Louisiana-Pacific Corp Q2 FY2021 Earnings Call

Good day, and thank you for standing-by. Welcome to the Louisiana-Pacific Corporation Q2 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker today, Aaron Howald, Investor Relations. Please go ahead, sir.

Thank you, operator, and good morning, everyone. Thank you for joining us today to discuss LP’s results for the second quarter of 2021, as well as our outlook for the third quarter. My name is Aaron Howald, and I'm LP's Director of Investor Relations. I'm joined this morning by Brad Southern, LP's Chief Executive Officer; and Alan Haughie, Chief Financial Officer.

Thanks, Aaron and good morning everyone. Thank you for joining us to discuss LP's results for the second quarter of 2021. Q2 was another remarkable quarter for LP Building Solutions. All our segments set records for sales and EBITDA in the second quarter, with over 150,000 housing starts in June, single-family mix over 70% and repair and remodel indices equally robust, we are encouraged that demand for LP's products remains very strong. As you will see on slide 6 of the accompanying presentation, net sales for Q2 reached $1.3 billion, more than 140% over Q2 of last year, which was of course a weak comp due to the onset of COVID-19. EBITDA was $684 million, generating $457 million in operating cash flow and $4.74 in earnings per share. Siding Solutions growth is a significant component of these results, as slide 7 illustrates. Siding Solutions includes primed and prefinished SmartSide, as well as innovative strand-based siding products sold under other brand names. Revenue for Siding Solutions grew by 39% compared to last year. This is composed of 27% volume growth, compounded by 9% price growth. In addition to market penetration and share gains, Siding is growing through product innovation, the most innovative and value-added subset of Siding Solutions, which includes SmartSide Smooth, Shakes and ExpertFinish and LP's new builder series siding, combined for 9% of total volume in Q2. This is compared to 6% last year and these new products contributed more than one point to the 9% increase.

Thanks Brad, and good morning. As Brad has already said, all segments set new records for revenue and EBITDA in the second quarter. Siding Solutions revenue grew by 39% and OSB and EWP prices were significantly higher in both North and South America. In fact, sales for EWP and LPSA doubled compared to last year with their combined EBITDA more than tripled. And Entekra delivered a record 324 units for $22 million of revenue, a tenfold increase over last year. As a result, LP generated $1.3 billion in sales, $684 million of EBITDA, $457 million of operating cash flow, and $4.74 in adjusted earnings per share. Page 8 of the presentation summarizes the year-over-year comparisons for revenue and EBITDA at a high level. Inflationary pressures in wages, raw materials and freight, especially when compared to softer prices last year produced an EBITDA headwind of $24 million. Maintenance and other spending account for the remaining adverse $31 million. The waterfalls on slides 9 and 10 show year-over-year revenue and EBITDA comparisons for the Siding and OSB segments. Siding Solutions saw volume growth of 27% and price growth of 9% for revenue growth of 39%. This generated an additional $81 million of revenue and $53 million of EBITDA and incremental EBITDA margin of 65%. Notably the 9% price increase in the quarter includes four percentage points from annual list price increases and three points on the packet that is from reduced discounts and rebates. The highest value-added subset of products, which includes ExpertFinish Smooth Shakes and Builder series punches well above its weight in terms of price accounting for just 9% of total volume, but over 100 basis points of the year-over-year price increase.

Our first question comes from the line of John Babcock from Bank of America. Your line is open.

Good morning and congrats on the quarter. I guess just starting out I was wondering how you're working with Siding customers in light of some of the capacity constraints you have in the second half of this year. I mean do you expect some of those customers to go elsewhere, or might this demand shift into 2022, when you have Houlton running? Any color you can provide on that would be useful.

Great question. We've been using an allocated order file since late last year, which has helped us engage with customers and understand their ordering needs early in the process. We have been able to produce for those orders and manage that volume across our network. Despite the constraints, we have successfully met our customers' demands. However, customers have not been able to build safety stock or extra inventory at our locations or in the distribution channel. We've been operating at full capacity, and our customers are also running very tight. I am confident in our ability to supply products to the market. Since the COVID shutdown in the second quarter of last year, we have not been able to build up safety stock or extra inventory. Although quarter-over-quarter growth may stabilize, we are still achieving high sales volumes. I believe we can meet market demand until Houlton is operational and able to enhance our production. I don't see significant substitution occurring at the distributor level; we're focused on supplying distributors with the SKUs they need for their local markets. If any substitution is happening, it's likely deeper in the supply chain during product shortages at the build or contract level. Given our growth trajectory, I'm optimistic about meeting current market demand with our supply. Growth may be somewhat limited year-over-year until Houlton becomes operational, but the increase in volume we are seeing quarterly makes me feel positive about our position.

Okay. That's very helpful. And then, next question, can you just talk about the demand environment in OSB right now, where customer inventories are in the channel and your initial thoughts on the sharp drop in OSB prices last week and where you think the market is going from here?

We can definitely provide additional confirmation regarding the challenges in retail. We've observed this trend, particularly with our retail pools, although we are somewhat less affected than some competitors. Nevertheless, our size means we still supply a significant volume to retail, which has been quite weak—about half of what we consider normal at this point. This might be partially due to the Fourth of July holiday. When comparing it to the past year, it appears consumers are allocating their spending to areas other than the wood products sections at Home Depot and Lowe's. While we haven't noticed a decline in demand from our other channel partners, there is some hesitation among distributors to make significant purchases due to the drop in OSB pricing. They seem to be waiting for potentially better prices next week. Thus, our current order situation reflects distributors mainly placing short-term replenishment orders with little enthusiasm for increasing inventory levels. To sum up, we can confirm the weaknesses in retail pools, but with solid demand in housing and repair and remodel sectors, we feel optimistic about distribution demand. However, the recent pricing trends have created a reluctance to buy.

Okay. And then, I guess, that kind of brings me to the next question. I guess, first of all, if you can just talk about how Peace Valley is running. It sounds like you started that up in June. If you can provide any sort of update on what sort of run rate you guys are at now? And also if you're having any trepidation regarding the timing of the start-up, I mean, recognizing I guess there is some weakness in the retail channel. But overall, I mean, is there sufficient demand out there to kind of keep that running? And then just kind of last piece of this question. I think in the past you had said that expected to maybe get around 150 million square feet to 200 million square feet out of that mill this year, but I think that assumes perhaps a little bit later the startup in the end of June, so any updates on that?

No, we're maintaining our target of 150 million square feet to 200 million square feet for the year, even though we began operations a few weeks earlier than initially planned. We are confident in our decision, despite the current pricing fluctuations since we started production. Looking at the housing start forecasts, we feel positive about reaching 1.5 million to 1.6 million units as a near-term estimate for housing starts. Based on that, the industry will require that level of production, which is why we initiated operations. I want to emphasize that our decision to start Peace Valley was not influenced by current pricing. At the time, we believed the long-term outlook for housing was robust enough to justify the mill in order to satisfy our customer demand. We continue to feel optimistic about that decision and the near-term outlook for housing over the next several years. Therefore, we plan to keep the mill operational, as we believe our channel partners will need that volume next year. Our channel partners have expressed their support for this decision as they plan for the upcoming quarters and anticipate a demand for that capacity. We’re fully committed to this decision.

Okay, great. Thanks for all the details.

You're welcome.

Thank you. Our next question comes from the line of Susan Maklari from Goldman Sachs. Your line is now open.

Thank you. Good morning everyone, and congrats on a great quarter.

Thanks, Susan.

Yeah. My first question is around the margins in Siding. As Houlton continues to progress and getting closer to being up and running, can you just help to give us some color on the cadence of, how we should be expecting the margins to come through over the next couple of quarters?

Yeah. This is Alan, here. I'll take this one. We'll fundamentally see the margin or at least the costs of the Houlton conversion hit the margin primarily in Q4 and Q1. That's on the shoulders of the year is what we'll experience those costs.

Thank you. Our next question comes from the line of Ketan Mamtora from BMO Capital Markets. Your line is now open.

Thank you. Brad, I was curious about the reported weakness in retail demand for OSB.

Ketan, we can barely hear you. Sorry to interrupt you. Can you repeat your question?

Aaron is it better?

Oh! Better, thank you, thank you. Go ahead.

Sorry about that. I was just curious, are you seeing a similar slowdown on the retail side even in siding, or has that demand held up better?

Ketan, good question and we have seen a slowdown in pools and siding, that slowdown cadence began later than it did in OSB and has not been quite as severe, but it has happened, yes. And back to John's question that has allowed us to allocate more production volume into distribution, since we're on a managed order model.

Got you. So is it sort of more kind of broad-based kind of demand slowdown, or is it sort of more kind of distributors looking to reduce their inventory position?

I don't believe distributors are trying to reduce their inventory because there hasn't been much inventory in the channel, especially at the start of the price decline. Overall, the channel has stayed quite lean this year. From the distributor's perspective, there's just a reluctance to purchase more than what is absolutely necessary, given the expectation that prices may decrease further. This hesitation is typical whenever prices fall, particularly as sharply as they have in recent weeks. On the other hand, when prices rise, there is a rush to buy because everyone expects prices to be higher the next day. We see this acceleration occurring at both ends when the price changes steeply. Does that address your question?

Thank you. Our next question comes from the line of Mark Weintraub from Seaport Research. Your line is now open.

Thank you. I wonder if Ketan's question was a little bit more on the siding side actually. And whether or not the weakness was perhaps the distributors pulling back inventory which I assume not so much the case. But in that same vein, are you seeing anything in the sheds business which I guess is a bit more DIY sometimes?

Yes, that's a good question. I want to clarify if I'm addressing the OSB question or the siding question. Regarding siding, the retail pools have slowed down, but not as significantly as in OSB. Many smaller shed manufacturers do buy products from retail, which has likely contributed to the slowdown. However, for our larger national or regional manufacturers and distributors, the pools remain strong. The weakness is mostly in the DIY segment, which does include some DIY shed production.

Got it. And I'm going to cut off if I don't jump in real fast. So, real quick just also when you're talking about the OSB, assuming that prices are flat here, does that reflect kind of that that's as good as I guess as any, or is that just methodological and you're not maybe asking the question differently, what is your best guess as to what's going to happen in OSB in the next month or two? And what will be the key drivers to look at?

The main factor is supply and demand, but I'm not comfortable making any predictions about pricing. The response to your initial question is that we had to set a baseline for OSB pricing based on the most recent published data. For those looking to forecast the upcoming quarter, it's important to consider your expectations for how OSB pricing may fluctuate throughout the quarter in relation to our guidance. I mentioned our views on channel inventories and what we perceive regarding order activity from retail. I'm open to discussing these topics, but I don't feel at ease making specific price forecasts.

Understood. Appreciate it. Thank you.

Yes, for those who didn't get to ask a follow-up, please return to the queue, and we'll gladly take those questions. It's not our intention to prevent anyone from asking a good follow-up question.

Thank you. Our next question comes from the line of Sean Steuart from TD Securities. Your line is now open.

Thanks. Good morning. A question on the CapEx guidance the $270 million figure for this year is up a little bit from the midpoint of the range you provided a quarter ago and it looks like most of the increment is higher sustaining maintenance CapEx. And I'm wondering if you can give us context, if that's just general cost inflation feeding into that if there's anything specific to this year is $120 million or higher the number we should be thinking about as the sustaining part of that CapEx going forward?

Yes, this is Alan here, I'll take that one. It's a good question. There were two factors involved. One is inflation and the other is the limited availability of engineers and contractors, which prompts us to act quickly whenever we can to secure the necessary expertise and complete the work. Both factors are fundamentally caused by the same economic conditions we're currently facing.

Okay. And just a quick follow-up. Engineered Wood Products in South America both strong topline growth there as well for those segments this quarter. Those are less transparent markets. Can you give us a sense of how prices are trending into the third quarter for those segments?

Yes, let me start with Engineered Wood Products. This is a price list and not a traded product. It represents our product sale, although we do sell supplies within that segment. Based on our handout, we have announced our price list for LVL and I-joist. We have managed to maintain good margins despite the price inflation of input materials like lumber, OSB, and veneer. Typically, we can retain some of that margin as prices begin to decline, especially with OSB, which tends to lag behind. In the short term, we feel optimistic about pricing in this area. However, as input prices continue to drop, we anticipate some competitive pressure in our Engineered Wood Products segment in the future, which may affect our ability to maintain reasonable margin levels. In South America, the market is quite interesting. Based on our 20 years of experience, OSB pricing tends to be more stable there. While we've seen good pricing this year, it hasn’t increased as much as in the United States. Nonetheless, the pricing trends in North America have made it somewhat easier for us to adjust prices in South America. Historically, pricing there has been stickier. Given the significant price changes in North America over the past year, it’s challenging to predict the implications for South America. In the past, once we managed to raise prices, we could typically maintain them. However, there might be competitive pressure in the future if North American imports begin to enter the market at low prices. For now, we are in a strong position regarding margins in South America for several quarters to come. Additionally, our operations there are running as well as they have in a long time. Although we have faced increases in raw material prices, our mill system is performing optimally, and we are making investments to improve it further. Thus, the midterm outlook for our South America business is very positive.

Thanks for that detail. Much appreciated.

Thank you. Our next question comes from the line of Paul Quinn from RBC Capital Markets. Your line is now open.

Yeah. Thanks very much. Good morning, guys. Maybe just start on siding and it sounds like customers will be almost on allocation until you get Houlton up. But where are you guys in terms of your pre-finishing capacity? And is that something that you need to spend some more money on to increase that capability?

Well, great question. We did – we viewed that with our Board last week and got approval for continued expansion of our pre-finished capacity both within some of the facilities that we currently manufacture and we're looking at growth in the Northeast. So we're actively looking for a location there to start up a pre-finished operation to service our Northeast segment in conjunction with the Houlton expansion or Houlton conversion. And so the growth has been phenomenal. It has stretched our capacity in pre-finish fortunately, and that's part of this sustaining growth capital that Alan talked to on the slide. The incremental investment required there is – in the world of OSB and siding conversions is relatively small. We're learning kind of the technology that we want to utilize in our pre-finish. If you recall our first two forays were through acquisitions and those two acquired companies had different paint systems in place. So we're in the process of standardizing that across our platform. And as I mentioned having the greenfield facility in Northeast. So there'll be continued investment in pre-finish as we grow it. So we should be talking about that many years to come and we're well on our way to our second phase there. We – I will say that the acquisition strategy that we had that was really testing our ability to make a product, sell a product, and market a product. We feel really good about all three of those things right now. So we're really doubling down on our prefinished strategy and we feel really good about our ability to grow that profitably over the long term.

Okay. And then over – one of your competitors on the siding side has come up with some pretty innovative product lines, particularly one with stucco right now and look to do brick down the way. Is that something that you guys have looked at? And do you have the ability to morph any different lookalikes?

Yes. Paul, we had a stucco panel several years ago. We're not selling it actively any longer. It was a really minty product that required some pretty sophisticated contractor learning. And so we struggled from a – to find finding time to get that training in place and contractors converted over to that system that was – would have been very economical that required a pretty substantial change in the way the stucco materials supply. Probably more detail than you're looking for in that answer so forgive me. But that is something that we have looked at. We decided to focus in other areas. We didn't see that as for our trials being a big opportunity for us. But as you know in certain regions of the country stucco is a predominant siding. And I would say we are not in a position right now to capitalize on that. We're way more focused on the pre-finish and ancillary products around pre-finish like corner pieces and that kind of thing. And then our second focus area right now is really increasing our penetration with the big builder with our builder series siding that we launched this year that we believe really gives us a competitive advantage with the big builder. And so that's where we see the significant growth coming over the next several years for us.

Great. That’s all I had. Best of luck and thanks.

Thanks, Paul.

Thank you. Our next question comes from the line of Kurt Yinger from D.A. Davidson. Your line is now open.

Great. Thanks and good morning, everyone. I just wanted to follow up on the pre-finished side. Could you just talk about what percentage of your pre-finish volume you internalize now? And then as you think about the long-term opportunity there, what kind of makes sense in terms of your own pre-finishing capabilities versus what you might still want to lean on your channel partners in terms of that product?

Yes, that's a great question. Last year during our Investor Day, we mentioned that our long-term goal is for 30% of our mix to be pre-finished. Let me explain how we envision this evolving over the next few years. We have expanded nationally, primarily focusing on the East, but we are also growing in the West with a standard color palette of 11 or 12 colors under our ExpertFinish brand. This makes us an attractive partner for both regional and national distributors. Our approach is national, utilizing a standard color set backed by the LP brand, which we believe positions us well for pre-finish growth. In the East, there will always be a market for custom colors, along with some SKUs that we manufacture but do not pre-finish. We are collaborating with local pre-finishers to become their supply partner for custom colors, which is primarily a niche market. Some of these pre-finishers are also selling our standard colors to supplement their production with custom ones. Currently, in the West, all our ExpertFinish and custom colors are serviced by independent pre-finishers, while in the East we aim to keep all ExpertFinish production in-house. I can envision us developing a vast national network and efficient manufacturing for ExpertFinish to cater to the national market while maintaining relationships with local pre-finishers who offer custom colors on our substrate. Additionally, I believe there will be pre-finishers who may choose to independently pre-finish our prime product under their own brand and sell that as well, as our substrate is very easy to work with and a preferred choice for independent pre-finishers.

Got it. Okay. That's really helpful. Thanks. And just on the strategic growth CapEx of $45 million this year. Can you just touch on any noteworthy projects within that? And then, I guess separately as we think about the next couple of years, how do you guys think about or plan for I guess capacity creep or unlocking incremental capacity within the existing Siding business. Is that something where you can gain a low single-digit percentage based on a certain level of spending, or any color there would be great?

We are excited about the $45 million investment in our product highlights. One significant project involves automating the manufacturing of our SmartSide shake product, which we're implementing at our Manitoba plant to increase productivity. Shakes are among our highest-priced and highest-margin products, and this capital project represents about half of the overall investment. Although it involves considerable upfront costs, it promises excellent returns. Additionally, we're automating our three-dimensional corners, creating corner pieces from trim as part of our innovative growth. I've also mentioned our pre-finish initiatives. Regarding your second question about increasing productivity beyond Houlton, we have several environmental projects approved in our recent board meeting that will enhance our capacity, particularly in one of our mills in Michigan that was previously constrained by permitting issues. We're focusing on optimizing our production mix to increase volume output, which will help us better meet market demands. Understanding our customers' SKU requirements allows us to fine-tune our production systems for gains of even 1% or 2% in siding volume, which can have a significant impact over a quarter. Currently, our Siding business is fully engaged in these initiatives as we anticipate being capacity constrained until Q2 of next year when Houlton is fully operational. In summary, our strategic capital outside of mill conversions for Siding is targeted at product innovation and enhancing productivity, enabling us to maximize our existing capabilities and support growth in our Siding division in the upcoming quarters.

Got it. Okay. Well, appreciate all the color Brad, and good luck in the back half guys.

Thank you.

Thank you. Our next question comes from the line of Ketan Mamtora from BMO Capital Markets. Your line is now open.

Thank you. Brad, I had a question on Siding. If inflation continues to remain high as we move through the back half of the year, how do you think about pricing strategically particularly in light of covering additional costs?

We appreciate the question. It's something we discuss in nearly every meeting with our Siding team. Over the years, we have aimed to maintain consistent price increases in the market, influenced by input costs. Our historical guidance regarding margins also shapes our decisions. In the past, during periods of significant raw material price increases, we have successfully implemented higher pricing. However, as Paul noted, we are currently facing a highly competitive environment from both vinyl and other hard sidings. Therefore, our pricing strategy includes a competitive positioning aspect that may vary by SKU, region, and channel. While rising raw material costs do inform our pricing discussions, they are just one of several factors that influence how we price each SKU across different selling regions. Ketan, I hope this clarifies our approach.

Yes, it did. I do have a follow-up though, but that's helpful. Brad, on the EWP side, a couple of quarters back you talked about looking at options. Any update there?

We are still actively evaluating strategic options. The process may be a bit slower than I anticipated six months ago when we first announced this, but we are continuing our assessment of alternatives. Our main focus is on maintaining the integrity of the system. We believe that LVL and I-Joist together under the Stark Truss brand hold value for our channel partners, many of whom are also involved with structural solutions. This belief may be extending the time we take to evaluate our options, as we recognize the value in keeping the business cohesive rather than selling each individual plan separately. Therefore, we are being selective about the options we consider due to this desire.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Aaron Howald for closing remarks.

Okay. Thank you everyone. Seeing no more questions, we will conclude the second quarter earnings call for LP Building Solutions there. Stay safe and we'll look forward to speaking with you again soon. Thank you, operator.

This concludes today's conference call. Thank you for participating. You may now disconnect.