Conifex Timber Inc

TSX:CFF

Earnings Call Transcript

[Operator]

Good afternoon, ladies and gentlemen. Welcome to the Conifex Timber Inc. Q4 Results Conference Call. I would now like to turn the meeting over to Mr. Ken Shields. Please go ahead, Mr. Shields.

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

Well, thank you very much, Eric, and good afternoon, everyone, and welcome to our call covering our Q4 2020 results and our full year 2020 results. Chief Financial Officer, Jordan Neeser, is with us today and available to respond to any questions you may have at the end of this call. Before moving ahead, we wish to emphasize that our #1 priority continues to be protecting the health and safety of employees and their families. The men and women at our harvesting locations, sawmill site and power plant deserve the credit for ensuring a safe work environment during this unprecedented global pandemic. We are most proud of the fact that Conifex recorded 0 lost time accidents during the recently completed year. Let's quickly deal with a housekeeping item. We will be making forward-looking statements and references to non-IFRS measures, and, therefore, call your attention to the warning statements set out on Pages 1 and 2 of the MD&A dated today that we released a short while ago. Besides recapping our recent results and financial position, the main topics we wish to cover with you this afternoon are review of our Q4 2020 lumber and power generation performance and an outline of our 2021 performance [ attains ] for the 2 businesses. For the quarter, net earnings of $2.3 million, equivalent $0.05 a share were reported. EBITDA was $6.8 million. And of course, EBITDA and net income were both held back by a production disruption at our power plant. And as we've indicated, our plant was curtailed in early December and resumed production in late February. For a full year basis, we reported a net loss of $6.5 million or $0.14 per share. In the second half, we earned $4.3 million or $0.09, but this was insufficient to offset the losses we incurred in the first half of $10.8 million or $0.23 per share. Full year EBITDA from our 2 main businesses was $9.7 million. And here again, we had negative EBITDA of $4.7 million in the first half and positive EBITDA of $14.4 million in the second half. I would now like to turn the meeting over to my partner, Andrew McLellan. He's our Vice President and General Manager of Northern BC operations.

[Andrew McLellan]

Thank you very much, Ken, and good afternoon, everyone. Let's start with our lumber operations. Our Q4 production was about even with Q3. In common with other sawmillers in the Northern interior region of BC, we experienced unusually wet weather conditions in Q4, which led to log harvest and delivery shortfalls. In response, we reduced our operating hours at our sawmill complex by approximately 10%. It appears this reduction will be maintained throughout the first half of 2021. We plan to ramp up our lumber production as soon as we have the benefit of our summer logging program. For the first half of 2021, we expect lumber production will be slightly higher than in the second half of 2020 and that we'll achieve an operating rate of 90% of our 2 shift rated capacity of 240 million board feet. A number of unanticipated production and/or shipment disruptions could hold us back and prevent us from achieving the aforementioned targets. However, on a full year basis, 2021 lumber production is anticipated to be 70% higher than in 2020. I'd like to turn to the Power Generation business next. As Ken mentioned, and we disclosed in the press releases, our power plant was curtailed between early December and late February because of the failure and a very technically sophisticated component within our plant. In December, we were advised that it would take approximately 5 months to manufacture and deliver new replacement by the original equipment manufacturer. Our initial plan was to repair the defective component and get the plant back up and running and install a new component when the plant was offline in Q2 of 2021. We were fortunate to have some good news about 2 weeks ago, [indiscernible], the new component was available earlier than expected. It was installed about 10 days ago, and we have achieved our power production targets since it was installed. We expect power deliveries in 2021 to be slightly lower than in 2020. And they're looking forward to a great year. I'll now turn the discussion back to Ken Shields.

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

Thank you, Andrew. Picking up on Andrew's comments, we expect insurance proceeds will enable us to recover a majority of the power plant repair costs and offset the income loss from the curtailment we experienced. Some of you on this call may remember back in 2014 when we had a similar force majeure event at our power plant. And in that instance, we were fortunate to receive insurance proceeds of $14.5 million to cover the repair costs and [ $2.5 million ] for business interruption, so a total of $17 million. We've not yet finalized our insurance claim on the most recent incident. Repair costs are anticipated to be a very small fraction of the previous claim while the business interruption claims anticipated to be higher than the previous plan. And for accounting purposes, we will recognize the business interruption proceeds on our income statement when they are received, and that's probably going to be in late in Q2 or sometime in Q3 in the year that we're in now. I wanted to talk a little bit about how the duties and trade disputes impact Conifex. And I think many of you would be aware that we differ from the major public SPF producers in the sense that nearly all lumber production is subject to duty deposit requirements, while a majority of the lumber produced by the other public companies is not. Accordingly, duty expenses impact our bottom line to a far greater degree than for any other company. For example, we achieved operating income of just over $3 million in 2020, after paying over $10 million in duties. It's all at our bottom line. It's highly leveraged to changes in duty deposit rates. The December 2020 reduction in deposit rates from 20% to 9% provides us a springboard to compile strong year-over-year improvements in net income. And we think our results are going to increase at a faster rate than the other public companies. Since the inception of the trade dispute, and after giving effect to the sale of our rights to receive duty deposit refunds, we now have USD 10.2 million on deposit that's potentially refundable to us. And our shipment and lumber price expectations for -- in '21, this amount could increase by something like 75% in the year. We also wish to point out that we have significant tax assets and loss carryforwards that are expected to enable us to avoid paying any cash income taxes if and when there is a potential duty refund. While we appreciate that the likelihood and timing of a full or partial refund of duties, it's highly uncertain. At a future date, we're confident that our finances will be materially strengthened by duty refunds. Speaking of finances, our gross debt now totals approximately $63 million, mainly represented by a long-term power loan with limited recourse to our lumber operations with a fixed interest rate and with a lengthy amortization period. After deducting cash balances, we ended last year with net debt of approximately $49 million, a net debt-to-cap ratio of 29% and available liquidity of $21.2 million. The $10 million revolving credit facility we advised you of on our last call continues to be undrawn. So we differ from the other public SPF producers in 2 main respects. First, the majority of our investment in fixed assets and all of our borrowings associated with our power generation business which, of course, has predictable cash flow streams as a result of that fixed price, take-or-pay contract, and there's roughly 15 years remaining on power purchase agreement we have signed with BC Hydro. The second point of differentiation is that aside from some minor equipment leases, our lumber business has been debt-free for the past 3 quarters. We have no claim on future cash flow to pay any material interest or to repay principal, to fund pension deficits or to fund any material capital expenditure commitments. On our last call with you, we announced that we received regulatory approval for a normal course issuer bid, which commenced on December 1 and which resulted in us repurchasing roughly 590,000 shares in the month of December. Our analysis indicates that we can continue to afford to fund an NCIB and concurrently maintain our strong lumber business balance sheet and fund projects that are necessary to remain compliant with enhanced safety and environmental regulations as well as quick payback projects and improve our operating reliability. As we reported back then, we launched our NCIB because we believe that our shares trade at a material discount to fundamental value. One reason we believe this is that we trade at a 30% discount to book value, while the other BC-based SPF producers trade at premiums. We appreciate the fact that returns on shareholder investment in the interior BC lumber sector have been lower than they have been in competing supply regions. And we also recognize that, if investors expect lower returns, shareholder investment, they will, of course -- those stocks will have lower trading price relative to book value. However, we remain confident that our return on shareholder investment is poised to increase as we move forward because we'll be moving to a greener log diet because we expect further supply reductions to take place in the interior of BC. And we also expect that export duties will be reduced or eliminated. And all those factors should contribute to a higher return on ship for investment. We're also aware that our present equity market capitalization infers the value for Conifex either on a per unit of lumber capacity basis or per unit of sustainable harvest basis, that's well below the fact that we received on recent dispositions at those two asset classes. So we continue to believe that share buyback plan is a good use of our surplus cash that we anticipate generating under current and foreseeable lumber market conditions, and we can be quite aggressive executing on NCIB without entailing our finances in any sense. So we look forward to our next call with you. We've had something like a 40% reduction in our overhead and admin expense. So we didn't quite get our ESG credentials developed and well documented, but most of the what's been done, and we are pleased that we'll be in a position to share them with you when we have our call reported on our Q1 results in April. So in closing, at Conifex, we believe we're well positioned with a strong safety culture very good level of fiber self-sufficiency in BC, abundant near-term opportunities to improve our fiber quality and, therefore, our lumber product mix. We have industry-leading power generation assets and an entirely a manageable debt load. So we thank you for taking time today to learn about Conifex and Jordan Neeser and I and Andrew would be faced to answer any questions analysts or shareholders may have. So against that background, we'll turn the meeting back to the operator.

[Operator]

[Operator Instructions] We will take the first question. Please go ahead, Marcus Campeau at RBC Capital Markets.

[Marcus Campeau, Associate]

Okay. Just starting with capital allocation. The lumber business is clearly going to be generating a lot of cash here. Could you walk us through how you're thinking about the opportunities ahead of you beyond the sawmill upgrades you've outlined and further share repurchases. Is there anything else that you're looking at that could be important down the road?

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

Well, Marcus, you've asked a very good question because this was an important part of the discussion at the Board meeting earlier today. And as we mentioned in our press release, that we're very comfortable committing to a series of smaller, quick return paybacks, and we intend to take full advantage of our share repurchase opportunity. But we are unable at this time to commit to a substantial modernization and upgrade program at our mill in Mackenzie because when it comes to BC every 10 years or so, they complete a Timber Supply Review. And the last one was done in 2014, and the new one is underway. And the last one concluded that operators in the Mackenzie TSA, or Timber Supply Area, had to almost exclusively focus on dead pine, sawlogs -- or dead through sawlogs. So we've got a few years now where we have had very little green sawlog process through our sawmill. And we think that the useful life of the dead timber in Mackenzie, there's very little commercial value remaining in these spans. And at the new harvest level determination will permit a major move into greener stance, just as harvest level redeterminations and other timber supply areas in BC have permitted a move into greener stance. So simply put, we'll probably build up a bit of cash and in the meantime, we are doing comprehensive feasibility studies and other analysis of how best to go about an upgrade and modernization of our sawmill site in Mackenzie. But until we have the results from the Timber Supply Review, it's unlikely that we'll -- we'd start committing capital to that.

[Marcus Campeau, Associate]

All right. Great. So just kind of following up on that one. If the Timber Supply Review does come out in your favor, would the primary focus be expanding capacity or sort of upgrading your processing and lowering costs?

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

We think that the primary focus of our markets that we -- first of all, with the tenures that we have and the open market log purchase opportunities we have from First Nations from BC timber sales, we think that optimal size sawmill, given log supply considerations, would be something around 300 million board feet. And we also think that, that's an optimal size in terms of the footprint that we have. And so that's what we're looking at. So the return on that investment would be based on having 60 million board feet of incremental lumber production. It would be based on having a higher lumber recovery factor. So we could -- we're probably capable of getting 5% to 8% more lumber out of every log that we processed. And it would be the third component of the turn would be driven by lower cash conversion costs because, as you can appreciate, when your mill starts up in the morning, you're pretty familiar with what your labor costs are for the rest of the day. And if that crude can produce 25% more lumber, you have a 25% dilution in your labor cost per [indiscernible]. So that's how we're looking at that, but there's a lot of engineering work that is just been launched, and we expect to have that study and analysis completed sometime in the second half of this year. And we also hope to be having some -- an insight into the like [indiscernible] harvest level [ determination ] at the same time.

[Marcus Campeau, Associate]

All right. Sounds good. Obviously, the focus right now is on the strength of the North American market. But right now, what are you seeing in the export markets that have been important to your business? And has there been any pickup recently in terms of demand and pricing?

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

Well, we have some core customers in Japan that we continue to service with our premium grade lumber, but the price move in the U.S. has been so significant that we have historically -- our shipments to Japan are more or less constant. But we've moved a big chunk of our volume of China and into the U.S. So we have probably 90% of our mill net realizations are a function of what's on in the economy U.S. market and 10% is based on what's going on in other markets. And that's a big change from where we were 2 or 3 years ago when the export market is probably accounted for something like 1/3 of our industry.

[Marcus Campeau, Associate]

Great. And then maybe just one last kind of technical one. Going to the financial statements, it looks like your log inventories were down pretty significantly year-over-year. Is there anything that we should read into that? Or is that just reflecting the timing of the reporting?

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

I'll let Andrew to answer that.

[Andrew McLellan]

Marcus, yes, good question. I think across the province and the interior of Northern BC certainly going into November and December, we all struggled with unusually wet weather conditions that were lagging from this summer as well and slow to cool off and get the temperatures that we like to typically enjoy in December. So that caused our log inventories to get to the levels that are a bit lower than we usually like to see it at this time of the year, but we've been increasing our logging capacity and expect in Q1 and Q2 to catch up our inventory levels so that we're able to continue to operate without disruption. We do expect to kind of run slightly reduced hours here in Q1 and Q2. But by the time we get into our summer logging program, we'll be back to capacity with our operations.

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

So Marcus, the number that you see at December 31 by the Easter weekend, we hope that's 5 or 6x what you're seeing there for December 31, and that's our target. And as long as the ground conditions remain frozen, we'd be there, and we should be able to maintain continuous operations through the spring break-up period.

[Operator]

[Operator Instructions] There are no further questions registered at this time. I would now like to turn your meeting back over to Mr. Shields.

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

Okay. Well, thank you very much, and thank everyone on the line. I just wanted to take a moment of everyone's time and acknowledge Jordan Neeser, who's here with us today as we publicly reported, joined us with the mining industry experience and is returning to the mining industry. We really appreciated him coming on board with us in the fall of 2018, this is we were in an incredible financial crunch, having bought some mills earlier that year, and witnessed a whopping deterioration in the commodity lumber price. And Jordan did a terrific job for us restoring our financial integrity and leaving us in a position now with a healthy current and anticipated cash balances and overwhelming amount of confidence that we can always service our debt base going forward. So Jordan, we wish you every success going forward. Thank you for your help and assistance over the period that we worked together.

[Jordan Neeser, CFO & Corporate Secretary]

Thank you very much, Ken. And I'm proud to hand the reins over to Winny Tang as CFO and Corporate Secretary. Winny has been a huge part of the Conifex team for the past 8 years and has led a number of key finance functions during this time. I've enjoyed our time working together. And over the past few months, we've been working together on a smooth transition, and I have nothing but confidence that, that will take place. So I certainly wish Winny and the entire Conifex team, all the very best in their incredibly bright future. Thank you, Ken.

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

Well, thank you, Jordan, and thank you, everyone, for your attention and interest in Conifex. Enjoy the rest of the day.

[Operator]

Thank you. The conference has now ended. Please disconnect your lines at this time. Thank you for your participation.