Earnings Call Transcript - WFG Q2 2023

Operator, Operator

Good morning, ladies and gentlemen. Welcome to West Fraser's Second Quarter 2023 Results Conference Call. After the speakers' remarks, there will be a question-and-answer session. 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 2022 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. Thank you. I will hand the call over to Mr. Chris Virostek. You may begin your conference.

Chris Virostek, CFO

Thank you, Hilda. Good morning, everyone, and thank you for joining our second quarter 2023 earnings call. I'm Chris Virostek, Chief Financial Officer of West Fraser, and joining me today are Ray Ferris, our President and CEO; and Sean McLaren, our Chief Operating Officer; and other members of the executive team. I'll begin with a brief overview of West Fraser's Q2 2023 financial results and then pass the call to Ray, who will give an update on the business as well as provide a few concluding remarks before we transition the call to Q&A. As a reminder, we report in U.S. dollars and all my references today will be the U.S. dollar amounts unless otherwise indicated. West Fraser generated $80 million of adjusted EBITDA in the second quarter, improving from the $58 million of adjusted EBITDA reported in the first quarter. Our North American EWP segment generated $126 million of adjusted EBITDA, up from $31 million in the prior quarter, a period that had included a $15 million inventory write-down. OSB prices that began to rise strongly midway through the quarter drove the majority of the sequential EBITDA improvement. The Lumber segment posted $10 million of adjusted EBITDA this quarter, up from nil in the prior quarter, with lumber demand showing signs of improvement as the second quarter came to a close. The Pulp & Paper segment struggled in the second quarter with negative $74 million of adjusted EBITDA versus $7 million in the prior quarter. The second quarter included a $24 million inventory write-down as a result of significantly declining pulp prices throughout the quarter. It's worth noting that this quarter was marked by considerable disruption within the Pulp segment with all four of our pulp mills taking downtime. In particular, Cariboo Pulp & Paper was down for a month in response to fiber availability constraints. Other mills took intermittent downtime due to energy prices, and we had a month-long maintenance outage at Hinton Pulp, which was significantly longer than originally anticipated. Pulp segment challenges notwithstanding, the mill shuts are now behind us and we have been especially pleased with the performance of our two BCTMP mills since they've come out of their maintenance. In Europe, adjusted EBITDA was $19 million in the second quarter as demand showed signs of weakness later in the period. These results were in line with $20 million in the first quarter. In summary, lower prices and maintenance downtime at our pulp business created a headwind this quarter, while improving pricing across our North American EWP business was the largest positive contributor to the company's sequential EBITDA improvement. In addition, continued strong contributions from our non-OSB panels businesses also helped. Cash from operations was $272 million for the quarter, in part owing to a reversal of the seasonal working capital build in Q1. Cash net of debt increased to $449 million from $309 million last quarter as our cash flow more than covered the $25 million of dividends paid and $106 million invested in capital expenditures. Subsequent to quarter end, we renewed and extended the maturities on both our revolving line of credit and our term loan, providing us with even further financial flexibility to execute on our corporate strategy. In terms of our operational outlook for 2023, we are reiterating our guidance for lumber and European OSB shipments. But given the stronger-than-expected North American demand for OSB, we are increasing the guidance range for North American OSB shipments. We now expect this year's OSB shipments to be in the range of 6.1 billion to 6.4 billion board feet on a 3/8-inch basis, up from our original guidance of 5.9 billion to 6.2 billion square feet. We are also modifying our expectations for capital expenditures, while we still expect capital investments to be in the range of $500 million to $600 million in 2023, given delays in equipment deliveries and the rate of expenditures year-to-date, we now expect this year's CapEx will be closer to the lower end of the guidance range. With that overview, I will now pass the call to Ray.

Ray Ferris, CEO

Thank you, Chris. Usually, Chris and I are together on these calls, but today I'm calling in from our Armour sawmill near Wilmington, North Carolina. Before discussing our financial performance for the second quarter, I want to emphasize some of Chris' comments regarding the disruptions we experienced in Q2, particularly in Western Canada. I can't elaborate on the pulp performance, but I'm relieved that the major shutdowns are behind us. The Alberta wildfires greatly impacted us, causing multiple evacuations, power outages, and employee disruptions. Our team focused on fighting fires and protecting our log inventories, which hindered performance in that crucial sector. Nonetheless, I'm very proud of how our Alberta team managed under challenging conditions. By late in the second quarter and early in Q3, conditions have returned to normal, which is encouraging. Now, turning to our outlook and our recent 2022 sustainability report, which we released a month earlier than last year. I commend the team for their hard work on this achievement. Founded nearly 70 years ago, we recognize the importance of acting responsibly toward the environment, our communities, and our employees while growing profitably. In 2022, we took significant steps toward becoming a sustainability leader, including planting an additional 66 million seedlings in our Western Canadian managed forests, adding to the 2 billion trees we've planted throughout our history. We are dedicated to investing in local communities, enhancing our diversity, equity, and inclusion policies, and we are committed to advancing credible environmental and social goals as we move forward. Earlier this month, we announced the planned sale of our Hinton, Alberta pulp mill to Mondi Group, a global leader in sustainable packaging and paper manufacturing. Mondi plans to invest approximately EUR 400 million or CAD 575 million in expanding the mill over the next few years, primarily for a new kraft paper machine. This transaction is expected to close by year-end, pending regulatory approvals. West Fraser will continue to supply fiber to the Hinton mill under a long-term contract from our Alberta sawmills. We believe this transaction creates a sustainable future for the pulp mill, which is beneficial for our employees, the Hinton community, and Alberta as a whole. It allows the mill to be managed by a proven leader with the expertise to maximize its potential while maintaining a vital fiber supply chain for West Fraser's operations in the area. As many know, the Hinton pulp mill has been challenging for us, and the next steps would have required significant capital and a market strategy for effective operation. Once the sale is finalized, the mill will receive necessary investments, allowing West Fraser to focus on key growth areas while benefiting from a long-term fiber supply agreement and more stable future cash flows. Now, regarding the second quarter, we faced somewhat weak demand early on, driven by the prior year's rapid increase in mortgage rates affecting overall consumption. However, as the quarter progressed, demand improved for key products, particularly OSB and Canadian lumber. This improvement enabled us to maintain more normalized operations compared to the downtime we experienced late last year. Looking ahead, the wood building products industry may still face challenges from rate hikes, labor constraints, and potential slower demand due to housing affordability issues. However, we've seen inflationary cost pressures moderate across our supply chain for raw materials. We believe this trend will continue throughout the remainder of 2023. In new home construction, we are seeing positive demand signals carried over from the spring building season, and the upward trend in mortgage rates appears to have eased. These factors are contributing to the consumption of our wood building products in new housing starts and repair and remodeling activities. We maintain that the North American market remains structurally underbuilt, and significant long-term demand exists. While uncertainties linger in the industry, we remain confident in our geographic and product diversity and in our operating and growth strategy. We have successfully navigated many industry cycles in the past, and we have the resources and financial flexibility to capitalize on opportunities as the demand environment improves in the coming years. We have been careful with our capital allocation strategy and have preserved capital in case we encounter a down market similar to the current situation. We intend to stick to this disciplined approach, which positions West Fraser to execute our operating strategy by investing in and enhancing our assets under varied market conditions while being ready to seize growth opportunities as they arise. Going forward, we will continue to focus on our strengths as a low-cost operator and remain committed to our capital allocation strategy. We look forward to a future with growth in demand for the sustainable, renewable building products West Fraser is known for. Now, I'll turn it back to you for Q&A.

Operator, Operator

And we have our first question from Hamir Patel from CIBC Capital Markets.

Hamir Patel, Analyst

Ray, given the strength we're seeing in the OSB market, how much potential does West Fraser have to debottleneck some of your existing OSB mills? And can you give us a sense as to where Allendale is operating at today?

Ray Ferris, CEO

I'll do my best here. First, I want to discuss Allendale. We have a team visiting that mill today. We are very pleased with how we're handling our capital expenditures, including the enhancements made to increase capacity at the mill, where we invested approximately $75 million. The ramp-up process has gone smoothly. We mentioned in the Management Discussion and Analysis that they have already received certification for 7/16s, putting us slightly ahead of our targets. I believe we're well-positioned to meet the growing market demand.

Hamir Patel, Analyst

Fair enough. And Ray, just turning to the Pulp & Paper side with the Hinton sale, are you considering some other potential opportunities to shrink your exposure there while still maintaining an outlook for your chips?

Ray Ferris, CEO

Well, Hamir, our integration strategy in Western Canada has been absolutely critical to our success to date, including Hinton. That remains key to how we were able to structure the Mondi transaction. I'll answer that, Hamir. There isn't a day where we aren't looking at our business and trying to determine how to improve it. That's our job, and we will continue to seek areas to strengthen the company.

Operator, Operator

Our next question comes from Sean Steuart from TD Securities.

Sean Steuart, Analyst

A couple of questions. I want to follow up on Hamir's question regarding the pulp. Can you give us a sense if we exclude the inventory write-downs, how concentrated were Q2 segment losses towards Hinton specifically if we exclude that asset?

Ray Ferris, CEO

Mr. Virostek, do you want to take a shot at that?

Chris Virostek, CFO

Yes, sure. Thanks, Sean. I would say, as we've said a number of times, when we look at our Pulp & Paper segment, we think we found a way to kind of clear out the challenges. In the quarter there, we had a shut that was much larger. I would say the anticipated price declines really affected all grades of pulp. Consistent with what we've said all along, our BCTMP mills, even in tough markets, performed reasonably well. It’s fair to say a big piece of the inventory write-down was not Hinton's fault, but Hinton did contribute a significant portion of the overall results in pulp in the quarter due to the extended shut.

Sean Steuart, Analyst

That helps. Chris. Second question is on the CapEx guidance here. You're indicating it will be towards the bottom end of the range. Can you qualify that as company-specific delays versus broader industry backlogs, how has that affected it? Are there any potential risks to the Henderson project timeline?

Ray Ferris, CEO

Well, Sean, good morning. I'll take a shot at that, and Chris can jump in. It's hard to comment on what others are seeing in the industry. I would say we continue to see improvements in supply chain access and availability for equipment, which is improving. The key aspect is access to skilled labor and contractors. That remains the biggest player causing delays. However, we still plan for the second quarter of next year for Henderson.

Operator, Operator

Your next question comes from Ketan Mamtora from BMO Capital Markets.

Ketan Mamtora, Analyst

Good morning, Ray and Chris, and thanks for taking my question. Perhaps first one, can you give us a quick update on your log decks in Alberta? Are you able to get logs currently?

Ray Ferris, CEO

Look, in Alberta, we typically bring all our log inventories during the winter. I wouldn't say it's had a big impact on our inventories at all. Our focus now is on salvage operations around burned timber in the areas we can. It's not been a significant issue for our inventories, and we’re managing our forestry operations.

Ketan Mamtora, Analyst

Got it. That's helpful. On the capital allocation side, with a strong balance sheet, how do you view share repurchases at this juncture given where the balance sheet is?

Chris Virostek, CFO

Yes, sure. As we entered the year, given the macro uncertainty, we felt it was prudent to be more conservative with our repurchase activity, especially with the cash balance drawdown that typically happens in the first quarter. As the macro environment clarifies, we'll look for opportunities to return surplus cash to investors through share repurchases. Demand has been resilient, and we're pleased to have financial flexibility to execute our strategy.

Operator, Operator

Our next question comes from Paul Quinn from RBC Capital Markets.

Paul Quinn, Analyst

Maybe start with Ray because I think Ray, you mentioned Europe being weaker towards the end of Q2. Can you give us more color on that and what your European OSB capacity is relative to the shipment guidance of $1 billion to $1.2 billion?

Ray Ferris, CEO

Those are good questions. If we need to change our guidance, we will. The operating strategy in Europe has been softer than in North America. We're operating at reduced schedules. We’re optimistic about the future, but there are challenges with higher inflation and other issues, and we’re monitoring how we operate in Europe realistically.

Chris Virostek, CFO

I don’t really have anything to add to that. So go ahead, Paul.

Paul Quinn, Analyst

All right. Maybe I'll switch it over to North American lumber. How would you characterize that market? Do you see that balanced, and what do we need to return to a normalized rate?

Ray Ferris, CEO

British Columbia continues to be a difficult place to operate due to costs and access to timber. In Alberta, we expect to return to our normal cadence going forward. Alberta is very important for us. Expect to continue managing effectively while we're experiencing ongoing challenges from forest fires. In the U.S. South, SPF prices are up as expected. Visibility into European imports isn’t clear, but we track all regions, and that is slowly improving. If we look at housing starts and repair/remodel activity, we are seeing some positive signals. It's too early to predict what Q3 and Q4 will bring.

Chris Virostek, CFO

No.

Paul Quinn, Analyst

Okay. Last question then. Congratulations on the startup of Allendale, it sounds like it's doing well. Where is that extra volume coming from?

Ray Ferris, CEO

Thanks, Paul. The extra volume comes from improved operating efficiency and good capital investment. Allendale won't be a meaningful contributor to that number, but we're looking at everything we can across our portfolio, including maintenance shuts and how we operate. It's a bit of both.

Operator, Operator

And our next question comes from Andrew Kuske from Credit Suisse.

Andrew Kuske, Analyst

I guess the question is for Ray, and it's along the lines of making the business better every day. How do you think about your businesses? Are there areas where you need greater scale, or are there opportunities to divest, as you did with Hinton?

Ray Ferris, CEO

Andrew, we'll look at every opportunity across our business. We have to challenge ourselves in everything we do. One advantage we have is the integrated logging strategy to extract the highest value from the forest. We take advantage of that value from our products. If owning those assets isn’t the best strategy, then we will reconsider.

Andrew Kuske, Analyst

I appreciate the color. Are you seeing different drivers and market behaviors in the U.K. versus Belgium?

Ray Ferris, CEO

Europe is completely different than North America. Inverness serves primarily the UK market while the Belgium operations serve unique markets. Both mills operate well independently. Germany is very different from France, which is different from Belgium. In general, we have to keep that in mind when operating across Europe.

Operator, Operator

Thank you. There are no further questions at this time. I would like to hand the call back to our presenters for any final remarks.

Ray Ferris, CEO

Thank you, Hilda, and everyone, thank you for joining our call today. Chris, Robert, and myself are available to answer questions. Thank you for calling in today, and we look forward to talking to you next quarter. Thank you.

Operator, Operator

Thank you. Ladies and gentlemen, this concludes your conference. Please disconnect your lines.