Western Forest Products Inc

TSX:WEF

Earnings Call Transcript

[Operator]

Good morning, ladies and gentlemen, and welcome to the Western Forest Products Fourth Quarter 2021 Results Conference Call. During the conference call, Western's representatives will make forward-looking statements within the meaning of applicable securities laws. These statements can be identified by words like anticipate, plan, estimate, will and other references to future periods. Although these forward-looking statements reflect management's reasonable beliefs, expectations and assumptions, they are subject to inherent uncertainties, and actual results may differ materially. There are many factors that could cause actual outcomes to be different, including those factors described under risks and uncertainties in the company's annual MD&A, which can be accessed on SEDAR and is supplemented by the company's quarterly MD&A. Forward-looking statements are based only on information currently available to Western and speak only as of the date on which they are made. Except as required by law, Western undertakes no obligation to update forward-looking statements. Accordingly, listeners should exercise caution in relying upon forward-looking statements. I would now like to turn the meeting over to Mr. Don Demens, President and CEO of Western Forest Products. Mr. Demens, please go ahead.

[Donald Eugene Demens, CEO, President & Director]

Thank you, Chris, and good morning, everyone. I'd like to welcome you to Western Forest Products' 2021 Fourth Quarter Conference Call. Joining me on the call today is Steve Williams, our Executive Vice President, Chief Financial Officer; and Glenn Antal, our Vice President of Corporate Development. So we issued our 20,214th quarter and full year results yesterday. I'll provide you with some introductory comments and then ask Steve to take you through a summary of our financial results. I'll follow Steve's review with our outlook section before we open the call to your questions. Before I begin, I'd like to recognize our team at Western for their continued strict adherence to our robust COVID safety protocols. Their dedication to safety has delivered another quarter with no COVID workplace transmissions or downtime. This result is a testament to our strong safety culture and the commitment of our people. 2021 was an exceptional year for Western. Our flexible operating platform allowed us to capitalize on strong lumber markets to generate a record adjusted EBITDA of $302 million. The combination of strong financial results and $52 million of noncore asset sales supported a successful repositioning of our balance sheet. Our net cash position at the end of 2021 of $130 million, combined with the extension of our credit facility to 2025, have positioned the company for future growth. Through the year, we continued our balanced approach to capital allocation as we returned $111 million to shareholders via dividends and share repurchases. And finally, we shared our financial success with our employees and communities, recognizing nonexecutive employees with COVID-related safety bonuses and a performance bonus, while simultaneously increasing community donations during the year. In addition to our strong financial results, we were also successful in advancing and executing on many of our strategic priorities. I was particularly pleased with the progress we made in advancing partnerships with indigenous nations. A highlight was the completion of the next phase of our Sawikin Limited Partnership with the Huu-ay-aht First Nations, with a recent purchase now own 35% of [indiscernible]. In addition to the ownership transaction, we also achieved a series of milestone agreements focused on joint and collaborative planning and forestry activities with indigenous nations in the traditional territories we operate. Through 2021, our team continued to demonstrate our vision and leadership in advancing indigenous relationships in support of reconciliation. We also continue to show our commitment to sustainability and ESG, being the first forest products company in North America to have transitioned to a sustainability-linked credit facility and with the release of our latest sustainability report. As part of that report, Western confirmed the net positive role or sustainable forest management practices and wood products have in fighting against climate change. I'm proud of our team at Western, and what we've been able to accomplish together, and I look forward to Western's continued success and growth in the future. I'll now turn it over to Steve to review our key financial results.

[Stephen Williams, Executive VP & CFO]

Thanks, Don. My comments will focus primarily on our financial results for the fourth quarter of 2021, with comparison to the fourth quarter of last year. We reported fourth quarter adjusted EBITDA of $52.5 million as compared to $71.1 million in the same quarter last year. Results in the fourth quarter of 2020 included a noncash export tax recovery of $31.6 million as compared to $3.3 million in the same period in 2021. Results in the fourth quarter of 2021 benefited from higher lumber and log prices, higher byproduct revenue from improved chip price realizations and lower export tax expense. Results were partially offset by lower lumber and log shipments, higher per unit timberland harvesting costs due to weather-related curtailments, higher stumpage expense, and higher performance-based compensation expense related to our strong financial results and an appreciation of our share price. Lumber revenue increased 4% compared to the fourth quarter of 2020. Higher lumber prices were offset by lower shipment volumes due to logistics-related disruptions. Our fourth quarter average realized lumber price was $1,634 per thousand board feet, an increase of 30% compared to the same period last year. Log revenue was lower in the fourth quarter of 2021 due to weather-related operating curtailments. We continue to direct export grade log supply to our sawmills to support lumber production. Byproduct revenue increased by $2.1 million, benefiting from improved chip realizations due to a higher NBSK pulp price. Freight expense was 13% lower compared to the same quarter last year. Lower lumber shipments more than offset higher freight rates and an increased use of higher cost break bulk vessels in response to global supply chain constraints for container vessels. An absence of export log shipments also reduced freight expense. Fourth quarter results included $4.6 million of export duty expense as compared to $12.1 million in the same quarter last year. At the end of the quarter, we had approximately $120 million of duties on deposit. Lumber production was flat compared to the same quarter last year. Operating curtailments related to log supply and severe winter weather impacted lumber production as well as differences in the net nominal production count due to product mix year-over-year. Log production in the fourth quarter of 2021 was 22% lower than the same quarter last year. Log production was impacted by weather-related curtailments caused by significant rainfall in November, followed by heavy snowfall in December. We ended the quarter with approximately 556,000 cubic meters of log inventory, which is lower than historical levels for the end of the fourth quarter. From a profit and loss perspective, fourth quarter net income was $28.5 million as compared to $34.4 million in the same quarter last year. Looking at fourth quarter cash flow and capital management. Cash provided by operating activities before changes in noncash working capital was $47.8 million in the fourth quarter as compared to $37.9 million in the same quarter last year. Cash used in investing activities was $13 million in the fourth quarter as compared to $5.5 million in the same quarter last year. We returned $37.8 million to shareholders during the quarter via dividends and share repurchases. In 2021, we returned over $111 million to shareholders, and we completed our 10% NCIB in January 2022. We ended the quarter with $130 million in net cash and $371 million in available liquidity and had an income tax payable balance of $64.1 million at the end of 2021. Don, that concludes my comments.

[Donald Eugene Demens, CEO, President & Director]

Thank, Steve. So let me start off our outlook section by touching on first quarter seasonality. Typical first quarters, our timber harvesting activity can be periodically interrupted by winter weather. Harvest volumes are typically skewed to the end of the quarter when the weather and light conditions support greater activity. From a market perspective, sales usually accelerates for the quarter. As we look to our markets, strong demand across our core markets have created margin opportunities for Western. In North America, we expect continued strong demand, combined with constrained supply to deliver above-trend level pricing over the near term. But we anticipate any supply-demand imbalances could lead to increased pricing volatility in the months ahead. In our Cedar segment, demand and pricing is expected to improve as we head towards the usually stronger spring season. In the coming months, we anticipate improved demand and pricing for all product categories in our niche segment. And finally, in Japan, we believe continued strong demand from the new home construction segment, combined with logistics constrained imported lumber supply, should support pricing through the first part of the year. In our log business, weather-related events limited harvesting activity in the first half -- or last half of 2021, resulting in lower than usual log inventories at the end of the year. So we'll look to rebuild our log inventories over the first half of 2022, but we may experience some log-related downtime at certain sawmills in the coming months. We expect domestic sawlog prices to remain strong, supported by limited supply and higher demand. Higher NBSK prices should benefit residual chip pricing in the coming quarters. All that said, the ongoing challenges related to COVID-19 and the global logistics issues continue to create uncertainty in our business and could lead to pricing volatility and ongoing shipping challenges in the near term. We will continue to leverage our flexible operating platform to match production to market demand and logistics capacity. We remain optimistic about the long-term growth opportunities for wood as a sustainable building product as the world looks to reduce its carbon footprint. Turning to recent industry developments. In November, the BC government announced its intention to work in partnership with First Nations to temporarily defer harvest in 2.6 million hectares of BC's most at-risk old growth forests. The proposed deferrals are province-wide, and if implemented, have been identified as temporary. The BC government continues to state that final decisions on deferral areas will be based on discussions between themselves and First Nations. Since the government's announcement, some First Nations on whose traditional territories we operate, have provided updates regarding their decisions on the provincial government's technical advisory panels proposed temporary deferral areas. In December, the Huu-ay-aht First Nations, whose traditional territory includes a portion of TFL 44 operated by Silicon Forestry Limited Partnership, announced their interim decision to uphold their right to harvest in the 4% of the proposed temporary deferral area that would have impacted harvest in the next 2 years. Huu-ay-aht have not yet, or have yet to release their final decision, and we are not certain when that final decision will be made. However, the nation has initiated a science-based integrated resource management planning process. Public communications state that this indigenous-led process will inform their decisions related to force management, including the government's old growth report going forward. Last month, Western and 4 members -- member nations of the Namecolis Council announced an agreement to work on a joint approach to managing forest in TFL 39 Block II that included a joint agreement for short-term deferral of 2,500 hectares while these plans are completed. The dialogue with the nations has allowed us to forward plan, and as such, we do not expect a material impact on our business as a result of these interim or final decisions. We continue to proactively work on fostering positive and mutually beneficial relationships with First Nations in support of sustainable forest management in BC. Moving on to the softwood lumber dispute. Effective December 1 of last year, the combined countervailing and antidumping duty deposit rates for Western increased from about 9% to approximately 18%. In January of this year, the U.S. Department of Commerce announced the preliminary combined duty rates from the third administrative review. The duty rates applicable to Western from the third administrative review are approximately 11.5%, which is lower than the current rate. We expect the final rates for the third administrative review to be implemented in August of this year. Currently, Western has over $120 million on of duty deposits on deposit with the U.S. Treasury, which, at today's exchange rate, is approximately CAD 150 million. Turning to capital allocation, we remain committed to a balanced approach to capital allocation, returning cash to shareholders while maintaining the flexibility to support growth initiatives. Since 2013, we have invested approximately $0.5 billion of capital in our business, while, at the same time, returning approximately $0.5 billion to shareholders via dividends and share repurchases. We plan to remain balanced and disciplined in our approach to capital allocation. Turning to what's next, our top priority remains the health and safety of our employees, contractors and communities and in working collaboratively with First Nations. Our long-term focus remains the same, to successfully and sustainably implement our strategic initiatives, to strengthen our foundation, grow our base, grow our business and deliver long-term shareholder value. And with that, operator, we can open the call up to your questions.

[Operator]

[Operator Instructions] We will take the first question. Please go ahead.

[Hamir Patel]

Hamir Patel. Don, I wanted to get your thoughts on what you're seeing from your channel partners in terms of demand, just particularly with the home center channel?

[Donald Eugene Demens, CEO, President & Director]

Yes, Hamir, I mean, we're pretty encouraged by the demand we're seeing throughout the markets we service. I think we're pretty clear kind of covered in our MD&A in kind of my opening comments. So it's a pretty positive operating environment currently, market environment. That said, I think on the logistics side, container, rail and truck capacity is constrained. And I think that's kind of the biggest challenges we see at least in the near term.

[Hamir Patel]

I believe maybe it was about a year ago, you kind of outlined the bigger focus on partnering with some of the big-box stores. Can you give us an update in terms of your Cedar business, how much is going directly to the 2 big home improvement retailers and how you see that evolving?

[Donald Eugene Demens, CEO, President & Director]

Yes. So I mean, last year, we were kind of in a similar position, very strong U.S. market. And as everyone knows, R&R took a step back through the middle part of the year. A significant portion of Cedar is still consumed in or sold through the box stores. We continue to work with Box to stock our lumber either directly or through the 2-step distribution. So I think whenever the business is getting strong, you're going to see more volume flow through the box stores and we've got our foot in the door there, and we expect to see a little more growth there this year.

[Hamir Patel]

Great. I just wanted to touch on the stumpage. I believe on the coast, it would have been a December revision. What kind of increase are you seeing there? And just given the current product environment, what sort of inflation would you expect going forward on the coast?

[Donald Eugene Demens, CEO, President & Director]

Sure. So I mean, for everybody on the call, I know you know it well, but -- there are 2 different equations for stumpages in BC 1 on the coast and 1 in the interior. Coastal stumpage equation considers variables that are specific to the coach market variables. And they're different than those in the interior. So -- but clear while a formula is going to drive stumpage calculations. I think our mix of harvest will drive any company-specific stumpage rates, right? So in the near term, based on the updated equation, we expect numbers to moderate because markets weakened late in -- or, I guess, the midpoint of 2021, and that's going to have an influence on the stumpage rate. But I have to say, given the current lumber market strength, I think we would expect that kind of respite and stumpage costs to be pretty short-lived. All that said, we look at every 1 of our permits and ensure it contributes margin. So while stumpage cost may be rising, we're going to remain focused on margin. And to be clear, I mean, Hamir, I think stumpage rates are similar to the interior because of the markets are going to be kind of lower in the next quarter or so. And then, based on markets, I think they're going to go higher.

[Hamir Patel]

Great. Just 1 for Steve. I'm not sure if you're able to provide a sort of preliminary CapEx budget for 2022?

[Donald Eugene Demens, CEO, President & Director]

Amir, maybe I'll throw that over to Glenn and get him to give you an update.

[Unknown Executive]

Yes, Hamir, not a problem. So historically, we've averaged about $30 million to $40 million annually in maintenance and some weather-related impacts in the second half of 2021 delayed some of that maintenance and real CapEx in 2022 about $10 million. We also have about $10 million in strategic capital products underway, focused on cost reduction and other efficiency initiatives. So rough math, for 2022, total CapEx of around $60 million is probably a reasonable number to use, Hamir.

[Donald Eugene Demens, CEO, President & Director]

And, Hamir, maybe if I can just add. I mean, Glen has done a good job of outlining what we're looking at this year. I think longer term, we're looking at increased investments in our operating platform likely around kiln capacity as well as over the next few years, we'll be looking at line upgrades for generational improvements from a technology point of view in a couple of our mills. So you can probably expect to see some time going forward, some announcements on additional capital required maintenance business and increasing kiln capacity.

[Operator]

We will take the next question from Paul Quinn.

[Paul C. Quinn]

Maybe just following up on this CapEx, the $60 million, it sounds like $10 million is a holdover from last year. But of the $50 million, -- you mentioned Killam's down. What -- where is the kiln going in? Are you putting in a kill or is it refurbishing? And how many are you putting there? .

[Donald Eugene Demens, CEO, President & Director]

Yes. So Paul, I think we tried to explain here the additional strategic CapEx that Glenn highlighted is the continuation of our productivity improvements focused on processing, mostly the DuPont [indiscernible] with an auto wrapper, a [indiscernible], different stacking and that should be done by the third quarter this year. The [indiscernible] and maybe line replacement would be done in subsequent years, and we're still doing the [indiscernible] engineering on that. So I just wanted to foreshadow that we're thinking about it and give you some insights into what our thoughts are. I expect we come to a conclusion here pretty shortly in the next few months and then come back to you.

[Paul C. Quinn]

Okay. And just remind me, how short of [indiscernible]? What percentage of your wood is dragged right now?

[Donald Eugene Demens, CEO, President & Director]

Well, yes. So we've got the largest investment in [indiscernible] capacity on the coast, as you know. How short we are depends on our product mix. So currently, at our big mill, we're kind of 50% to 60% covered, but we've got product lines that are still green that we support. And we'd like to see that obviously, the opportunity to grow. Overall, 50% to 60% is probably a good number. And we like the opportunity on the [indiscernible] side because don't buy lumber selling typically through the cycle at higher prices than the renumber. So it provides greater flexibility for us. So installing the [indiscernible] will allow us to pursue margin opportunities through the cycle.

[Paul C. Quinn]

Okay. That's helpful. And just back to the old growth deferral, the government's experiment here, you stated no material impact across your areas. Just wondering when you think about for the -- I mean, you guys do a lot of low trading on the coast. So the rest of the cost, outside of our area, how material do you think that is going to be? And is it going to affect your ability to access logs?

[Donald Eugene Demens, CEO, President & Director]

Yes. So good question. So just to be clear, like in TFL 44 and 39 Block 2, where the announcements have been made by the First Nations, we don't foresee material impacts right now based on what's been announced so far. Other First Nations are still going through the process to try to respond to the government. So that's sort of a wait and see. I think how it's going to impact the other suppliers on the coast, again, I can't foretell how they're going to be impacted. But what I can tell you is that we have spent years in developing relationships with First Nations on the coast. I'm really pleased with the progress we made just this past year in working with First Nations identifying integrated resource management planning, and we've been invited to participate in some of those. And I'm hopeful that our work, over the last number of years, will support our business through greater certainty. And working with First Nations, I think we have an opportunity to provide greater benefits to the nations. So hard to say, Paul, how it's going to impact log supply from others. I do like our positioning.

[Paul C. Quinn]

What about the deferrals with respect to the forest profile? Is it -- I suspect it's heavy to Cedars -- would that be a fair statement?

[Donald Eugene Demens, CEO, President & Director]

Well, if you go back to the deferrals, the 2.6 million hectares, a portion of -- and these are all public numbers, I'll quote you. Half of it is probably outside the timber harvesting land base. So areas that weren't going to be harvested anyway. About 80 -- and from the studies, we've seen 88% of the temporary deferrals are actually in the interior, 12% on the coast. How it's going to impact the profile? I mean, obviously, it depends site-by-site. I'd be reluctant to jump to conclusions, which I think other people have about how this is all going to play out. I think I'd remind you that they're temporary. They're -- and they're going to require First Nations' approval and support. And so really hard to tell exactly how it's going out here. But again, I reiterate, I kind of like our position in -- and our efforts to work proactively with First Nations.

[Paul C. Quinn]

Okay. And then maybe just back to the business. That niche segment that you've got, I think that's been impacted by the over the last number of years by the downturn in oil specifically. I thought there was a number of products that you made for that sector. Just wondering if that's seen a big comeback and what are the key products that we should follow? Or what are the key businesses that would really drive that niche segment going forward?

[Donald Eugene Demens, CEO, President & Director]

Sure. So great point. So -- and you're absolutely right. So in our niche segment, the products you want to think about would be appearance products for the molding and millwork sector, appearance timbers, and those are quite often priced [indiscernible] center for timbers particularly, and you can see those in random lengths. And then, of course, the industrial segment which oil and gas, large infrastructure projects like pipelines. And yes, you're absolutely right. The appetite for -- through the -- I guess the oil patch and for these large infrastructure projects for lumber has increased pretty dramatically. And I think that's what I referred to in my opening comments. So we see across the product lines, whether it's appearance, whether it's timbers or whether it's products, for the infrastructure business, they're all in high demand with very strong pricing.

[Paul C. Quinn]

Okay. And last question, just Japan seemed particularly strong here. You guys have operated in that area forever. Do you see the strength is sustainable going forward?

[Donald Eugene Demens, CEO, President & Director]

Well, the strength in Japan is pretty much correlated to the strength in housing. What we saw an opportunity last year to kind of reestablish ourselves when our customers were short of wood from other supplying regions. And I think it really -- it's really important for us to explain this well. Our flexible operating platform allowed us to transition products out of the U.S. and, to some extent, China back into Japan. We levered our relationships with break bulk carriers because there still was -- containers were extremely short. And we positioned ourselves last May to extend order files through the balance of the year at very attractive pricing, record pricing and significantly increased volumes. So all of our components of our business had to come together. And so we've certainly benefited. I think looking forward, housing market still remains strong. Our work with our customer base, I think, I would hope would be rewarded because we were there to deliver products when they needed them and others weren't. So I'm pretty encouraged at least for the first part of the year here, and we're going to continue to try to extend order files in Japan. I mean, we're trying to do it right today through second quarter. So pretty encouraged.

[Operator]

[Operator Instructions] We will take the next question from Sean Stuwart.

[Sean Steuart, Research Analyst]

I just want to follow up on your last point on Japan and more with respect to your lumber shipment mix into the first quarter. So Q4 skewed more heavily to Japan away from commodity grades, which makes sense given how you just laid it out. We've seen commodity prices skyrocket simply last year. How should we think about your mix into Q1 for lumber shipments?

[Donald Eugene Demens, CEO, President & Director]

Sure. So I think when you think about our mix -- there is a number of ways I can go here, but let me just start off by discussing the mix of the segments as you've asked. So in 2021, our production and shipments of commodity lumber increased by 20% relative to 2020, which, of course, was strike impacted. And it kind of normalized at about 50% of our business being commodity, 50% specialty products. Within the specialty mix, of course, as you saw right at the very end of the year, our volume to Japan increased pretty substantially. So a couple of things are going on. I think within our commodity mix, 60% of our volume ended up going to North America. And that's the target we can move between export and North America when markets allow us to. I think looking forward, what you want -- what you want to think about is that on a volume basis, I think, Japan is going to stay about where it is, although working hard with with home companies and suppliers of the home companies who are concerned about their supply chain now after last year and whether or not we can grow volume there is going to be our focus. But I think you can consider for the near term that volumes stay about the same. And you'll see commodity lumber volumes pick up a little bit for 2 reasons: one, of course, we get account gain when we start producing lumber into North America. The other reason is we've had a few production challenges due to lower log inventories. And so a couple of the larger log mills have taken some downtime here in the first quarter. We're working hard at expediting harvest where we can to rebuild log inventories and keep them going. But I think you can anticipate that just as a mix component, little more commodity and the Japan volume will stay about the same.

[Sean Steuart, Research Analyst]

Okay. That's great. Second question is on larger scale capital allocation initiatives beyond the CapEx program, which Glenn laid out nicely. And I guess I'm wondering, with respect to potential acquisitions or larger capital deployment initiatives, and maybe this is not something you can answer, but is the Board's perspective, they'll wait until your official retirement, your successors in place before they would consider something along those lines? Or are you guys still looking at opportunities through this interim period?

[Donald Eugene Demens, CEO, President & Director]

Yes. Let me comment on the retirement piece, and then I'll throw it over to Glen on capital. I think I made an announcement earlier in February that I'd be retiring and provide the Board a pretty darn long lead time through March of 2023. So business as usual here at Western, and we will be reviewing capital allocation opportunities with our Board and whether that includes investing in our business or acquisitions, we're returning monies back to shareholders on a regular basis. Maybe over to you, Glen, if you want to answer [indiscernible]?

[Unknown Executive]

So maybe I'll touch more broadly on the capital allocation. Let me as you're aware, we remain committed to a balanced approach to capital allocation, which includes the payment of our regular quarterly dividend. We're successful in returning about $111 million to shareholders via dividends and share repurchases in 2021, accelerating those repurchases in Q4 as we thought an attractive opportunity to return additional capital to shareholders. We completed the maximum under our normal course issuer bid in January of this year. As you are probably aware, TSX rules only allow a maximum of 10% of the float under NCIB over a 12-month period, meaning that we won't be able to renew our NCIB until August of this year. That said, we retain the flexibility for other return of capital alternatives, and we'll consider all options, which may include considering increasing our dividend, considering a substantial issuer bid or considering a special dividend. We continue to evaluate and discuss return of capital with our Board every quarter. And at the same time, we do remain focused on strategic growth initiatives, including our strategic capital investment projects as well as growth opportunities. And as you're aware, on the growth side, we continue to explore growth opportunities that will increase our share of specialty products and create long-term shareholder value. On the M&A side, that's probably going to be focused in the U.S. Pacific Northwest as well as potentially developing strong 2-way relationships in Japan. But as you're aware, from an M&A perspective, while we continue to be active, we're going to be disciplined in our approach. And any acquisitions will need to make sense over the long term and be accretive and create long-term shareholder value.

[Operator]

There are no further questions registered at this time. I'd like now to turn the meeting back over to Mr. Demens.

[Donald Eugene Demens, CEO, President & Director]

Great. Thanks, Chris, and thanks, everyone, for your continued support. Appreciate your interest in our company and your time on the call this morning. Steve Glenn and I are available if you have any follow-up questions. And otherwise, we look forward to sharing our first quarter results with you in May. With that, have a great day. Thank you.

[Operator]

Thank you. The conference is now ended. Please disconnect your lines at this time, and thank you for your participation.