Earnings Call Transcript - WFG Q3 2024

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the West Fraser Q3 2024 Results Conference Call. This call is being recorded on Thursday, October 24, 2024. During this conference call, West Fraser's representatives will be making certain statements about West Fraser's future financial and operational performance, business outlook and capital plans. These statements may constitute forward-looking information or forward-looking statements within the meaning of Canadian and United States securities laws. Such statements involve certain risks, uncertainties, and assumptions, which may cause West Fraser's actual or future results and performance to be materially different from those expressed or implied in these statements. Additional information about these risk factors and assumptions is included both in the accompanying webcast presentation and in our 2023 annual MD&A and annual information form, which can be accessed on West Fraser's website or through SEDAR+ for Canadian investors and EDGAR for United States investors. I would now like to turn the conference over to Sean McLaren, President and Chief Executive Officer. Please go ahead.

Sean McLaren, President and CEO

Thank you, Emily. Good morning, everyone, and thank you for joining our third quarter 2024 earnings call. My name is Sean McLaren, President and CEO of West Fraser. Joining me today are Chris Virostek, Senior Vice President and CFO; Matt Tobin, Senior Vice President of Sales and Marketing; and other members of our leadership team. On the earnings call this morning, I will begin with a brief overview of West Fraser's Q3 2024 financial results and then pass the call to Chris for additional comments before I share some thoughts on our outlook and offer concluding remarks. West Fraser generated $62 million of adjusted EBITDA in the third quarter of 2024, representing a 4% margin. Note that this quarter was impacted by a $32 million lumber export duty expense related to the 2022 calendar year. Results were varied across our business again in Q3 with relative strength in our North American Engineered Wood Products segment and stronger-than-expected demand for SPF lumber, offset by continued softness in SYP lumber demand. In the third quarter, levels of new home construction in the U.S. showed further signs of stabilizing and the U.S. Central Bank began to trim its benchmark interest rates, which we believe is supportive of demand for OSB, and to some extent, SPF lumber. That said, mortgage rates remain relatively elevated and still appear to be constraining existing home sales activity and the repair and remodeling segment, which we expect has a greater relative impact on SYP lumber demand. On a trailing 4-quarter basis, adjusted EBITDA was $630 million, which is an improvement from the $561 million reported at year-end 2023. We've now been able to maintain a trailing 4-quarter EBITDA above $500 million throughout this latest down cycle that started back in late 2022, aided by actions we have taken, including acquisitions, strategic initiatives to optimize our mill portfolio, and a relentless focus on cost and margin opportunities. In terms of our balance sheet, we have more than $2 billion of total liquidity at quarter end, which offers us the financial flexibility and strength to support a consistent capital allocation strategy through the cycle. With that overview, I'll now turn the call to Chris for additional detail and comments.

Chris Virostek, Senior Vice President and CFO

Thank you, Sean. And a reminder that we report in U.S. dollars, and all references are to U.S. dollar amounts unless otherwise indicated. The lumber segment posted an adjusted EBITDA loss of $62 million in the quarter compared to a $51 million adjusted EBITDA loss in the second quarter. Note that the third quarter of 2024 included the previously mentioned $32 million export duty expense that relates to the 2022 calendar year period. Excluding the impact of this prior period adjustment, lumber adjusted EBITDA would have been a loss of $30 million, a nearly $20 million improvement from the prior quarter. Our North American EWP segment generated $121 million of adjusted EBITDA in the third quarter versus $308 million in the second quarter. The Pulp & Paper segment generated $2 million of adjusted EBITDA in the third quarter, below the $9 million reported in the second quarter. Finally, in our European business, adjusted EBITDA was $1 million in the third quarter versus $6 million in the second quarter. Lower prices were the largest factor for the sequential EBITDA decline across our North American Engineered Wood Products and lumber businesses, which was only partially offset by higher North American OSB shipments. Our lumber business continued to benefit from the actions we took earlier in the year to curtail production at three of our higher-cost mills, essentially replacing that higher-cost volume with production from other lower-cost mills, which is positive for our overall cost structure. In the U.S. South, on a year-to-date basis, our SYP shipments are now down more than 10% from 2023, and notably, our Q3 shipments are down nearly 12% versus the prior quarter. With regard to softwood lumber duties, we recorded a $32 million duty expense in Q3 related to the finalization of the AR5 rates. West Fraser's AR5 final combined rate, which now forms the cash deposit rate, is approximately 11.9%. This is the cash deposit rate that will be in effect until the U.S. Department of Commerce finalizes AR6, covering the period of January 2023 to December 31, 2023. If our AR6 finalized CVD rate were to remain unchanged from the AR5 finalized CVD rate and the AR6 finalized AD rate is the same as West Fraser's estimated rate for that period of 8.84%, our combined finalized rate would be approximately 15.7% and would take effect next August, remaining in effect through August of 2026. Cash flow from operations was $150 million in the third quarter, with our cash balance net of debt and lease obligations at a healthy $463 million, similar to the $469 million reported last quarter. The nominal change in our net cash balance reflects some further release of working capital this quarter, offset by $107 million of capital expenditures and approximately $65 million of cash deployed towards share buybacks and dividends. With that brief financial overview, I will pass the call back to Sean.

Sean McLaren, President and CEO

Thank you, Chris. We remain steadfast in our strategy and proud of the company we have built with its geographic and product diversification that has allowed us to weather the challenging lumber markets we have experienced for more than a year now. As seen in the figure on Slide 7, our North American EWP segment has generated $760 million of adjusted EBITDA over the last 4 quarters, a period of challenging cyclical conditions for our other segments. This diversity in our wood building product offering has allowed us to generate $630 million of adjusted EBITDA on a consolidated basis over the trailing 4 quarters, shown in the figure at left, which is more than 2.5 times the level of pro forma EBITDA experienced in the down cycle of 2019. I'll now shift to our outlook and add some concluding remarks. We remain encouraged that the Fed's rate hiking cycle is seemingly in the rearview mirror and that rate cuts are now the general market expectation over the near term, which should be supportive of demand for wood building products in the housing and repair and remodeling markets we serve. Further, West Fraser's overall inflation risks are relatively benign, with costs having stabilized across much of our supply chain. As such, and based on what we can see today, we are confident that we are unlikely to experience meaningful upward cost pressures over the near term. For our lumber operations in the U.S. South, we continue to make progress refining and optimizing our operations by removing costs and looking for additional margin opportunities. Although market conditions for SYP remain challenging today, the industry supply-demand balance appears to be stabilizing, which is supportive for the industry over the medium term. As a reminder, between permanent shift reductions, mill closures, and indefinite curtailments, we have reduced available capacity by more than 800 million board feet since 2022, which includes the latest announcement to indefinitely curtail 110 million board feet at our lumber mill in Lake Butler, Florida. We have also reduced the number of shifts or hours of operations at various lumber mills across our platform. In conjunction with these capacity adjustments and to manage costs, we have transitioned assumptions to our lower-cost, more productive mills where we have been spending our modernization capital. SPF products realized better demand than we originally expected in Q3 as new housing markets appear to have demonstrated more resilience than repair and remodeling markets in which we tend to see a greater demand pull for our SYP products. In our North American EWP business, we continue to ramp production at our Allendale OSB mill, where we are pleased with the cost progression of that facility. We still expect the mill to be among our lowest-cost OSB facilities when it achieves its full operating rate. Given this backdrop, we now expect SPF shipments to slightly exceed the top end of our previous 2024 guidance range of 2.6 billion to 2.8 billion board feet, while we reiterate our previously reduced 2024 guidance for SYP shipments in the range of 2.5 billion to 2.7 billion board feet. We also now expect 2024 North American OSB shipments to be closer to the top end of the guidance range of 6.3 billion to 6.6 billion square feet on a 3/8 basis. Lastly, we are narrowing the guidance range for our 2024 capital expenditures to $475 million to $525 million versus our previous guidance range of $450 million to $550 million. Before I shift to my concluding remarks, I wanted to briefly reflect upon the attractive returns generated for our shareholders. Our shareholders have been rewarded for their patience as we have executed on our plans to grow the business, both organically and inorganically. We have optimized our portfolio through dispositions and/or closures of highly variable or underperforming assets such as the pulp mill divestments we recently completed, and we have returned surplus capital through dividends and buybacks. You should expect us to do more of the same on our journey towards creating value for our shareholders. In conclusion, the downward trend in interest rates looks to be favorable over the near term, which should be supportive for industry demand. We are taking actions that we expect will make us even stronger when the industry begins its recovery from the current downturn. We will continue to focus on costs and margins in order to build a more resilient business through the cycle while maintaining the type of financial strength that gives us the flexibility to take advantage of opportunities as they arise. We remain optimistic about the longer-term demand prospects for West Fraser and look forward to continuing to build one of the world's leading wood building products companies. With that, we'll turn the call back to the operator for questions.

Operator, Operator

The first question comes from Ketan Mamtora from BMO Capital Markets.

Ketan Mamtora, Analyst

Sean, perhaps to start with, can you give some additional color on how the R&R demand is trending as we think about lumber? Did we see any signs of stabilization as the quarter progressed? Or is it more of the same and looking for interest rates to drop before things actually start to stabilize?

Sean McLaren, President and CEO

Ketan, I'll make a couple of comments here and then maybe ask Matt to fill in what I miss. From our perspective, as the quarter progressed, we have seen a little better demand on the Southern Yellow Pine side. That being said, I think largely, the recent price improvement has been related to the supply-side adjustments that we and others have taken. Our treated businesses, our treated customers are our best proxy for that. But with that, maybe I'd ask Matt to add in anything he'd like to.

Matt Tobin, Senior Vice President of Sales and Marketing

No, I think I agree on the supply adjustments that have created positive pricing environments for us. We believe that there are multiple factors that influence that pricing, and our demand is one of them. Our long-term view of R&R is unchanged. Historically, it's a GDP-like grower, and we expect that to be the case over the medium to longer term.

Ketan Mamtora, Analyst

Understood. Just maybe one more on this. You talked about in SYP, supply/demand starting to get in a better shape, yet SPF, you've taken up your volume targets. Any sort of high-level thoughts on why we've not seen a bigger price response in SPF given that new residential is holding up better relative to R&R?

Sean McLaren, President and CEO

Yes. I mean there's a lot of moving parts, Ketan, to what customers do and the products they choose to buy or not to buy. I would say to look beyond the benchmark pricing. You would see there was quite a spread early on in the quarter between SPF and SYP, and that's corrected. But if you go to the wider widths, such as 2x6, 2x8, those spreads continue to be quite dramatic, better for SPF. Combined with more curtailments on the SPF side, the supply-demand balance is in a little different spot there than SYP, and that's why there's more volume coming from us than SPF.

Ketan Mamtora, Analyst

Got it. And just one last question from me. Chris, as you think about CapEx for next year, without getting into specific projects, how would you have us think about it at this point? Would it be similar to '24, lower, higher, just at a high level?

Chris Virostek, Senior Vice President and CFO

Yes. We'll have some guidance out when we release year-end around where we think the CapEx range is going to be next year. I'd say if you think about the last couple of years, we've had quite a bit of projects underway, and we're happy to be bringing those projects to completion just as maybe we're reaching an inflection point on the demand side, and that will really prepare us well for the backside of this cycle when it improves. A few things, Henderson will be wrapping up, which has been a big project and part of our CapEx here over the last couple of years. I don't think we're quite ready to start something as big as Henderson again in the near term. We do have more opportunities, but I'd say we're still considering those things. Where we've been the last couple of years is a good place to start, but it's probably a little bit to the downside on that number going forward just because we're bringing so much stuff to completion over the next couple of quarters, which we're excited about.

Operator, Operator

And your next question comes from Sean Steuart from TD Cowen.

Sean Steuart, Analyst

A couple of questions. I want to first touch on capacity closures in the South. You attributed some of the recent price momentum for Southern Yellow Pine lumber to the capacity shut announcements. A lot has been announced. It feels like a lot of that won't actually start to hit the market until towards the end of this year and into early 2025. So wondering if you can give some context on how much of the initial price response is actual markets getting tighter or speculative buying ahead of the supply reductions actually hitting the market?

Sean McLaren, President and CEO

Yes. Sure, Sean. I guess it's hard for me to speak for the entire industry, but I will speak for us. We took action early in the year. As things really deteriorated further through Q2, we took further action. I would say that the impact of that action was fairly quick. The inventories are relatively small in a southern mill compared to what you'd see in a northern mill or areas with bigger log in-process inventories. Our customer demand patterns, specifically at West Fraser, are probably a little better, but not materially different. But the improvement we've seen in our business has been related to the actions we've taken on the supply side.

Chris Virostek, Senior Vice President and CFO

I think, Sean, when you're unwinding all the inventory at a mill in the north and the supply chain, the length of it and the logging season and so forth, it's probably a matter of months to see the impact as you unwind everything. In the South, when we think about our recent experience around the facilities that we've closed in the South, it's a matter of days or weeks until the inventory is exhausted.

Sean Steuart, Analyst

Got it. So Lake Butler was all the inventory off at this point?

Chris Virostek, Senior Vice President and CFO

Correct. Yes, very quickly.

Sean Steuart, Analyst

Second question is on softwood lumber trade file. We've seen a competitor borrow against receivables on the duty file. You guys don't need the money, but wondering if you can comment on those types of opportunities and any updated thoughts on a path forward here? Do we just need to wait for the elections to play out before we get any potential momentum towards this? Any updated thoughts on the trade file?

Chris Virostek, Senior Vice President and CFO

Maybe I'll take the liquidity side of it, and Sean could deal with the path forward. I would say that when we think about where we are from a liquidity standpoint, I would agree that we don't need to raise the money through some sort of duty transaction. We repaid our notes a couple of weeks ago, and our gross debt is down to $200 million. We just got an upgrade this week from Moody's, upgraded another notch. So I feel very good about the investment-grade rating that we have and our ability to access capital markets if there was something out there compelling for us to do. So I think for us, our primary sources of financing would be the traditional sources of financing that we would tap into. So I think on the liquidity front, we're very well covered off from that standpoint. Sean, maybe you want to comment on the path forward here?

Sean McLaren, President and CEO

Yes, sure. Maybe a couple of comments on the path forward. My perspective is really that there is not a lot new to report. As everyone on this call knows, West Fraser has always been supportive of some type of managed trade. However, there's a lot of moving parts in the political arena, and this is a deal between two governments. It's tough to see how something happens in the short term, but I guess you never know. I would say that at West Fraser, our focus is on controlling what we can, such as our costs and how that plays into any duty rates that we're going to be exposed to, and continuing to litigate to get a refund of money that is owed to us.

Operator, Operator

And the next question comes from Ben Isaacson from Scotiabank.

Ben Isaacson, Analyst

First question, Sean, can you talk about your order book for SYP, SPF and OSB? What should it be at this time of the year? And is it evolving from where it's been over the summer?

Sean McLaren, President and CEO

Ben, I'll just make a quick comment and then maybe Matt can add. But our order book currently is normal, and it typically doesn't materially change seasonally. It generally is not that long, and it's a cash market, and it moves around a little bit but not a great extent and nothing unusual that I would say today. Matt, anything to add to that?

Matt Tobin, Senior Vice President of Sales and Marketing

No, I covered it.

Ben Isaacson, Analyst

Okay. Moving on to the supply curtailments that we've seen in the industry. So I understand we've seen about roughly 5 billion board feet, and most of that looks like it's going to be structural. Do you think that the supply side has now done enough and we really are just waiting for demand to normalize? Or do you think that there's still more curtailments needed to get down to a steady state of demand?

Sean McLaren, President and CEO

Again, it's really tough to say because it really depends on what future demand is going to be. I can only speak to the actions we've taken. As I mentioned, we've taken action to curtail over 800 million board feet since 2022, which has brought us to a point where we're essentially in balance with our customers' current demand. If that changes, we'll change to adapt. The moves we've made have positioned us well to build from here as demand improves.

Ben Isaacson, Analyst

Fair enough. And then just the last question for me on the OSB side. You mentioned in the press release that curtailments at the mills have created chip shortages for pulp producers, which has increased demand tension for pulp logs and is impacting OSB margins. Can you talk about where we are on that kind of path? Are pulp logs still going to go higher in your view over the next couple of years, or is that starting to stabilize? And when OSB prices get back to their normal run rate, we should have normal margins?

Sean McLaren, President and CEO

Yes. Ben, I'd say it's very localized depending on the drain and where the pulp mill is located. In the short term, our view would be that longer-term, our OSB business and pulpwood is well positioned. There will be more production over the long term shifting to Southern Yellow Pine, which will create more chips, which in combination with the number of pulp mill closures that have happened in the U.S. South this year, we believe will mean there will be a favorable trend for wood costs long-term versus any short-term spikes we might see.

Operator, Operator

And your next question comes from Hamir Patel from CIBC.

Hamir Patel, Analyst

Sean, when you think of the closures announced in the South over the past 12 months, it looks like they totaled maybe over 1.5 billion board feet. How much of that do you think is actually being dismantled versus just sort of being in a cold idled state that perhaps would come back in a stronger market?

Sean McLaren, President and CEO

Hamir, again, hard for me to comment on what everybody else is doing. I'll just comment on West Fraser. We've had four Southern mills closed, two of which have been permanent and two indefinite. It's a nuance, in my view. All that means for West Fraser is that we don't immediately begin taking down the mill. A good proxy for us is if you go back to 2008; we announced closures, and some were dismantled after about a year or so, while some were left indefinite but took 5 years before they all restarted. These are not short-term decisions; adequate wood supply, lumber market conditions, and reinvestment plans are needed to make these mills competitive again. There are a lot of factors that go into that before we make that decision. In terms of others, it's hard for me to comment.

Hamir Patel, Analyst

Fair enough. That's helpful. And Sean, I just want to ask about the European panels business. It looks like it's basically gone to zero over the past year. I know historically, that used to be the steadiest part of field Norbord business. What do you think it's going to take to restore profitability in Europe?

Sean McLaren, President and CEO

It continues to be slow over there. In Q3 for us, we had a major shutdown at our MDF facility in Scotland that had been planned for some time, which impacted our results. On the OSB side, we've seen a bit of price improvement and more volume improvement. It's going to take just general economic improvement in Europe for things to get back to normal or where they were previously. We feel quite good about our position. Our investments have put those plants in a good place in a tough market.

Operator, Operator

And your next question comes from Matthew McKellar from RBC Capital Markets.

Matthew McKellar, Analyst

I'd like to start by asking about your conversations with customers in the lumber business and specifically, if you're hearing a greater desire from the big box home centers to secure larger volumes of lumber in the contract for 2025?

Chris Virostek, Senior Vice President and CFO

I think that demand — our customer demand, we're filling our customer demand relative to what we're looking for through what I would say is the season right now for 2025 planning. Those volumes can adjust as the markets adjust and shift over time. From a customer standpoint, they see the shortage of homes long-term and the strong fundamentals, but still have uncertainty around affordability. But certainly, we're doing that planning with our customers to ensure they're supplied over 2025.

Matthew McKellar, Analyst

Okay. Maybe next, on lumber operations in the U.S. South, you mentioned looking for additional cost savings and margin opportunities. Can you provide a bit more color around what type of opportunities and projects you're pursuing in the South right now?

Sean McLaren, President and CEO

Yes, Matthew. A lot of the opportunities will be a continuation of what we've discussed previously. We've taken out a lot of high-cost volume with the four mills we've curtailed. As we bring on volume, we're modernizing plants, and that will be coming on mid-next year. Other projects that we've completed are all related to margin improvement. This includes better recovery, better grade, better productivity, and better working conditions that improve turnover. We've been at this for a while, and it will be a continuation of those efforts, which we expect will continue to make our Southern business more competitive.

Matthew McKellar, Analyst

Great. And then last one for me, just a quick clarification on Caribou. It looks like you expect to be down for four weeks in the quarter versus maybe two weeks previously. Can you talk about what drove the change there?

Sean McLaren, President and CEO

Yes. Absolutely, Matthew. So Caribou — it's been 18 months since our last major shutdown. We had a lot of work lined up for our major shutdown. We expected it to be a full two weeks. However, we had additional two projects that we wanted to complete, along with our fiber supply situation with all the sawmill curtailments in British Columbia. We need to ensure we have adequate fiber supply to get through the coldest months. The additional two weeks will allow us to finish those additional projects while securing fiber supply for next year. We feel good about it.

Operator, Operator

At this time, we have no other questions. Please proceed.

Sean McLaren, President and CEO

Thanks, Emily. As always, Chris and I are available to respond to further questions as is Robert Winslow, our Director of Investor Relations and Corporate Development. Thank you for your participation today. Stay well, and we look forward to reporting on our progress next quarter.

Operator, Operator

Ladies and gentlemen, this concludes the conference. You may now disconnect your lines.