Canfor Pulp Products Inc

TSX:CFX

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen, and welcome to the Canfor and Canfor Pulp Fourth Quarter Analyst Call. A recording and transcript of the call will be available on Canfor's website.During the 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 company 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.And I would like to turn the conference over to Mr. Don Kayne, Canfor and Canfor Pulp's Chief Executive Officer. Please go ahead, Mr. Kayne.

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

Okay. Thank you, operator, and good morning, everyone. Thank you for joining the Canfor and Canfor Pulp Q4 2018 Results Conference Call. I'll make a few comments before I turn things over to Alan Nicholl, our Executive VP 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 Q4.Joining Alan and I today are Kevin Pankratz, Senior VP of Sales and Marketing; and Stephen MacKie, Senior Vice President of Canadian Operations. I would also mention that in January, Kevin Pankratz assumed the responsibility for the sales and marketing of our pulp group in addition to our lumber group. Then Brian Yuen, who has had several years of increasing responsibilities in our pulp group, was appointed Vice President of Pulp Paper Sales and Marketing. Before I discuss the fourth quarter, I'd like to make a couple of comments about 2018. Canfor Pulp reported record operating income of $247 million and a return on invested capital of 37%. Canfor Corporation reported operating income of $609 million, the highest in over 10 years, and a return on invested capital of 19%. These results were achieved in a year which featured extreme transportation challenges, extreme weather events, significant forest fires, log supply constraints, significantly higher log cost and market volatility. Despite these many challenges, our people performed exceptionally well under these difficult circumstances.During the year, we completed our $100 million investment in green energy upgrades at Taylor and Northwood. In addition, our 350 million board foot, USD 125 million organic capital program at our U.S. South operations remains on track to be substantially completed by the end of 2019. The spending includes large sawmill rebuilds at Camden, South Carolina and Moultrie, Georgia, a new planer at Fulton, Alabama and continuous dry kilns at Darlington, South Carolina and Urbana, Arkansas.Now turning to the fourth quarter. Earnings were significantly impacted by a sharp decline in market pricing for both lumber and pulp with a consolidated operating loss of $79 million.Now turning to the fourth quarter. Earnings were significantly impacted by a sharp decline in market pricing for both lumber and pulp with the consolidated operating loss of $79 million.For Canfor Pulp, the company had a challenging quarter, generating operating income of $16 million, which was down significantly from the third quarter, principally due to lower shipment levels, reflecting repair work on our recovery boiler at Northwood and a natural gas pipeline explosion near Prince George.Total scheduled and unscheduled downtime reduced our NBSK production by 90,000 tonnes. Global softwood kraft pulp markets are projected to remain steady throughout the first half of 2019, reflecting a forecast increase in demand in China and reduced supply due to the traditional spring maintenance period for our pulp mills.Moving to our lumber business. We reported an operating loss of $88 million. Our lumber production was down significantly in the quarter, reflecting a series of production curtailments in British Columbia and inclement weather in the U.S. South, which impacted log inventories, log profiles and overall manufacturing costs.We have further curtailed our B.C. operations in Q1 by $90 million feet across our system, primarily in Vavenby, Houston and MacKenzie due to continued log supply constraints, significantly increased log cost and market conditions. We will continue to review our operating rates as market conditions warrant.Current markets have been challenging. However, our outlook is for pricing to stabilize and gradually increase, which we have begun to see in early 2019. We expect the normal seasonal pickup in demand to coincide with relatively low inventory in supply chains and have seen strong increases in both our retail and builder business. Demand from offshore markets continues positive after a strong Q4 and expected to remain solid through the first quarter of the year. Overall, supply continues to be impacted in B.C. with an estimated 1 billion board feet of announced temporary or permanent capacity reductions. We are encouraged that a memorandum of agreement for a new 5-year term has been reached with the USW. The agreement includes 7 of Canfor's certified mills in British Columbia. The USW will be conducting ratification votes on the agreement over the coming weeks. In addition, we have 3 mills represented in the negotiation process being led by the Interior Forest Labor Relations Association. We remain optimistic that a settlement will be reached between the association and the USW. Transportation networks have been generally good, but we are seeing increased challenges due to significant cold weather in parts of Western Canada.With respect to our previously announced greenfield mill in Washington, Georgia, we are deferring any decision on this project to the end of 2019. This decision is based on challenging market conditions and inflationary cost pressures. In terms of Softwood Lumber Agreement, there are currently no negotiations underway. In early December, a NAFTA panel was formed that includes 3 Canadian and 2 American panelists. We'll be following the decisions of the panel very closely.Finally, we are anticipating closing the VIDA transaction shortly. We are extremely excited about our investment in Europe as it further diversifies our business from both a geographic and product profile standpoint, an earnings profile that is much more consistent than what we typically see here in North America.This purchase supports our long-term strategy of growing our high-value and noncommodity lumber businesses and further positions the company for strong, stable earnings in the future.I will now turn the call over to Alan Nicholl, who will provide an overview of our financial results.

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

Thank you, Don, and good morning, everyone. My comments will focus principally on our financial performance for the fourth quarter by reference to the previous quarter. And 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 the Canfor Pulp websites in the Investor Relations section under Webcast. And the presentation highlights consolidated and segmented results, and I'll be referring to this presentation during my comments.For the fourth quarter of 2018, Canfor reported a shareholder net loss of $52 million or $0.42 a share, down from net income of $125 million or $0.98 a share reported for the third quarter, and net income of $132 million or $1.02 a share reported for the fourth quarter of 2017.On Slide 3 of our presentation, we highlight various nonoperating items, net of tax and noncontrolling interests, which affect the comparability of our results between the quarters. In the fourth quarter of 2018, these items totaled $24 million, the largest being a $29 million expense related to countervailing and antidumping duty deposits. After adjusting for these nonoperating items, the shareholder net loss was $28 million or $0.23 a share for Q4 compared to net income of $157 million or $1.23 a share for the third quarter.As highlighted on Slide 6 of our presentation, the lumber segment recorded an operating loss of $88 million for Q4, down $237 million from the previous quarter. After adjusting for CVD and ADD, as highlighted on Slide 5 as well as an inventory write-down of $37 million at year-end, the Q4 operating loss was $11 million, down $203 million from a similarly adjusted operating income of $192 million in Q3.The major variance reflected substantially lower Western SPF and Southern Yellow Pine lumber prices, which translated into materially lower unit sales realizations. These declines were accompanied by higher unit log costs in Western Canada and lower production and shipments.The significant price erosion reflected slowing North American demand coupled with excess inventory in the supply chain. The North American Random Lengths Western SPF price averaged USD 327 per thousand board feet, down some 32% from the previous quarter, while prices for other grids saw a more moderate correction.Southern Yellow Pine sales realizations reflected a 6% decline in the benchmark 2 by 4 price but declines in wider-width dimensions were more pronounced, some of which was attributable to seasonal factors.As a result of these weaker market conditions as well as log supply constraints and allocated log costs, the company took approximately 100 million board feet of curtailment at its B.C. lumber operations in Q4. And this was the primary contributing factor accounting for a 12% decline in production and a 14% decline in shipment volumes in the current quarter.The higher unit manufacturing costs in Q4 reflected a 10% increase in Western Canadian log cost, resulting mainly from the timing of market-based stumpage increases, higher purchased wood costs and log supply shortages as well as lower productivity in both regions, reflecting both the impact of curtailments in B.C. as well as weather-related challenges at the company's U.S. South operations. Log cost in the U.S. South remained stable through the quarter.Canfor's Pulp and Paper segment comprises the results of Canfor Pulp Products Inc. As highlighted on Slide 7, the company reported net income of $14 million or $0.21 a share for the fourth quarter of 2018 compared to net income of $43 million or $0.66 per share for the previous quarter.As Slide 7 highlights, the Q4 financial results reflected the continuation of the scheduled maintenance outage at Northwood from the previous quarter. The previously announced repairs to Northwood's No. 5 recovery boiler, unscheduled downtime taken as a result of a third-party natural gas pipeline explosion in Prince George just in -- early in the quarter, and to a lesser extent several other operational challenges during the quarter, all of which reduced NBSK pulp production by approximately 90,000 tonnes. In addition, BCTMP production was impacted by a 7-day curtailment in late December as a result of reduced residual fiber availability following various sawmill curtailments in the region.At the end of December, and into January, the company experienced kiln-related operational disruptions at 2 of its NBSK pulp mills. While these challenges have now been resolved, the related production loss was approximately 20,000 tonnes early in the first quarter of 2019.Unit manufacturing costs in Q4 were significantly were higher than previous quarters as a result primarily of the lower Q4 production as well as higher related maintenance, energy and chemical costs associated with unscheduled outages particularly at Northwood.Sales realizations were broadly in line with the previous quarter as weaker U.S. dollar list prices to China were partially offset by higher list prices to North America and proportionally higher shipments to the U.S. and, to a lesser extent, Europe.Operating income for the company's paper segment in Q4 is $4 million, up slightly from the previous quarter, reflecting solid operating performance of the company's P.G. paper machine and steady paper unit sales realizations.Capital spending for the fourth quarter totaled approximately $140 million and included approximately $100 million for the lumber business and $40 million in Canfor Pulp. In 2018, capital spend totaled just over $400 million and comprised $272 million for lumber and $121 million for pulp.As Don mentioned, the company continues to execute on the USD 125 million organic growth program, targeting an additional 350 million board feet of production in the U.S. South. And we remain on schedule to have this program substantially completed by the end of this year.Including organic growth, our 2019 forecasted capital spend is approximately $300 million, with approximately $190 million for lumber and $110 million for pulp. At the end of the year, Canfor, excluding Canfor Pulp, had cash of $246 million and drawn debt of $408 million, with $450 million of available liquidity under its operating line as well as additional CAD 100 million and USD 100 million term debt facilities, both of which are currently undrawn. All of our operating and term credit facilities now go out to 2024 or later. It's currently contemplated that the VIDA acquisition price will be paid from the company's cash on hand, the additional term debt facilities and the balance from the operating line. We are currently forecasting Canfor's net debt to total capitalization at the end of Q1 to be approximately 30% when we typically have our peak log inventories. This is significantly below the level at which any financial covenants would kick in. And while these debt levels are relatively high for Canfor's standards, we anticipate a healthy reduction in the second quarter as our Western Canadian log inventories consumes during the spring breakout.Canfor Pulp had net cash of $7 million with available liquidity of $99 million at the end of the year. Net debt to total capitalization, excluding Canfor Pulp, is 7% and on a consolidated basis was 6%.Yesterday, Canfor Pulp's board of directors approved the continuance of the quarterly dividend of $0.0625 a share for the fourth quarter. And finally, by way of information, our earnings in 2019 will reflect the transition to new lease accounting standards. And as a result, our EBITDA is projected to increase by approximately $13 million for lumber and $1 million for pulp.And with that, Don, I'll turn the call back over to you.

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

All right. Thanks, Alan. So operator, we're now ready to take questions from the analysts.

[Operator]

[Operator Instructions] And your first question will be from Sean Steuart at TD Securities.

[Sean Steuart, Research Analyst]

Just so I understand the Western Canadian lumber production this quarter, you took a 100 million board feet of downtime related to markets and variability constraints. Your production was down 130 million board feet sequentially in Western Canada. Is the rest just holiday shuts and that's the component we would expect to come back in Q1? Is that the right way to think about it?

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

Yes. No, for sure, Sean. Maybe I'll get Stephen to give you a bit of an update on our current and forward planning here around the shutdowns.

[Stephen MacKie, Senior Vice President of Canadian Operations]

Yes, sure. Thanks, Don. Just in terms of the gap between 100 million capacity reduction and the 30 million -- the incremental 30 million that we were off there, some of that was just operational challenges related to the fourth quarter, winter weather, log profile and delivery issues as well as, as we worked through the USW negotiations and some operating rate changes in terms of labor disruptions that were associated with those negotiations.

[Sean Steuart, Research Analyst]

Okay. So the tough weather extending into Q1, if I'm thinking about 90 million board feet tied to weak markets and log availability issues, there could be incremental curtailments on top of that related to weather, that sort of stuff?

[Stephen MacKie, Senior Vice President of Canadian Operations]

In terms of the forecast for Q1, I think that I would say there, Sean, is that we did take additional capacity reductions, as you say, for the 90 million. We did -- we have experienced some extreme weather conditions as we work our way through Q1 here that have had some impacts and we've only just recently concluded and are pleased, as Don indicated in his comments, with the memorandum of the agreement we signed that impacts the majority of our USW certified mills. So we're hoping that a lot of that will be behind us as we work through the balance of Q1.

[Sean Steuart, Research Analyst]

Okay. I think you said Western Canadian log costs were up 10% sequentially. Can you give us a sense of how you're expecting your log cost to trend over the short- to mid-term in Western Canada in the next few quarters?

[Stephen MacKie, Senior Vice President of Canadian Operations]

Sure, Sean. Stephen here again. I'll tackle that one. So yes, we did see 10%, as Alan referenced, in quarter-over-quarter increase in Q4. Really, we're expecting those trends to kind of continue through the balance of 2019 compared to what we saw in 2018. Q4 numbers were disproportionally a little bit high in terms of that increase as we prioritized shipments of some purchased wood and deferred quota deliveries to capitalize on a stumpage reduction that was coming due here in January. As you know, we are anticipating lower stumpage for the first half of 2019 as a result of the market conditions that we experienced in the back half of 2018, but then stumpage will increase again in the second half '19. So all in all, we do expect continued upward pressure on log cost in British Columbia, and we would expect that trend to continue until we see some material rationalization and permanent capacity reductions.

[Sean Steuart, Research Analyst]

Okay. And maybe to that point, Stephen, you guys referenced potential to permanent shuts, I suppose on this call, but your thoughts on how much more supply in the interior needs to come out permanently across the industry to rightsize the production base to the fiber resource going forward. Do you have any thoughts there?

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

Yes. Sean, it's Don. Just on that, as we've kind of talked about before, our view has been and continues to be in total that we believe there has to be approximately 7 to 8 mills that need to go away, about 2 billion overall roughly in terms of production. So depending on the size of the mill, it gives you a bit of a sense overall. What we've seen so far between -- like, I mentioned I think in my comments, maybe I didn't, but in terms of the permanent shuts and what we've seen so far is it equates to about 1 billion of that. But a lot of that's not permanent, right? so we still think there's a fair bit of rationalization that has to take place. And certainly, with the way things are looking right now and the challenges at British Columbia, we think that might be maybe advanced that we may see some of that. Not ourselves, but I think we'll see that across the industry more in probably 2019 than we would have originally thought.

[Operator]

Next question will be from Ketan Mamtora from BMO.

[Ketan Mamtora, Analyst]

Don, Alan, the first question, I just want to talk a little bit about and get your thoughts on housing. Obviously, there are a lot of crosscurrents going on right now in the back half of last year, housing activity slowed. But in the last couple of months you've also seen rates come down a lot and we've had affordability issues last year. So can you talk about what you guys are seeing right now in terms of activity and your expectation for the spring season?

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

Go ahead, Kevin.

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

Sure. It's Kevin Pankratz here. And you're right, we did see a little bit of a pause in Q4 on housing. But our expectation is that housing is going to come in around 1.26 for the year. I think we'll get the final results here next week on February 26 when we get the actual confirmation, but that is our expectation. And for 2019, based on our intel and the conversations with customers, we expect to see a modest pickup for 2019, maybe approaching 1 3.

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

Stephen -- maybe one thing to add, Kevin, to that is just because it's just interesting and it's actually a bigger consumer of lumber is on the retail side, and we -- through the back half of the year, and we're seeing that continue into Q1 also, is some very positive numbers in terms of the DIY side of the business or retail side of the business with the big boxes. And you know them, Home Depot and Lowe's, those types, and that's encouraging. And it's been a significant increase. They're more than we've typically seen in past years. So that gives us a lot of a -- a good -- a fair bit of encouragement in terms of trying to gauge consumer confidence and consumer sentiment going forward. And so that's -- I guess, that's maybe the only thing I would add to that in addition to the comments that Kevin responded to around the home building side.

[Ketan Mamtora, Analyst]

Got it, that's very helpful. And can you also talk a bit about offshore demand in China, both in lumber as well as in pulp?

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

Yes, well, maybe -- Kevin, you can -- why don't you answer that one on the lumber? Maybe Brian can talk a little bit more on pulp.

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

Sure. Yes, on the lumber side here, we've actually seen some pretty good demand here really picking up in Q4 where we've had significant increase in our shipments starting -- with it being impacted in November and December. And based on our current order file, we have that trend continuing well into Q1 and into April. So pretty strong demand in order files in place for China from the lumber perspective. And Brian, maybe just a comment on the pulp side.

[Brian Yuen]

Sure, Kevin. Yes, on the China side, we saw the market bottom out at the end of 2018. Since then we've seen that the market has stabilized. And in fact, as China comes back to rebuild their pulp stocks, we've seen an uptick in softwood demand. So we anticipate that moving forward, optimistic that prices will be trending up.

[Ketan Mamtora, Analyst]

Got it. That's very helpful. And then one last kind of cleanup question. This is regarding the duty. So we saw a pretty sharp drop in Western SPF prices. Your volumes of SPF was also down quite a bit, yet the duties were down only $2 million quarter-over-quarter. What am I missing?

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

Yes, so it's a fair question. So the duties in Q4 reflected a higher ADD rate that applied not just to the quarter but actually to the 18-month period under review. And that was largely a factor of dynamics in B.C., principally the higher cost and the lower pricing. We did offset that, Ketan, as you probably gathered by shipping more offshore and obviously the production curtailments were just [ in line to be shipped ] in the quarter as well. So hopefully that helps answer your question.

[Operator]

At this time, Mr. Kayne, we have no further questions. I would like to tell turn the call back over to you, sir.

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

All right. Thanks, operator, and thanks to all of you that were on the call. We appreciate your interest in Canfor, and we'll talk to you at the end of Q1.

[Operator]

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time we do ask that you please disconnect your lines. Enjoy the rest of your day.