Earnings Call Transcript - WFG Q1 2021

Operator, Operator

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Joint West Fraser Q1 2021 Results Conference Call. During this conference call, 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, expected synergies and the redemption of the Norbord 2023 notes. These statements include forward-looking statements, 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 & 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&A. These filings can be accessed 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. Mr. Ferris, you may now begin your conference.

Ray Ferris, CEO

Well, thank you, Sylvie, very much for that. Well, good morning, everyone, and welcome to our first quarter 2021 conference call. I'm joined today by Chris Virostek, our Chief Financial Officer; Chris McIver, our Senior VP of Marketing and Corporate Development; and several other members of our executive team. I will make a few opening remarks, and then I'll pass the call to Chris Virostek for a review of our West Fraser's first quarter results and then make some concluding comments, and then we'll, of course, take your questions. And just a reminder to everyone, the financial results are now in U.S. dollars. It remains an exciting period 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 in and operate in. Manufacturing building materials from a sustainable and renewable forest is but one very important part of the required solution for society to meet its climate change objectives. On February 1, 2021, we acquired the Norbord business and a highly capable and well-managed team. I want to thank and acknowledge how hard and diligent our finance, legal, HR and IT teams are working to make the transition as smooth as possible while relentlessly supporting our manufacturing operations, frankly, without missing a beat. In fact, our operations performed well in the period. And you'll see in our first quarter results, which Chris will highlight later, the significant financial contribution the OSB business has already made to West Fraser. With that backdrop, I'm pleased to report that the first quarter 2021 was another strong quarter for West Fraser. We remained agile and continue to work hard at minimizing the COVID-related business disruptions, thanks to our focus on the health and safety of our employees and communities. I'm proud of what our team has accomplished. In North America, the strength in U.S. home construction activity from the second half of last year continued its recovery from the weakness that unfolded during the early stages of the COVID-19 pandemic, spurring demand for wood building products. In fact, home construction, measured by new home starts has recently reached levels not seen since 2006. Repair and remodeling have also remained robust, driving solid demand for lumber and wood panels. On the lumber side, the construction of our new manufacturing complex in Dudley, Georgia, has progressed well as the mill and planer are now operational and the rest of the site is expected to come on later in Q2. We anticipate approximately 170 million board feet of additional production as the Dudley mill ramps up towards its full annual production capacity over the next several years. On the OSB side, supply has struggled to keep up with the stronger-than-expected recovery in OSB demand in recent quarters. And that strength has carried into the first quarter of 2021. In response to that increased demand, we announced the restart of the Chambord, Quebec mill, which began to produce and ship panels in late March, ahead of our original expectations. Those panels are now helping to meet the demands and needs of our customers for the important spring building season. The Chambord mill is expected to ramp towards its annual rated capacity of 550 million square feet over the next 18 to 24 months. With that, I'll now pass the call over to Chris.

Chris Virostek, CFO

Thanks, Ray, and good morning, everyone. When we last reported earnings in mid-February, the recovery in lumber and OSB demand was significant. That demand strength continued through the first quarter and remained elevated versus historic norms, owing to continued strength from new home construction and renovation applications, lean channel inventories, and a limited supply response. West Fraser has been adding hours and shifts where possible across our manufacturing network to increase supply and attempting to secure additional transportation resources for delivery of product. Another item of note, our consolidated first quarter results include the financial results of Norbord as of February 1. As of January 1 this year and for all comparative periods presented, we are no longer excluding export duties in our adjusted EBITDA calculations. Our reportable segments now include the acquired North American OSB business and the pre-existing West Fraser panels business as North American Engineered Wood products, and the acquired operations in the U.K. and Europe are reported as a separate segment. In terms of financial performance, West Fraser generated record consolidated adjusted EBITDA of $1 billion in the first quarter, up from $453 million in the last quarter, in part due to the addition of Norbord's results as of February 1. I will note that this first quarter EBITDA was reduced by $93 million for an acquisition-related noncash purchase price accounting impact related to inventory fair values. This raised our cost of goods sold to their fair value as of the date of closing as required by accounting standards. $86 million of this EBITDA reduction was attributed to the North American Engineered Wood Products segment and $7 million was attributed to the European Engineered Wood Products segment. In the prior quarter results of $453 million of adjusted EBITDA, there was a $95 million benefit for the retroactive adjustment to duty rates for 2017 and 2018. Now to highlight some of Q1 segmented financial results. The Lumber segment reported adjusted EBITDA of $646 million versus $425 million in the fourth quarter of 2020, with the positive effect of higher pricing offsetting lower shipments, higher fiber costs and the retroactive duty adjustment in Q4. Our North American Engineered Wood Products segment performed well in the first quarter. Adjusted EBITDA for the segment grew to $353 million from $48 million in the prior quarter, with gains primarily due to the addition of the OSB results for February and March, but as well due to higher plywood pricing, which more than offset fiber and raw materials cost inflation. OSB shipments were slightly lower than expectations due to extreme winter weather disruptions in the U.S. South. Adjusted EBITDA in the Pulp and Paper segment increased to $11 million in the first quarter from negative $20 million in the fourth quarter, owing to higher pulp pricing and reduced downtime for maintenance activities. We continue to see signs of a recovery in pulp markets. Lastly, adjusted EBITDA in the newly formed European Engineered Wood Products segment was $11 million, representing Norbord's February and March results for that geography, which, as I noted earlier, was reduced by $7 million due to a noncash purchase price accounting adjustment to cost of goods sold. We are seeing recent market strength continue in Europe as demand for OSB continues to grow. Shifting to capital allocation in the balance sheet. Capital expenditures were $62 million in the first quarter, up moderately from the first quarter of last year. We remain on track to invest approximately $450 million on capital projects in 2021 and continue to focus on realizing the benefits of the capital we have spent in the past few years. We view share buybacks as an appropriate use of excess cash, where we believe our shares are trading below intrinsic value. Over the first quarter, we bought back $102 million worth of West Fraser shares under our normal course issuer bid. Those shares were repurchased at an average price of CAD82.86, well below our internal view of intrinsic value and more than a 20% discount to yesterday's closing. We are also pleased with the level of U.S. trading liquidity we've seen for West Fraser with the New York Stock Exchange listing. Our trading volume, which accounted for less than 10% of our total trading volume on the exchanges in February now regularly exceeds 20% of our total daily trading volume. Given the strong Q1 results, our financial liquidity increased materially, exiting the quarter with $2.55 billion of available liquidity. Leverage was modest, exiting the quarter with total debt of $1.3 billion and net cash of $164 million. You will notice also that in conjunction with our Q1 earnings release, we have announced plans to redeem the Norbord 2023 notes in combination with the recently completed redemption of the 2027 notes. We will therefore have executed on plans to redeem and retire an aggregate $665 million of high-yield Norbord debt, which will ultimately reduce annual interest costs by approximately $40 million and help rationalize our capital structure. To meet the reporting requirements under the Norbord note indentures, we provided a summary and discussion of Norbord's first quarter results, including the month of January and an addendum to yesterday's earnings news release. On a stand-alone basis, Norbord had generated $526 million of adjusted EBITDA in Q1 and ended the quarter with $114 million of net cash. With that, I'll turn the call back over to Ray for our outlook on 2021 and an update on select projects and the integration.

Ray Ferris, CEO

Thank you, Chris. In terms of our end markets, record low mortgage rates and the ongoing trend toward greater work-from-home options continues to create strong incentives for people to purchase new single-family homes and undertake renovations and do-it-yourself projects. Remote working, when combined with the underlying housing formation deficit has continued to drive demand for single-family homes, which consumes 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 longer-term economic implications of the effects of COVID-19, we remain optimistic about the favorable market fundamentals we're currently seeing, supported by the underlying environmental benefits of building with wood, which have never been more clear and more widely accepted. Keeping our employees and community safe and focusing on servicing our customers' needs remain our key priorities. Our job is to create value in our company for our shareholders. As most of you're aware, the considerable cash accumulation we're now seeing is a relatively new trend. We will look for every opportunity to create shareholder value. Therefore, you can expect us to be patient, thoughtful and balanced in our capital allocation strategy going forward. With the significant milestones recently achieved at our Dudley and Chambord Mills, I am pleased to announce an advancement of our capital program that will see us invest an additional $180 million across several projects through 2023. In the Lumber segment, we expect to invest approximately $150 million at five of our U.S. South mills, which furthers our execution and strategy in that region. These investments will increase capacity and increase the value of our products while reducing production costs overall. In the North American Engineered Wood Products segment, we expect to invest approximately $30 million to both reduce manufacturing costs and improve productivity. These are low-risk, proven projects within our operating portfolio, with an average payback expected to be roughly three to four years. I would again like to reinforce that all this activity is happening against the backdrop of the integration of the Norbord business. We knew that we had a great team in business joining West Fraser, which would immediately add capacity and ability to the team. I'd like to acknowledge that our OSB team has hit the ground running and are embracing the future and are rapidly working through synergies in how to make our company even better. The level of engagement and building momentum has been impressive. Although it's still early days, I have confidence that we remain on track to achieve our targeted annual synergies of $61 million over the next 18 to 24 months. Safety remains our quest. We know we can eliminate serious incidents and injuries in our company. Despite driving overall injury rates and severity to record lows throughout the Company, we have much more work to do. Finally, it is our employees that continue to do the heavy lifting and delivering strong safety and operational results, all while dealing with obstacles and challenges of the still ongoing pandemic. It is this dedication and perseverance of the many people across the Company who I am most thankful for and proud of. Thank you. And with that, operator, we'll turn it back to you for questions.

Operator, Operator

One moment, please, for your first question from Sean Steuart at TD Securities. Please go ahead.

Sean Steuart, Analyst

Ray, question on the next leg of the strategic capital plan. So piecing together the incremental lumber and engineered wood projects that you highlighted towards the end of your comments there, would that yield a 2022 overall CapEx number in the same ballpark as 2021? Is it less? Is it more? I'm just trying to piece all that together with your maintenance CapEx and think about what the budget might look like for 2022?

Ray Ferris, CEO

I would say that it's likely in the same range for 2022 as the number we're using for 2021. Additionally, if we come across more high-return capital opportunities that we can execute and implement quickly throughout the year, we would be eager to pursue those. However, for now, I believe it's probably in that range.

Sean Steuart, Analyst

Okay. And are you seeing any cost inflation for capital projects, deal or other inputs, contractor backlogs, that sort of stuff? Is that having any material effect on budgets for these projects at this point?

Ray Ferris, CEO

So Sean, I want to mention that even before the pandemic, there were significant stresses in the system related to labor, suppliers, and inflation. While there may have been a brief calm during the pandemic, we've certainly continued to experience a similar pace of challenges. I wouldn’t say there has been a significant change in our observations, but for the past several years, we have consistently faced pressure on costs and productivity. This has become a part of our daily operations, and I don’t believe it's a new issue we've encountered recently; it’s something we’ve been managing for some time.

Sean Steuart, Analyst

Okay. Last question for now. You've built up more lumber inventory than your peers did this quarter. Are you seeing any easing of shipping constraints into the current quarter? Are you going to be able to move some of that inventory into the market at a better clip coming up?

Ray Ferris, CEO

I think the short answer would be we've seen shipping improve in the early parts of Q2.

Sean Steuart, Analyst

Could you move that? I believe you accumulated just over 100 million board feet in Q1. Will you be able to sell all of that this quarter?

Ray Ferris, CEO

Well, ask me at the end of Q2, and I'll be able to tell you. But I would say we're trending well, but we've got quite a bit of work to do.

Chris Virostek, CFO

If you look at the pattern of the last few years, Sean, it's not unusual that there's a little bit of slippage in Q1. It's usually caught up in Q2. It's not entirely within our control, but certainly, we're doing everything we can to secure those resources to move the product to the market.

Paul Quinn, Analyst

Just wondered, you've got lots of CapEx projects going on in terms of additional volume with Dudley. Just wondering what we should anticipate for sort of the end of the year 2021 shipment levels relative to 2020? Should we see a material pickup? And if so, how much?

Chris Virostek, CFO

Yes. We've put the guidance in there in terms of what we think the production levels of SYP and SPF, we think are for the year. It's the same as kind of what we put out in February at about $3.3 billion on SPF and about $3 billion on SYP. We would expect on a full-year basis that we're shipping all of our production, subject to some seasonal fluctuations. So that's what we've kind of put out there for the last two publications in terms of where we're thinking lumber shipments are headed on a full-year basis.

Ray Ferris, CEO

This capital won't impact 2021, for sure.

Paul Quinn, Analyst

Okay. Regarding the sustainability of the current pricing trend in lumber, do you anticipate a pullback at some point in the summer? It seems to be increasing by 8% to 10% each week, and there are many questions about how sustainable this trend is.

Chris McIver, SVP of Marketing and Corporate Development

Well, Paul, I would say that your estimate would be as good as mine. But if you look historically, one would say that this won't last forever. And I don't think we think it will. Saying that, though, there does seem to be very strong underlying demand, that's potentially different than what we've seen over the last number of years. So we think the fundamentals are really good in housing and R&R. I can't speculate as to where prices are going, but they are very high.

Paul Quinn, Analyst

Okay. Lastly, OSB markets are currently priced higher than lumber prices on a relative basis. Some mills have been restarted, indicating a need for more capacity. You mentioned Chambord and Norbord's revival of their cordial line. I'm curious if you are evaluating the current mill base along with potential greenfield or brownfield projects at existing mills.

Ray Ferris, CEO

I'll try to answer that, Paul. We are always looking to grow the Company and improve it. My response will be quite general, but historically, we focus primarily on organic growth, which we believe drives the best value. While I wouldn't rule out a greenfield project, it usually ranks lower on our capital allocation strategy. We evaluate all options, but our primary focus is internal growth.

Paul Quinn, Analyst

All righty. Look forward to your Q2 results.

Operator, Operator

And your next question will be from Mark Wilde at Bank of Montreal. Please go ahead.

Mark Wilde, Analyst

Just to start out, I wondered when we're thinking about capital allocation, Norbord had a variable dividend policy. How would you guys think about the potential for either a variable dividend or for the payment of special dividends in extraordinary times like this? Just any general sense?

Chris Virostek, CFO

Mark, thanks for your question. This situation has developed quite rapidly over the last few months regarding cash accumulation and the current state of our balance sheet. While it has come about swiftly, I don't believe we can resolve it just as quickly in four to six months. We plan to approach this matter with patience and careful consideration, as Ray mentioned. It's essential to be prudent and methodical during this time. We'll evaluate all available options. Although we're not making any commitments today, we're continuously exploring various avenues to enhance shareholder value and will be discussing all alternatives in the upcoming quarters.

Mark Wilde, Analyst

Okay. Reasonable and rational reply, Chris. Ray, can you give us any thoughts on what you think both the lumber and the panel markets are able to supply these days just in terms of start levels? I mean, is there enough capacity out there in OSB to support, let's say, 1.8 million? And what would the number look like over in the lumber market right now? Any sense?

Ray Ferris, CEO

Yes, Mark. We included some information in our investor presentation that outlines our perspective on the current supply in relation to today's demand. I won't provide a specific number since I can't speak for all the supply initiatives happening in the industry right now. However, strong pricing is likely to drive supply to increase more quickly, which is difficult to predict. We have consistently indicated over the years that once we reach 1.4 million housing starts, based on our supply observations and uncertainty around when demand will hit that level, we expected significant pressure in the system. Clearly, the jump to around 1.6 million housing starts has created considerable strain. The situation is similar in the OSB market; the challenges aren't fundamentally different. Overall, we're witnessing the industry's struggle to supply a market currently running at about 1.6 million starts.

Mark Wilde, Analyst

Okay. All right. And then Ray, is it possible to just give us a kind of a brief thumbnail on what you're seeing on the trade side, both what you think the potential is for lumber and OSB imports in North America? And then also what kind of activity levels you're seeing in terms of your exports, both out of Western Canada and any exports out of the Southern U.S.?

Ray Ferris, CEO

Well, I'll start, and I'll kind of see if I can get Chris to save me here. But I think we've been surprised that there hasn't been a stronger response from Europe on imports. I mean, obviously, European imports are up. They're up pretty significantly. I think we've always recognized there was probably a bit of a limit to those. I think we're kind of seeing that. I think it's an indication of how strong other markets are around the world that are maybe keeping those limited import opportunities even lower than maybe what we'd expect. There are obviously fewer OSB imports than lumber, a lot more production in Europe and on lumber than there is on OSB. I think it's pretty limited about the opportunities to see OSB come into the U.S., but we're looking at that as well. Chris, do you want to add anything?

Chris Virostek, CFO

Yes, Mark, I would just add that we've definitely seen a reduction in exports on the lumber side and, to a much lesser extent, on the OSB side, which is considerably smaller. This has contributed somewhat to the shortfall. I expect this trend to continue. We are observing some recovery in Japan, but it seems that China is able to obtain enough fiber at their current pricing, making them satisfied without reaching the levels we're seeing in North America. Regarding Ray's comments, the European lumber market is significantly stronger than it was in the previous upturn, which is a major factor in the lack of supply response from that region.

Mark Wilde, Analyst

Yes, it seems to me that the market is shifting the conversation regarding the U.S. candidate trade case. I've seen a lot of information from the National Association of Homebuilders, but I'm unsure if this is truly leading to any actions behind the scenes at the moment.

Ray Ferris, CEO

So Mark, I think the short answer is that we hope it will change the dialogue, which is certainly what we wish for. However, fundamentally, it really hasn't changed the dialogue so far. We're just working through our CVD and ADD and administrative reviews, and that's the process happening at this point, as far as I'm aware, with nothing else going on.

Operator, Operator

Next question will be from Hamir Patel at CIBC. Please go ahead.

Hamir Patel, Analyst

I wanted to ask about the former Norbord OSB business, specifically the specialty segment, which I believe comprises about 20% furniture and 5% Japan. Could you provide insights on how prices changed in Q1? Looking ahead for the rest of the year, is there a specific date when that business might be repriced?

Chris McIver, SVP of Marketing and Corporate Development

Hamir, it's Chris here. I would say that the industrial business is a strategic business on the OSB side to diversify. Quite frankly, from our view, it's been very successful. With regards to pricing, it's a bit slower than the commodity side, but we are seeing substantial improvements and continue to expect that to happen. But they're different markets and different end uses.

Hamir Patel, Analyst

And Chris, can you remind us, are those formally indexed to the randomized prices at all?

Chris Virostek, CFO

Yes, Hamir, I'm not exactly sure how that's done.

Ray Ferris, CEO

Yes, I'm not sure we can discuss how we sell that aspect. However, we appreciate that business. It operates on a different cycle compared to other commodity pricing, which has its ups and downs. We view this as a positive for the long term. In the short term, it's easy to have wishes about performance. Nevertheless, our long-term strategy is sound, and we believe it will succeed as pricing fluctuates.

Hamir Patel, Analyst

I had a question about the business, specifically regarding Norbord. I know they used to have a more significant mill profit sharing arrangement across their mills. Is that still in place considering the current labor agreements, or has it all transitioned to the approach used by West Fraser?

Ray Ferris, CEO

Well, interesting question, Hamir. Wage and Benefit management programs that people have are still in place.

Hamir Patel, Analyst

Okay. Just last question for me. BC stumpage, given how things are playing out, what sort of year-over-year increase do you think we'll see '21 versus '20?

Ray Ferris, CEO

Year-over-year, I believe we’re looking at a $30 increase in July. I prefer not to forecast the year-over-year increase, but we are definitely observing rising BC log costs throughout the year.

Operator, Operator

Thank you. And at this time, Mr. Ferris, we have no other questions registered. Please proceed.

Ray Ferris, CEO

Well, thanks for that. I'll just remind everybody that I think 80% of our business now is outside of BC, which is what it is. Listen, thanks to everyone, and thank you, Sylvie. As always, Chris and I are available to respond to questions as is Robert Winslow, our Director of Investor Relations. Thank you for your participation, and stay safe, and we look forward to talking to you next quarter.

Operator, Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Have a good weekend.