Earnings Call Transcript - WFG Q2 2021

Operator, Operator

Good morning, ladies and gentlemen, and welcome to the West Fraser Q2 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 US 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 on production and shipments and the completion of our substantial issuer bid. 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.

Raymond Ferris, CEO

Thank you, Michelle, and thank you for that disclaimer. Well, listen, good morning, everyone, and welcome to our Q2 2021 conference call. I'm joined today by Chris Virostek, our Chief Financial Officer; and Chris McIver, Senior Vice President, Marketing and Corporate Development; and several members of our executive team. This morning, I'll make a few opening remarks, and then I'll pass the call to Chris Virostek for a review of West Fraser's second quarter results before I make my concluding comments, and then we'll take your questions. I'd like to start with a couple of important housekeeping items. Today, we will limit the scope of our comments to those already provided in our Q2 disclosures, and we'll refrain from addressing any questions related to our company or market outlook beyond what has already been provided in those disclosures. Further, after this morning's earnings call and in the absence of any material developments that will require a news release, we do not intend to make any additional comments to investors or analysts until after our substantial issuer bid expires, which currently is intended to expire on August 17, 2021. Finally, you will have noticed in our earnings release that we have announced a virtual investor and analyst event to be held on September 16 at 2:00 p.m. Eastern Time, 11:00 Pacific. We are planning for the event to be approximately two hours in duration, and we'll have further details at a later date. With that out of the way, let's move on to our comments for this quarter. It has been a captivating time 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 and operate in. Manufacturing building materials from a sustainably renewable forest is but one very important part of the required solution for society to meet its climate change objectives. On the topic of sustainability, I am pleased to share that this summer, West Fraser will plant its 2 billionth tree as part of our reforestation program. This is a proud and long-standing commitment to sustainability and the environment in the communities in which we operate. We've been sustainably managing forests in British Columbia and Alberta for more than 65 years. For every tree we harvest in the woodlands that we manage, we plant two seedlings in its place. This is a significant milestone for the company, and we couldn't have achieved it without the support of our employees, contractors, community stakeholders, and many others. It's all part of our renewable resource management that contributes to the goals of supporting global climate change and carbon sequestration. Now on to our Q2 results overview. I'm pleased to report that we had another strong quarter for West Fraser as we remained agile and continued to work diligently at minimizing COVID-related business disruptions, thanks to our focus on the health and safety of our employees and communities. We remain proud of what we've accomplished so far. In North America, we experienced continued strength and recovery in US home construction activity, spurring demand for wood building products. In fact, home construction, as measured by new home starts, recently reached levels not seen since 2006. Despite what appears to be a short-term pullback in repair and remodeling activity, we expect this segment to remain relatively strong in the longer term, supported by new home sales activity and aging housing stock. The slowing of the repair and remodeling market was more evident for lumber and plywood, which has a greater exposure than our balance of engineered wood products to repair and remodeling. On the lumber side, the new manufacturing complex in Dudley, Georgia became fully operational in the second quarter, and the mill continues to make progress ramping up. On the OSB side, supply continues to struggle to keep up with the stronger-than-expected recovery in OSB demand experienced in recent quarters. As you are aware, in response to this increased customer demand, and in the midst of a pandemic, we announced the safe restart of our Chambord, Quebec mill, which began to produce and ship panels in late March. Chambord remains on track to ramp up towards its annual rated capacity of 550 million square feet on a $0.00375 basis, and we're very pleased with the progress to date.

Chris Virostek, CFO

Thanks, Ray, and good morning, everyone, and thank you for joining us. As a reminder, our consolidated second quarter results now include a full three months of financial results from Norbord. As of January 1 this year and for all comparative periods, we no longer exclude export duties in our calculation of adjusted EBITDA. When we last reported earnings in early May, the recovery in lumber and OSB demand was strong and net demand strength continued through most of the second quarter. Demand for new housing construction, in particular, was elevated versus historic norms. In terms of financial performance, West Fraser generated consolidated adjusted EBITDA of $2.16 billion in the second quarter, up from $1 billion last quarter, largely due to the addition of Norbord's financial results for a full three months as well as higher lumber and panel prices. Recall that in the prior quarter results, there was a $93 million EBITDA reduction, which was an acquisition-related non-cash purchase price accounting impact for the one-time inventory adjustment that raised our cost of goods sold to their fair value upon closing of the Norbord acquisition. Moving onto segmented results. Our Lumber segment reported adjusted EBITDA of $994 million versus $646 million in the first quarter of 2021, driven by higher pricing and higher shipments, partially offset by higher fiber costs. In our North American EWP segment, adjusted EBITDA increased to $1.106 billion from $353 million in the prior quarter, with gains primarily due to the addition of Norbord results for a full three months as well as higher OSB and plywood pricing, which more than offset fiber and raw material cost inflation. Adjusted EBITDA in the Pulp & Paper segment increased to $25 million in the second quarter from $11 million in the first quarter, owing to higher pulp pricing. Finally, adjusted EBITDA in the European EWP segment was $39 million in the second quarter, up from $11 million in the prior quarter. We continue to see recent market strength in Europe as demand for OSB continues to grow. Shifting to capital allocation and the balance sheet. Capital expenditures were $66 million in the second quarter, slightly higher than capital spending in the prior quarter. Note that due to some lengthening lead times on projects currently underway, we are now expecting our 2021 capital expenditures target to be in the range of approximately $400 million to $450 million versus our prior guidance of approximately $450 million. We continue to view share buybacks as an appropriate use of excess cash and we believe our shares are trading below intrinsic value. In the second quarter, we bought back $233 million worth of West Fraser shares under our normal course issuer bid at an average price of CAD90.85. We also amended our NCIB in the second quarter, allowing us to acquire an additional 3.54 million shares for an aggregate authorization of 9.58 million shares. We also remain pleased with the level of U.S. trading liquidity we've seen for West Fraser shares with the addition of the New York Stock Exchange listing. Our US trading volume, which accounted for less than 10% of our total trading volume on US and Canadian exchanges in February, now regularly reaches 35% of our daily total trading volume. Given the strong Q2 results, our financial liquidity increased materially, exiting the quarter with $3.39 billion of available liquidity, up from $2.55 billion last quarter. Leverage was modest, exiting the quarter with total debt of $500 million and net cash of $1.7 billion. In combination with the early redemption of the Norbord 2023 and 2027 notes, we have now retired 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.

Raymond Ferris, CEO

With that, I'll turn the call back over to Ray for an update on our outlook on 2021, recent developments in capital allocation, and on the Norbord integration. In terms of our end markets, low mortgage rates and the ongoing trend toward greater work-from-home continues to create strong incentives for people to purchase new single-family homes and undertake renovations and do-it-yourself projects. 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 long-term economic implications of the effects of COVID-19, we remain constructive and optimistic about market fundamentals. That is underpinned by the environmental benefits of building with wood, which have never been more clear and more accepted. However, at the same time, it's important to recognize that wildfires and wildfire risks we're seeing in Western Canada as a result of extreme heat and dry conditions. The province of British Columbia has recently declared a provincial state of emergency and the wildfires are affecting access to logging areas in some of our operating areas and are impacting transportation networks that we rely on to move our products. This has resulted in temporary suspensions of production due to raw material shortages, evacuation orders, and difficulties, as I discussed, about moving our finished products by truck and rail. In order to address the wildfire situation in Western Canada, its transportation challenges, log cost availability, variable and short-term demand, and overall inventory levels, we may, from time to time, adjust our activity levels at our operations as we had previously done. As a result, our production and shipments in the second half of 2021 may be impacted. More importantly, keeping our employees and community safe during these challenging times and focusing on servicing our customers' needs remain our key priorities. On last quarter's earnings call, we noted that the considerable cash accumulation we are seeing was a relatively new trend. And that you could expect us to be thoughtful, patient, and balanced in our capital allocation strategy. As you're also aware, we've taken a key step towards that commitment, commencing early this month with a substantial issuer bid, which we have offered to repurchase up to CAD1 billion of our common shares. This SIB is by way of a modified Dutch auction with a tender price range of CAD85 to CAD98 per share and is set to expire on August 17, 2021. We look forward to sharing with you the results of this SIB tender process when those results become available. In terms of the Norbord integration and as noted previously, our team continues to work rapidly work through synergies and how to make our company even better. The level of engagement and the building of momentum remain impressive and high. Now only five to six months into it, I remain confident that we are on track to achieve our targeted annual synergies of $61 million over the next 12 to 18 months. Safety remains a key priority for the company. We know we can eliminate serious incidents and injuries. Despite driving overall injury rates and severity to continued new lows throughout the company, we continue to see incidents that tell us we have much more work to do. Our employees continue to do the heavy lifting in delivering strong safety and operational results, all while dealing with the obstacles and challenges of the still ongoing pandemic as well as the evolving risk of Western Canadian wildfires. The strength and resiliency of our employees is impressive. It's this dedication and perseverance of the many people across the company, I am most thankful for and proud of. Finally, I'd like to recognize Brian Balkwill, our Vice President of Canadian Wood Products, who is retiring from West Fraser after a long and distinguished career. I want to acknowledge Brian for his significant contributions he has made to the company while helping to advance West Fraser and being a key driver and leader of the West Fraser company culture over the last 35 years. We have one thing that we tell our people in the company is that our job is to leave it better than you found it and to move the ball. Brian has done that. Brian, you'll be missed. Thank you, and congratulations as you move on to your next adventure. With that, we'll turn the call back to the operator for questions.

Mark Wilde, Analyst

Ray, first of all, I want to just start by congratulating you on a good quarter. And I also want to, again, kind of acknowledge that we're getting a much more detailed slide deck from you each quarter, and I think better disclosure in the MD&A, and I appreciate that. To start out, I'd just be curious on your thoughts about sort of the speed and magnitude of the lumber price correction that we've seen and maybe sort of any color on how that's flowing over into the export side of your business?

Raymond Ferris, CEO

Thank you, Mark. I really appreciate that. Regarding the slide deck and the details, I would like to mention that Chris and Robert are the ones enhancing that, and we value the feedback. I’m going to ask Chris McIver to provide some insights about the question concerning export markets.

Chris McIver, SVP, Marketing and Corporate Development

Mark, just to clarify, you're speaking more on the lumber side than the OSB side? Or are you speaking generally about both?

Mark Wilde, Analyst

Actually, about both, if you could.

Chris McIver, SVP, Marketing and Corporate Development

So yes, I mean, I think I'd be a bit remiss to say if I didn't say that we are a bit surprised at how quickly the prices have come off, but that really is a reflection of how quickly they went up. So we did expect a correction. We thought it might be a bit more muted and take a little bit more time. We're not surprised to the level we've come to at this time in the short term because we actually fundamentally believe we went too high, and we think we've probably gone a little bit too low as well in the correction. So I think we're seeing a little more stability on the lumber side right now, where sales are picking up a bit. OSB is a little bit behind. That market hung in a bit better. And quite frankly, we think the demand for panels is probably a little stronger at this time than it is for lumber. So we think it's got a bit more to go, and we're not seeing a lot of demand until we find some sort of bottom there, but we believe we will. And with regards to export, it was very difficult to participate in export markets during this run-up over the last year. They just couldn't keep up. But saying that, Japan actually got to levels very similar to North America, and the prices there are still holding up. We expect to see a bit of weakness there over the next while. So that market looks pretty good. China, we've reentered, not in a significant way, but we're putting some more product over there, quite frankly, because some of the pricing is quite favorable. So we never exited any of the export markets. We did reduce our volumes, and we're picking those up a little bit now.

Mark Wilde, Analyst

And then I wondered, Ray, if you can give us just some sense of how you would expect BC fiber cost to move as we go through the second half of the year and into the first half of next year. I know you've got some of this in your MD&A. But if you could just kind of walk us through, I mean, to those of us who don't live this every day. It's a fairly complicated set of adjustments that get made over time.

Raymond Ferris, CEO

I believe it's quite clear for the second half of the year. It's already known that stumpage will increase on October 1. The effect of stumpage can vary by region. Therefore, different areas may experience this increase differently, but it will be significant, likely in the $30 range, though it could be higher or lower. This will have an effect. There are two key points to consider. We buy quota logs, which are directly linked to stumpage, but we also acquire a substantial amount of logs from the open market, and the pricing for these two can differ. Ultimately, it depends on how much quota we decide to obtain and how much we’ll purchase from the market, which adds complexity to the situation. Additionally, conditions can change. Predicting this is challenging. Another factor is policy, which influences our ability to access land in specific areas to secure the volumes we need. These industry conditions are generally understood, but we anticipate that the first half of the year was difficult, and it is likely that the second half will also pose challenges.

Mark Wilde, Analyst

And finally, do you have any sense right now about sort of where the cost position of the overall BC lumber industry is relative to kind of current market prices?

Raymond Ferris, CEO

I believe the cost of logs is quite high for everyone. While each situation may differ, I think we're all in a similar range. However, I can't provide further clarity on that.

Mark Wilde, Analyst

And then I guess, actually, one other question. Just any sense from you or maybe from Chris McIver, about just where we stand in terms of lumber inventories at both the mill level and the customer level and whether there's maybe some variation with maybe producers who have been doing a lot of R&R or big box business versus people who are more tied to new res?

Raymond Ferris, CEO

Before I bring Chris into the conversation, I want to emphasize two points. First, it's crucial to understand that we operate an integrated business in British Columbia, which includes plywood, MDF, and lumber. We also have other integrated operations within the company that are worth acknowledging. Many of our other businesses are performing well. Additionally, if we examine the management discussion and analysis, the production and shipment figures for the first half are fairly balanced. It's clear that we had a solid understanding of where we began the year, which gives a good overview of our current status. Now, I'll let Chris address that further.

Chris McIver, SVP, Marketing and Corporate Development

So yes, I think you're asking the right question. It is a story of two different markets right now. DIY, or R&R, has dropped off a lot. And there's a few reasons for that. I mean, I think people are doing different things and fixing their decks and houses right now. So we've seen box store programs slow tremendously, and their inventories were relatively high. That business started slowing a couple of months ago, and we think that the inventories are getting in better shape and we expect by the fall, they'll be back doing some buying. New housing is very busy. They don't have enough. They can't quite keep up. And inventories for those who are supplying that business, we think, are relatively low. So overall, not in a bad position, but we need the R&R folks to come back, which we think they will in the fall.

Hamir Patel, Analyst

Ray, the non-fiber cost inflation that the press release pointed to in the south. Is that labor turnover? Or does that reflect maybe some more permanent wage cost inflation that you've had to absorb this year?

Raymond Ferris, CEO

Well, good morning, Hamir. Good question. I would say the bulk of it would be non-wage inflation. Well, sorry, actually, wage inflation is obviously a part of that. However, when we invest in wages, we typically see that will be rewarded on that side. Turnover actually remains very similar to previous years. So that's really not it. But listen, we are seeing cost pressure outside of wages and really everything from transportation through the supply chain, there is an impact.

Hamir Patel, Analyst

And the press release pointed to some elements of market downtime in the back half of June. Could you quantify how much that was and at least backward-looking in July so far how much have you taken?

Raymond Ferris, CEO

We haven't assigned a specific number to that, Hamir. What I can say is that our approach remains consistent with our past operations, as we will adjust based on various factors. Logs are one of those factors, along with weather, inventory levels, and market conditions. So it's really just a continuation of our current strategy. We're committed to managing our business to address these challenges, but I wouldn't provide a specific number.

Hamir Patel, Analyst

Just a last question for me. It seems like the weakness on the R&R side largely is on the DIY component and the contractor side, at least for other building products appears strong. I was curious if you guys have any work about what percent of R&R, I think the slide deck showed 41% is R&R. But what portion of that is DIY versus contractors?

Raymond Ferris, CEO

Hamir, I can't provide a specific breakdown since we haven't analyzed that in detail. It's crucial to note that there may be some temporary pullback, whether it's due to sticker shock or seasonal factors like heading to the beach. However, the main focus is on single-family homes, and overall, the fundamentals remain strong. We're confident in the growth of DIY projects, deck expenses, and other areas. It's understandable that growth had to slow a bit after the spike in 2020, but our outlook suggests continued growth in repair and remodel on a quarterly basis over the next year or two.

Paul Quinn, Analyst

But just wondering why CapEx this year is so back-end weighted. I mean, if I take a look at sort of the 5-year average, it's slightly back at weighted sort of 55% in the back half, 45% in the front. But this year looks, if I take the midpoint of your guide, it's kind of 30% in the front, 70% in the back. Why is that?

Chris Virostek, CFO

I might get into trouble for saying this, but I believe we have been quite focused on finalizing a significant acquisition and managing various capital projects last year. Ray likely suggested that we take a pause, which explains why our efforts have been ramping up. The current situation is primarily due to timing; it’s not a lack of focus on our part. We have two startups in the first half and a major acquisition, and our intention is to accelerate progress. It’s common for our capital program to be uneven, as it doesn’t follow a consistent flow.

Paul Quinn, Analyst

And then your MD&A referenced US southern yellow pine log increase costs. I'm just wondering if that's a regional thing? Or are you seeing that broadly distributed across the US?

Raymond Ferris, CEO

Well, the answer is both. So I would say, generally, most of our issues have been regional. And whether it's weather, other environmental factors, or just increased competition. But I'd say it's mostly regional in those areas. We've seen this from time to time to see those log costs come down as the weather impacts subside, but there has been some cost inflation across some of the regions.

Sean Steuart, Analyst

A couple of questions. Chris Virostek as markets moderate here and we get a sense of where things will start to normalize for the company from an earnings and cash flow perspective. Do you have any updated thoughts on what an optimal capital structure looks like for the company? I guess, the general sense is you want to keep ongoing strong liquidity on the balance sheet, but are there any metrics you guys are focusing on over the long run, is something you're targeting?

Chris Virostek, CFO

I think as the businesses are coming together and we sort of maybe get a bit of this volatility in the rearview mirror we're looking at all those things. I think, rightly, as you indicate, the investment-grade rating, we think, is important to us. I think it enables us to weather tough times like we had in early 2020 and 2019, with a measure of confidence. And to do things like we did in 2019 to continue on with our capital program and maintain our dividend in early 2020 when things were tough. So I think what we're looking at among those things as well, we got two new startups. We've got an ambitious capital program. We want to be able to return capital to shareholders but we've got to be able to manage volatility when it occurs, which can be unpredictable at times. So I guess what I would say is more to come on that here over the next probably several quarters as we kind of work through that and get a bit more in the rearview mirror post-acquisition and see things. But I think the guidance would be, we're going to remain conservative and balanced. We're in a volatile industry, where cash flows can change materially in the short term, and we don't want that to put the company at risk in any way.

Sean Steuart, Analyst

And then further to that question, as Norbord is integrated and your thoughts can turn back to potential M&A. The bias in the investment community is assumptions that you look at U.S. sawmills and maybe growth in Europe as well. Would stuff like cross-laminated timber be of interest to you guys potentially? There's obviously one significant bankruptcy that's just happened there. But more niche-focused engineered wood products, is that something that would potentially be of interest?

Chris McIver, SVP, Marketing and Corporate Development

Sean, I'll address that. What I want to emphasize is that as we moved into the OSB and the integration, I truly believe—and it seems we are witnessing this. We feel we have created additional capacity in the company to pursue projects and opportunities. Our integration process is progressing well. It's part of our core identity. Ultimately, it revolves around what strengthens and improves the company. Consequently, it's challenging to decline opportunities. We're open to exploring everything that we believe adds value for our shareholders. Our main targets are indeed the ones you mentioned. The OSB team has significantly enhanced our engineered wood portfolio, which now positions us to grow in other areas as well. Therefore, I wouldn't rule anything out; we find all options intriguing. Currently, our main focus has been on supporting the softwood lumber board and the growth of cross-laminated timber (CLT) in that market. We will continue that support and prioritize the growth of CLT participants, with the hope of supplying them with lumber and other products. Additionally, we remain interested in exploring other engineered wood products like CLT over time.

Mark Wilde, Analyst

I'd like to just come back on some capacity issues. First of all, you mentioned in the MD&A that the ramp-up at Dudley is likely a multi-year process. And that's a site where you've already got like a trained labor force. Can you just help us in thinking about how long you would expect a ramp-up of a new facility to typically take? And what that curve might look like?

Raymond Ferris, CEO

We have significant experience with major capital projects and start-ups, and while they vary, we believe having a foundation of long-term loyal employees is a considerable advantage. It is certainly possible to achieve success in a greenfield setting as well. Typically, we anticipate that reaching close to capacity is a two-year project. Our recent start-ups have shown improvement, and we are confident we are getting better at this process. However, it requires a substantial amount of energy, personnel, and focus. Generally, it takes around two years, but there are always engineering challenges to address along the way, as well as the need for retraining and adapting to new technology, which takes time for people to become proficient and for the setup to be effective.

Mark Wilde, Analyst

And then the other thing on the sawmill side, I noticed this announcement just a week or two ago of a $400 million board foot sawmill in North Carolina, which is much larger than any of the other projects I've seen announced over the last few years. Do you have any perspective on this? Is this a sign that maybe sort of the whole step-up in scale for a southern sawmill is likely to take a big leg up here or would there be something that could be particular to that situation? Because typically, there may be $250 million to $300 million board feet seems to be what people are building. This one is probably half again as large.

Raymond Ferris, CEO

No, I don't think I can speculate on that. If you look across North America, there are small mills that can be highly profitable and large mills that can also be very profitable. The profitability depends on factors like location, terrain, and timber supply. Each situation is unique, and the average sawmill size speaks for itself. We have small mills with excellent margins as well as larger mills that also have strong margins and everything in between. My personal opinion is that you should build the mill that fits that location. That's what we do. I can't speculate on their decision-making process; I'll leave that to them.

Mark Wilde, Analyst

The last thing I want on supply is just in the slide deck this morning, you've got something kind of showing the ability of the OSB industry capping out at about 1.5 million starts on the existing supply base. From a West Fraser standpoint, if you were thinking about adding further capacity beyond the restart of Chambord, any thoughts about how you would do that? I mean could you debottleneck or add second lines in an existing mill or would you want to think about an entirely new mill and a new location?

Raymond Ferris, CEO

It's difficult to decline either option, Mark. If you examine our actions, including what we announced in December and again in June regarding optimizing capacity and enhancing value, we've been and will continue to invest in OSB. We believe there are more projects we can pursue in that regard. Our approach to capital allocation is quite clear; we prefer to reinvest in our current assets to improve them and then consider opportunities for expansion in those areas. Therefore, I cannot say definitively that both options will be considered, but our priority is to enhance what we currently possess. Additionally, if you review our commitments since December, they are quite substantial.

Operator, Operator

There are no further questions at this time. So I will turn the conference back over to Mr. Ferris. Please go ahead.

Raymond Ferris, CEO

Look, thanks, everyone, for joining the call this morning. Thank you, Michelle. As always, Chris Virostek and I are available to respond to further questions, as is Robert Winslow, our Director of Investor Relations & Corporate Development. Look, stay safe, and we look forward to reporting out on our progress in the next quarter. Thanks, everyone.

Operator, Operator

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