the wider dimensions in the south. Can you give us an idea, is that a normal mix with a normal sales mix for you guys this quarter in terms of the dimensions? And absent 2 by 10 places in the so catching up is a mix shift coming in the first half of the year that might expedite that price recovery?
Chris McIver: It's Chris again. Yes, I would say that our mix was pretty normal. But when you do see the two before hold up and then whites not hold up as well, you can see that big gap come. Now we are seeing the whites recover some this quarter and certainly demand for whites is up and it seems like to before in the South holds up pretty much throughout most cycles, whereas when we see things slow down, we certainly see what we can. And with regards, I think our mills are always tweaking as to our great mix or certainly are with mix.
Ted Seraphim: Without giving numbers, I think a lot of our capital plans in the U.S. so is to give us a bit more flexibility in terms of producing a higher percentage to buy for as time goes on here, so that that will be a focus for us as well.
Sean Steuart: Wondering if you can speak on Western Canadian fiber costs and maybe differentiate what you saw in Q4 between BC and Alberta and how you see those costs trending into the first half of 2019?
Ray Ferris: Sean, it’s Ray here. So, I'll take a stab at that. Sean, I mean you know in British Columbia the past trend you know despite curtailments I - there could be some softening, but quite frankly our expectations that we expect that trend to continue for some time until you know the true kind of rationalization happens in British Columbia. In Alberta, you know a little bit more responsive to market. So you know log cost you know did come down, fiber cost did come down in Alberta and they have kind of flattened out. So you know I would say that's kind of our view of the you know first part of 2019 but it's going to depend on quite frankly on lumber market conditions.
Sean Steuart: We've heard from some of your competitors that bidding for logs in BC has become more rational, if not late last year certainly early this year is that consistent with what you've seen?
Ray Ferris: I think it's a matter of context and perspective. I think it depends on how you look at it. I would say you know to qualify you know it means ease slightly, but it's still very difficult out there and - and there is a lot more work that needs to be done.
Sean Steuart: Last question for me the panel segment, the Canadian plywood pressure was – was pretty transparent, but the margins still came under quite a bit of pressure. Can you give us an idea of the – the shifts curtailment you had for the LVL segment. How much that fit into weaker margins and is that shift still curtailed into – into early 2019
Ted Seraphim: I’ll take Sean that so you know our LVL strategy so I would say they’re kind of separate things so our LVL strategy it's less a reflection of a reduction of production and more about kind of how we've gone the market. And in 2017 we made a change at the plant, the target kind of a different product mix basically higher strength values and that came with a view that it probably means lower production, but better margins. I'm pleased to say that's kind of where we are at. So I would say LVL is a -- remains a pretty good little business for us but I think what you've seen in the balance of the plywood sector is you know frankly similar cost pressure on blogs and a dip in short-term plywood pricing.
Operator: Your next question is from Mark Wilde from Bank of Montreal. Mark, please go ahead.
Mark Wilde: I wondered Chris if we could just come back to the lumber inventory issue for just a minute. I was -- I've been hearing a lot of the same stuff that you were suggesting but then I saw this story in random lengths last week and that was suggesting that dealer inventories were off more. Did you see that and what did you make of it because it didn't seem consistent with other sources I've check with?
Ted Seraphim: Yes. I did see it mark. And again it isn't consistent with what we're hearing. But random links does a pretty general survey from my understanding. I don't know how much science is behind it you know. So you know what we can tell you though is that what we're hearing from our customers every day is that, and quite frankly at the beginning or within a couple of weeks ago, when business got a little bit better, you sure saw people wanting to buy in a hurry and get the products shipped to market, which tells me their inventories aren’t that big. So I really can't specifically comment on the random lives.
Mark Wilde: I really didn't know how much rigor there was behind that survey. So I was a little cautious myself. Chris Virostek, can you give us any sense of where the big buckets are going to be in terms of CapEx in 2019? And just the – sort of it looks like that to the midpoint you're going to be up about 8% or 10% just year-on-year in 2019?
Chris Virostek: Yes. I can start, then Ray can probably chime in. I think as we look at sort of relative comparison of 2018 to 2019, we do have two pulp mill shutdowns coming in 2019. And as we started off the call, we see a big pipeline of opportunities there in the U.S. sales with respect to modernization and continuing to work on, on those projects. So I think when we think about some of the priorities that we've laid down relative to capital, it's, you know it's modernizing those U.S. mills and bringing them along to where we think that there realistically, realistically should be, and then continuing to work on our pulp reliability, but the majority of that CapEx would be destined for the U.S. Ray, anything you want to add to that?
Ray Ferris: No, I think that covers. I mean I think we're - to I think one of the previous questions I would say, just this is that we're pretty excited about the platform and the runway we have in U.S. sales; and so it's really kind of deploying as much capital at really some wonderful projects to as quickly as we can as without disrupting our kind of our operating platform. So we're kind of full…
Mark Wilde: And then, I wondered can we talk a little bit about China both in terms of kind of the pulp business, but also in terms of the lumber business I noticed you know year-on-year your volumes in a lumber were pretty flat going into China I'm just kind of curious in that business whether this slowing that we are seeing in other businesses in China having any impact on the lumber business?
Chris Virostek: Mark, it’s Chris again. You know what I'd say about our China business on the lumber side is we target a very steady volume month-to-month. We – you know some of our competition particularly smaller producers tend to chase the market whether it's in North America or whether it's in - in Asia. We've got a pretty big commitment there. And so we're pretty stable. We like the volumes that we're doing there. More or less we hold it steady and opportunistically we’ll go up and down a little bit you know and we're seeing demand continuing strong there on the lumber side, not overwhelming and there is competition but – but it's very steady for us. So you know with regards to pulp we certainly going into Chinese New Year, we did see a bit of a weakening in the market, but saying that our order file for our pulp group you know has stayed very strong excuse me and we you know we expect the market to recover there and we'll see what happens as they come out of the Chinese New Year so.
Mark Wilde: And then, the last one for me is it possible for you guys to size the – the mid-January curtailment impacts that you announced?
Ted Seraphim: Well I think - I think the curtailments we announced I think Chris was 50 million board feet for the quarter. And so that's what - that's what we have there and again we took our sawmills’ third shifts down at - on top of that we took our third shifts down at the sawmills January the 14 at Fraser Lake and Quesnel and you know we'll be taking the third shift are in the planer probably sometime in the second quarter. So you'll start to see the net impact of that 300 million board feet start to happen over the second and third quarter.
Operator: [Operator Instructions] We do have a follow-up from Mark Wilde at Bank of Montreal. Go ahead, Mark.
Mark Wilde: Just a follow-up Ted. This might be the last time you have to answer this question. Can you just talk a little bit about sort of the issues that happened in the fourth quarter?
Ted Seraphim: I thought I would skate through it. I'm going to do one more call I think - I like to do maybe one more call but…
Mark Wilde: Hopefully any question though.
Ted Seraphim: No, I was going to have Ray answer the operating questions but I think I'll take this one. Boy I think we've talked about this just about every quarter for the last couple of years. And we had - we had a good third quarter in Hinton and we've had a number of quarters that we've been encouraged and we really struggled in the fourth quarter and you've heard me say this before and I'm going to say two comments and starting to feel very repetitive. I think the first comment is, we won’t tell you that we’re feeling good about until we've got three or four solid quarters behind us and we continue to feel that way. Secondly though, we are putting a ton of effort in reliability and some days, some weeks we don't feel like we're seeing the benefits of it. But what I can say is that when the mill runs, well it runs better than it used to, and our folks are putting a ton of effort and focus on putting the right measures into reliability in terms of asset quality and how we're running the mill from an operating standpoint. So it's just like one of those things, you're not seeing the benefits of all the hard work, but we feel we've got a good plan of action and we've got a big maintenance shut down coming this quarter. I know we're much better prepared for it than we've been in the past. Obviously, it will be a lot of, a fairly likely shut down and will be challenging, but the key I think will be to see how we come out of that in the second quarter and I'm hopeful that we'll have a strong good shut down and a strong second quarter so when Ray report second quarter results, he'll say Ted's gone and Hinton's running well.
Mark Wilde: Just one other one. You talked about sort of the changes in your kind of transportational logistics out there. And it looks like you shipped production basically this quarter, but are you seeing any transportation issues at all either from an availability or from kind of a cost standpoint here?
Ted Seraphim: We were running for some transportation issues from time to time, much less so than last year, but we've also put measures in place, Mark, that allows us to adapt to that. We've made some larger commitments to other modes of service. And I think as we said last year, we've really got our mills and our sales groups totally engaged with our transportation folks so that we can be much more nimble and have the ability to load trucks, railcars you know whatever it takes to move the product. So I think we are, I think you know whether it's been better, I've got to say you know our major rail carriers did a much better job this year than, than last year and I know they’ve put a lot of focus on it. But we've also created the capability to have flexibility in our system. So you know so far so good.
Operator: At this time, there are no further questions. You may proceed.
Ted Seraphim: Well thank you very much for joining us on the call and stay warm and we'll talk to you in a few months.
Operator: Ladies and gentlemen this concludes today's conference call. We thank you for participating and we ask that you please disconnect your lines.