Canfor Pulp Products Inc

TSX:CFX

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Welcome to the Canfor and Canfor Pulp Third Quarter Analyst Call. A recording and transcript of the call will be available on Canfor's website.During this call, Canfor and Canfor Pulp's Chief Financial Officer will be referring to a slide presentation that is available in the Investor Relations section of the company's website. Also, the companies would like to point out that this call will include forward-looking statements. So please refer to the press releases for the associated risks of such statements.I would now like to turn the meeting over to Mr. Don Kayne, Canfor and Canfor Pulp's Chief Executive Officer. Please go ahead, Mr. Kayne.

[Donald B. Kayne, President, CEO & Director]

All right. Thank you, operator, and good morning, everyone. Thank you for joining the Canfor and Canfor Pulp Q3 2018 Results Conference Call. I'll make a few comments before I turn things over to Alan Nicholl, our Executive Vice President of Canfor Pulp Operations and Chief Financial Officer of Canfor Corporation and Canfor Pulp. Alan will provide a more detailed overview of our performance in Q3.Joining Alan and I today are Peter Hart, our Vice President of Pulp and Paper Sales and Marketing; Kevin Pankratz, Senior Vice President of Lumber Sales and Marketing; and Stephen Mackie, our Senior Vice President of Canadian Operations.Our third quarter earnings were solid, although weaker than the record levels of Q2, with Q3 operating income of $202 million. For Canfor Pulp, the company also had a solid quarter, generating operating income of $61 million, down from the record second quarter, principally due to lower shipment levels and previously announced downtime.During the course of the downtime, we discovered damage to several tubes in Northwood's #5 recovery boiler. The team is working to reduce the impact of this repair on our business, but at this point, we expect an additional reduction of NBSK production in the fourth quarter of 60,000 to 70,000 tonnes.Pulp supply and demand remains relatively well balanced, and price levels were similar quarter-over-quarter. For the remainder of the year, we anticipate stable market conditions and good pricing levels to continue into the new year.Yesterday, the Canfor Pulp Board approved a special dividend of $2.25 a share. While we have been looking at accretive growth opportunities for CPPI, we have determined that there are limited compelling opportunities in the near term. As a result, the board has determined that returning capital to shareholders is appropriate at this time.Moving to our lumber business. We generated operating income of $149 million. Lumber production was down in the quarter as operations were impacted by forest fires in British Columbia and Hurricane Florence in the U.S. South. The fire season in British Columbia was significant, and in addition to disruptions at several of our operations, access restrictions to our woodlands resulted in lower harvest levels and increased competition for purchased wood across British Columbia. We continue to work diligently on improving our lumber and grade recovery with a significant focus on value-added market and product development opportunities to offset these increases.We continue in our negotiations with the United Steelworkers through CONIFER and IFLRA on a new contract for many of our BC mills. We believe reaching a fair and reasonable agreement is in the best interest of our employees and our company, and we remain optimistic that a deal can be reached. Despite this, we have seen job action this morning, unfortunately, at one of our operations.Transportation networks have returned to normal as weather conditions have improved. The majority of the inventory builds in Q1 and Q2 have been eliminated. While current markets have been challenging, our outlook is for pricing to stabilize and gradually move higher with the reduction of inventory levels, reflecting higher seasonal demand and continued strength in the repair and remodeling sector. In the longer term, we remain very positive on market fundamentals for lumber and the macro environment for our products.Demand for offshore markets continues to be solid, and we expect increased volumes to overseas markets during Q4 and on into Q1 and Q2 of 2019. Our 350 million board foot organic capital program remains on track and to be completed by the end of 2019. The spending includes large sawmill rebuilds at Camden and Moultrie, Georgia, a new planer at Fulton and continuous dry kilns at Darlington and Urbana.On our previously announced greenfield mill, we continue to work to resolve the contractor issue. Recently, we have been working through specific issues, including longer lead times, higher steel costs and continued labor challenges. We expect to have a final decision by the end of this year.Finally, in regard to the Softwood Lumber Agreement, there have been no significant developments on the negotiation of a settlement since last quarter as Canada works through its appeals with the ITC and the WTO. We are pleased that the new NAFTA agreement has retained the important Chapter 19 dispute resolution process.So with that, operator, I will now turn it over to Alan Nicholl to provide an overview of our financial results.

[Alan R. Nicholl, CFO & Executive VP of Finance]

Yes. Thanks, Don, and good morning, everyone. As usual, my comments this morning will focus principally on our financial performance for the third quarter of 2018 by reference to the previous quarter. Full details of our results are contained in the Canfor Pulp and Canfor news releases, both of which were issued yesterday afternoon. And as always, you'll find an overview slide presentation on both the Canfor and the Canfor Pulp websites in the Investor Relations section under Webcasts. The presentation highlights consolidated and segmented results, and I'll be referring to this presentation during my comments.For the third quarter of 2018, Canfor reported shareholder net income of $125 million or $0.98 a share, down from net income of $170 million or $1.32 a share recorded for the second quarter of 2018 and up from net income of $66 million or $0.51 a share recorded for the third quarter of 2017.On Slide 3 of our presentation, we highlight various nonoperating items, net of tax and noncontrolling interest, which affect the comparability of our results between the quarters. In the third quarter of 2018, these items totaled $32 million, the largest being a $31 million expense related to countervailing and antidumping duty deposits compared to $38 million expense in Q2. After adjusting for these nonoperating items, shareholder net income for Q3 was $157 million or $1.23 a share compared to $214 million or $1.66 a share for the second quarter.As highlighted on Slide 5 of our presentation, the lumber segment recorded operating income of $149 million for Q3, down $55 million from the previous quarter. Adjusted lumber operating income for Q3 was $192 million, down $64 million from the similarly adjusted operating income of $255 million in Q2.North American benchmark 2x4 #2 prices for both Western SPF and Southern Yellow Pine were well down from historical high levels seen in the previous quarter, declining USD 116 and USD 101 per 1,000 board feet, respectively, primarily due to higher inventory levels to the supply chain.Canfor sales realizations averaged a more moderate decline, reflecting a strong order file as we entered the third quarter as well as a higher-value sales mix and improved offshore pricing.Lumber shipments were down 4% quarter-over-quarter, for the most part reflecting a drawdown of inventory in the previous quarter as well as the effects of both the wildfires in Western Canada and Hurricane Florence on our operations.Lumber production was 3% lower than the prior quarter, largely reflecting the disruption caused by the aforementioned severe weather. Unit manufacturing costs in the current quarter were moderately higher, reflecting increased market-based stumpage and the significant weather-related impacts, which resulted in lower harvested log volumes and increased competition for purchased wood in BC. Log costs in the U.S. sites remain stable through the quarter.Canfor's pulp and paper segment comprises the results of Canfor Pulp Products Inc. As highlighted on Slide 6, the company reported net income of $43 million or $0.66 a share in Q3 compared to net income of $63 million or $0.97 a share for the previous quarter.As Slide 6 highlights, the company's Q3 financial performance reflected fairly balanced market conditions. Sales realizations were in line with the previous quarter as record high North American NBSK pricing and the weaker Canadian dollar offset a slight decline in the China-U.S. dollar NBSK pulp price.The biggest contributor to the lower earnings were shipments, which were down 20% from the previous quarter. This decline reflected a significant drawdown of inventory in Q2, a 10,000 tonne vessel slippage into October, the impact of early fall maintenance as well as softer market demand from China that we saw in the first part of the quarter.Our pulp production was down 4% from the second quarter, and for the most part, this reflected higher scheduled maintenance downtime at Northwood in late September, with this shut spanning quarter end. This more than offset increased BCTMP production following the commissioning of the energy reduction project at our Taylor mill at the end of June.Unit manufacturing costs were modestly higher than the previous quarter, reflecting, for the most part, market-related increases in fiber costs.Operating income for the paper segment in Q3 was $3 million, up $2 million from the previous quarter, and primarily reflected improved sales realizations and a weaker Canadian dollar, which offset higher slush pulp costs.As previously announced, towards the end of September, Northwood extended its scheduled maintenance outage on one production line to enable necessary chip replacements at its #5 recovery boiler. This was in order to rectify damage discovered during our routine scheduled maintenance inspections.Also in early October, third-party natural gas pipeline explosion near Prince George resulted in further unscheduled downtime at the company's NBSK pulp facilities. As a result, total scheduled and unscheduled outages are anticipated to result in approximately 85,000 to 90,000 tonnes of reduced NBSK pulp production in this fourth quarter.Capital spending for the third quarter totaled approximately $117 million and included $79 million in the lumber business and $33 million in Canfor Pulp.The company continues to execute on its USD 125 million organic growth program in the U.S. South, and we remain on schedule, as Don indicated, to have this substantially completed by the end of 2019.In 2018, our forecasted capital spend for lumber is approximately $260 million and $95 million for pulp, with similar spending currently anticipated for 2019.At the end of Q3, Canfor, excluding Canfor Pulp, had net debt of $8 million with available liquidity of $356 million. And Canfor Pulp had net cash of $205 million with available liquidity of $99 million. Net debt to total capitalization, excluding Canfor Pulp, was just under 1%. And on a consolidated basis, net cash to total capitalization was 8.8% as cash balances exceeded outstanding debt.Yesterday, Canfor Pulp's Board of Directors approved the continuance of a quarterly dividend of $0.0625 per share for the third quarter. The board also approved a special dividend of $2.25 a share as a result of strong cash generated by the business over the last year and the absence of any compelling major internal or external strategic growth opportunities on the immediate horizon.And with that, Don, I'll turn the call back over to you.

[Donald B. Kayne, President, CEO & Director]

Yes, thanks very much, Alan. And so, operator, we're ready to take questions from analysts now. Thank you.

[Operator]

[Operator Instructions] Your first question comes from Sean Steuart of TD Securities.[Technical Difficulty]

[Donald B. Kayne, President, CEO & Director]

He must have had a difficult question.

[Operator]

I do have Paul Quinn of RBC Capital Markets.

[Paul C. Quinn, Analyst]

Just on the labor side. I think you got 4 mills with CONIFER and 3 with IFLRA. Where are the rest of the BC mills? In terms of the labor negotiations, do they follow the same pattern agreement from CONIFER and IFLRA?

[Donald B. Kayne, President, CEO & Director]

Paul, maybe we'll get Stephen to answer that one.

[Stephen MacKie, Senior Vice President of Canadian Operations]

Yes, for sure. So you're right, we do have 4 of our operations in BC represented by CONIFER, 3 more down in the southern interior represented by IFLRA through the negotiation process. We have 3 mills that are independent that are represented by the USW, but we would deal with -- through direct negotiations with USW. And then we've got some facilities that are, one, the nonunion and a couple represented by other unions. So that's how it breaks down.

[Paul C. Quinn, Analyst]

Okay. And so, typically, if we went back to the last contract negotiations, didn't that get set by CONIFER and then followed by the others? Is that the way it -- sort of the usual patterning?

[Stephen MacKie, Senior Vice President of Canadian Operations]

Yes. The pattern actually -- you're certainly right, there's usually pattern industry bargaining. It wasn't actually done by or led by -- or concluded by, sorry, by CONIFER last round. It was actually Canfor that did set the pattern for the industry last time. But this -- in this particular negotiation round, we have chosen to go through the industry associations for the bargaining.

[Paul C. Quinn, Analyst]

Okay. And then just moving on to the lumber side and in your greenfield decision by year-end. If you make that decision by year-end, when can we expect that production up? And does that -- have you seen the list of projects out there from others? Does that worry you at all in terms of supply in the marketplace down the road?

[Donald B. Kayne, President, CEO & Director]

Yes, it's a good question, and it's something that we're obviously watching here. I mean, I think we're -- ourselves is probably -- if we make a positive decision, which we're not there yet, as we said early in the New Year's, probably from that point, a couple of years before we get to a point where we're actually running at plan levels. In terms of concern about others, yes, we're -- you're always concerned what others are doing, but really, we're more focused on our own decision there around whether we build, so -- of course. And the other thing I would say, too, Paul, maybe is we're still a little bit skeptical, too, in terms of how much of that actually materializes at the end of the day and not so much whether it's done or not by the time frame it is completed.

[Paul C. Quinn, Analyst]

Yes. Just like yours gets pushed out, you expect some of the greenfields and some of the additions to get pushed out as well?

[Donald B. Kayne, President, CEO & Director]

Yes, that would be our view. I mean, we've said before, and we're talking about it this morning a little bit, I mean, we don't think there's a capability to build more than 3 per year. So 3 per year is one thing, but which year, right? So we're not -- maybe this -- next year is probably pretty solid, but once you get all beyond that, it could be pushed out. That would be our view, but time will tell.

[Paul C. Quinn, Analyst]

Okay. That's helpful. And then just on log cost inflation, if you could break that down, sort of what you're seeing as a percentage in Canada versus United States.

[Donald B. Kayne, President, CEO & Director]

Yes, we're looking at some gains next year, obviously, in British Colombia, similar to what we've seen this year and then in the U.S. South, probably around that 2% number, Paul.

[Paul C. Quinn, Analyst]

And then just -- you mentioned you look for a growth opportunity for Canfor Pulp. But what does that look like if there is? Is that other mills that you would acquire or different areas that you're going into? And then just a follow-up question on that. Just on your joint venture, looking at different, I guess, areas of pulp, how is that progressing?

[Donald B. Kayne, President, CEO & Director]

Well, I won't answer the second part of that one, the first part, Alan. We -- I mean, really, we've -- always looking at our opportunities. There's just not many that -- especially in an environment we're in today from a cost standpoint and opportunity standpoint, Paul, we haven't found anything yet that's really accretive that we would -- and also strategic, really, that we would consider something we had to have. So we -- and as a result of that, that's really why we -- when we thought long and hard on how do we deal with the shareholders, and that's why we ended up with a special dividend, right? But in terms of the second question, Alan, you're involved in that quite a bit.

[Alan R. Nicholl, CFO & Executive VP of Finance]

Yes. So just for clarity, Paul, you're referring to a JV that we have with respect to our biofuels initiative or...

[Paul C. Quinn, Analyst]

Yes.

[Alan R. Nicholl, CFO & Executive VP of Finance]

Yes. So that continued -- we continue to make small gains, but we continue also to guide to any commercialization of that effort being several years away, but it's being led well, and we're getting more encouraged these days, that's for sure. So some ways away from commercialization.

[Operator]

Your next question comes from now Sean Steuart of TD Securities.

[Sean Steuart, Research Analyst]

A couple of questions, guys. Because you don't break out your log sales or chip revenues, it's tricky to handicap your price realizations on the lumber side quarter-to-quarter. Can you give us a sense of, ex log sales and chips, how your lumber mill nets trended this quarter relative to the benchmarks? And I guess I'm just trying to gather how much better you were than the benchmarks this quarter and if there's a counter effect in Q4 where the decline might be a bit more severe.

[Donald B. Kayne, President, CEO & Director]

I'll put that over to Alan. But just one thing to -- just on that, that I think is important is that I think we're continuing to see and we get encouraged by the fact that -- and we've talked about this quite significantly over the years, is our ongoing strategy and focus to try to differentiate ourselves outside of the commodity markets. I think -- certainly, I think we're always encouraged to see some of the gains that we're seeing in terms of some of these value-added products that we really focus on developing ourselves and seeing some of the higher returns on them that aren't so related to the commodity markets. So I think part of it, for sure, is related to that. But I'll let Alan answer the other part of your question, Sean, around log prices and share prices and impact.

[Alan R. Nicholl, CFO & Executive VP of Finance]

Yes, Sean. So good question. So the way I would answer that is by saying, yes, we did see small increases relatively for residual chip prices and also log sales and some of the latter being seasonal -- seasonally based. But the vast majority of that delta that you're looking at was attributable to our sales realizations in the lumber space. And I think it reflects a lot of the seasonal factors as well as our strong focus on the value-added side of things, and we're benefiting clearly in Q3 from both those -- for both Western SPF and Southern Pine as well.

[Sean Steuart, Research Analyst]

That's encouraging. Alan, can you give some context on the costs associated with the pulp downtime in Q4? I think we have a pretty good sense on the boiler rebuild or maintenance on the tubes anyway, but with the additional downtime related to the gas supply issue, any numbers you can give us on dollar costs anticipated with that downtime?

[Alan R. Nicholl, CFO & Executive VP of Finance]

Yes. It's hard to get into too many specifics there, Sean. But I think what I would guide you to, I think you and maybe several others noted that the reduced production is close to 30% of our capacity. And I think that will be reflected pretty much through our Q4 results. Beyond that, it's hard to give you any definitive guidance, but hopefully, that would help you in terms of your financial modeling at such time.

[Sean Steuart, Research Analyst]

Yes. And just last question for me. Do you guys have any plans for lumber downtime in BC through the current trough? Do you just wait to see how the labor negotiations play out? Any thoughts on temporary downtime to keep your inventories balanced?

[Donald B. Kayne, President, CEO & Director]

Yes, I think what -- I guess all I would say there, Sean, is like probably everybody is doing in these markets, we were. I think it's prudent to continue to review all the operations, frankly, and just to kind of see where we are and what we should maybe look at from an operating point of view. But mostly, it's mostly due -- I mean, almost virtually all due to some of the issues that we're seeing on log sourcing and also log profiles and, I guess, obviously combined with market prices as well, right? So those are the 3 components really that are -- we're going to base any decisions that we may make down the road on, but right now, we're not at that stage.

[Operator]

Your next question comes from Mark Wilde of BMO Capital Markets.

[Mark William Wilde, Senior Analyst]

I want to just start off by talking about housing. I mean, I'm as surprised as anybody by these numbers that we've seen coming out of the housing market over the last 3 or 4 months. But they kind of are what they are. And I just -- I wondered what gives you kind of the continued confidence when we're looking at these numbers now for 3 or 4 months in a row that housing really is still on a sustained upward trajectory?

[Donald B. Kayne, President, CEO & Director]

Yes, for sure, and that's one segment, of course, that -- and it's a key one. It's not the only one, but it's certainly a key one that we look at on that one. I mean, obviously, what we do look at and -- we've got our own -- we do our own analytics in terms of what we think is going to happen there and how that's going to trend going forward and the impact and so forth. But I think as much though, because of the customer base that we have where, as you know, we deal very direct with our customer base and most of the business that we do is direct with the end users. As we talk a lot to some of the large national builders and large pro-dealers, and if you combine all that together, that's exactly the information that we try to determine on a weekly, monthly, quarterly, and frankly, more looking out longer, even 1-, 2-, 3-year kind of time frame. And from all the information, all the intel from speaking to some of the senior guys in the industry across all those areas I just spoke about, Mark, they're all very, very positive for the future. And while they -- in these last few months, which we don't really focus on anyway, but just on that, in the last couple of quarters even, they certainly think that part of that, perhaps, the slowdown was due to some of the high price levels that we encountered during that period. But overall -- it may be a bit of the inventory that's been around, but overall, I think there's not -- we haven't noticed one single change in approach, projection, assumption going forward. We're just looking at housing segment on its own. So despite everything short term, we're still very, very confident in our thesis, confident in our macro assumptions that we've been articulating for several quarters now.

[Mark William Wilde, Senior Analyst]

Yes. Well, I'll just say -- we haven't seen like a 10-year period like this for housing starts, I think, ever since World War II. But what is a little concerning is the data just had not been coming in very strong. And if you look at the market down here, these housing homebuilder starts are down about 40% since the start of the year. And I always hate to kind of completely discount what the financial markets are thinking.

[Donald B. Kayne, President, CEO & Director]

Yes, yes. I think one other thing, Mark, just where you're on, just on that and I -- we try to get accurate information around it, too, and it's hard, but if you do talk to them, the one element, too, that doesn't get talked about too much but we're hearing about them more and more is just the availability of labor and how much does that restrict actual housing starts itself because we know ourselves at Canfor. I think everybody, every industry, nevermind our industry, is facing the same thing. It's hard to get qualified skilled tradesmen and are -- from speaking with some of these builders that you have mentioned or spoke about, they're definitely seeing that also.

[Mark William Wilde, Senior Analyst]

Okay. I want to talk a little over that kind of southern timberland and your log costs. I'm just curious, there are a couple of articles that have run in the Wall Street Journal the last 2 weeks about all the incremental supply of kind of southern timber. I wonder if you have seen those articles and if you have any reaction to them.

[Donald B. Kayne, President, CEO & Director]

Yes, we definitely have seen them. And again, it's consistent to what our folks in the U.S. South have been telling us. We had our board down there this week for our board meetings, and we had a very intensive discussion with our senior southern pine operators down there, including our President, but all their log fellows as well talked a lot exactly about this topic. And their view there is unchanged, and that is that for the foreseeable future here, and perhaps 5, 10 years from now, they are talking even longer, but just say 5 to 10 years, they don't -- they see very, very little escalation at all in price as a result of reduced supply on the market. They figure there's going to be strong supply for the next several years.

[Mark William Wilde, Senior Analyst]

Okay. And the last one I have for you, Don, is just in terms of the prospective new mill, as you're going through this process and you're kind of -- you're looking at the market, looking at a lot of other things, are you also looking at alternative locations for the mill outside of Georgia?

[Donald B. Kayne, President, CEO & Director]

We are. I mean, when we chose Georgia at the time, and is still the case, I mean, we still believe it in terms of fiber because as we've said many times, fiber is the kind of key consideration along with people and availability of labor. But from a fiber standpoint and a labor standpoint, that's a solid location, so no question. But we also have 2 or 3 other locations that would potentially fit the same criteria well. So I guess the simple answer to your question is, yes, we do some other ones on the table as well that may serve us down the road.

[Operator]

[Operator Instructions] We have a question from Mark Wilde again of BMO Capital Markets.

[Mark William Wilde, Senior Analyst]

Just one final one as long as there are no others. I'm just curious, Don and Alan, what you are seeing in terms of kind of southern lumber because of this low-cost position. And if nibbling at kind of market share that's typically belonged -- or markets that have typically belonged to, say, Pacific Northwest producers, Western Canadian producers, Eastern Canadian producers, just maybe talk about that issue.

[Donald B. Kayne, President, CEO & Director]

Yes. I mean, I think -- no, nothing material in our view probably overall. Maybe, Kevin, you hit it and maybe add a bit to that. But I mean, one of the things that we're doing proactively in the south, Mark, and it's going to take some time, but we've seen some recent evidence of some of the successes as overseas opportunities for Yellow Pine as well. And just like we tackled 10 or 15 years ago in terms of Asia and our need to develop alternative markets for spruce, we're starting to see some pretty good uptick. I know Kevin and our team is working hard on that in places like India, in places like China. And we were -- both Kevin and I were over there recently and saw some surprising examples of some of the successes already that we're seeing there. So I think as much as -- what we're trying to do is control what we can control, and that is try to develop and build the markets where they make sense, particularly on the value-added side and on the new applications side of the business. But Kevin, you spent a lot of time over there now. You want to add to Mark's comment?

[Kevin Pankratz, Senior Vice President of Sales & Marketing]

Yes. No, the only other thing I could see is perhaps just a bit more expansion on MS North, Don, where there's engineering values that could be implemented should the economics work. That's the only other thing to add. The offshore component is a real critical focus for us where we see that we can leverage that position.

[Donald B. Kayne, President, CEO & Director]

It's a good question, Mark, but I mean, we're just trying to stay -- again, be proactive on that. And I mean, some of the dollars that we spend on our sawmills in the south to -- particularly in the dry kiln side of the business and focusing on improving the quality of our products, I think -- we also think it's allowing us to get into markets, too, that require a bit higher quality that we maybe weren't able to achieve a couple of years ago, say.

[Mark William Wilde, Senior Analyst]

Okay. And, Don, when you talk about like the price -- how your price realizations were better in the third quarter than a lot of the indices, does business like that board operation that you and I went to a couple of years ago down in South Georgia, is that also figured into the equation?

[Donald B. Kayne, President, CEO & Director]

Yes, it does. I mean, that's a small operation, but it's a great example, I mean, between Thomasville, and then, of course, we've got the one that we bought in the U.S. South or in the BC Southern Interior at WynnWood. So yes, absolutely. And those -- I've said before, but those are examples where we don't relate it at all to what Random Lengths pricing is doing. And most of that business is, as I'm sure others that we've got the same situation, it's not -- it's all committed business, right? So yes, I know exactly, and there's just several things that, I mean, I think with the fiber that we have across the corporation, we certainly believe there's additional opportunities as well. So...

[Operator]

At this time, there are no further questions. Please proceed.

[Donald B. Kayne, President, CEO & Director]

All right. Thanks very much, operator, and thanks, everyone, for joining us on the call today and we'll talk to you next quarter. See you.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.