Interfor Corp

TSX:IFP

Earnings Call Transcript

[Operator]

Ladies and gentlemen, thank you for standing by and welcome to the Interfor quarterly analyst conference call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would like to now hand the conference over to your speaker today, Ian Fillinger, President and CEO. Please go ahead, sir.

[Ian M. Fillinger, President, CEO & Director]

Thank you, operator. Welcome, everyone, to our Q3 '20 investor analyst call. Firstly, I'd like to say that I hope you and your family are safe, healthy and doing well during this pandemic. With me today, we have Bart Bender, our Senior Vice President of Sales and Marketing; along with Rick Pozzebon, our Senior Vice President and Chief Financial Officer. Our agenda today will start off with myself providing a recap of our strategic priorities and key themes. I'll then pass the call to Rick, who will cover off financial matters; and then over to Bart, who will cover off markets. Turning to our strategic focus. We continue to focus on operational excellence. This is an underlying driver of our company to achieve greater returns on capital today and through the cycle. Accordingly, our portfolio status has been adjusted in 2020. We continued to right-size the B.C. Coastal business. Earlier this year, we acquired the additional timber for our Interior B.C. region, and we have now embedded this volume into our Adams Lake facility. We've completed a major upgrade at one of our U.S. Pacific Northwest stud mills, and we've also divested from one of our specialty mills in Oregon. And in the South, we've completed major projects at 3 of our 9 operations. We continue to work hard on our capital allocation discipline to ensure best returns for our shareholders. Our improvement efforts were balanced across the company as we made progress in all of our regions. All of our operating regions improved their production volumes quarter-over-quarter, as COVID and capital improvement projects were addressed and completed. Of note, we recorded the highest production-per-hour in our mills for the entire company since we started our southern modernization program. Our conversion and overhead costs both continue to trend positively through our ongoing cost control and increased production levels. We also closed down our head office in Vancouver and relocated the staff to our Metrotown office in Burnaby. Our total cash cost decreased $30 quarter-over-quarter, driven by relatively stable log costs and lower conversion costs across all of our regions. Our capital spending program continues to advance forward as we continue to modernize and improve not only our operating costs but also our value extraction from logs. Last quarter, we spent $23 million to improve our plants across all regions. Working capital and its impact on cash flow continues to be a key focus for us. We've implemented a new disciplined procedure earlier this year by matching market demand to both our lumber and log inventories and also our mill operating schedules. This ensures we don't build excess volume into the supply chain and we're as lean and mean as possible. Turning to our financial results. Our Q3 adjusted EBITDA was an all-time record at $222 million. Our lumber margins were very strong, and we continue to focus on efficiency and cost across our company. Lastly, we have significant financial flexibility to consider external capital deployment and also other options, which Rick will address. In closing, we are focused on maintaining the health and safety and well-being of our employees, to continue to drive cost reductions and we're matching our production rates to our order files. That concludes my opening remarks. I'll now hand the call over to Rick.

[Richard Pozzebon, Senior VP & CFO]

Thank you, Ian, and good morning, everyone. Before getting started, I'll refer you to the cautionary language regarding our forward-looking information on the first page of our Q3 MD&A. As Ian mentioned, Interfor generated record adjusted EBITDA of $222 million in Q3, improved from $43 million in the prior quarter. This improvement reflects significantly higher realized lumber prices and shipment volumes, as well as a continued focus on costs across our business. Our average realized price was $910 per thousand board feet, up 41% over the preceding quarter, driven by the record lumber market appreciation. As is typical, Interfor's realized lumber prices lag to key benchmark prices due to timing differences between orders and shipments. Lumber shipment volume was up 24% over the second quarter, in which sales were limited by production curtailments in response to COVID-19 uncertainty and project-related downtime. Cash income taxes have been nominal year-to-date and are expected to remain so over the near term in Canada and over the midterm in the U.S., based on existing tax loss carryforward balances and current tax legislation. Cash flow generated from operations in the second quarter was $175 million. This includes a $39 million investment in working capital, of which the majority is related to the impact of increased sales levels on trade accounts receivable. In terms of capital expenditures, $23 million was spent in Q3 with approximately $17 million of that related to discretionary projects, which are progressing well. Our balance sheet strengthened further quarter-over-quarter, and we continue to have ample financial flexibility. We ended the quarter with net debt of $89 million and available liquidity of $637 million. Our liquidity is comprised of $311 million of cash on hand and our undrawn revolving term loan. In addition, softwood lumber duties on deposit with the U.S. government totaled $121 million at quarter end, substantially all of which are not recorded on our balance sheet. Regarding capital allocation, our objective over the long-term is to generate returns for our shareholders above Interfor's cost of capital while maintaining a conservative balance sheet appropriate for the lumber industry. In this regard, we've revised our near-term internal CapEx plans to spend approximately $115 million in 2020 and $150 million in 2021. At the same time, we continue to pursue growth through acquisition but remain disciplined in evaluating opportunities against our return hurdles. When surplus liquidity exists after considering these priorities, we will assess the various options for returning capital to shareholders. In this regard, Interfor has announced a normal course issuer bid to purchase up to 10% of the company's public share float over the next 12 months. We believe that the purchase of Interfor shares may represent an appropriate allocation of capital, depending on the market price. In summary, Q3 financial results were exceptional, and we are well-positioned with a strong balance sheet to execute on our priorities and maximize returns for our shareholders. That concludes my remarks, and I'll hand the call over to Bart.

[J. Barton Bender, Senior Vice President of Sales & Marketing]

Thanks, Rick. I'll give some market comments. The strength in our lumber markets seen in late Q2 '20 continued through Q3 '20. Demand was elevated in all end-use sectors, most notably residential construction and repair and remodel. Seasonality in Q4 has prompted all parties to take a breather as we ready for 2021, and we are expecting price volatility to continue through the quarter and into 2021. In North America, the market fundamentals are encouraging. Residential construction is showing no signs of weakness. And in fact, the 2021 outlook from the major homebuilders talk to continued strength in their markets. It seems the desire for space has prompted new entrants into the housing markets and a shift away from higher-density urban areas. With repair and remodel, the activity levels from our customers remain above the recent averages, however, off slightly from the peaks seen in Q2 and Q3. Seasonality will play a role here. Our expectations are for continued strength in repair and remodel as we enter 2021. Our export markets have been less active for us in Q3, both from Japan and other Asian countries. Japan is largely attributed to a reduction in housing starts in the year. Recovery has started in this regard, so expect our business will improve in 2021. Our customers in China have options for lumber beyond North America, so went faced with significant price increases, they have an ability to source elsewhere. Activity has picked up in Q4 as our ability to compete has improved. With respect to inventories, always difficult to pinpoint. Our intel continues to tell us that the levels in the market are at seasonal lows and can be best described as lean. Further, from Interfor's perspective, our own inventories are 30% lower at end of September 2020 versus the prior year. It's worth noting these inventories are substantively sold. We only have operational levels of unsold and support all mills with workouts. I would suspect this is a similar situation to our competitors and really tells us that supply at the mill level should also be regarded as lean. Overall, we're optimistic that the fundamentals that drove the demand for lumber in 2020 will continue in 2021. With that, I'll hand it back to you, Ian.

[Ian M. Fillinger, President, CEO & Director]

Okay. Thanks, Bart. Thanks, Rick. So operator, we're good to open up the call to any questions from analysts.

[Operator]

[Operator Instructions] Your first question comes from the line of Sean Steuart from TD Securities.

[Sean Steuart, Research Analyst]

Two questions. The 2021 CapEx guidance up a little bit year-over-year from, I guess, low levels in 2020. Ian, can you give us specifics on where the incremental discretionary chunk of the '21 spend is going? And I know you guys have sort of gotten away from the Phase 1/Phase 2 of U.S. South modernization. Any detail you can give us on larger projects that will be in the mix next year?

[Ian M. Fillinger, President, CEO & Director]

Yes, Sean. While we'll complete Phase 2, which is largely Eatonton, Georgia and then Thomaston down in Georgia, which is a major project that we've approved a year or so ago, but we're rescoping that actually down. And the rest of the capital is pretty balanced across the organization. There's projects at several mills in the South. There's a project in British Columbia that's on the books that we're just getting out to finish the final budget on that. So I would say it's heavily into the South. You complete a few of the major ones down there. And then it's smaller strategic projects in the other regions, less so in the Pacific Northwest after the project that we just completed there, which was substantial.

[Sean Steuart, Research Analyst]

Got it. And Ian, can you give us some context on fiber cost trends? I think we have a pretty good sense of what will be happening in B.C. early next year. But Pacific Northwest, U.S. South, what trends are you seeing or are you expecting in those regions?

[Ian M. Fillinger, President, CEO & Director]

Yes, for sure. So in the South, pretty stable, Sean, quarter-over-quarter. In the path going forward, we're not seeing price appreciation there. So that looks solid and balanced. And then in the Pacific Northwest, in the short term there's some actually views in what we're seeing relative to the fires that happened in Oregon and in Washington, that there is some price relief in the Pacific Northwest regarding the salvage wood that's happening now. So in the short term, seeing a decrease, we do think that the Pacific Northwest eventually, once that salvage wood is consumed and dealt with, that it will be a little more responsive to whatever the lumber price is doing at that time. But in the short term, it's actually flat or down in some of our operations in the Pacific Northwest.

[Sean Steuart, Research Analyst]

Okay. Just one last question for me. Rick, you mentioned with respect to the cash tax profile, you gave some generalities around the transition in Canada and the U.S. I'm wondering if you can just dial in a little bit more and give us a sense of where your overall tax shields are in each country.

[Richard Pozzebon, Senior VP & CFO]

For sure, Sean. In Canada, we've got CAD 54 million of NOLs at September 30. And in the U.S., we've got USD 94 million at September 30. And just looking out in Canada, it's possible just depending on lumber markets, we could be paying cash taxes in the next 6 to 18 months, it really just depends. And in the U.S., given some of the legislation down there, it allows us to accelerate our CapEx write-offs that likely won't be for 1 or 2 more years, although depending on the market.

[Operator]

Your next question comes from the line of Hamir Patel from CIBC Capital Markets.

[Hamir Patel]

I wanted to ask you about -- in the U.S. South, it seems like there's a lot of composite decking capacity coming on in the U.S. over the next few years. Do you think that could start to weigh on demand for lumber from your treating customers as kind of as we move through 2021?

[Ian M. Fillinger, President, CEO & Director]

Yes. I think, Hamir, I'll probably pass that over to Bart to hit on that particular segment.

[J. Barton Bender, Senior Vice President of Sales & Marketing]

Yes. I mean any time you get in a very high-priced environment, there's always the possibility of substitution that can take place. And so composite decking is one of those things. So it's always a possibility. However, from what we've seen from the markets and the indication that we see from our customers, we expect the demand for those types of items to continue strong. I think there's room for everyone in the market that we're currently in.

[Hamir Patel]

Okay. That's helpful. And just the last question I had was, just wanted to follow up on the Hammond mill. Any update on timing of the likely sale?

[Richard Pozzebon, Senior VP & CFO]

Sure. I can take that. So we're still working through a sale process and in terms of timing, it likely won't be in 2020.

[Hamir Patel]

Okay. And any idea of the sort of magnitude of the potential proceeds?

[Richard Pozzebon, Senior VP & CFO]

Not at this time.

[Operator]

[Operator Instructions] Your next question comes from the line of Mark Wilde from Bank of Montreal.

[Mark William Wilde, Senior Analyst]

Good morning. It's a nice quarter, guys, and I think good capital decisions. Bart, I wondered if we could just talk about sort of what you're seeing in the market right now, it seemed to me that the commentary in the trade papers last night was a little bit more constructive. What's your rate of the situation?

[J. Barton Bender, Senior Vice President of Sales & Marketing]

It's a good question. I mean, obviously, the markets are shifting around quite a bit so far in Q4. I think that the market needs to build some inventory. It's very lean out there. It's very lean at the mills. And there's just a reluctance to do it at the high prices that we had. And so there's been adjustments made, and I think we're now establishing what I would call investment levels. And that's bringing some people off the fences in, and they're now starting to purchase for whatever consumption they're going to have for the balance of the year, but probably more importantly, the Q1-Q2 season next year. I think the expectation is that the business should be fairly decent. And so there's some wood that needs to be bought. One thing I'd point out, when you look at the -- how pricing has moved, I mean, it's -- the different species have really moved differently. If you look at SEM Yellow Pine and SPF, and those seem to be the big sort of commodity species that saw the most volatility. There's others, obviously, very important for us, the Doug-Fir, the Hem-Fir and those types of things that didn't see the same degree of volatility, and we're seeing the same adjustment take place, but it's now getting reestablished at investment levels that are different for each of those species.

[Mark William Wilde, Senior Analyst]

Okay. And then can you give us a sense of kind of where your order books are at this point?

[J. Barton Bender, Senior Vice President of Sales & Marketing]

You mean in terms of an order file?

[Mark William Wilde, Senior Analyst]

Yes.

[J. Barton Bender, Senior Vice President of Sales & Marketing]

We always have an order file for the mills. We very seldom get below a week and often, we're north of 2 weeks. And in a real aggressive fir market were 3 to 4 weeks. So order files are possible. It's just a matter of meeting the price levels that you need in the marketplace. So right now, we're -- I would just call it right around 2 weeks to 2.5 weeks, somewhere in there.

[Mark William Wilde, Senior Analyst]

Okay. All right. That's helpful. And then the final one, I was curious about was just -- you addressed export markets out of Western Canada. But I know you've had a plan, you and others, to try to develop export markets out of the Southern U.S. more. And perhaps you could just give us a little update on that.

[J. Barton Bender, Senior Vice President of Sales & Marketing]

Yes. That's -- it's a good question. I would say the impacts have been fairly similar. The overseas markets seem to be able to compete on the lower-grade type products. And so that business continues, whether it's in the South or in the West. It's more the 2 and better that there was really a competitive issue. And for the South, when we get into situations where there is a big gap between what can be achieved in North America versus overseas, we get strategic and kind of reduce our business to what we call maintenance levels. And this is simply keeping our strategic distributors or customers in some supply, but not as high of a supply as you would get normally. The gap, if you look at the gap in Q3, it was just -- it was too significant. There was too much of an opportunity cost. And so there was a general pullback, and I would say that, that would be the case for any of us, quite frankly.

[Mark William Wilde, Senior Analyst]

I was just going to ask one final question I had is usually the industry builds some inventory kind of fourth quarter, early first quarter. And I'm just curious, given that there just doesn't seem to be a whole lot of inventory out there right now, are we going to be able to get back to some kind of a normal level by midway through the first quarter? Or is there a potential that with as strong as housing seems to be right now that we enter next year with inventory still on the low side?

[J. Barton Bender, Senior Vice President of Sales & Marketing]

Well, you're kind of hitting the $64 million question right there. It's -- the market would like and needs more inventory. It's fairly lean today. But I mean, you have to kind of put yourself in the distributors' shoes. I mean it's -- they don't want to build inventories at these kind of levels. So I think it's pretty much hand-and-mouth. It's what they need short term, until they determine that they've got something that they can feel that's fairly risk-adjusted for them to put on the ground for future business. So I think largely, the volumes that are getting bought today are sold or they're going against business needs in Q1 or balance of this year. So it's a really tough question to ask. I mean I think that we're going to end up going into Q1, quite similarly to how we went into Q1 last year at the lower end range of inventory levels in North America. And how that's going to translate into pricing through Q1 is kind of anyone's guess at this point. But I would say that we're encouraged with where we are.

[Mark William Wilde, Senior Analyst]

Okay. All right. I'll turn it over. And again, I'm happy to see both CapEx not ramping up sharply which often happens when people get in good markets and then the return of capital to shareholders.

[Operator]

There are no further questions at this time. I'll turn the call back over to the presenters.

[Ian M. Fillinger, President, CEO & Director]

Okay. Just some concluding remarks. I'd like to thank everyone for dialing in, participating in our update call this morning and obviously, the interest in our company. If you have any further questions, just track down myself, Rick or Bart, and we'd be happy to address those. Thanks, everyone. Have a great day.

[Operator]

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.