West Fraser Timber Co. Ltd. (WFG) on Q2 2021 Results - Earnings Call Transcript
Operator: Good morning, ladies and gentlemen, and welcome to the West Fraser Q2 2021 Results Conference Call. During this conference, West Fraser's representatives will be making certain statements about potential future developments. These forward-looking statements include certain statements about West Fraser's future financial and operational performance, including the impact of foreign exchange rates, credit ratings and mill maintenance shutdowns; West Fraser's business outlook, including forecasted US housing starts, market conditions, demand for products and available supply and expectations concerning costs; West Fraser's capital plans, including the completion and ramp-up of capital projects and the benefits of such projects; the softwood lumber dispute, including adjustments to duty rates and related proceedings, the integration of Norbord into the West Fraser business and expected synergies and recent developments, including the impact of wildfires on production and shipments and the completion of our substantial issuer bid.
Raymond Ferris: Thank you, Michelle, and thank you for that disclaimer. Well, listen, good morning, everyone, and welcome to our Q2 2021 conference call. I'm joined today by Chris Virostek, our Chief Financial Officer; and Chris McIver, Senior Vice President, Marketing and Corporate Development; and several members of our executive team. This morning, I'll make a few opening remarks, and then I'll pass the call to Chris Virostek for a review of West Fraser's second quarter results before I make my concluding comments, and then we'll take your questions. I'd like to start with a couple of important housekeeping items. Today, we will limit the scope of our comments to those already provided in our Q2 disclosures, and we'll refrain from addressing any questions related to our company or market outlook beyond what has already been provided in those disclosures. Further, after this morning's earnings call and in the absence of any material developments that will require a news release we do not intend to make any additional comments to investors or analysts until after our substantial issuer bid expires, which currently is intended to expire on August 17, 2021. Finally, you will have noticed in our earnings release that we have announced a virtual investor and analyst event to be held on September 16 at 2:00 p.m. Eastern Time, 11:00 Pacific. We are planning for the event to be approximately two hours in duration, and we'll have further details at a later date. With that out of the way, let's move on to our comments for this quarter. It has been a captivating time for forest products, being a meaningful part of an industry that provides sustainable and renewable building products required for a low-carbon economy, simply by participating in the life cycle of the forest that we live and operate in. Manufacturing, building materials from a sustainable renewable forest is but one very important part of the required solution for society to meet its climate change objectives.
Chris Virostek: Thanks, Ray, and good morning, everyone, and thank you for joining us. As a reminder, our consolidated second quarter results include now a full three months of financial results from Norbord. And as of January 1 this year and for all comparative periods, we no longer exclude export duties in our calculation of adjusted EBITDA. When we last reported earnings in early May, the recovery in lumber and OSB demand was strong and net demand strength continued through most of the second quarter. Demand for new housing construction, in particular, was elevated versus historic norms. In terms of financial performance, West Fraser generated consolidated adjusted EBITDA of $2.16 billion in the second quarter, up from $1 billion last quarter, largely due to the addition of Norbord's financial results for a full three months as well as higher lumber and panel prices. Recall that in the prior quarter results, there was a $93 million EBITDA reduction, which was an acquisition-related non-cash purchase price accounting impact for the one-time inventory adjustment that raised our cost of goods to their sold to their fair value upon closing of the Norbord acquisition. Moving onto segmented results. Our Lumber segment reported adjusted EBITDA of $994 million versus $646 million in the first quarter of 2021, driven by higher pricing and higher shipments, partially offset by higher fiber costs. In our North American EWP segment, adjusted EBITDA increased to $1.106 billion from $353 million in the prior quarter, with gains primarily due to the addition of Norbord results for a full 3 months as well as higher OSB and plywood pricing, which more than offset fiber and raw material cost inflation. Adjusted EBITDA in the Pulp & Paper segment increased to $25 million in the second quarter from $11 million in the first quarter, owing to higher pulp pricing. And finally, adjusted EBITDA in the European EWP segment was $39 million in the second quarter, up from $11 million in the prior quarter. We continue to see recent market strength in Europe as demand for OSB continues to grow. Shifting to capital allocation and the balance sheet. Capital expenditures were $66 million in the second quarter, slightly higher than capital spending in the prior quarter. Note that due to some lengthening lead times on projects currently underway, we are now expecting our 2021 capital expenditures target to be in the range of approximately $400 million to $450 million versus our prior guidance of approximately $450 million. We continue to view share buybacks as an appropriate use of excess cash, and we believe our shares are trading below intrinsic value. In the second quarter, we bought back $233 million worth of West Fraser shares under our normal course issuer bid at an average price of CAD90.85. We also amended our NCIB in the second quarter, allowing us to acquire an additional 3.54 million shares for an aggregate authorization of 9.58 million shares. We also remain pleased with the level of U.S. trading liquidity we've seen for West Fraser shares with the addition of the New York Stock Exchange listing.
Raymond Ferris: Thanks, Chris. In terms of our end markets, low mortgage rates and the ongoing trend toward greater work from home continues to create strong incentives for people to purchase new single-family homes and undertake renovations and do-it-yourself projects. The underlying housing formation deficit has continued to drive demand for single-family homes, which consumes more wood, more of our wood building products than multifamily. While we recognize there are many factors outside of our control that can temporarily influence markets, including uncertainty around the long-term economic implications of the effects of COVID-19, we remain constructive and optimistic about market fundamentals. That is underpinned by the environmental benefits of building with wood, which have never been more clear and more accepted. However, at the same time, it's important to recognize that wildfires and wildfire risks we're seeing in Western Canada as a result of extreme heat and dry conditions. The province of British Columbia has recently declared a provincial state of emergency and the wildfires are affecting access to logging areas in some of our operating areas and are impacting transportation networks that we rely on to move our products. This has resulted in temporary suspensions of production due to raw material shortages, evacuation orders, and difficulties, as I discussed, about moving our finished products by truck and rail. In order to address the wildfire situation in Western Canada, its transportation challenges, log cost availability, variable and short-term demand, and overall inventory levels, we may, from time to time, adjust our activity levels at our operations as we had previously done. As a result, our production and shipments in the second half of 2021 may be impacted. More importantly, keeping our employees and community safe during these challenging times and focusing on servicing our customers' needs remain our key priorities.
Operator: Your first question comes from Mark Wilde of BMO.
Mark Wilde: Ray, first of all, I want to just start by congratulating you on a good quarter. And I also want to, again, kind of acknowledge that we're getting a much more detailed slide deck from you each quarter, and I think better disclosure in the MD&A, and I appreciate that. To start out, I'd just be curious on your thoughts about sort of the speed and magnitude of the lumber price correction that we've seen and maybe sort of any color on how that's flowing over -- into the export side of your business?
Raymond Ferris: Well, again, Mark. And look, thanks for that. Look, when it comes to the slide deck and the detail, I'd love to take -- but that's really -- that's Chris and Robert that are improving that, and we appreciate the feedback. I'm going to kind of ask Chris McIver to kind of maybe talk a little bit about the question really around export markets, I think.
Chris McIver: Mark, just to clarify, you're speaking more on the lumber side than the OSB side? Or are you speaking generally about both?
Mark Wilde: Actually, about both, if you could.
Chris McIver: So yes, I mean, I think I'd be a bit remiss to say if I didn't say that we, we are a bit surprised at how quickly the prices have come off, but that really is a reflection of how quickly they went up. So we did expect a correction. We thought it might be a bit more muted and take a little bit more time. We're not surprised to the level we've come to at this time in the short-term because we actually fundamentally believe we went too high, and we think we've probably gone a little bit too low as well in the correction. So I think we're seeing a little more stability on the lumber side right now, where sales are picking up a bit. OSB is a little bit behind. That market hung in a bit better. And quite frankly, we think the demand for panels is probably a little stronger at this time than it is for lumber. So we think it's got a bit more to go, and we're not seeing a lot of demand until we find some sort of bottom there, but we believe we will. And with regards to export, it was very difficult to participate in export markets during this run-up over the last year. They just couldn't keep up. But saying that Japan actually got to levels very similar to North America. And the prices there are still holding up. We expect to see a bit of weakness there over the next while. So that market looks pretty good. China, we've reentered, not in a significant way, but we're putting some more product over there, quite frankly, because some of the pricing is quite favorable. So we never exited any of the export markets. We did reduce our volumes, and we're picking those up a little bit now.
Mark Wilde: And then I wondered, Ray, if you can give us just some sense of how you would expect BC fiber cost to move as we go through the second half of the year and into the first half of next year. I know you've got some of this in your MD&A. But if you could just kind of walk us through, I mean, to those of us who don't live this every day. It's a fairly complicated set of adjustments that get made over time.
Raymond Ferris: I'll try to do that. I think it's pretty straightforward for the second half of this year. I think it's publicly available that stumpage will rise on October 1. Stumpage impacts can be different depending on the region that you're operating in. But the -- so everyone may see it somewhere differently, but it's going to be a significant increase. And somewhere in the $30 range, but it could be more or less than that. And so it's going to have an impact. So you've got two things that happen. We obviously purchased quota logs, which are directly tied with stumpage. But we purchased a lot of logs on the open market and the pricing of those two can be different. So it really comes down to how much purchase would we go after, how much quota would that we bring in. And that's where it becomes a little bit more complicated. And those things -- those conditions change, Mark. So it's very difficult to predict. The other aspect is policy. And those things that, despite whatever the economic part is, is what's our ability to access the land base in certain areas in order to get the volumes that we require. And so I think it's -- I think those are things that are pretty well-known in the industry, Mark. But I would say our view is that it probably will be a difficult -- it was a difficult first half. It will probably be a difficult second half.
Mark Wilde: And finally, do you have any sense right now about sort of where the cost position of the overall BC lumber industry is relative to kind of current market prices?
Raymond Ferris: Probably the same as yours, Mark. I think the cost of logs on, are pretty high for everyone. And -- so I mean, I think, again, I think everybody is different. But I think we're all in the same area code. And we're probably in that area code, is what I'd say. But I can't give you any more direction than that.
Mark Wilde: And then I guess, actually, one other question. Just any sense from you or maybe from Chris McIver, about just where we stand in terms of lumber inventories at both the mill level and the customer level and whether there's maybe some variation with maybe producers who have been doing a lot of R&R or big box business versus people who are more tied to new res?
Raymond Ferris: Just before I kind of get Chris to kind of maybe weigh in there, I'll just say 2 things. One, it's important to remember that we run an integrated business in British Columbia. So we run plywood, MDF, and, of course, a lumber in BC. And of course, we have other integrated models in the company. So it's important to recognize that. Many of our other businesses are holding up quite well. And when I look at the MD&A, I think it's important to note when you look at the first half production and shipments, pretty balanced. I think people knew where we entered the year, and I think it probably gives a pretty good description of where we are currently. So -- but I'm going to let Chris kind of talk -- answer that.
Chris McIver: So yes, I think you're asking the right question. It is a story of 2 different markets right now. DIY, or R&R, has dropped off a lot. And there's a few reasons for that. I mean, I think people are doing different things and fixing their decks and houses right now. So we've seen box store programs slow tremendously, and their inventories were relatively high. That business started slowing a couple of months ago, and we think that the inventories are getting in better shape and we expect by the fall, they'll be back doing some buying. New housing is very busy. They don't have enough. They can't quite keep up. And inventories for those who are supplying that business, we think, are relatively low. So overall, not in a bad position, but we need the R&R folks to come back, which we think they will in the fall, so.
Operator: Your next question comes from Hamir Patel of CIBC.
Hamir Patel: Ray, the non-fiber cost inflation that the press release pointed to in the south. Is that labor turnover? Or does that reflect maybe some more permanent wage cost inflation that you've had to absorb this year?
Raymond Ferris: Well, good morning, Hamir. Good question. I would say the bulk of it would be non-wage inflation. Well, sorry, actually, wage inflation is obviously a part of that. However, when we invest in wages, we typically see that will be rewarded on that side. Turnover actually remains very similar to previous years. So that's really not it. But listen, we are seeing cost pressure outside of wages and really everything from transportation through the supply chain, there is an impact.
Hamir Patel: And the press release pointed to some elements of market downtime in the back half of June. Could you quantify how much that was and at least backward-looking in July so far how much have you taken?
Raymond Ferris: We haven't put a number on that, Hamir. And what I would say is it's not inconsistent with how we've operated in the past, which is we're going to adjust our operations based on a number of factors. Logs are one aspect of it, weather, inventory levels, and market conditions. So I think it's kind of just -- honestly, it's really a status quo. We're going to run our business to meet those challenges. But no, I wouldn't put a number on.
Hamir Patel: Just a last question for me. It seems like the weakness on the R&R side largely is on the DIY component and the contractor side, at least for other building products appears strong. I was curious if you guys have any work about what percent of R&R, I think the slide deck showed 41% is R&R. But what portion of that is DIY versus contractors?
Raymond Ferris: Hamir, I can't -- I'm sure there's somebody out there that does a pretty good job of breaking that down, but we really haven't dissected that. I think the important part is, is that whether it's sticker shock or people head into the beach, a temporary pullback, certainly. But the driver really around single-family houses. I mean, everything else looks good. The fundamentals remain strong. DIY, deck, expenses, all those other things, we're pretty confident that, listen, growth had to slow a little bit from the spike that we saw in 2020. But our -- everything that we see would indicate that continued growth in R&R on a quarter-to-quarter basis, maybe not, but over the next year or 2, absolutely.
Operator: Your next question comes from Paul Quinn, RBC Capital Markets.
Paul Quinn: But just wondering why CapEx this year is so back-end weighted. I mean, if I take a look at sort of the 5-year average, it's slightly back at weighted sort of 55% in the back half, 45% in the front. But this year looks, if I take the midpoint of your guide, it's kind of 30% in the front, 70% in the back. Why is that?
Chris Virostek: Well, I'll probably get myself in trouble. But here's what I would say is that, look, we may have been pretty focused on completing a pretty major acquisition and completing a couple of -- we had quite a bit of capital going on last year, as you're aware. And probably, Ray probably said, let's just take a -- so really, we've been going gangbusters. So it's only back-end weighted just because that's the flow of what's happened. And it's just a timing issue. And maybe a bit of an unintended -- I don't want to say lack of focus because that would put, say that I'm the problem. But two startups in the first half, a major acquisition, our foot is intended to be on the gas pedal. It's not unusual to see our capital program be a bit lumpy. It's not an even flow type of business.
Paul Quinn: And then your MD&A referenced US southern yellow pine log increase costs. I'm just wondering if that's a regional thing? Or are you seeing that broadly distributed across the US?
Raymond Ferris: Well, the answer is both. So I would say, generally, most of our issues have been regional. And whether it's weather, other environmental factors, or just increased competition. But I'd say it's mostly regional in those areas. We've seen this from time to time to see those log costs come down as the weather impacts subside, but there has been some cost inflation across some of the regions.
Operator: Your next question comes from Sean Steuart of TD Securities.
Sean Steuart: A couple of questions. Chris Virostek as markets moderate here and we get a sense of where things will start to normalize for the company from an earnings and cash flow perspective. Do you have any updated thoughts on what an optimal capital structure looks like for the company? I guess, the general sense is you want to keep ongoing strong liquidity on the balance sheet, but are there any metrics you guys are focusing on over the long run, is something you're targeting?
Chris Virostek: I think as the businesses are coming together and we sort of maybe get a bit of this volatility in the rearview mirror we're looking at all those things. I think, rightly, as you indicate, the investment-grade rating, we think, is important to us. I think it enables us to weather tough times like we had in early 2020 and 2019, with a measure of confidence. And to do things like we did in 2019 to continue on with our capital program and maintain our dividend in early 2020 when things were tough. So I think what we're looking at among those things as well, we got 2 new start-ups. We've got an ambitious capital program. We want to be able to return capital to shareholders but we've got to be able to manage volatility when it occurs, which can be unpredictable at times. So I guess what I would say is more to come on that here over the next probably several quarters as we kind of work through that and get a bit more in the rearview mirror post-acquisition and see things. But I think the guidance would be, we're going to remain conservative and balanced. We're in a volatile industry, where cash flows can change materially in the short term, and we don't want that to put the company at risk in any way.
Sean Steuart: And then further to that question, as Norbord is integrated and your thoughts can turn back to potential M&A. The bias and the investment community is assumptions that you look at U.S. So sawmills and maybe growth in Europe as well. Would stuff like cross-laminated timber, be of interest to you guys potentially? There's obviously one significant bankruptcy that's just happened there. But more niche-focused engineered wood products, is that something that would potentially be of interest?
Chris McIver: Well, anyway, Sean, I'll try and field that one. Look, one thing I want to say is I think as we said as we went into the OSB and the integration, I mean, I really believe, and I think we're seeing that. We feel we've built more capacity in the company to take on projects and opportunities. And I think our digestion is going very well. So it's just fundamentally in our DNA. It really comes down to what makes the company stronger and better. And so it's hard to say no to anything. I think we're going to look at anything and everything that we think enhances value for our shareholders. I think the primary targets are the ones that you mentioned. The OSB team, I think we have -- our engineered wood portfolio is quite strong now. I think that gives us the opportunity to learn and think about growing in other areas. So I wouldn't take anything off the list. It's interesting to us. Our primary focus today would be -- we've been a big supporter of the softened lumber board and the support of CLT and the growing of that market. We continue to do that and support the direction of CLT. I'd say today, our primary focus is to make sure that we -- the CLT guys continue to grow, and hopefully, we can sell lumber and other products to them. And -- but other engineered wood products like CLT are things of interest that we'll explore over time.
Operator: Your next question comes from Mark Wilde, BMO Capital Markets.
Mark Wilde: I'd like to just come back on some capacity issues. First of all, you mentioned in the MD&A that the ramp-up at Dudley is likely a multi-year process. And that's a site where you've already got like a trained labor force. Can you just help us in thinking about how long you would expect a ramp-up of a new facility do typically take? And what that curve might look like?
Raymond Ferris: And we've got a fair amount of experience of major capital and start-ups. So they're not all the same. We think it's an inherent advantage to start with a base of long-term loyal employees, and it certainly can be done in greenfield as well. But typically, we're thinking that to get to close to capacity, it's a two year project. And I would say our recent start-ups have been better than our -- I think we believe we're getting better at this, but it takes a tremendous amount of energy, people, and focus. But I would say two years and it's really there are always engineering issues to work through as you to that or misses. And retraining and a lot of new technology that does take people time to kind of get up to speed and to work the king set up but I have two years.
Mark Wilde: And then the other thing on the sawmill side, I noticed this announcement just a week or two ago of a $400 million board foot sawmill in North Carolina, which is much larger than any of the other projects I've seen announced over the last few years. Do you have any perspective on this? Is this a sign that maybe sort of the whole step-up in scale for a southern sawmill is likely to take a big leg up here or would there be something that could be particular to that situation? Because typically, there may be $250 million to $300 million board feet seems to be what people are building. This one is probably half again as large.
Raymond Ferris: No, I don't think I can speculate on that. Look, I think if you look across North America, there's small mills that can be extremely profitable and large mills that can be extremely profitable. I think it's specific to that location or terrain or opportunity, perhaps around timber supplies. And so I think each situation is unique. I'd let the average sawmill size speak for itself. But I think, look, we've got small mills that have great margins, and we've got larger mills that have great margins and everything in between. So I think it's -- my personal opinion would be, it's you build the mill that you think is appropriate for that location. That's what we do. I can't speculate how they came with their decision, but leave that to them.
Mark Wilde: The last thing I want on supply is just in the slide deck this morning, you've got something kind of showing the ability the OSB industry kind of capping out at about $1.5 million starts on the existing supply base. From a West Fraser standpoint, if you were -- as you get deeper and deeper into OSB, if you were thinking about adding further capacity beyond the restart of Chambord, any thoughts about how you would do that? I mean could you debottleneck or add second lines in an existing mill or would you want to think about sort of an entirely new mill and a new location?
Raymond Ferris: So hard to say no to either of those, Mark. So I think if you look at what we've done, including what was announced in December and what we announced, I think, back in June about debottlenecking capacity and value run. We've invested -- continue to invest in OSB. We think we have more projects to bring forward like that. I think our capital allocation history is pretty straightforward. We like to reinvest in what we have and make it better and then look for those opportunities to expand in those areas. So I really can't say that both of those will be on the table. But first is going to be how do we make what we have better. And again, if you look at what we've kind of committed to since December, it's not insignificant.
Operator: There are no further questions at this time. So I will turn the conference back over to Mr. Ferris. Please go ahead.
Raymond Ferris: Look, thanks, everyone, for joining the call this morning. Thank you, Michelle. As always, Chris Virostek and I are available to respond to further questions, as is Robert Winslow, our Director of Investor Relations & Corporate Development. Look, stay safe, and we look forward to reporting out on our progress in the next quarter. Thanks, everyone.
Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.
