West Fraser Timber Co., Ltd Q3 FY2021 Earnings Call

Good morning, ladies and gentlemen, and welcome to the West Fraser Q3 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 U.S. 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, the recently announced acquisitions of Lufkin, Texas SYP lumber mill and the Allendale, South Carolina OSB mill, and West Fraser's plans to start the Allendale OSB mill. These statements include forward-looking statements within the meaning of Canadian and United States securities laws and are intended to provide reasonable guidance to investors. The accuracy of these statements depends on a number of assumptions and is subject to various risks and uncertainties that may cause future events to differ materially from the events implied by these statements. 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 risks and uncertainties in the company's annual management's discussion and analysis as supplemented by other risks and uncertainties as set out in the company's quarterly MD&As. These filings can be assessed on West Fraser's website or through SEDAR for Canadian investors and EDGAR for United States investors. Accordingly, listeners should exercise caution in relying upon forward-looking statements. After the speakers' remarks, there will be a question-and-answer session.

Thank you, Chris. Good morning everyone and thanks for joining our Q3 2021 earnings today. Chris Virostek, CFO and I'm joined today in our Vancouver office by Ray Ferris, West Fraser's President and CEO; Chris McIver, Senior Vice President, Marketing and Corporate Development; and several members of our Executive team. This morning, I'll start with a brief recap of our Q3 financial results and then I'll pass the call to Ray, who will provide an update on the business, including a discussion about some of West Fraser's recent activities, the opportunities we see ahead for the company, followed by a few concluding remarks before we transition to Q&A. In the third quarter, we experienced a significant product price reduction from levels in the first half of the year across lumber, OSB, and plywood. In addition to softer demand in the third quarter, we faced several other challenges, including a very active wildfire season in BC, which affected our ability to access the land base and to ship our products, transportation availability constraints, and raw material and other input price challenges. We had three separate shutdowns in our pulp business, including an unscheduled outage at our Cariboo mill and an extended annual shut at pulp. Higher power costs in the summer also negatively affected the pulp mill. We also faced disruptions from a log yard fire at our shipment BC lumber mill. Throughout the period, we adjusted the pace of our operations across our business to respond to these challenges. This resulted in a lower level of shipments than we experienced in the first half of the year. Despite these headwinds, in our core markets, the benefits of our product and geographic diversity of production were a significant advantage in the quarter. We had continued strong results in our EWP business, both in North America and in Europe, where we reported a record quarter. Ray will touch on this performance more in his comments. Our MDF, LVL, and private businesses that are part of our fiber integration strategy in Western Canada all performed well. While our financial results declined from the pace of the first half, we still recorded adjusted EBITDA of $786 million in the third quarter, which represents a margin of 33% of sales. The majority of the change in adjusted EBITDA from the prior quarter is attributable to price with the volume of productions playing a small part and cost headwinds also moderating the results. Cash flow from operations was $914 million and after repurchasing CAD1 billion of shares in our substantial issuer bid and continuing to execute on our normal course issuer bid. Our cash balance net of debt declined only modestly to $1.6 billion. With the recent announcements of the two acquisition transactions, we continue to deploy capital, not only to shareholder returns but also to attractive growth opportunities. In November, we expect the AR two rates relating to the softwood lumber dispute to be finalized and set the new cash deposit rates for countervailing and antidumping duties for the Canadian softwood lumber industry. We expect our rate for cash deposits to change from 8.97% to 11.38%. Whereas the rate for all other non-mandatory put respondents in Canada will be 18.32%. These rates will be in place until at least August of 2022. With that financial overview, I'll now pass the call to Ray.

Thank you, Chris, and thanks to everyone for joining our call today. I will refer to a few specific slides from our presentation during my comments. Despite the challenging operating conditions in several regions, I am pleased to report that the third quarter of 2021 was another strong quarter for West Fraser. Our team has stayed resilient and agile, working hard to minimize COVID-related disruptions. Specifically, our BC interior Cariboo lumber and plywood operations faced the most significant challenges this quarter due to wildfires. It’s important to note that these operations are highly integrated, as we often extract both plywood logs and saw-logs from the same tree. I am proud of our BC team's ability to manage the integrated wood, plywood, lumber, and MDF products business responsibly and profitably during this tough period. On February 1, 2021, we acquired Norbord, and although it has only been nine months, it is exciting to see the advantages of product and geographic diversity that this acquisition has brought to Fraser. There are several areas I could highlight, but I will focus on a few. First, product diversity. Our OSB team faced market and operational challenges in Q3, yet our results remained strong, largely due to our growth in the specialty OSB business. As shown on slide three, specialty sales, which include our OSB products for industrial and export markets, have continued to grow and now represent about 30% of our North American shipments, compared to around 23% five years ago. This strategic shift to specialty has significantly reduced our exposure to commodity OSB by about 450 million square feet over that timeframe, roughly equivalent to one small OSB mill. Notably, this growth has occurred amid record high commodity prices. Our specialty and industrial team has continued to explore new opportunities, and we prefer the specialty business since it generally experiences less pricing volatility and maintains more stable margins and volumes compared to our commodity OSB business. We anticipate sustained growth in this area, along with similar businesses. Another point worth highlighting is our geographic diversity. Moving to slide four, our European EWP operations had a record quarter, generating $90 million of adjusted EBITDA, which is more than double our previous best quarter for that segment. This reflects the benefits of our geographic diversification, as customer demand in Europe is often influenced by North American markets. We expect continued demand for West Fraser's wood-based panel products in Europe, with opportunities for our domestically produced panels to gain market share against imports. To address this demand, we plan to ramp up production and shipments from our Phase 2 investment at our Inverness mill in Scotland. Our European operations are well-managed and performing exceptionally well, which encourages us regarding future opportunities. Next, I want to discuss two transactions in our Building Products business that occurred after the reporting period: the acquisitions of a lumber mill and an OSB mill. We are optimistic about the demand for Wood Products, supported by a strong balance sheet that allows us to pursue attractive M&A opportunities. On slide five, I will start with the Angelina Forest Products lumber mill in Texas. We are excited about this acquisition and are confident in obtaining the necessary regulatory approvals to finalize the transaction. While the headline price of about $300 million, or $276 million after tax attributes, is substantial, we believe it is a fair price for the mill. We expect this mill to be one of the lowest-cost lumber mills once operational. There is significant strategic value in the Angelina mill as it is a modern operation located in an area with abundant low-cost fiber and near growing markets in the USA. We anticipate immediate cash flow contributions after the deal closes, which would be much faster than establishing similar cash flows from a greenfield project. Moving to slide six, we have announced our acquisition of Georgia Pacific's OSB mill near Allendale, South Carolina. Similar to Angelina, we are eager to close the Allendale deal after securing the necessary regulatory approvals. Like Angelina, Allendale is situated near low-cost, abundant fiber and growing end markets. We estimate an additional $70 million investment will be needed to upgrade and optimize the mill before restarting it. Once that investment is complete, we expect Allendale to be one of the lowest-cost OSB mills in our portfolio. We also expect to achieve production and cash flow from Allendale much sooner compared to building a new mill, which typically takes at least three years and requires significantly more capital investment, exposing us to greater risks. Now, I’d like to briefly touch on Wood Products and sustainability. We recently released our 2020 sustainability report, and over the summer, West Fraser's plans have been reinforced. We believe a thoughtful ESG strategy forms the foundation for building long-term financial resilience. Establishing these goals requires a clear and credible action plan along with effective metrics, supporting our commitment to the environment and the communities we operate in. The Wood Products industry aligns well with the circular economy and plays a crucial role in combating climate change. As global demand shifts towards more sustainable and renewable building materials, we foresee increasing opportunities for new products and uses of Wood Products. Additionally, on slide eight, I want to highlight an area experiencing growth in North America, specifically mass timber. Although we are not planning to move into large-scale production of CLT at West Fraser, we recognize the significant increase in projects. According to the Softwood Lumber Board, mass timber projects in North America rose from 74 in 2018 to over 1,240 by September 2021, indicating impressive growth. The board also anticipates substantial long-term growth for mass timber, potentially adding between three million to six billion board feet of incremental lumber demand, roughly equivalent to 300,000 to 600,000 new housing starts. While it's early, we are optimistic that this trend will supplement conventional housing and remodeling demand, providing vital support for the North American Wood Products industry in the years ahead. In summary, we are pleased with our results this quarter, despite various market and operational changes. After repurchasing CAD 1 billion in shares through a substantial issuer bid and an additional $100 million under our normal course issuer bid, we ended the quarter with strong liquidity. We continue to advance strategic capital projects while pursuing growth through acquisitions, reinforcing our resilience to meet customer needs despite upcoming market challenges. Looking ahead, we expect a quieter fourth quarter, and we believe we are seeing initial signs of demand recovery after a soft third quarter. We remain optimistic about the long-term fundamentals of the Wood Products sector. Our focus will continue to be on operational excellence, leveraging the benefits of strategic capital, and executing growth projects at Dudley, Chambord, and Inverness while aiming to finalize the Angelina and Allendale acquisitions. Furthermore, we will enhance our ESG disclosures as we refine our credible and thoughtful ESG strategy, which aligns our ambitious goals with achievable plans, and we will take the necessary time to ensure this is done correctly. Lastly, I want to acknowledge Peter Wijnbergen, our President of Engineered Wood Products, who will be retiring at the end of this year after a remarkable career. Having joined Norbord in 1987, Peter dedicated his entire career to the OSB and Wood Products industry, helping Norbord become the largest OSB company globally. His leadership was pivotal during Norbord's integration into West Fraser. We are grateful for his contributions, and his expertise and passion will be missed. Until his retirement, Peter will continue in his current role while we designate new responsibilities within the organization. I have confidence in our team's ability to rise to the challenge ahead. We'll now turn the call back to the operator for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session.

Thanks. Good morning Ray, good morning Chris.

Good morning Mark.

To start out, I wondered, Ray, could you just give us a little perspective on the rally that we've seen in the Wood Products markets over the last eight weeks and some of your thoughts on where you see us going through the balance of the year?

Well, good morning Mark and that's a good point. I'm going to ask Chris to share his thoughts on that. Please go ahead, Chris.

Good morning Mark.

Hi Chris.

Yes. Just, I mean, I think there's a few things. Housing, we've slowed down sort of in the second quarter, or late second quarter or the third quarter. But the really big change for us was around R&R and DIY. And we've really seen both those sectors come back very strongly as prices come back for OSB Lumber. And housing is still struggling a little bit I think with supply chain issues, but the underlying demand is there. So, I think a combination of all of those. I think the big factor for the drop in pricing, by the way, we fully expected sometime was that it was really the R&R and DIY, not as much a single-family housing back-up. And as it's come back and people have kind of reengaged, we've seen a pretty good rally into a spot where we think that for the next little while, we will see some sort of seasonal slowdown. We expect in the next month or two. And all those sectors, we see the demand, future demand is pretty strong.

Okay, that's helpful. Ray, my second question is about the emphasis you've placed on vertical integration during my long association with West Fraser, particularly in Canada. I'm curious if your experience in the Southern US and Europe, where vertical integration is not present, has prompted any reconsideration of your strategy in Western Canada.

Thank you, Mark. As we've mentioned before, especially in the US, there are significant differences compared to our operations in Western Canada. In the US South and Europe, the need for vertical integration is greater due to the abundance of markets and opportunities for chips and residuals. Our company began with a strong focus on BC and Western Canada, where vertical integration was more critical. However, in these other regions, it has not been a key part of our strategy. Moving forward, our Canadian business will continue to be integrated, which we value, but in the US and Europe, vertical integration is not a priority in our focus.

Okay. And the last question is for Chris Virostek. Chris, could you discuss the input cost pressures you are experiencing? The third quarter number of $50 million is significant, but considering the current situation in transportation and the trends we've seen in areas like resin, I might have expected that figure to be even higher. Can you provide some insight into the third quarter and your expectations for the fourth quarter? Sure. We'll try to give a bit more color on that, I guess. We operate in a number of different fiber baskets and the dynamics of how those fiber prices move is kind of different in each of those things. And I think the other thing to remember is that in the case of the fiber procurement in the regions that we operate in the north, it's not a sort of linear procurement of fiber throughout the year. So, there's a big seasonal element to that. And a lot of those things are linked to the commodity prices with varying degrees of lag. So, I think, we're starting to see in some regions on the fiber cost some relief. In other regions like BC is going to be into the first quarter before we start to see that relief. On the other inputs like energy, transportation, we've dealt with challenges there for a while. It's just the order of magnitude of those. Transportation, it's been availability has been a challenge there. I think, we're starting on tower. As we move into the winter, it's probably getting a little better. But we've got to manage through these things all the time, right? And fiber being the biggest element, we think, particularly in BC, there's one more quarter before we turn the corner on BC fiber as that in the public domain in terms of the stumpage. But the others, we've got to work our way through that every time.

Chris, has the energy issue over in Europe been big enough to cause any disruptions for you in the European operations?

It's been a cost pressure. It's not disruptive to us or taking us off kind of our offering. And I think recently, they've started to ease. But operationally, no impact, certainly an impact on cost. But hopefully, that's an answer for it. But it does look like things are easing somewhat. But energy prices around the world are quite frankly an issue I think from a company point of view, kind of how I think through that Mark is sometimes it's hard to predict what will happen, whether it's in China or Europe or Alberta or the U.S. itself on some of these types of things. But what I do like is our diversity is that that platform and that portfolio have allows us to kind of shift things around as needed to respond to the market and/or mute the impact of those issues.

Yes. Okay, that's helpful, Ray. I'll turn it over. Thank you.

Thanks, Mark.

Thank you. Your next question comes from Sean Steuart, TD Securities. Sean, please go ahead.

Thanks. Good morning guys. If you're listening in, congratulations to Peter on a really great run. A couple of questions. Europe was exceptional this quarter and very strong price momentum across your product portfolio there. Can you give us a sense of how that's trended into the fourth quarter? There was in the MD&A wording around strength continuing into Q4? And should we read that as prices continuing to improve or leveling off at really high levels, how should we think about the trajectory near-term?

Good morning, Sean. Peter is here with me, and I appreciate your comments. Regarding Europe, we did see a slight softening in the fourth quarter after an exceptionally strong third quarter. The reasons for this could be seasonal, but we believe our operations are continuing to strengthen in that region. We are well positioned to seize the available opportunities. Our perspective is that this remains a strong business. Looking ahead to 2022, we anticipate performing quite well with reasonable market conditions.

And with the strength in Europe, has the M&A opportunity set there changed in light of how strong markets have been, especially through the back part of this year?

I'm not sure I can answer that well, Sean. I think anytime, whether it's Europe or wherever you are, I think strong pricing, good results bring stuff to the market. So, I can't say whether it's changed or whether it's the same. But I do think these sorts of times do encourage probably more opportunities. But I'm not sure that's relative to change from quarter to quarter sort of them.

Okay. Last question for me. Allendale, it was our impression that the current owner of the asset, part of the reason to take the mill down was labor issues in that region. How do you guys assess the labor availability in South Carolina? And does that inform the pace at which you expect to restart the asset? Any context on that issue.

We are very excited about this opportunity. The quality of the asset is important, and although there are some debottlenecking issues to address, we are planning to invest in that area. Peter and his team have a solid understanding of the situation, and we are confident in our approach. The fiber basket and the close proximity of markets and our other businesses enhance our position. While labor markets are challenging everywhere, whether in the U.S. South or Northern Canada, we believe our team in the U.S. South is equipped to handle these difficulties. This is a crucial part of our strategy to meet our expectations in the USA. I want to emphasize that Allendale presents a challenge similar to those in all our operations, and the team has shown they are capable of meeting that challenge.

That's helpful detail. Thanks very much Ray. That's all I have.

Thanks, Sean.

Thank you. Your next question comes from Paul Quinn with RBC. Paul, please go ahead.

Yes, thanks very much. Morning guys.

Morning Paul.

Interesting quarter. You did a lot lower in lumber than I anticipated but a lot better in OSB. But so maybe just to start on the lumber side, you were down like over 90% sequentially versus a competitor has got a less favorable geographic footprint and it was down in North America only 76%. Is there something that happened within your lumber operations in the quarter that that was problematic for you?

That's a great question, Paul, and I’ll do my best to answer it. The wildfire activity in British Columbia was largely concentrated in the areas where we operate, and we were significantly affected. Despite our sawmills being down, we managed to continue shipping from some of our operations. However, with many of our mills not running, our costs increased considerably, even though we were able to reduce inventories in certain regions. Additionally, a few months ago, we experienced record high pricing in the lumber market, particularly regarding stumpage costs in Alberta, which remained high despite market prices falling. We believe that many of these issues are short-term and should not persist as we move into the fourth quarter and the first quarter of next year. There is, however, a slight delay in Alberta's adjustments and, quite frankly, significant impacts from the wildfires West Fraser faced in British Columbia.

Okay, that's really helpful. Maybe just discussing Angelina's acquisition. I mean, it's an expensive acquisition. On your Investor Day, you highlighted Dudley, which was this idea of building a new sawmill adjacent to existing? And it sounded like you had a runway of those opportunities. Why do you think Angelina is supposed to a Dudley like do over?

It's not just one option or the other; we are pursuing both. We have other projects, such as the LA Project, and we plan to continue along that path. The opportunity with Angelina arose, and we seize chances like that when they present themselves. It's truly about managing both opportunities. If similar opportunities arise in the coming year, we would definitely consider doing another Dudley, and if another Angelina opportunity comes up, I hope we can take on both projects again.

Okay. I'd like to offer my congratulations to Peter for retiring. I have a question about the Allendale facility. Regarding the $70 million investment, what is the issue with that mill? It's something that everyone in the industry has been curious about, especially since it hasn't been addressed in recent years. Does a significant portion of the $70 million need to go towards replacing or fixing something major?

Morning Paul. Well, I think this mill has a very solid press and finishing line for the present finishing. It is, in our view overly complex feeding into that part of the process. And so, this $70 million really has two intentions. One is to this military idle for a number of years in the capacity of maintenance. But more importantly, we would like to take that complexity out of the system, so that the mill is more easily to operate both, instead of work. And that also will help us with an earlier question around hiring people to operate the mill. So, that's the intent. Peter and Kevin have convinced us and the rest of the team that they have a world-class backend, and I think Peter and the team have a very good idea, well, not a very good idea, but they know exactly what we're going to do in order to kind of fix the front-end and then transform this well. But it is front-end versus back-end.

Great, that's helpful. Thanks guys. Best of luck.

Thank you.

Thank you. Your next question comes from Mark Wilde, BMO. Mark, please go ahead.

Thanks. Ray, just to talk maybe your other acquisition, Angelina. Is it possible to get a sense of like why it would take three or four years to get a mill that's already been running for almost two years? How would take that long to get it ramped up to full production?

Mark, I agree with you. I think that timeline is too long. I believe we're fairly conservative in our analysis and approach to these matters, which might be overly cautious. Our expectations are to achieve this much faster, but I still feel that timeframe is excessive. That's just how we evaluated the opportunity.

Okay. I wanted to also just talk a little bit about kind of southern fiber prices, which have been really, really low for the last 12 or 14 years. I'm picking some stuff from not large brand managers. But we are starting to see some pockets of acceleration maybe Central Alabama and some other places, where there's a lot of new demand coming to the market. First, I'm curious, are you seeing any of that? And then, secondly, when you look at deals across the south in lumber, have you been underwriting as kind of anything close to kind of current log price levels going forward?

On the first topic regarding fiber prices, we have certainly observed short-term spikes in log prices, although I'm not sure if this is different from previous years. The fluctuations are less about supply and demand and more related to weather conditions. The number of contractors and available supply also play significant roles. Extreme weather events, such as those experienced in the Florida and Georgia region, can hinder the industry's ability to respond effectively, despite the availability of logs, and can complicate the return to normal inventory levels. Generally, we find that prices tend to rebound once weather conditions improve, as the logs are still present. While there are localized challenges, weather remains the primary factor, along with constraints faced by suppliers, contractors, and labor.

On the second question, Mark, I think, when we do these evaluations, it's very specific to the regions. And I think we have pretty good insights in the regions that we operate and the regions that we look at around long-term fiber availability and security, right? And that's part of the calculus that we do. It's, I think, as both of you have friends, it's very region-specific. And we take those region-specific considerations into account when we're looking at whether it's M&A or whether it's organic capital, it's a region-specific fiber availability that held part of the analysis.

Okay. All right. Last one for me. Just possible to get an update on the ramp-up at Chambord?

Sure. So Mark, I think, we're ahead of our start-up schedule. And Peter may want to jump in here. But we've been certified across pretty much all of our key products and thicknesses and from an AP point of view. But we're on track or ahead of track of what our forecast was. It's proceeding well. And I'm not sure that's a great answer to your question, but the start-ups going well at this point.

Okay. Well, let me just add my congratulations to the other folks to Peter. It's really been a great thing to see kind of the transformation of Norbord over the last several years and then the combination with West Fraser.

Thank you.

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.