Canfor Pulp Products Inc

TSX:CFX

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen. Welcome to the Canfor and Canfor Pulp Fourth Quarter Analyst Call. A recording and transcript of the call will be available on the 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 each 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 risk 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, CEO, President & Director]

All right. Thanks, Operator, and good morning, everyone. Thanks for joining the Canfor and Canfor Pulp Q4 2017 Results Conference Call this morning. I'll make a few comments before I turn things over to Alan Nicholl, our Chief Financial Officer for both Canfor Corporation and Canfor Pulp. Alan will provide a more detailed overview of our performance in Q4 and for 2017 overall. And then we will take questions. Joining Alan and I today are Brett Robinson, President of Canfor Pulp; Peter Hart, Vice President of Pulp Sales; Kevin Pankratz, our Senior Vice President of Lumber Sales and Marketing; and Stephen MacKie, our Senior Vice President of Canadian Operations. So taking a look at our results, beginning with Canfor Pulp, the company generated a record high quarterly operating income of $67 million in the quarter, surpassing the previous high by $14 million. Demand for pulp was very strong in the last half of the year, driven in part by China and its new restrictions on the import of recycled paper. After the unexpected 11,000 ton outage in November, the mills ran well in December and production was in-line with the previous quarter. The pulp market appears well positioned for the remainder of the first quarter and into the standard spring maintenance period in Q2. We continue to be cautious around incremental pulp supply, but are encouraged by good demand from most regions. Moving to the lumber business. Our operations ran well but faced a number of transportation issues and weather challenges that impacted production and also shipments at year-end. North American demand was strong and supply constraints kept prices high through most of the quarter. In our view, the gap between SPF and Southern Yellow Pine will be lower than we've seen historically due to the continuing reduction in supply from Canada. Offshore markets were particularly good in Japan, and Canfor had a record year in Japan in 2017. China continues to be stable with increasing volumes of higher-value products. Our outlook for 2018 is for continued slow improvement in market demand and at a rate that will offset incremental supply in the U.S. South. Challenges to new capacity additions and better-than-expected demand will result in strong prices going forward. And finally, yesterday, we announced that our Board of Directors has approved construction of a greenfield sawmill in Washington, Georgia. Late last night, we were advised by our contractor of a previous commitment that may prevent them from constructing the mill. Clearly, it will take some more time to get a fuller understanding of the situation, but we remain fully committed to building a greenfield mill. The impact of this event, in terms of timing cannot be quantified at this time, but we will provide further updates as they become known. I will now turn it over to Alan, to provide an overview of our financial results.

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

Thanks, Don, and good morning, everyone. As usual, my comments will focus principally on our financial performance for the fourth quarter of 2017 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. As always, you'll find an overview slide presentation on both the Canfor and Canfor Pulp websites in the Investor Relations section under webcasts. This presentation highlights consolidated and segmented results and I'll be referring to this presentation during my comments. For the fourth quarter of 2017, Canfor reported shareholder net income of $132 million or $1.02 a share, up from net income of $66 million or $0.51 a share reported for the third quarter of 2017, and net income of $38 million or $0.29 a share reported for the fourth quarter of 2016.On Slide 3 of our presentation, we highlight various nonoperating items, net of tax on noncontrolling interest, which affect the comparability of our results between the quarters. In the fourth quarter, these items totaled $17 million, the largest item relating to recovery with respect to countervailing and antidumping duty deposits. After adjusting for the aforementioned items, shareholder net income for Q4 was $115 million or $0.89 a share, compared to $85 million or $0.65 for the third quarter.As highlighted on Slide 5 of our presentation, the lumber segment reported operating income of $155 million for Q4, that was up $62 million from the previous quarter. The increase reflected both solid lumber demand and CVD, ADD true-up adjustments in the fourth quarter. U.S. and Canadian housing starts were both up from the previous quarter, and the improving market conditions translated into increasing Western SPF and Southern Yellow Pine sales realizations, which more than offset a 9% decline in lumber shipments due to capital-related downtime in the U.S. South and weather-related production and transportation challenges in Western Canada. As you can see on Slide 6 of our presentation, adjusted operating income include a $45 million recovery of countervailing and antidumping duty deposits. This recovery was comprised of 2 components: firstly, the adjustment of CVD and ADD preliminary deposit rates from 20.26% and 7.72%, respectively, to final determination rates of 13.24% and 7.28%. And secondly, a subsequent true-up of the ADD accrual rate from 7.28% to 1.1%, to reflect current 2017 sales and cost data versus the 2015, '16 period of review. Of the $45 million net recovery, $16 million pertain into the fourth quarter. Unit manufacturing costs were moderately higher than the previous quarter, with the severe weather conditions contributing to higher purchase wood and log hauling cost as well as lower productivity. Canfor's pulp and paper segment comprises the results of Canfor Pulp products Inc. As highlighted on Slide 7 of our presentation, the company reported a record high net income of $45 million or $0.69 a share in Q4 2017, compared to net income of $13 million or $0.19 a share for the third quarter, and net income of $10 million or $0.15 a share for the fourth quarter of 2016. Adjusted shareholder net income for Q4 was $48 million or $0.73 a share, compared to $13 million or $0.19 for the third quarter. As you'll see on Slide 8 of the presentation, Canfor Pulp's results reflected the continued strong demand for global softwood pulp in Q4, in part, reflecting new Chinese government restrictions on imports of recycled mixed paper. The average China NBSK pulpless price was up 29% from the previous quarter, resulting in improved sales realizations quarter-over-quarter. Pulp shipments were broadly in-line with the previous quarter, with the benefit of a 14,000 ton vessel shipments slippage from late September being canceled out by a vessel delay at the end of December due to the adverse weather. Pulp production was also in-line with the previous quarter, as improved productivity later in Q4 largely offset an unscheduled outage at the Northwood mill due to a chip leak in the number 5 recovery boiler. Unit manufacturing costs were consistent with the previous quarter. Operating income for the paper segment in Q4 was $7 million, up $3 million from the previous quarter, with increased paper sales realizations and shipments more than offsetting higher slushed pulp cost. Capital spending in the fourth quarter totaled approximately and $94 million, including $65 million for the lumber business and $28 million in Canfor Pulp. Our total 2017 capital spend was approximately $170 million for Canfor and $80 million, including major maintenance, for Canfor Pulp.For 2018, after taking account of our announced Springfield sawmill, we anticipate capital spending for lumber will be in the region of $340 million and for Canfor Pulp about $90 million. Consistent with the prior quarters, Canfor Pulp's Board of Directors yesterday approved the continuance of a quarterly dividend of $0.0625 per share. Also in the fourth quarter of 2017, Canfor spent about $16 million on a share repurchase program, purchasing approximately 633,000 shares at an average price of $24.80. At the end of 2017, Canfor, excluding Canfor Pulp, had net debt of $174 million, with available liquidity of $356 million. And Canfor Pulp had net cash of $77 million, with available liquidity of $101 million. Net debt to total capitalization, excluding Canfor Pulp, was just over 9% and on a consolidated basis, 4.6%. And with that, Don, I'll turn the call back over to you.

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

All right. Thanks, Alan. So operator, we're now ready to take questions. Thank you.

[Operator]

[Operator Instructions] Your first question is from Hamir Patel from CIBC Capital Markets.

[Hamir Patel]

Don, I was wondering, how much flexibility do you have in the South to maybe modify some of your mills to make more 2x4 given the pricing premium versus the wides?

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

Yes, I think, it's a good question, Hamir. I think for the most part we've got fair bit of flexibility. And we've sort of built and focused hard on trying to work on diversifying our production to incorporate not only 2x4, but some of the wider woods too, because we -- in a lot of cases it provides a lot more opportunity for more of the higher-value products. So that's what we've tended to do. But yes, we've got -- we can make more 2x4, if we choose to. But at this point the balance that we have today is probably pretty close to where we will -- what we will be seeing in the future too.

[Hamir Patel]

Okay. Fair enough. And Don, I wanted to touch about exports. It looked like in your annual report that they were up year-over-year. Just curious given the strong pricing we're seeing in the U.S, how do you think about where those export volumes trend? And then maybe what's the opportunity to grow exports out of the U.S. South?

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

Yes, well first of all, I think there -- on the second part of the question, I think there's opportunities or I know Kevin may want to talk about this a bit more here with you now or later. But yes, certainly, we think a big part of what we're doing down the South is in terms of where we've been trying to locate our mills, a good consideration has been to be close to Tidewater, because we do believe there's a significant opportunity. In the past, what we found is in the U.S, there's not -- there has been an awful lot of folks on offshore and export business. But clearly, with the India starting to become a bit bigger of factor and some of the opportunities in Asia, we do believe there is a material opportunity to increase shipments over there more and more.

[Hamir Patel]

That's helpful. I just wanted to ask you about something about labor constraints we're seeing in the U.S. I know we're seeing some of the builders explore factory built homes. Just curious, how you're maybe positioning yourself to serve that segment of the market? And maybe how big is that, in terms of overall demand?

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

Yes, that's a -- I think that's the next transformation that's going to take place in the industry, frankly, Hamir, over the next 5 to 10 years. I mean, clearly driven by the labor, and difficulties that are currently exist-- that currently exist. But also more importantly, where and when it get even worse, in our view, down the road here. So in the construction business, in the U.S., I think certainly, the major builders have recognized that themselves. And I believe that we're going to see more and more of them researching and actually developing more of the prefab plants and more industrial plants that will produce wall panels or trusses and so forth. I think that's -- as a long-term deal, that's probably over the next 1, 2 to 5 years. But it is something, that model is in existence in Japan and in most of the other countries, frankly. And so our belief is that, that will continue to increase as we move forward, as the construction industry transforms into more factory built housing.

[Operator]

Your next question is from Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

Couple of questions, guys. Feel like we come back to this one every couple of quarters, but broader capital allocation question, Canfor Pulp is trading less than 4x trailing enterprise [ LED ] EBITDA and I appreciate we're at the, arguably, close to the peak of the pulp cycle, but can you explain your thinking on allocating capital between discretionary growth in your lumber business, whether it's the greenfield mill or organic CapEx of the existing asset base versus buying Canfor Pulp back in at the Canfor level?

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

Yes. Sure, Sean. We've been talking an awful lot about that as you can imagine over the last several months here. Maybe, Alan, why don't you speak to Sean a little bit in the detail there, he might find interesting.

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

No, for sure. So clearly as you've detected from our recent press releases and just some of our general commentary, we're very keen to grow our lumber platform, most recently with this announced greenfield site. So yes that clearly is a key focus for us. As too is preserving our top quartile performance right across our whole fleet of assets in North America. So the lumber business and related activities is clearly a big focus for Canfor and takes a higher priority than the other one that you just highlighted. In terms of Canfor Pulp, clearly, I think all of us have been pleasantly surprised by just how stronger markets have been even in the last 6 months. And even as we look at, quite frankly, to the first half and the next couple of quarters. So our cash position is much better, quite frankly, than we forecast even 6 to 12 months ago. And we're very motivated to make that cash work. And so we're very keen now to look more closely at growth acquisitions. We believe our balance sheet could support those quite comfortably today, whereas we may have had a few more reservations to even 12 months ago. So I think we're feeling pretty good about growth for both the lumber and our pulp businesses. And that's really the priority for us today, Sean.

[Sean Steuart, Research Analyst]

Are you guys seeing pulp mills coming to market for acquisition?

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

Right now, we're not hearing a lot of that. But our view is -- I mean there's not a whole lot of really high-caliber pulp mills. We talked about this before in previous calls. But listen, the way I look at it, Sean, is that we've got an excellent cash position and we are keen to look more closely. And particularly as we go through maybe some softness here in the back half of the year then that's something that may come into play. The other thing is relevant to, of course, is the energy side of things. We've done well there in terms of our investments. We're very pleased with what we've done. And we do believe that there could be potentially more energy plays that we want to look at more closely particularly in the next 12, 18 months.

[Sean Steuart, Research Analyst]

Okay. And question on the greenfield project in Georgia. And it seems like this is maybe a developing topic for you guys. But could you speak to any recourse you might have with your contractor with respect to potential delays. Any insight you can provide there?

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

Yes, Sean, for -- it is real fresh. I mean this is late last evening, I mean as in I think we might have mentioned it or maybe not in our press release. But yes, there's nothing more that I can fill you on this stage, clearly, we've got -- we're looking into it further as we speak. And -- but all I will say though is as we learn more about it, we will definitely communicate it to everyone, exactly our position. But right now I can't really share too much more on it right now, just frankly, because we're still trying to make sure we got all the right facts here.

[Operator]

Your next question is from Mark Wilde from BMO.

[Mark William Wilde, Senior Analyst]

I wonder, just coming back to the greenfield down in Washington, is that a -- like can you give us some sense, is that a national or international contract? I mean would they have issues with being able to do that work in another location if you moved to a plan b site?

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

Yes. I mean, potentially. But I mean, I think that the contractor is -- for sure, operates in and supplies equipment internationally. I think, if we chose to move, we're not even saying that we -- we'll move, yes. At the end of the day, we're still trying to understand the situation 100% first. But I think, though the contractor may have other -- there may be other commitments elsewhere. But at this point, literally, Mark, and I'm not trying to dance around the question, but we really got aware -- we came aware of this late last night. So we really -- and with this call early, first thing this morning, we really haven't gotten all the details here frankly. But we will have him shortly. And Pat or Alan will certainly update all of you as they become known here in the next little while.

[Mark William Wilde, Senior Analyst]

Yes. Can I just go back to sort of the original decision that kind of site there and can you just give us a sense of, sort of, what were the critical factors for you in that location?

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

Yes, for sure. There's 3 really, I mean, there are 2 main ones. But the 2 factors that are clearly the key considerations and that we did the most due diligence on, a significant due diligence, and that's why it took us so long to come to a conclusion, is number 1, is residuals and residual offtakes and because that's been a huge challenge for some companies down there. And so we recognize that, so we wanted to make sure where ever we went that we have that offtake, or at least a solid plan for that. The other one is obviously people, right? As you probably heard, maybe not. Down there, that's getting tough everywhere and no different down there. So we wanted to make sure we're in a location that was close to major metro areas if possible, where we had a larger base to draw from. That's why we chose where we did, right? So those were the 2 main ones. Of course, the other one that we always have anchored any acquisition on is a fiber quality and volume sustainability. That is a bunch of smaller ones like I mentioned earlier I think around access to Tidewater and those sorts of things. But clearly, the residual piece and the employment piece and availability of human resources is probably the 2 key ones.

[Mark William Wilde, Senior Analyst]

Yes. Why you'd be, I can see where you'd be very good for both residuals and for people, because you're pretty close to the University of Georgia there as well as to Augusta. I wonder though, Don, in regard to that site, we just had an announcement, Tuesday night, that Georgia-Pacific was going to build an even bigger sawmill about 35 miles away. Can you talk about, sort of, what impact that would have just in, sort of, fiber supply in that basket?

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

Yes. For sure. And we -- for us, we've done a -- we began the work basically -- we did -- first of all, we knew that mill was there, we weren't sure what was going to happen there, but clearly we built that into everything that -- in terms of our planning there, Mark. So we've felt and still feel that there is significant fiber of the quality and the size that we believe we need to run the mill. So we're not -- we weren't concerned about that at all and we're still not, 100%. That's the really significant area for fiber. And we actually -- we've made a trip down-- well, several trips down there, but -- actually, were down there a couple of weeks ago with couple of our board members to and we had chance to see some of it first hand, but there's clearly a lot of it down there. And that's why we put a lot of effort in there in the last 6 to 9 months. Assuming that there could be some changes there that actually materialize 2 days before we announced.

[Mark William Wilde, Senior Analyst]

Yes. Okay. All right. And then I wonder if we can just toggle over to Western Canada and you can give us some sense of kind of where the log cost you think are going to be moving to in 2018? I'm just curious here, we know that supply has become more of an issue in the BC Interior, yet at the same time, we know there's probably going to be a lot of salvage logging that takes place after the fires. And I just wondered if you could kind of help us as we think about the puts and takes there?

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

Yes. For sure, Mark. Well, you know what I'll do, I'll past it over to Stephen, because I know that him and his folks have put in a lot of work into that exact question and concerns. So Stephen, why don't you update, if you don't mind, Mark around that?

[Stephen Mackie]

Yes. Sure, okay. So yes, obviously as we've seen, and you can see in our results, we have a continued due experience log cost escalation in BC. As a result of some of the fiber supply constraints in a post-mountain pine beetle area as well as the implications of the worst forest fire season we've seen in BC. And we see some of them -- others reaching out into our traditional operating areas and some significant pressure on purchase wood, as well as lots of constraints related to weather and trucking capacity. There's been some significant challenges through Q4 in getting fiber supply to our operations and those challenges have persisted through Q1. And we would anticipate continued upward pressure on log costs in British Columbia through the balance of 2018.

[Mark William Wilde, Senior Analyst]

Okay. And then Stephen, if I could just -- the big uptick that we've seen in like SPF pricing, to what degree has that thrown a lifeline to some marginal mills? Mills that you might have expected to exit the market over the next year or 2?

[Stephen Mackie]

Yes, So a good question, Mark, for sure. And I think our position would be that there is certainly -- there's a need for capacity rationalization in British Columbia to better align with the available sustainable fiber supply. Obviously, the market conditions that we've got today in the U.S. and quite frankly, in every market around the world, are supporting operations and allowing people to reach out further, go further to get fiber supply and pay more. And we're seeing that in some of the extreme bidding behavior in the province of BC. So I think generally, everybody is making money today and has profitable operations. So that is going to create some challenges, obviously and have people operating longer. So it certainly has changed the picture.

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

We would still Stephen say now though -- at least our belief would still be consistent, that we think over the next 2, 3, 4 years here, and is kind of increasing that's focus here, that 6 to 8 mills are going to either shut here at some point.

[Stephen Mackie]

Yes, absolutely, Don, the fiber supply won't support that capacity that we have today, but its' going to drag it out for a while.

[Mark William Wilde, Senior Analyst]

Yes. Okay. Yes, what I was getting at. Last question I have for right now, just Alan, can you give us some sense in '18 here, what we're looking at for both kind of a reported tax rate as well as where you think your cash tax rate is going to come in?

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

Yes, so I think without getting into a whole lot of detail, we can maybe deal a little bit of with this offline, Mark. But it's very consistent with where you expect to go in light of the recent tax changes, both in Canada and the U.S. So the effective rate is around 25%, something like that. Just...

[Mark William Wilde, Senior Analyst]

Okay. And then the cash rate?

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

Yes. It's roughly -- it's something in that order of magnitude as well.

[Operator]

Your next question is from Paul Quinn from RBC Capital Markets.

[Paul C. Quinn, Analyst]

Just a question on pulp. Sounds -- reading through the press release that you're slightly optimistic over there in the next couple of quarters. What are you seeing in the longer term for softwood in terms of capacity adds? Because I'm not seeing a lot and I think the market could last a little bit longer than a couple of quarters.

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

For sure, Paul. Brett, why don't you take that.

[Brett Robert Robinson, President]

We see some capacity coming on in Q2 and then looking further out there's not a lot of growth other than creep in the existing mills. So pretty low growth to answer your question.

[Paul C. Quinn, Analyst]

And on that subject, if you creep wood, what are you guys using as an assumption? Is that 1%, is that what you're seeing in the Canfor mills?

[Brett Robert Robinson, President]

Well, obviously, we want to grow anything we see as a good opportunity, high-return project. But typically, over history, that's about what we've seen, yes.

[Paul C. Quinn, Analyst]

Okay. And then just flipping over to the lumber side on the growth idea and M&A opportunities, we saw a pretty high benchmark valuation last year with the Gilman transaction. Is that because some of the potential sellers to ask for the moon at this point or is there still opportunities out there?

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

For sure, it's had an impact. I mean, I think that may be folks that weren't interested before, come back and say, well, if you're willing to do this or that, they might be more interested. But frankly, we've always had our position here, we're not overpaying period. We're -- and which also causes to look at other opportunities such as greenfield, right, Paul? And so, we're going to -- we'll keep looking at it. But right now, we think the valuations are high and at this point, right? So we're just continuing to -- we're in no rush here. Hopefully, this will -- the greenfield that we're talking about will come to fruition here, of course. And plus, you add to that the organic growth and we see -- we think we can build it a bit more economically through those channels and possibly on M&A. Although, there -- as things -- we're still looking at M&A as it comes up, right? And there's still the odd thing that pops here and there. But nothing at this point that I could fill you on in anymore around any pending deal or so forth, right? So -- but clearly they've gone up, the multiples for sure.

[Paul C. Quinn, Analyst]

Okay, then you guys mentioned India is a growing destination. What kind of volumes did they sell into India in '17? And what do you think you can do in like 5 years?

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

I'll let Kevin talk about that. He was just there for the last couple of weeks. And so maybe, Kevin, why don't you fill everyone in on it?

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

Sure, Paul. Volumes have been quite limited to date. But what we see, there's some really good opportunity in a lot of different segments, be it furniture, doors, even some wood frame construction. So we're quite optimistic about it in a 5-year time period. But still, lots of work to do there. We're seeing that softwood Lumber and logs are starting to make a little bit more of an impact compared to 5 years ago and we see that trend continuing. And we remain optimistic about the opportunities in India.

[Operator]

There are no further questions at this time. Please proceed, Mr. Kayne.

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

All right. Thanks, operator. And thanks, everyone for joining the call. We appreciate your interest in Canfor, and we look forward to talking to you at the end of Q1. Have a good day. See you.

[Operator]

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