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Good morning, ladies and gentlemen, and welcome to the West Fraser Q4 2017 Results Conference Call. Forward-looking statements. During this conference call, West Fraser's representatives will be making certain statements about potential future developments. These forward-looking statements are intended to provide reasonable guidance to investors, but the accuracy of these statements depend on a number of assumptions, and it is subject to various risk and uncertainties.Actual outcomes will depend on a number of factors that could affect the ability of the company to execute its business plans, including those matters described under the Risk and Uncertainties in the company's annual MD&A, which can be accessed on West Fraser's website or through SEDAR and as supplemented by the company's quarterly MD&A. Accordingly, listeners should exercise caution in relying upon forward-looking statements.[Operator Instructions] This call is being recorded on Thursday, February 15, 2018.I would now like to turn the conference over to Mr. Ted Seraphim, President and CEO. Please go ahead.
Thank you, and thank you all for joining our call today. I have Chris Virostek and Rodger Hutchinson with me as well as a number of our other Vice Presidents on the line. I want to start by recognizing the extraordinary efforts of our employees in 2017, as we continue to realize improvements in production cost and margin despite a number of external challenges. Most notably, the fires in the interior British Columbia last summer truly tested our employees and their families. We still have much work to do to improve our operating results, whether it's improving reliability at a number of mills, further implementation of our capital plans and, of course, a continued focus on people development.We continue to see tremendous upside potential in our operating performance as we implement and develop capital plans for 2018 and 2019 for our legacy mills as well as the mills we acquired last year in the government transaction. With respect to lumber markets, we are encouraged by the improving supply-demand fundamentals. U.S. housing starts of approximately $1.2 million are coming into line with a view we have held for some time, which is at a $1.3 million starts that demand and supply would be in good balance. With North American lumber demand projected to grow at 2 billion board feet per year and with an expectation of modest increases in overall U.S. lumber production over the next few years, likely in the 750 million to 1 billion board foot range annually, we remain optimistic in our outlook. With that, I will turn it over to Chris.
Thanks, Ted. There were a few developments in the fourth quarter that I'd like to touch on. In early November, revised rates for CVD and ADD were issued. Our company-specific CVD rate dropped from 24.12% to 17.99%. Accordingly, we recorded in the quarter a reversal of CVD duties, previously expensed and paid at the 24.12% rate, as well, we performed an analysis of the potential ADD rate using actual data for the period. As a result of the trend in lumber prices through the second half of 2017, we estimate our potential ADD rate to be substantially lower than the final rate of 5.57%. Accordingly, we recorded a $17 million benefit to earnings in the fourth quarter.To summarize, total duties paid in the year were $85 million, of which $48 million were expensed at expected rates and $37 million was established as a receivable for payments made in excess of the final CVD rate and expected ADD rate.In the fourth quarter, duties paid were $20 million with $17 million recorded as income as a result of the previously mentioned adjustment to rates.Our adjusted EBITDA of $341 million for the quarter excludes any impact from duties, positive or negative. The tax cuts in JOBS Act passed in the U.S. prior to year-end reduced the U.S. income tax rate and provided for immediate expensing of capital expenditures. For West Fraser, this will mean a decrease in our go-forward effective tax rate to approximately 24% to 26%, and we estimate the immediate expensing of capital, coupled with other tax attributes, will delay us paying any significant cash taxes in the U.S. for the next few years.Adjusted EBITDA of $341 million or 24.8% of sales was a quarterly record for West Fraser. Strong pricing across all product segments contributed to the results. Lumber-adjusted EBITDA margins reached 26%, as shipments grew by nearly 3% from the third quarter, aided by the addition of the Gilman operations, but held back late in the quarter by transportation, resource limitations and bottlenecks. Panel margins were in line with the prior year quarter, but off the record pace of Q3. Pulp margins increased substantially due to better pricing and strong BCTMP performance. Cash flow from operations in the quarter was $254 million, and we ended the year with net debt to capital of 12% and available liquidity of approximately $800 million.For the year, we generated approximately $900 million of cash flow from operations, and reinvested approximately $860 million of that back into the business through a capital expenditure and the purchase of the Gilman Companies. In addition, we returned $45 million of cash flow to shareholders through dividends and share buybacks. We announced yesterday our second increase in our dividend in the last 6 months to $0.15 per share for the quarter.Our Gilman integration is on track, all major systems have been converted, and we are starting the process to deploy capital to these mills as part of our anticipated spending of $300 million to $350 million for 2018.Markets have started the year off strong, particularly in lumber. However, the first month of the year presented number of weather-related challenges as severe weather in the U.S. South resulted in number of lost production days due to cold temperatures, power curtailments and road conditions. In addition, securing transportation continues to be a challenge in Western Canada. Log inventories remain below targeted levels in a number of areas as a result of the fires in the past summer in BC.With that, I'll turn it back to Ted for some closing remarks before we open it up for questions.
Thanks, Chris. I would just like to take the opportunity to recognize Rodger Hutchinson, as this is his last quarterly call before he retires at the end of March. We just celebrated Rodger's 23rd anniversary with the company yesterday. We have all benefited from Rodger's tremendous financial skills. He also represents West Fraser's core values internally and of course externally. And I know we are all proud to have worked with him. I have especially enjoyed my working relationship with Rodger as well as the great friendship that we have developed over the years. With that, I would like to turn the call back to the operator and remind you all that this is your last opportunity to ask Rodger some really hard questions. I think he is ready for you. So we'll turn it over to the operator for questions. Thank you.
[Operator Instructions] Your first question comes from Hamir Patel from CIBC Capital Markets.
Ted, you mentioned potential capacity or production growth in the south of, I think you said, 750 million to 1 billion board feet a year over the next couple of years. That to me would seems to be a bit less and maybe what creep than what some of the new announcements at least on a nameplate basis would suggest. So I'm just curious what sort of constraints do you see playing out in the U.S. South to sort of limit production growth?
Yes. I think first of all, last year, I think the production in U.S. South grew in that range. And I think as we look forward, I mean, obviously, the U.S. South has got timber, that's not the issue. I think the issue comes down to other than debottlenecking large projects. There's only so many equipment vendors that are out there. So I think getting the equipment, it will be a challenge to get past that level of production. And I think secondly, people always have to think about where the residuals are going to go, chips and so on. Because the pulp and paper market in U.S. South is not really growing. And I think, finally and most importantly, and I don't think -- I think people underestimate this. Labor is a significant issue in the U.S. South. And I'll just give you some examples here. Hourly turnover rates in Canada, at least in our mills, are in the single digits. In the U.S., they can range anywhere from 30% to 60% depending on the mill and the company, and we are at the low end of that range, but we definitely have a lot of work to do. So my point here is, if hourly turnover is a challenge with a strong economy in the U.S., getting -- hiring employees is going to be a real challenge. And I think just to build on that a little bit, this is one of the reasons we bought Gilman. We have the ability with that acquisition to grow our production, have higher labor productivity, consume the same amount of timber and produce 20% less chips, because the lumber recovery at those mills, even though they are well run, is 20% below the lumber recovery at our legacy U.S. South mill. So we for years have felt that growth in greenfield capital projects in U.S. South will be rather limited, given those 3 factors that I just mentioned, which are labor and engineering as well as homes residuals and chips.
It's helpful. And just question for you on the plywood side, at least in your outlook anyway, it sounded like you guys were a little bit more cautious there. Just curious how you think about that market? Any interest in building out a presence in the U.S. from what I understand your current almost exclusively Canada, so how do you think about that?
Well, I think first of all, we tend to be cautious in our outlook for markets. And even today, when you're looking at plywood prices in Canada, they're actually coming back to the levels they were in the second half of last year. I think we're approaching $600. So the Canadian plywood market is probably a bit stronger than our outlook is stating today. But again, we're going through the winter which is really hard to predict with the next few months will be like, but it is relatively strong. But coming back to growth for us, we like the plywood business. We would not shy away from an acquisition in plywood in the South that makes sense, but they're rather limited. And I think that's probably the biggest limitation for us. They're rather limited. And fundamentally, while we're very interested in that, our real focus right now is to build out our lumber platform in the U.S. South and invest in the 21 sawmills we have down there, but that doesn't mean we wouldn't look at plywood assets.
Fair enough. That's all I had, and Rodger, best of luck in retirement.
Your next question is from Sean Steuart from TD Securities.
Few questions for you guys. Just following up, Ted, on Hamir's question on the CapEx spend, and I appreciate a lot of the $300 million to $350 million you'll be spending this year. We'll go to the South. When you're talking about better lumber recovery factors, can you help us conceptualize how much you envision adding to your U.S. South capacity over the next couple of years?
I think, as we look at our current capacity, I believe it's about $3.1 billion fee. I think over the next 3 or 4 years, we'll probably see -- probably a 10%, 12%, maybe 15% increase on that, but again, that would take time. And frankly, coming back to my comment about capital, if we could get more capital earlier, we'd do it faster, but capital will be a challenge.
Okay. And Ted, another question on pulp markets. It looks like BCTMP prices in China are under some pressure. There's reports of lower resale prices for NBSK there as well. How much of that do you attribute to inventory management around Chinese New Year versus maybe more of a sustained correction in the pulp market?
Well, I think, Sean, first of all, I think if anybody said they predicted the pulp market rate for 2017, I think they'll be lying. I think we were all way too conservative. So I think -- I just want to make sure when I make my comments about our outlook, it's really a little difficult to understand because what happened last year was a significant restriction in imported recycled fiber. Those restrictions have been relaxed a little bit, at least for the next quarter, so we'll have to see where that goes. Chinese New Year always plays a role. The one thing I would say is, we are very strong in our order books for NBSK. And so the challenge won't be over the next 3 or 4 months, it'll probably be at least sometime in the second quarter if things soften. BCTMP is a little bit different right now, honestly, because the board market, they have taken a bit of downtime lately, so the board market appears to be, at least today, slightly oversupplied. So we're seeing some reductions in the band for BCTMP. We still have decent order files. But again, that can flip a switch in 60 days. So our outlook is a bit uncertain for pulp markets. I think the conservative you would be that we should expect softening this year, that may be systemic. We expected that last year, but given the size of the Chinese pulp market, it's, I think, a real challenge to predict what will happen this year. And we could be surprised to the upside. I don't know if that's helpful at all, Sean.
It's helpful. It's -- I've had trouble calling the cycle as well. One last question on the dividend policy, I guess, for Chris. It was actually a relatively modest increase not that we were necessarily forecasting one. How do you think about the dividend yield relative to your available capital base, which is substantial and your overall capital structure right now? Chris, maybe remind us of any targets you have for dividend payout over the mid- to long term?
Thanks, Sean. So we're -- as we think about the capital allocation and how we deploy capital that we generate through the business, I think we try to keep in mind that maintaining a strong balance sheet throughout all the cycles is important and continuing to reinvest in our mills to maintain our cost position are the priorities, and those will continue to be the priorities. I think we find ourselves in a situation now with markets performing as they are and seeing the benefit of the capital expenditure over the last several years that we find ourselves with more options around how to deploy capital and to return capital to shareholders. We look at the dividends as one element of that, but most importantly, and I think the feedback we've heard loud and clear is, whatever we decide to do on dividends, it's going to be sustainable throughout all market cycles. And so it's an ongoing evaluation for us. We don't set specific targets around payouts and so forth given the volatility in these markets and how quickly things can move, but we're trying to make a prudent assessment of the right level over the long term that can be sustainable in good markets and in bad.
Your next question is from Paul Quinn from RBC Capital Markets.
All right, couple of questions. One, just -- we've seen lumber prices take off in the earlier part of the year and you mentioned some weather issues and transportation. Is it all around that? Or where do you -- what your assessment on lumber inventory in the channel?
Well, I think we believe the lumber inventory is pretty tight in the channel. The only reason I hesitated there is -- I know it's very important to you guys to kind of get a sense of where the markets are going over the next months and quarters. From our perspective, we don't spend a lot of time thinking about that. What we spend our time thinking about is kind of our longer-term view, and our longer-term view is really positive. I mean, the year started out much stronger than I think anybody forecasted, and I think, Paul, the weather had a big impact on it. But I think the other issue has been with all the volatility last year, with duties on, duties off, I think buyers were very reluctant to take risk and build inventory. So they came into -- sorry, 2018 with very low inventories. And so once you have any hiccup in the supply chain, it's having an impact on the market for sure. I don't know if that's helpful.
Okay. And we sort of looked at North America and sort of that describes the situation there. Offshore markets, maybe you could give us some color on what do you see in China, Japan and other Asia?
Well, I tell you what, Chris McIver is on the line. He was just in parts of Asia recently. So why don't I let him give you a bit of color. Chris, are you on the line?
Yes. I would say, if you start with Japan, which is our traditional, sort of, high-value market, demand is very strong from all segments, single-family, apartments, multifamily. And so that's good. Quite frankly, anything we can produce within those grades is pretty easy to sell. We just had a few guys over in China. I would say that market is pretty strong. It seems to be taking the new pricing within reason fairly well, and the demand there is -- again, we're -- we limit our position over there. We got a significant position, but we could certainly sell more if you want. And I think that they're pretty optimistic about the market when I come back from Chinese New Year. And we're starting to do a little business in some of the other markets, be the Middle East or India and so forth. So obviously overall, it's probably strong. It's certainly stronger than it was this time last year, and -- but it's behind North America for sure.
Okay. Great. And then, I guess, operating performance at Hinton, it's something you haven't talked about this quarter. I don't want to jinx it, but just curious as to whether that mill continues to make gains?
Well, I think everybody on the line knows how much I enjoy speaking about 1 specific mill out of 47, but we're -- I was really pleased with how we started the first half of last year. I think we all were. And we had a really tough third quarter and start to the fourth quarter. So the mill is running better. But as I said many times, and thanks for saying you don't want to jinx. It is -- we need to have a good 12, 18 months behind us before that doesn't become -- I mean, I look at the production every day for that mill, just so you know. And we've talked about it quite frequently. So we -- when that mill runs well, it runs really, really well, and we've just got to improve the reliability there. And our folks are very committed to it. This year, we don't have any shutdowns. So we don't have any big issues in front of us. So I've got a lot more confidence going into 2018 and remote reliability, again, how we ended 2017 and the fact that we don't have a large maintenance shutdown in front of us. And so I hope that I can report. And you'll see that with our production, I hope I can report as the year goes by that we're making or continuing to make progress. But we're definitely not where we need to be yet.
Okay. And just lastly on capital allocation. You pointed out, you made almost -- generated $900 million in cash flow, and you've outlined the CapEx even at $350 million on the high end. Last year, you increased dividends and bought back some shares. How should we be thinking if 2018 is similar to '17 that we should see a similar increase in the dividend and a whack load of shares being bought back or...
Well, I think -- maybe I'll take a stab at it. And when we look at last year, we basically used all the cash we generated. Between the Gilman acquisition and our capital, we basically utilized most of our -- the cash we regenerated. I think we paid down some debt, of course. But the one thing, as we -- as Chris said, we really want to invest capital in our business, and if we can accelerate our capital spending program, we will do that. Because we've got lots of good projects with us, and again, Gilman provides more in the pipeline. And we also want to grow. And I think about last 12, 13 years of this company, we've kind of grew in the lumps. We bought Weldwood in 2005, and all of a sudden, 2007, we buy the U.S. assets of International Paper. And acquisitions come in a lump. So I think we definitely still want to grow, and we're going to continue to look for things that fit us and make us better, not just bigger, but they make us better. As Chris said, we think our investors value dividends to a certain degree, but they really value a steady dividend. And we're going to continue to monitor that and see if it makes sense for us to look at further growing that dividend in time. And then when it comes to share buybacks, we were quite active in that in 2016. Last year, I think there was a lot of uncertainty around the SLA. We were very keen on the Gilman acquisition, and we became aware of that fairly early in the year. So we've kind of kept our powder dry when it comes to share buybacks. I expect that we will buy back shares this year to the extent I can't really say at this time, because we're not afraid of having cash on our balance sheet at this point in the cycle. But we're going to continue to look for opportunities to grow the company, Paul. It's just -- sometimes it comes when you least expect it.
Okay. And Rodger, thanks for the help. We wish you best of luck, but I think it's probably better directed to your wife now as you're going to be home 24/7.
Yes. It's kind of wondering when Sean said best of luck to Rodger, he's retiring.
Yes. Paul, I'm sure my wife would agree with you. It is better directed towards her.
[Operator Instructions] Your next question is from Mark Wilde from BMO Capital Markets.
Rodger, good luck, and good luck to your wife.
We're spending a lot of time with Rodger's wife to make sure she's ready for him.
Yes. All right. I wondered, to start, maybe Chris could help us in just kind of parsing out how big the impact from both kind of weather and these transportation logistics issues were in fourth quarter? And then, what your best guess is based on what you've seen so far here in the first quarter, because you've called this out in the earnings release?
So I think it's -- it was probably less of an impact in the fourth quarter than it was in the first, as we started to see that extreme cold weather in the south. And I don't think we're at the point where we're going to quantify what those impacts were, because we still have the opportunity to potentially make some of that up through the balance of the quarter. I think these things are reasonably typical this time of year. There may be order of magnitude a little bit more severe this year, particularly in the U.S. South than in prior years. And I think, we called it out on the basis that just to temper and make sure we think about the first quarter that while lumber markets are strong, it's not the only thing to sort of factor into our calculus around the first quarter is that we will have some challenges around those things. On the other hand, the weather could break next week, and we could have a great next couple of months. So it's really hard to predict. It's been a bit of a challenge, the first few weeks, but we're working hard to try to overcome it.
Maybe I can just add one comment there. I think not specifically about that, but it just indicates to me that when we have a supply disruption, the impact, it shows you how strong the lumber market is. We had the fires last summer, and that took out 55 million feet of our production, probably 100 million feet or so in the interior. And we saw the impact that had on the market. And so we're working hard to -- as Chris said, to ship our product, work with our carriers, work with our mills, whatever we can do. But I really do believe that it's just an indication of the strength of the market. The impact that -- a little bit of weather disruption has on lumber market. [indiscernible]
Okay. Yes. Ted, is it possible to kind of go into this transportation issue a little more because I know there was the rail issue in Western Canada 1 week or 2 ago? Warehousers said, they had a mill in BC that they couldn't get rail cars into for 2 weeks. And then we've got this trucking issue which is all over North America, and you guys use trucks to bring logs in, and in the South, you use trucks to take lumber out.
Yes. Well, I think a lot of it's seasonal right now, and I think the question is we have a longer-term issue. And I know our industry is working on it in Canada with government and with the carriers. And I look at our size, and I'm challenging -- Chris McIver is responsible for transportation, I'm challenging Chris and his folks to -- and our mills to think about the fact -- there's a fact of life here, we have trouble every wintertime. So I think the challenge for all of us is to figure out is there another solution? And I don't think we know what the answer to that is, Mark. It's a bit perplexing because we don't really have a -- we don't have control over it like we have over our operations. But it really is a challenge and I -- the economy continues to strengthen. I think it's going to be challenge, not just for our industry but for many industries. So I'm hopeful that we can use our size to help us overcome it, frankly, better than our competitors.
Yes. And can you -- just toggling over to one other kind of cost issue. With the tight labor in the -- particularly in the U.S. South, are you seeing kind of rates go up for both your contractors out in the field and also, what you're paying at the sawmills?
Not so much. I think it's fairly modest. And -- but we believe there's going to be a long-term trend in terms of labor cost increasing. And we don't have an issue with that. Obviously, our labor cost in Canada are much higher than they are in the U.S. and our goal is to make sure our employees are paid well, while we improve some of productivity. So the capital we're spending, I think it's going to do a couple of things. It's going to help us have higher starting wages because the jobs will be more technical. Secondly, in our industry, we're working really hard improving the working conditions. That's one of the reasons we're spending a lot of capital in our mills. And so I think, we are competing for labor. And it's not just rates, it's working conditions, it's the quality of the mills and it's the way you give people opportunities. So as I said in my opening comments which were pretty short, I said we're working on operational improvements, capital. But where we spend a ton of time in this company is on people and people development, and I think it's a big challenge, and we're working real hard to get ahead of it. So markets might be a bit of a short-term concern, but we see it really as a more of a longer-term issue. And if we do it well, hopefully, it will give us a competitive advantage.
Yes. And hopefully, it drops those turnover rates. Just one other question.
Yes. What I mean, we got turnover rates in Canada in single digits, why can't we get close to that in U.S. if we apply ourselves properly.
Yes. My last question is just, Ted, if you can maybe give us a little perspective -- you've really been on kind of a 10- or 11-year march to get the Southern U.S. mills up to West Fraser's standards. And can you just help us in understanding where you think you're adding that process right now?
Wow, that's a big question. So I'll try and answer as quickly as I can. I think, first, I think it really comes down to operational excellence, people, so I just talked about that, and capital. So capital is the simplest one to talk about. If you exclude the Gilman mills, I would have said, we were -- and I think I said it last year, I would have said, we were probably 50% to 60% through it. Our initial capital is primarily around planers and kilns. And we've -- we built the new sawmill basically at Newberry last year. We're going to be starting up basically a brand-new sawmill in Opelika, Alabama in the third quarter. And so we've got some sawmill projects that are -- and that's where our growth will come from. We've got the planer and the kiln capacity primarily to get us there. And then when it comes to people, it really comes down to leadership and Ray Ferris and Sean McLaren -- Ray Ferris is our Chief Operating Officer, and Sean, who runs U.S. South, and Chuck Watkins, who runs our manufacturing down there. And they are senior guys who have done a tremendous job building a strong leadership team, and we saw -- we do benchmark ourselves against others. And we've seen improvement over the last 3 years, and we've got -- I'd say, we're halfway there in terms of improving those assets from an operating and -- maybe more than halfway there on the capital side. I look at the Gilman mills we bought. As I -- as we said, when we bought them, they have the same EBITDA margin as the West Fraser average. Good mills, great management, and I said that. What they suffered from what was the lack of capital. So I'd say, at the Gilman mills, it's -- we're probably -- we've got a lot of great capital projects in front of us. So I think -- I'm hopeful that we can say in 2 or 3 years, we've got those mills from a capital standpoint at the same spot where all our mills will be in the sales. So I think we got a still a good 3-year journey in front of us when it comes to capital.
We have a follow-up question from Sean Steuart.
Just 1 follow-up guys. On the duties, as we go forward here, maybe can you give us some perspective on the administrative review process? And in 2018, how should we think about how you will expense duties quarter-to-quarter? I guess, I'm thinking specifically on the ADD. Will you expense at your final rate as it stands now? Or will you assess it at what you think is the appropriate rate given the moving pricing?
Well, I was waiting for a really hard question because we'd throw it to Rodger, but I'll take on the first part. So basically, administrative review starts next January. And I think we have until, basically, June I think, June or July of 2020 to have that complete. And then, of course, there's always appeals, but I think from our perspective, if we're being conservative, I think we should expect that we'll be paying these duties through June of 2020. And in terms of how we expense, I'll leave it to Chris and Rodger to answer that.
Yes, I think on AD front, Sean, given that there's a fairly standard methodology for that, that enables us to sort of go and look at what we think the estimated actual rate is going to be. We'll periodically take a look at that each quarter in 2018 and beyond to see if there's anything material change there in terms of it. But given how far we've drawn it down in terms of where we think it's likely to be through 2017, I wouldn't expect major changes to that in 2018.
Just so I understand that, Chris, and you'll expense it at what you deem to be the appropriate rate given where pricing is?
Correct. Yes. For ADD, yes.
There are no further questions at this time. Please proceed.
Well, again, thanks very much for joining us on the call, and Chris and Rodger are available for any follow-up questions. And we'll talk to you in the quarter. Thanks a lot.
Ladies and gentlemen, this concludes your conference call today. We thank you for participating, and ask that you please disconnect your lines.