Conifex Timber Inc

TSX:CFF

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Welcome to the Q1 2019 Conifex Timber Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields, CEO. Please go ahead, Mr. Shields.

[Kenneth A. Shields, Chairman, CEO & President]

Well, thank you, and good morning, everyone, and welcome to this call covering our Q1 '19 results. CFO, Yuri Lewis; and Executive VP, Hans Thur, are here with me, and we're all available to respond to any questions you may have at the end of this call.Let's quickly review 3 key points about the financial information we're about to discuss and review on this call. First, we will be making forward-looking statements and references to non-IFRS measures. And therefore, I call your attention to the disclaimer on the second slide.Second, we're going to be referring to adjusted EBITDA, which is EBITDA adjusted for the noncash impact of foreign exchange translation gains or losses on U.S. dollar denominated long-term debt. Most of you are already aware that the majority of our borrowings are in U.S. dollars and because most of the debt was drawn down to fund the development of the business in the U.S., so it's denominated the in U.S. currency.We believe that adjusted EBITDA is a better indicator of our operating performance in any reporting period. Third, our Q1 results and results of comparative quarters have been reclassified to give effect to the sale of Lignum Forest Products that we completed on April 2 or 3 of this year.For example, Lignum revenues are not included in the revenue figures I'm just about to review with you. This morning, we reported Q1 2019 revenues from continuing operations of $133.7 million, a sequential decline of 2%, but an increase of 43% compared to Q1 of last year. The year-over-year gain reflects a build-out of our U.S. lumber business.In common with other B.C.-centric sawmilling companies and consistent with the guidance we've provided on our last call with you, Q1 adjusted EBITDA improved sequentially, but not by a sufficient amount to enable us to achieve positive EBITDA. On a consolidated basis, adjusted EBITDA improved $4.5 million to reach negative $2.7 million in Q1 versus negative EBITDA of $7.2 million in the closing quarter of 2018.Adjusted EBITDA in Q1 of this year was $10.9 million lower than in Q1 of 2018. The negative EBITDA is entirely due to our BC lumber operations since our power generation and U.S. South lumber businesses achieved positive EBITDA in the most recent quarter.At our B.C. mills, the cumulative effects of continuation of the weak lumber prices, punitive duty impositions on U.S. shipments, record high log costs and the higher unit cash conversion costs and lower shipments that result from production curtailment, they all added up to negative EBITDA.On the other hand, bioenergy segment EBITDA of $4.7 million matched the record high EBITDA we achieved in Q4 of 2018. This supports the outlook we shared with you on our last call when we indicated we expect further improvement in bioenergy segment EBITDA in 2019 over 2018.Looking at lumber, we discussed our lumber segment in considerable detail on our March 27 call. The main new development since then has been the production curtailments we recently announced for May at our Fort St. James and Mackenzie sites.We are pleased that a majority of our lumber production is now sourced from the more competitive U.S. South lumber supply region. From a base of 0 in Q1 of last year, annualized production reached 418 million board feet in Q1 of this year. We have further upside to our U.S. production. Our near-term target is for annualized production to increase by approximately 50 million board feet to 470 million board feet annualized in the second half of 2019. This year's abnormally high and prolonged rainfall in many parts of Arkansas has led to local log shortages and ship curtailments at several mills in the state. Our El Dorado site has not been materially impacted, but our Glenwood site is one of something like 6 or 7 mills in Arkansas that have been unable to maintain continuous productions due to log shortages.With normal log deliveries, the same site production gains underway at our 2 Arkansas mills will have a favorable impact on cash production cost per thousand board feet of lumber produced. We're also continuing our work to capture more value out of every log we process and more value out of every board we produce. We're sticking with the target and shared with you on the last call when we outlined that we expect our U.S. mills to lower their ranking on the industry cost curve by about $25 per thousand board feet between Q1 of this year and Q3 of this year. In summary, we know we have more work to do in the U.S. South, but we're confident we have the people, fiber supply and converting facilities to realize the cash flow generation potential we established for entering the lumber business in the U.S. South.Turning to finances. Our MD&A discloses that we continue to actively manage controllable expenses and working capital levels to optimize our liquidity. Our MD&A also discloses that we're prepared to consider monetizing certain assets that are not central to our mid- and long-term development as a North American lumber producer compiling superior EBITDA margin.Since our last call, we have most frequently been asked 2 key questions. Number one, what's the outlook for future lumber production from the interior region of B.C.? And number two, how might industry rationalization be impacted by new provincial legislation? I'm sure you all understand that there is no one short simple answer to these questions. So permit us to take a couple of minutes now to share our views about the likely path forward for the interior B.C. forest sector.In the past, we've talked about the changes underway in the intensely competitive lumber industry. We explained how 2 little sustainable saw logs supply is available in the interior B.C. forest sector to support currently installed 2 ship lumber production capacity. Our first conclusion is that interior B.C. lumber production will contract over the next few years. Our second main conclusion is that a contraction in lumber production typically results in a contraction in the amount of fiber available to the pulp, pellet and biomass power sectors.Here is why. First of all, fewer sawmill residuals are produced than available as a byproduct of processing logs into lumber. And sawmill residuals, of course, include wood chip, sawdust, planer shavings and bark. Second, however, lower harvests from saw timber stands also mean that less coproduct fiber such as pulpwood and bio logs and fewer harvest residuals such as treetops and barks will be made available to the pulp, pellet and power sectors.On April 1, 2019, B.C. premier, Horgan, challenged forest industry executives to and I quote, "find a new vision for a competitive forest sector" that seeks to maximize the midterm timber supply, manage constraints on the land base, maintain community and economic stability and incorporate First Nations interests. On April 11, Bill 22 was introduced, which as minister Donaldson stated, will allow for more government say on behalf of the people of B.C. on how tenures are transferred or acquired. We can't speculate how other operators see rationalization proceeding and tenure transfer approvals being granted. But in our case, we've completed much of the study and analysis necessary to identify ways to optimize fiber sourcing and delivery in and around Fort St. James and Mackenzie B.C. The overarching conclusion we reached is that numerous synergies are available for sawmill operators to join forces with the pulp and power sectors to coordinate fiber procurement from both higher value saw timber stands and from lower value non-saw timber stands.For example, there are opportunities for sawmill to gain incremental supply from the saw timber produced as a coproduct from lower value stands harvested by pulp mill and power plant operators. There is also opportunities for pulp mill and power plant operators to gain incremental feedstock supply from the pulp and bio logs produced as a coproduct when saw timber stands are harvested. This leads us to conclude that with the cross sector and collaboratively developed log harvest and delivery plans, additional affordable fiber can be made available, and this additional fiber will help mitigate forecasted declines and capacity utilization rates in B.C.'s lumber pulp, pellet and power segments.Simply put, by teaming up with other fiber consuming stakeholders and by embracing heightened First Nations engagements in our industry, we believe we can meet the premier's challenge to come up with a new vision for a competitive forest sector and support provincial government objectives to maintain community and economic stability.We also believe that any tenure transfer approvals necessary to achieve these favorable outcomes would be forthcoming. Wrapping up our call, our Annual General Meeting is on June 24, and we look forward to your attendance and to bringing you up-to-date at the meeting. We expect to be able to disclose that the momentum we enjoy in the U.S. South is contributing to growing EBITDA generation. We also hope to have more information to share with you about any asset monetization opportunities available to us as we explore ways to optimize fiber procurement and forest sector competitiveness in the locations we operate in the interior B.C. We thank you for taking the time today to learn more about Conifex, and we would be pleased to respond to any questions analysts or shareholders may have. So we'll turn our discussion back to the operator.

[Operator]

[Operator Instructions] Mr. Shields, we have our first question from Sean Steuart of TD Securities.

[Sean Steuart, Research Analyst]

The questions on the balance sheet and levers that are available to bolster liquidity for your company. Can you give us a sense of how you expect working capital to shift through the remainder of the year? Appreciating you, you didn't have to build up significant log inventories in B.C. in Q1 because the operating rates are going to stay low. How should we expect that to progress through the remainder of the year? And generally speaking, how much working cap do you think is available to pull out of the system?

[Kenneth A. Shields, Chairman, CEO & President]

Well, I could answer part of that. And Sean, as I'm sure you appreciate that we have 2 sources of funding for operations, one is cash flow and I'm sure your analysis concludes that the B.C. forest sector needs something like USD 400 to be in a positive cash flow generation situation after paying duties. And secondly, in our case is that we have some cash that's potentially available from asset monetization initiatives. And clearly, we've been working hard on identifying the best business plans for the locations we operate. We've had a chance to do some early testing as to what the reaction is from other partners in the region. And back when we agreed to our loan modification amendments, we committed to roughly $75 million-or-so of debt reduction in the 12 months period beginning April 1 of this year. And everything that we've seen so far in the case that that's a realistic achievable target. And Sean, coincident with that is that we have a smaller footprint in B.C. and less working capital requirements would be necessary to support the smaller footprint. So that's a rather lengthy answer as to provide you some insight into how we're looking at cash inflows and outflows over the next 12 months.

[Yuri Lewis, CFO & Corporate Secretary]

And I would add, Sean, that as you know that at the end of Q1 is typically the heighten log build and then shortly after we sold -- completed the sale of Lignum, which was mostly a unwind of working capital. So I think given the announced curtailments in Q2 and then the wind -- the drawdowns in the Q1 inventories, like -- I think, as we wind back up, I think, it's going to -- there's not going to be additional draw, I would say.

[Sean Steuart, Research Analyst]

And I guess, just further your comment on potential asset sales. When might we expect to hear something on that front? And how much of this is complicated by Bill 22? Any thoughts on your timing for potential dispositions?

[Kenneth A. Shields, Chairman, CEO & President]

Well, I mentioned in my comments, Sean, that we've got a Shareholders Meeting on June 24, and there is a good chance we might have some news to share with you then. And I would say that there is also a good chance if we don't have news available on that date, that we will when we report our Q2 results. So that's the window that we think that some of these initiatives that we're exploring and discussing could materialize.

[Operator]

The next question is from Paul Quinn of RBC Capital Markets.

[Paul C. Quinn, Analyst]

So just back to Sean's question on asset monetization. What -- I mean, you've done some initial work there, just wondering what the -- and you've sold some tenure in the past. I think you'll recall it was somewhere around $150 per cubic meter, B.C. Just curious of that, are you still holding in the market, is it -- as you're feeling that it's increasing potential log shortages are getting more acute? Or is Bill 22 having an adverse effect on the value?

[Kenneth A. Shields, Chairman, CEO & President]

Well, Sean -- Pardon me, Paul, let me share my views with you is that, first of all, we think that tenure values in B.C. have come down a bit for a couple of reasons. Number one is that when we did the transactions in 2015, there was more of dead pine timber that had more commercial value in the stand than we have today. So that's a factor that would impact tenure values, namely the deterioration in the commercial value of many timber stands in B.C. And the second thing that it appears to me has happened is that people generally have less optimistic views about the potential supply-demand balance in lumber in North America. And they aren't factoring in as why a profit margin on lumber manufacturing, and that will limit or tamper the amount that people are prepared to pay for the tenure. So Paul, we look very closely at these values last month because we're telling people that we have a book value per share that's 4 or 5x multiple of our current share price. And so we satisfied ourselves that the balance sheet carrying value for our forestry assets are appropriate and in line with the current -- our current estimate of tenure financial values that supports the book value of our company, whether it's in the high -- pardon me, in the low triple digits for cubic meter or in the high double digits, it's probably in that range given the location and other factors that are associated with the tenure.

[Paul C. Quinn, Analyst]

Okay. And then just on your initial work, what's -- can you give us an idea of the overall interest i.e., do you have -- is there a good number of people that are interested in some of the things that you're talking about in terms of assets to sell?

[Kenneth A. Shields, Chairman, CEO & President]

Well, we mentioned on our March 27 call that there are a great many forest industry stakeholders that are communicating with us and others to gain a better understanding as to the consequences of potential future harvest reductions. So in the areas that we operate in the Prince George and Mackenzie regions, I'm -- my guess is that of all the sawmillers operating in that region that we probably have the highest degree of saw timber self sufficiency and one of the older, in terms of age, sawmill complexes. So you can see that, Paul, that to be the basis for -- of considerable interest in discussing opportunities that are mutually advantageous, but we're not at the stage where we can make a final decision and precisely determine our path forward. We still have more work to do on fiber flow optimization in our region and that work is going to take a while to get done. It might be done by the 24th of June, but it might run a little longer than that.

[Paul C. Quinn, Analyst]

Okay. And then just on the Bill 22 that seemed to come out of nowhere, it didn't seem to involve industry consultation, although the premier talked about working together with the industry. Do you think that will have a material effect on your asset sales?

[Kenneth A. Shields, Chairman, CEO & President]

We're not -- we think that the value of the asset is a function of its scarcity value much more so than the value that might be impacted by future regulatory considerations. I think many of you would know that I was on the board of Slocan Forest Products for approximately 20 years when it grew from 1 mill to 1.5 billion board feet of capacity or something, and I seem to recall that every transaction that I did over that period required Forest Minister approval. And so it indicated that you can grow businesses and transact when you have a ministerial approval component to the industry.

[Paul C. Quinn, Analyst]

Okay. And then just last question, just maybe a question to Hans, just on the weak SPF pricing. Is that a surprise to you? I mean obviously, weather was a factor, but it continues to be weak here and well below breakeven pricing? Do you see that materially turning around in Q2?

[Hans Thur, Executive Vice President]

Yes. Thanks, Paul. Yes, no doubt, it has caught everybody by a bit of surprise that it -- we haven't seen that Spring Valley materialize. I mean reflecting back now when we look at what took place where people started buying some inventory ahead late in the fourth quarter in anticipation of what transpired last year in the first quarter when prices ran up so high and then when we got impacted with the weather, a lot of that material ended up being in the inventories at the retail level, the distribution level and the wholesale level. And it's just taking -- taken a lot longer to get that move through the chain, the supply chain than we've anticipated. At this point in time, we sense that, that is happening and it's moving through, but the buyers in all segments are fairly skittish going forward here, getting close to summer time. But we do sense that things will continue steady and move up slightly as we go through the year, and perhaps we'll get a market that goes a little stronger into the summer than it does historically.

[Operator]

[Operator Instructions] We'll now take the next question from Roshni Luthra of CIBC Capital Markets.

[Roshni Luthra, Analyst]

Ken, just a couple of questions for you. First, wondering like, how does profitability on your SPF exports to China today are compared to what you've realized in the U.S. after the 20% duty? And what are you seeing in the Chinese market?

[Kenneth A. Shields, Chairman, CEO & President]

Well, thanks for the question. And Roshni, we'll have Hans Thur answer that question.

[Hans Thur, Executive Vice President]

So our business into China year-over-year is pretty steady state. You will see in our numbers, it reflects about of our Canadian business, SPF business about 20% to 25%, and that we're still in that -- we have a window of percentage at this point in time. Prices are competitive in China, as we've seen more supply coming in from Russia and Europe on that sense. Now you mentioned on the duties, that's specific more to the U.S. shipments and we've seen -- not that we're in the business of shipping logs to sell the Yellow Pine logs to China, but that is basically deteriorated from where it was a year ago. And on the lumber side, that we're seeing a lot less lumber at this moment in time of SP -- or sorry, Southern Yellow Pine going to China as a direct reflection of the duties there from the U.S. to China or the tariffs.

[Roshni Luthra, Analyst]

Great. Fair enough. And then like -- so after July 1 the stumpage revision, just thinking about B.C., what do you think the breakeven lumber prices might be after July 1?

[Kenneth A. Shields, Chairman, CEO & President]

Well, the information that we were reviewing the other day indicated that the, what I call that, overall rate in B.C. is going to go up somewhere between $10 and $15 per cubic meter. And typically, there are about 3.5 cubic meters that are required to make a thousand board feet of lumber. But everyone has a different approach to managing log cost of which stumpage is a component of delivered log costs. And just where we happen to be located in Mackenzie and some of the changes we plan to make to our delivery and haul distances we don't think that we will be able to -- we don't plan to absorb the full increase in the amount that I mentioned earlier because by adjusting our log sourcing and so on, we think we can contain the stumpage price increase to probably something like 75% of the increase in the posted rates.

[Operator]

As there are no further questions registered at this time, I would like to turn the meeting back over to Mr. Ken Shields.

[Kenneth A. Shields, Chairman, CEO & President]

Okay. Well, thank you very much once again for your interest in our company, and we hope we see many of you at our Shareholders Meeting on the 24th of June. Thank you, enjoy the rest of your week.

[Operator]

Ladies and gentlemen, the conference has now ended. Please disconnect your lines at this time. Thank you for your participation.